Management Accounting: Costing and Budgeting Assigment 2

There are three pairs of budgeting methods as follow: - Fixed budget and Flexible budget - Incremental budget and Zero based budget - Top-down imposed budget and Bottom-up participated/s

BANKING ACADEMY, HANOI

BTEC HND IN BUSINESS (FINANCE)

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We, Blue Bubble Group hereby confirm that this assignment is our own work and not copied or plagiarized from any source We have referenced the sources from which information is obtained by us for this assignment.

Members Full Name English Name Signature Date

Đỗ Linh Chi Julie 26 th June 2012

Bùi Thanh Hằng Phoebe 26 th June 2012

Nguyễn Phương Thảo Pitts 26 th June 2012

Cao Nguyên Hồng Anh Chip 26 th June 2012

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Unit Outcomes

Outcome Evidence for the criteria Feedback Assessor’s decision Internal

Verification

First attempt

Re- work

3.1

Select appropriate budgeting methods for the organisation and its needs

3.2

Prepare budgets according to the chosen budgeting method

4.1

Prepare an operating statement reconciling budgeted and actual results

4.2

Outcome Evidence for the criteria Feedback Assessor’s decision Internal

Verification

LO4

Report findings to management

Assignment

( ) Well-structured; Reference is done properly / should be done (if any)

Overall, you’ve

Areas for improvement:

ASSESSOR SIGNATURE DATE / /

NAME:

(Oral feedback was also provided)

STUDENT SIGNATURE DATE / /

BUDGETARY PLANNING AND CONTROL

Prepared for: Ms Nam Giang Dao

The Unit Leader for Managing Financial Resources and Decisions

Unit 9: Management Accounting: Costing and Budgeting

Banking Academy, Hanoi

BTEC HND in Business (Finance)

Submitted: 26th June, 2012

Prepared by:

Do Linh Chi – Julie (F04-029) – F04B

Bui Thanh Hang – Phoebe (F04-054) – F04B

Nguyen Phuong Thao – Pitts (F04-156) – F04B

Cao Nguyen Hong Anh – Chip (F04-002) – F04B

EXECUTIVE SUMMARY

Budgets are established with many purposes such as planning the use of resources; vehicle forforecasting; means of controlling the activities of various groups within the firm, motivatingindividuals to achieve performance levels agreed and set, or communicating the wishes andaspirations of senior management Some examples above have shown the importance of budget

in Management Accounting Through budgets, the manager can control activities in theorganization by measuring progress against the original plan, making adjustments wherenecessary

In this report, the researchers will show real applications in Phong Phu Company, VinabikeCompany, and Riley Labs Form the data is given by three companies; budgeting methods, cashbudget, operating statement and performance report are prepared, calculated, analyzed based onthe knowledge and investigation of the researchers According to these specific examples, theresearchers hope to provide useful information about Management Accounting for readers

Table of Contents

MAIN BODY 8

Task 1: Operating Budgets 8

1 Budget definition 8

2 Comparing standard costing and budgeting 8

3 Purposes and benefits of budgeting process 10

4 Budgeting methods 12

4.1 Fixed budget and Flexible budget 12

4.2 Incremental budget and Zero-based budget 14

4.3 Top-down budget and Bottom-up budget 16

5 Prepare budgets for Phong Phu Company 17

5.1 Select appropriate budgeting method for Phong Phu Company 17

5.2 Prepare budgets for Phong Phu Company 18

Task 2: Cash budget 30

Task 3 37

Subtask 3a: VARIANCE 37

1.1 Definition 37

1.2 Calculate 38

Subtask 3b: FLEXIBLE BUDGET 46

CONCLUSION 50

REFERENCES 51

Aims/Purpose, Scope

The purpose of this report is to prepare forecasts and budgets for a business At the same time,monitor performance against budgets within the business The scope of the report includes:

 Explain the purpose and nature of the budgeting process

 Select appropriate budgeting methods for the organisation and its needs

 Prepare budgets according to the chosen budgeting method

 Prepare a cash budget

 Calculate variances, identify possible causes and recommend corrective action

 Prepare an operating statement reconciling budgeted and actual results

 Report findings to management in accordance with identified responsibility centres

According to “Budgeting for the Better Performance” (published in 2003) budget has four basic

characteristics:

- The budget must be quantified: it must be indicated by the numbers, often some real

money In addition, the budget may include funds plan on time, workforce planning, …

- The budget must be prepared in advance: it must be made before the plan to implement

that budget The data in real time or after the budget is not listed in the budget

- The budget must be applied to a specific period of time: it is made for a period of time

specified (usually a year)

- The budget is a plan of action: in addition to the actual figures, tables also include

budget data related to what has not happened

2 Comparing standard costing and budgeting

Standard Costing and Budgeting are intended to help businesses achieve maximum efficiency, aswell as good cost control In both methods, the actual performance is compared with pre-

determined criteria, based on the difference of them for analysis, evaluation and reporting.

Besides, they also interact with each other, “budgeting is essential to determine standard costswhile standard costing is necessary for planning budgets” (Anon, 2012).

However, they also have some differences, and they are shown in the table below:

Prepared for the short-term operating Prepare for the long-term operating

Based on standard cost, historical costs and

estimates

Based on technical information and is fixedscientifically

Used for different functional departments

(sales, production, finance, personnel, etc), so

it requires functional coordination

Used mainly for production, management andmarketing function so it does not requirecoordination between departments

Emphasize cost levels should not be exceeded Emphasize the cost levels should be reducedBased on comparison between actual and

budgeted results to analysis

Based on variances to analysis

It is not useful for controlling or reducing costs

because it often sets maximum limitation

without considering the cost effectiveness of

It expresses financial accounts It expresses cost accounts

Table 1: The differences between Budgeting and Standard Costing

3 Purposes and benefits of budgeting process

Every organization has developed strategies for each period, with using budget they will ensureachievement of the objectives as planned In this scenario, Phong Phu Ltd manufactures and sellstwo products (A and B with high standard), as well as they are manufactured in two processes

(cost centres P1 and P2) According to BPP Professional Education, 2004, page 155, “using a

budget has six further purposes/ benefits”, they are show as follow:

PURPOSES/

BENEFITS

EXPLANATION

Planning The managers are always busy with the daily business operations of each

department, they tend to avoid formal plan if they are not related to theirspecific job Therefore, the use of funds will help managers establish a formalplan It enables them to find out the problems in the implementation plan andprovide solutions to stop them before they occur in practice In addition, costs

to prevent errors that may occur is always less than the cost of error correction

after the plan is done so enterprises now often made before the budget work.Organizing The system of control helps the manager in comparing the actual results with

the budget results By dividing economic and human resources in the mostfinancially potential areas, each department can find out the cause leading toeach mistake and take the replacement in time

Controlling By investigating variances of differences between actual and budgeted, the

company can find out problems and failures in actual operation, and thentaking corrective actions From that, managers can have an insight whetheroperations are up to expectations

Co-ordinate

activities

Each department has its own responsibility in a company The budgetingprocess links the plans and financial budgets of each department It can be saidthat, it encourages communication up the organization from subordinates tosuperiors, and across departments also For example, there are two cost centresP1 and P2 in manufacturing process of Phong Phu Ltd They have to co-ordinate closely together to gain the product's quantity or revenue as planned

g

Ava to communicate ideas and plans in a company, a formal system is sorelyneeded Based on it, the employee can identify their own works in the general

plan “Communication might be one-way, with managers giving orders to

subordinates, or there might be a two-way dialogue” (BPP Professional

Education, 2004, page 155)Motivating When there is a system that helps employees to recognize their performance at

high or low, good or bad will stimulate them to work hard and maintain anenthusiastic attitude towards the job Besides, it also helps the managerunderstands the strengths and weaknesses of each employee From that, he/she can improve or adjust the position reasonably to develop the whole

potential of their staff

Table 2: The purposes of budgeting process

4 Budgeting methods

Every business needs a budget to plan activities There is no right or wrong way to create a budget, but it is the best way to monitor the volume of cash business and predicts its future earnings and expenses There are three pairs of budgeting methods as follow:

- Fixed budget and Flexible budget

- Incremental budget and Zero based budget

- Top-down (imposed) budget and Bottom-up (participated/self-imposed) budget

Each method has its own advantages and disadvantages, so depending on the current financial situation, each company will choose different budget methods which are suitable.

4.1 Fixed budget and Flexible budget

Definition

A fixed budget (static budget)

is made without regard to potentialvariations in business activity Suchbudgeting might be effective forcompanies with low variable costs,but otherwise is likely to beinaccurate (Anon, 2012)

For example, if total annualbudget of the company is staticbudget in which actual sales in theyear could reach $ 10 million, $ 20million or more, the advertisingcosts is always $ 500,000

A flexible budget is developedusing budgeted revenues or costamounts based on the level of outputactually achieved in the budgetperiod (Perego, 2006)

For example, a company (usingflexible budget) has cost theadvertising expense accounts for 6%monthly revenue, so the amount paidfor these costs will increase ordecrease based on sales volumes

Applying

This budget should be used forcompanies have monthly expensesalmost fixed, as well as in a stableeconomic conditions It can takenon-profit organizations are typicalexamples

It expresses clearly advantages

in the economic environmentchanges, as well as in businesses withthe cost of frequent changes in eachperiod It also shows that profitorganizations should apply to thiskind of budget

- No need to adjust the budget each

month because in the fixed budget,

annual expenses are unchanged

- Allow to plan ahead because it will

take into account all expenses andallow companies to plan according

to their goals and needs

- Easier to Track and Keep Budget

because the amount is not changed

in every month, so it does not need

to spend much time in trackingfixed budget

- Show revenues and expenses thatshould have occurred at the actuallevel of activity

- Reveal variances due to good costcontrol or lack of cost control.From that, managers can evaluatethe working effect of employee tomotivate them and make anappropriate plan in the future

- Improve performance evaluation

Disadvantages - No clear difference between the

sales of the year because this

budget does not requirecompanies calculate the inflationrate in the period when priceschange

- It does not have any flexibility to

deal with change in the

emergencies, personnel,competitive pressure

- All competitors know your weak

- Makes prediction difficult because

in construction, there are manycosts are not completely changed

- Too many variables make

mangers get difficulty incontrolling costs of departments

- Complicated because it needs a lot

of time to develop cost steps,especially when in the middle ofcreating budget standards

point so they can outspend you.

Table 3: Distinguish between Fixed budget and Flexible budget

To sum up, any budget has its own advantages and disadvantages However, in the real life, mostbusinesses should be using both static and flexible budgets during the course of their business operations Thus, they can choose the more appropriate budget for the particular department in each period of time

4.2 Incremental budget and Zero-based budget

Definition

Incremental budget is the forecast

of fixed overhead costs, computed byadding or subtracting a predeterminedpercentage from the historical costs,current or past budgets (Anon,

Incremental Budgeting, n.d)

Zero-based budget is a methodfor preparing cash flow budgets andoperating plans which every yearmust start from scratch with no pre-

authorized funds (Anon, Zero

Based Budgeting n.d.)

Applying

This is a budget prepared using aprevious period’s budget or actualperformance as a basis withincremental amounts added for the newbudget period

Zero-based budget requireseach activity to be justified on thebasis of cost-benefit analysis,assumes that no presentcommitment exists, and that there is

no balance to be carried forwardAdvantages - The budget is stable and change is

- Forces budget setters to examineevery item

- Allocation of resources linked toresults and needs

- Develops a questioning attitude

- Wastage and budget slackshould be eliminated

- Prevents creeping budgets based

on previous year’s figures with

- Co-ordination between budgets iseasier to achieve.

- The impact of change can be seenquickly

- No incentives to reduce costs

- Encourages spending up to thebudget so that the budget ismaintained next year

- The priority for resources may havechanged since the budgets were setoriginally

- It a complex time consumingprocess

- Short term benefits may beemphasized to the detriment oflong term planning,

- Affected by internal politics can result in annual conflictsover budget allocation

-Table 4: Distinguish between Incremental budget and Zero-based budget

Summary, Both zero-based budget and incremental budget are popular financial methods used

by successful companies Each method works differently and they both have their advantagesand disadvantages Incremental budget often leads to wasteful spending by employees becausethey do not want to lose their budget The biggest drawback of zero based budget is that itrequires much more work to implement this method and it is often unpopular with employees.Therefore, the companies should have the balance between two methods to avoid disadvantages

of them

4.3 Top-down budget and Bottom-up budget

Definition Top down Budget is where budget

is created by starting from the highestlevel working towards the bottom usingparametric relationships (Arthur, n.d)

Bottom up budget is a type ofbudgeting that attempts todetermine the underlying costs foreach individual department or

segment of an organization and thentotal up each department (Anon,

Overview of Bottom Up Budget, n.d)

Applying

The upper-level management of acompany comes up with thebudget The budget numbers arepassed down the corporate ladder to thelower-level departments of a business

This process starts out small

by looking at the individualcomponents and costs Then, theinformation is gotten from eachmanager and total it up in order tocome up with a budget for thecompany as a whole

Advantages

- Do not have to rely on lower-levelmanagers to come up withbudgeting information

- Allow the lower-level managers tofocus on their departments andwhat they do best

- Take less time

- Promote upper- level commitment

- Provide accurate estimate ofcosts

- Improve the morale of theemployees based on theirinvolvement in the budgetingprocess

- Every department will beexpected to come up with thenew budget

- Clear and detailed information

Disadvantage

s

- Upper-level executives may nothave enough knowledge about theindividual departments to come upwith a budget

- The budgets may not be realisticbecause of this lack of intimateknowledge

- Low motivation of lower- level

- Upper- level management hasless influence on budgetingprocess

- The budget might beexaggerated

- Time consuming and costly

Table 5: Distinguish between Top-down budget and Bottom-up budget

It can be said that, Top-down and bottom-up are methods for allocating and reporting budgetamounts, it means they both have their particular effectiveness in the organization Therefore, theorganization can use one method for its entire business, or use a combination of two methods bychoosing the method that is most appropriate for each part of the organization.

5 Prepare budgets for Phong Phu Company

5.1 Select appropriate budgeting method for Phong Phu Company

To prepare the budget for Phong Phu Company, the first thing needs to do is defining what kind

of method which the company should apply into make its budgets Phong Phu focuses onproducing two products A and B, so among six methods, flexible budget and zero-based budgetmethods are more useful to set budget for the company in the future Moreover, this companyalso has some fixed manufacturing overhead cost, which incur during the production process, sothe flexible budget is not totally suitable to set budget for Phong Phu Company Besides,according to the scenario, Phong Phu uses two process to produce (cost centre P1 and P2), andthe zero-based budgeting encourages setting budgets systematically, so it seems to be moreappropriate to establish budget for the firm

5.2 Prepare budgets for Phong Phu Company

In zero-based method, there are many budgets can be planned, such as: sales/ revenue budget,production budget, raw material budgets, direct labor budgets, and manufacturing budgets

Firstly, sales/ revenue budget was set to make basis of identify budget for production

Table 6: Sales budget of Phong Phu Company (unit: £)

Note for sales budget:

Applying the formula:

Budgeted revenue = budgeted sales in units x budgeted price per unit

- Budgeted revenue of product A = 11,200 x £ 150 = £ 1,680,000

- Budgeted revenue of product B = 12,900 x £ 90 = £ 1,161,000

Next, P2 budget production was established from two products A and B through two processes in

a specified order To calculate the number of finished products to be manufactured in P1, thetotal required for products used in the process 2 must be determined first Production requiredfrom process 2 will be established basing on finished good required that is relied on budgetedsales in units

Table 7: Production budget in the department 2 (unit: £)

Note for production budge in P2:

According to scenario, in manufacturing process, reject rates arising from an inspection at theend of cost center 2 (P2) are 5% of product A and 8% of product B

 Good yield of product A and product B in cost centre 2 respectively:

- Good yield in cost centre P2 of product A = 100% - 5% = 95%

- Good yield in cost centre P2 of product B = 100% - 8% = 92%

Based on good yield, gross production needed from cost center P2 can be calculated by theformula:

Gross product require for product = Good yeild∈cost centre P 2 Fish ed good required

- Gross product require for product A = 11,400 : 95% = 12,000 (units)

- Gross product require for product B = 12,880 : 92% = 14,000 (unit)

Production budget of process 1 is based on production budget of process 2

Table 8: Production budget of the department 1 (unit: £)

Note for production budge in P1:

According to scenario, in manufacturing process, reject rates arising from an inspection at theend of cost center 1 (P1) are 10% of product A and 15% of product B

 Good yield of product A and product B in cost centre 1 respectively:

- Good yield in cost centre P1 of product A = 100% - 10% = 90%

- Good yield in cost centre P1 of product B = 100% - 15% = 85%

Based on good yield, gross production needed from cost center P1 can be calculated by theformula:

Gross product require for product = Good yeild∈cost centre P 2 Fished good required

- Gross product require for product A = 12,150 : 90% = 13,500 (unit)

- Gross product require for product B = 14,025 : 85% = 16,500 (unit)

Thirdly, it is assumed that all direct material issues will be utilized in cost center P1, so Direct Material budget will be built based on production required of cost center P1

(Product A)

Y (Product B)

Budgeted cost of Direct material to be purchased £ 677,000 £ 396,400

Table 9: Direct material budget in P1 (unit: £)

Note for direct material budget in P1:

We have: Product A is manufactured by material X and product B is produced by material Y

 Total direct material = Required production x Direct material needed per unit

- Total direct material X required for product A = 13,500 x 2.5 = 33,750 (pound)

- Total direct material Y required for product B = 16,500 x 3 = 49,500 (pound)

- Budgeted cost of direct material X = 33,750 x £ 20 = £ 677,000

- Budgeted cost of direct material Y = 49,500 x £ 8 = £ 396,400

Fourthly, direct labor budget of P1 and P2 are based on required production

Table 10: Budgeted direct labor cost in P1 (unit: £)

Note for direct labor cost budget in P1:

We have: Require product in units = Gross production required in each department.

- Total direct labor required for product A in P1 = 13,500 x 1= 13,500

- Total direct labor required for product B in P 1 = 16,500 x 0.6 = 9,900

- Budgeted cost of direct labor for product A in P1 = 13,500 x $10 = £ 135,000

- Budgeted cost of direct labor for product B in P 1 = 9,900 x $10 = £ 99,000

Table 11: Budgeted direct labor cost in P2 (unit: £)

Note for direct labor cost budget in P2:

We have: Require product in units = Gross production required in each department.

- Total direct labor required for product A in P2 = 12,000 x 2 = 24,000

- Total direct labor required for product B in P2 = 14,000 x 0.9 = 12,600

- Budgeted cost of direct labor for product A in P2 = 24,000 x £ 10 = £ 240,000

- Budgeted cost of direct labor for product B in P2 = 12,600 x £ 10 = £ 126,000

Fifthly, manufacturing overhead budgets of cost centre P1 and P2 will be created by direct laborhours of each cost centre

Budgeted fixed overhead allocated to each product £ 47,250 £ 34,650

Table 12: Budgeted for fixed manufacturing overhead in P1 (unit: £)

Note for budgeted for fixed manufacturing overhead in P1:

- Total DL hours required = 13,500 +9,000 = 23,400

- Budgeted fixed overhead rate = Total¿overhead ¿

Total DLhours

= £ 81,600

23,400 = £ 3.5 per hour

- Budgeted fixed overhead allocated to product A = £ 3.5 x 13,500 = £ 47,250

- Budgeted fixed overhead allocated to product B = £ 3.5 x 9,900 = £ 34,650

After that, Manufacturing overhead in P1 will be built by results of fixed manufacturingoverhead budget as follow:

Budget for total manufacturing overhead in P1 A B

Total budgeted variable manufacturing overhead £ 67,500 £ 49,500Plus: Total budgeted fixed manufacturing overhead £ 47,250 £ 34,650

Table 13: Budget for total manufacturing overhead in P1 (unit: £)

Note for budget for total manufacturing overhead in P1:

- Total budgeted variable mfg OVH of product A = 13,500 x £ 5 = £ 67,500

- Total budgeted variable mfg OVH of product B = 9,900 x £ 5 = £ 49,500

- Manufacturing overhead cost of product A = £ 67,500 + £ 47,250 = £ 114,750

- Manufacturing overhead cost of product B = £ 49,500 + £ 34,650 = £ 84,150

Setting fixed manufacturing overhead and manufacturing overhead budgets in cost center P2 inthe same way

Budgeted fixed overhead allocated to each product £ 1,600 £ 42,840

Table 14: Budget for fixed manufacturing overhead in P2 (unit: $)

Note for budgeted for fixed manufacturing overhead in P2:

- Total DL hours required = 24,000 + 12,600 = 36,600

- Budgeted fixed overhead rate = Total¿overhead ¿

Total DLhours = £ 125,55036,600 = £ 3.4 per

hour

- Budgeted fixed overhead allocated to product A = £ 3.4 x 24,000 = £ 81,600

- Budgeted fixed overhead allocated to product B = £ 3.4 x 12,600 = £ 42,840

After that, Manufacturing overhead in P2 will be built by results of fixed manufacturing

overhead budget as follow:

Table 15: Budget for total manufacturing overhead in P2 (unit: £)

Note for budget for total manufacturing overhead in P2

- Total budgeted variable mfg OVH of product A = 24,000 x £ 3= £ 72,000

- Total budgeted variable mfg OVH of product B = 12,600 x £ 3 = £ 37,800

- Manufacturing overhead cost of product A = £ 72,000 + £ 81,600 = £ 153,600

- Manufacturing overhead cost of product B = £ 37,800 + £ 42,840 = £ 80,640

Sixthly, making Expense budget of Material used regarded as material expenditure in P1

- Budgeted cost of desired ending DM inventory £ 12,000 £ 2,800

Table 16: Ending inventory budget for materials (unit: £)

Note for Ending inventory Budget for materials:

We have:

Budgeted cost of ending DM inventory = Ending DM inventory x Cost per DM unit

- Budgeted cost of ending DM inventory of X = £ 20 x 600 = £ 12,000

- Budgeted cost of ending DM inventory of Y = £ 8 x 350 = £ 2,800

Seventhly, building budget of work-in-process and costs of work-in-process to be used in P2

Table 17: Ending inventories budget for WIP in P1 (unit: £)

Note for ending inventories budget for WIP in P1

- Budgeted cost per unit A of WIP = £ 923,577

12,150 = £ 76

- Budgeted cost per unit B of WIP= $ 578,423

14,025 = £ 41

- Budgeted cost of ending WIP inventory of product A = £76 x 300 = £ 22,800

- Budgeted cost of ending WIP inventory of product B = £ 41 x 125 = £ 5,125