Task 8
3.1 Explain the purpose and nature of the budgeting process.
Task 8
IN business,budget can be defined as a plan for an organization is outgoing expenses and incoming revenues for a specific time period.
Budgets are used in many organizations to
Track and control spending
The purpose is to ensure that available funds are used according to plan,within preset limits and not exceeding available funds.
Support funding requests
The purpose is to justify the use of funds and to help plan future spending accurately by describing how funds will be used.
The budgeting process:
Companies and organizations typically develop and implement budgets on a periodic basis at fixed intervals. The norm in private industry is to produce a plan for each fiscal year. Some government organizations also prepare annual plans, but two-year (biennial) budgets are also common in government. Although plans are sometimes adjusted in "real time" (that is, they are treated as flexible budgets after start of the planning period they cover), such changes are exceptions to the normal rule, which is to keep the forecast intact (static) once implemented.
In the period of time between issuance of one budget and the next, planning-related decisions and plans are referred to as the budget cycle or process. In large companies, large educational institutions and non profit organizations, and in government organizations, the process normally extends across months, if not the entire period between budgets.
For those involved in the budgeting process there can be many specific steps and requirements to meet, and the nature and timing of these vary widely among companies and organizations. Most large organizations in fact publish a description of their own process, calendar, and approval requirements on the internet. This information is sometimes publicly accessible, or it may be accessible only to employees with authorized access to it.
In any case, anyone setting out to prepare a funding request for the first time will normally begin by accessing this source.
Although specific steps and timing vary from organization to organization, the budgeting process everywhere almost always includes steps for: * Assessing variances between actual and forecasted figures in the previous period's plan. * Identifying and then prioritizing business needs and objectives for the forthcoming period. * Identifying and evaluating:
Incoming revenue forecasts.
Current trends or changes that may have spending or revenue implications, such as new mandates to reduce spending, expected changes in staffing levels, or changes in expected business volume.
Risks or potential emergencies that could impact either incoming funds or spending needs. * Ensuring that individual funding proposals in the complete plan package are prepared in consistent format, and that proposals competing for funds can be compared fairly. * Ensuring that procedures and methods are in place for implementing the plan and monitoring actual spending and incoming revenues. * Packaging and communicating funding requests to those responsible for reviewing and approving budget proposals.
In large companies and organizations the process is managed and "driven" by, a Budget Office. This office works with managers, department heads, and others who will seek funding approval, but also with the senior management, legislative bodies, and senior officials who will make approval decisions. The result is that all budget proposals are developed according to local policies and rules, and that the entire proposal package is reasonable and aligned with organizational objectives.
Task 9
3.2 Select and explain the following budgeting methods for the organisation and its needs. (a) Incremental budgeting vs Zero-based budgeting ?
What is zero based budgeting and how does it compare to incremental budgeting?
Zero based budgeting is an approach to budgeting requiring that every expenditure be justified. In other words, each potential spending item starts with an assumed value of 0, with all changes above that having to be justified. This contrasts with the more usual practice, incremental budgeting, in which each spending item is started at last year's (or last term's) level, and the next period's level is planned as an increment (positive or negative change) to that level.
Advocates of the zero based planning favor the approach because it is based on demonstrated needs and resources, not on historical spending levels, which arguably leads to more efficient allocation of resources. The zero based approach can be very effective, for instance, in detecting and eliminating inflated budgets, or those that include obsolete or wasteful operations.
Zero based budgeting also helps avoid a practice common under the incremental approach, whereby managers approaching the end of the budget period ensure that they spend all funds available to them, whether such spending is necessary or not. Some managers believe that if they do not spend all of this period's plan, they will receive less in the next period (in some organizations, this belief is supported by historical fact).
In a large organization, however, the zero based approach may call for very substantial research and analysis in order to justify every funding request—an investment in time and organizational resources that is not, in its own right, justified. Under the Incremental approach, formal justification (e.g., business case analysis) is normally required only for capital spending proposals or for significant spending increases in operating expense categories. * (b) Top down budgeting vs Bottom up budgeting ?
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There are two basic approaches to developing a budget: 1. ------------------------------------------------- Top down – This is where you develop or set the total or top budget and then break it down into the component parts within that budget. 2. ------------------------------------------------- Bottom up – This is where you start with a list or plan or schedule of the things you want to do and then cost it up to get the total budget.
What Is a Budget?
In this lesson, we will explore various types of budget controls used in organizations. In order to understand the various budget controls, let's first define the term 'budget.'
A budget is a financial plan for saving, spending and borrowing money. A budget helps an organization determine whether it can operate based on projected income and expenses for a period of time. A budget is generally prepared for a period of one year but is broken down monthly for various is vital for organizational planning for resources like people, materials and money. The purpose of a budget is: * ------------------------------------------------- To provide a projection of revenues and expenses * ------------------------------------------------- To forecast an organization's financial future based on the outcomes of organizational plans * ------------------------------------------------- To measure and compare projected expenses to actual expenses * ------------------------------------------------- To establish a cost ceiling for operational, or short-term day-to-day expenses, and capital, or long-term expenses for major projects
We now know that a budget is used to project income and expenses for a period of time. But how are budgets used as a management control? Let's visit a few universities to see how budget controls work for them.
Types of Budget Controls
There are several budget controls used in organizations: * ------------------------------------------------- Top-down budgeting * ------------------------------------------------- Bottom-up budgeting * ------------------------------------------------- Zero-based budgeting * ------------------------------------------------- Flexible budgeting
Top-Down Budgeting
Top-down budgeting starts at the top of an organization and is handed down to lower departments. There are several pros and cons to this type of budget control.
TD University's science department uses top-down budgeting. Top management creates the department's budget based on a combination of forecasting for future revenues and expenses and the previous year's actual budget results and sends the money down the university pipeline.
Top-down budgeting can be a good thing because lower management does not have to take time to prepare the budget. This is a time-saver for lower management, who are more involved in the operational process rather than the overall strategic plan.
However, a budget prepared by those who are not directly involved with the day-to-day operations of a department may not be aware of the particular expenses related to the department. This could be problematic for lower-level managers who may not be able to retain the necessary resources to meet organizational objectives. Once the budget is given to the department, monies can be spent according to what has been allocated. Supplies can be purchased, professors can be paid and student activities can be planned.
Bottom-Up Budgeting
Bottom-up budgeting starts at the bottom of an organization. A budget is decided by lower-level management and then presented to top management for approval. Top management will either approve the proposed budget or send it back down to lower management for review and modification. There are several pros and cons to this type of budget control.
Budget University's art department uses bottom-up budgeting. The dean of the art department decides how much money he needs to run the department. These decisions are based on the same sort of information used in top-down budgeting like forecasting and the previous year's actual results.
Bottom-up budgeting can be a good thing because lower management plans the budget based on the needs of the specific department. A manager of a department is more familiar with what is required, like supplies, labor and capital, to meet departmental goals.
However, lower management may not have the experience in creating complicated financial documents. Lower management may not be aware of the overall strategic plan of the organization. The budget may not be feasible because of top management plans to allocate resources elsewhere in the organization like toward capital improvements or a major purchase of equipment.
Rather than the decisions being made by those who are outside of the department, those who are closest to the department make the decisions. Professors and staff in the department provide the Dean with a list of their anticipated needs and he creates a budget around the costs of thing like buying clay, brushes and paint. While this method is practical because the dean of the art department knows what he needs to teach aspiring young artists, he is not an expert in accounting. He may not know how to write the document correctly. * Reference:http://study.com/academy/lesson/budget-controls-top-down-bottom-up-zero-based-flexible-budgeting.html
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Task 10 * 3.3 Prepare budgets according to the chosen budgeting method and be able to illustrate with the relevant examples. *
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Choosing a Budget Method
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A budget is nothing more than a written estimate of how an organization — or a particular project, department, or business unit — will perform financially. If you can accurately predict your company's performance, you can be certain that resources such as money, people, equipment, manufacturing plants, and the like are deployed appropriately.
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Kinds of budgets
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When it comes right down to it, you can budget any activity in your organization that has a financial impact. Two of the most common budgets are * ------------------------------------------------- Cash budget: An estimate of a company's cash position for a particular period of time. * ------------------------------------------------- Operating budget: A business's forecasted revenues along with forecasted expenses, usually for a period of one year or less.
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Line items in your operating budget may include: * ------------------------------------------------- Labor budget: The total labor cost to be expended for a set period of time calculated by taking every person in an organization, department, or project and multiplying the number of hours they are expected to work by their wage rates. * ------------------------------------------------- Sales budget: An estimate of the quantity of goods and services that will be sold during a specific period of time. * ------------------------------------------------- Production budget: A forecast thatstarts with the sales budget's estimates of the total number of units projected to be sold, then translates this information into estimates of the cost of labor, material, and other expenses required to produce them. * ------------------------------------------------- Expense budget: An estimate prepared for travel, utilities, office supplies, telephone, and many other common business expenses for a given period. * ------------------------------------------------- Capital budget: The total costs and maintenance fees planned for your company's fixed assets.
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The best kind of budget is the one that works. You can choose from three key approaches to developing a budget: * ------------------------------------------------- Top down: Budgets are prepared by top management and imposed on the lower layers of the organization. Top down budgets clearly express the performance goals and expectations of top management, but can be unrealistic because they do not incorporate the input of the very people who implement them. * ------------------------------------------------- Bottom up: Supervisors and middle managers prepare the budgets and then forward them up the chain of command for review and approval. These budgets tend to be more accurate and can have a positive impact on employee morale because employees assume an active role in providing financial input to the budgeting process. * ------------------------------------------------- Zero-based budgeting: Each manager prepares estimates of his or her proposed expenses for a specific period of time as though they were being performed for the first time. In other words, each activity starts from a budget base of zero. By starting from scratch at each budget cycle, managers are required to take a close look at all their expenses and justify them to top management, thereby minimizing waste.
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Each has its advantages and disadvantages, and each approach can work well, although the pendulum is clearly swinging in favor of the bottom up approach.
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Budget tricks of the trade
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Budgets provide a kind of early warning system that, when compared to actual results, can inform you when something is going wrong that needs your immediate attention.
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When your expenditures exceed your budget, you can do several things to get back on track: * ------------------------------------------------- Review your budget. Before you do anything else, take a close look at your budget and make sure that the assumptions on which it is based are accurate and make sense in your changing market. If your market is growing quickly, you may need to adjust up your estimates. Sometimes, it's the budget — not the spending — that is out of line. * ------------------------------------------------- Freeze spending. One of the quickest and most effective ways to bring spending back in line with a budget is to freeze expenses such as pay raises, new staff, and bonuses. * ------------------------------------------------- Postpone new projects. New projects, including new product development, acquisition of new facilities, and research and development, can eat up a lot of money. However, if you are too zealous in curbing spending when you need to develop new products or services to compete, the result can be disastrous for the future growth and prosperity of the company. * ------------------------------------------------- Lay off employees and close facilities. This is the last resort when you're trying to cut expenses. Although these actions will result in an immediate and lasting decrease in expenses, you also face an immediate and lasting decrease in the talent available to your organization. Productivity and morale of remaining employees may also suffer.
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* * * * Task 11 * A new business started production on 1 January. Sales are planned to start in Febuary and to be as follows for the rest of the year. * | * Sales revenue | * February | * 10,000 | * March | * 20,000 | * April | * 30,000 | * May | * 50,000 | * June | * 80,000 | * * All sales will be made on 1 month credit terms. The business plans to offer a cash discount (of 2% of the amount owned) to those customers tho pay by the end of month of the sale. * * 50% customers are expected to qualify the discount. The remaining customer are expected to pay according to the credit terms It is planned that sufficient finished goods inventories for each months sales should be available at the end of the previous month . * * Material purchases will be such that there will be sufficient row materials inventories available at the end each month to meet the following months planned production. This planed policy will operate from the end of the January. Purchase of ingredient materials will be on two months credit (that is buy in one month, pay in moth three) * The direct labor cost, which is variable with the level of production, is planned to be 20% finished goods. * * Purchase and finished goods budgets for the six months ending 30 June : * | * Jan | * Fed | * Mar | * Apr | * | * $000 | * 000 | * 000 | * 000 | * Purchases | * 10 | * 20 | * 20 | * 30 | * Finished goods | * 20 | * 20 | * 30 | * 40 | * * Production over heads are planned to be $5,000 each month, including $1,000 for depreciation * Non-production overheads are planned to be $6,000 a month of which $1,000 will be depreciation * Various kitchen appliances costing of $25,000 will be bought and paid for during January * Except where specified,assume that all payments the place in the same month as the cost is incurred * 3.4 You are required to prepare a cash budget form 1 January to 31 April and also to provide suggestions to ease cash flow problems. * (1) * * Cash Budget | * Particulars | * January | * February | * March | * April | * Receipts | * | * | * | * | * Share issue | * 100,000 | * | * | * | * Opening balance | * - | * 62,000 | * 53,000 | * 43,700 | * Sales | * | * | * | * | * 50% | * - | * - | * 5,000 | * 10,000 | * 48% | * - | * 4,900 | * 9,800 | * 14,700 | * Total sales | * | * | * | * | * Total receipts (A) | * 100,000 | * 66,900 | * 68,700 | * 68,400 | * | * Payments | * | * | * | * | * Purchase | * - | * - | * 10,000 | * 20,000 | * Labor cost | * 4000 | * 4000 | * 6000 | * 8000 | * Production Overhead | * 4,000 | * 4,000 | * 4,000 | * 4,000 | * Non-production Overhead | * 5000 | * 5000 | * 5000 | * 5000 | * Kitchen appliances | * 25000 | * | * | * | * Total payments (B) | * 3,8000 | * 13,000 | * 25,000 | * 37,000 | * Closing balance (A-B) | * 62,000 | * 53,900 | * 42,800 | * 31,400 | * (2) how to ease of flow problem
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Teach employees to upsell and cross-sell
Increase your profits by increasing your average order size. To do so, train your staff to suggest related products or more expensive options for the product or service the customer requests. If you sell online, see if you can enable upsell and cross-sell features in your shopping cart.
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Watch check clearance times
Money in the bank isn't money to spend -- at least not immediately. Although the Check21 laws make it possible for banks to process checks faster (and therefore debit your account faster), the law does not require banks to release funds any faster than in the past. Thus, your bank may take two business days or more to clear local checks. If your customers are out-of-state, your bank may hold deposits for up to 10 business days. If there are sizable amounts of money involved, those 10 business days can seem like eternity.
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Accept credit cards to speed up cash flow
You don't have to be a retail store to accept credit cards from your customers. Businesses and government agencies as well as consumers use credit cards to make a wide variety of purchases. Instead of waiting 30 days, 60 days, or more to collect payment from your customers, you can get paid in 2 or 3 days by asking them to pay you with a credit card instead of having you bill them. You'll have to pay a percentage of each sale to the credit card company, and possibly a monthly fee, but those expenses may be negligible when you consider the time and money you'll save by not having to send out monthly statements. This is a win-win arrangement. The customer can still string out payments, but you're not on the end of the string. An added bonus: speeding up cash flow can help you speed up payments to your creditors, which may lower or eliminate interest payments you make on your payables.
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Shift your receivables to a finance company
If your customers don't like to pay bills for your type of product or service with a credit card, or if the amount is too large for them to feel comfortable charging, look for finance companies that will offer loans to your customers. Again you get paid now, the customer or patient gets to string out payments, and you don't have to go to the trouble of sending out monthly statements.
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Get some or all of your money up-front
Don't do spend weeks or months working without pay. When you negotiate deals, plan to get at least a third of the money up front if you are working on a long time project. If possible, spread the remaining payments so you cover all your ongoing expenses for the project.
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If you don't know your customer and it would be difficult to collect if they didn't pay or if they never came to pick up work they ordered, insist on payment in advance. That way you don't have a collection problem. * Reference：http://www.businessknowhow.com/money/cashflow.htm * * Task 12 * ABC is a company making wallets the following are the budgeted and actual income statement for KP for the month of June 2013. * | * Budget | * Actual | * Output (production and sale) | * 1,000 units | * 1,200 unit | * Sales revenue | * $20,000 | * $22,880 | * Raw materials | * $9,000 (3,000 units) | * $12,932 (3,189 units) | * Fixed overheads | * $8,000 | * $9,000 | * Operating profit | * $3,000 | * $3848 | * * 4.1 You are required to: a) Calculate a flexible budget & flexible budget variance and state whether is favourabe or adverse b) Sales volume variance c) Sales revenue variance d) Materials cost variance e) Overhead variance f) Analyze both static & flexible budget and give recommendations to improve ABC performance in relation to the departments involved. * * Particulars | * Budget | * Actual | * Flexed | * Variance | * F /UF | * Output (production and sale) | * 1,000 unit | * 1200 unit | * 1200 unit | * 200 units | * F | * Sales revenue | * $20,000 | * $22,880 | * $24,000 | * ($1,120) | * UF | * Raw materials | * $9,000 (3000 units) | * $12,932 (3180 units) | * $9,540 (3180 units) | * ($3,392) | * UF | * Fixed overheads | * $8,000 | * $9,000 | * $8,000 | * ($1,000) | * UF | * Operating profit | * $3,000 | * $3848 | * $6,460 | * ($2,612) | * UF | * * The budget plan is unfavorable in all sense the sales revenue variance is (22,800-24,00=$1,120). * The raw materials variance is significant in this budget it is ($3,392) it is very clear that is a huge difference may be because of inefficient management of spending, also its seen a difference in overhead that is ($1000) so that the profit variance is ($2612). * Management must undergone training to control the cost. * * *
Task 13 * 4.2 prepare an operating statement reconciling budgeted and actual results. Using standard absorption costing method to illustrate with the relevant examples. * * Standard Operating * Standard costing is a control system for comparing the planned costs and revenues with actual results in order to report variances for the purpose of performance measurement and control. Cost variances are usually reported to management in cost reconciliation statements.When sales variances are included the reconciliation is usually in the from of a standard cost operating statement. The format of the reconciliation is different under marginal and adsorption costing. * ABSOPRTION COSTING * Suppose the following variances had been calculated for the most recent period. * * | * $ | * | * Sales volume profit | * 80,000 | * adverse | * Sales price | * 10,000 | * favourable | * Direct material price | * 6,000 | * adverse | * Direct material usage | * 2,000 | * favourable | * Direct labour rate | * 8,000 | * adverse | * Direct labour efficiency | * 3,000 | * adverse | * Variable overhead expenditure | * 6,000 | * favourable | * Variable overhead efficiency | * 4,000 | * adverse | * Fixed overhead expenditure | * 12,000 | * favourable | * Fixed overhead volume | * 7,000 | * adverse | * * Budgeted sales and production for the period were 50,000 units.Standard selling price was $20 per unit and standard cost was $12 per unit, giving a standard profit of $8 per unit.Actually only 40,000 units were produced and sold and actual profit was 4332，000 * A reconciliation of budgeted and actual profits could be presented as shown in Figure 1 opposite. Throughout this article the text in italics is for information only and would not be necessary in the actual statement. Note that the statement clearly distinguishes between the effect of sales volume on profit, and operational expenditure and efficiency effects on profit. * * Standard costing is a control system for comparing the planned costs and revenues with actual results in order to report variances for the purpose of perefoemance measurement and control.Cost variances are usually reported to management in cost reconciliation statements. When sales variances are included the reconciliation is usually the from of a standard cost operating statement. * * Costing Statements * A clear reconciliation of budgeted and actual costs and revenues is important to help focus management attention on variances. * Figure 1 :Operating statement - standard absorption costing * Period:most recent | * | * | * $ | * | * Budgeted profit(50,000 units x $8 per unit profit) | * | * | * 400,000 | * | * Sales volume profit variance | * | * | * 80,000 * | * adverse | * Standard profit from actual sales (40,000 units x$8 per unit profit) | * | * | * 320,000 | * | * Variance | * (F) * $ | * (A) * $ | * | * | * Sales price | * 10,000 | * | * | * | * Direct material price | * | * (6,000) | * | * | * Direct material usage | * 2,000 | * | * | * | * Direct labour rate | * | * (8,000) | * | * | * Direct labour efficiency | * | * (3,000) | * | * | * Variable overhead expenditure | * 6,000 | * | * | * | * Variable overhead efficiency | * | * (4,000) | * | * | * Fixed overhead expenditure | * 12,000 | * | * | * | * Fixed overhead volume | * | * (7,000) | * | * | * Actual profit | * 30,000 | * 28,000 | * 2,000 | * | * | * | * | * 322,000 | * | Second, there would be no fixed overhead volume variance, as fixed overhead is not absorbed into production units. In addition there could potentially be changes in reported profit, but this is not the case in our example, as there is no change in finish goods inventory levels. The marginal costing operating statement is shown in Figure 3. Under marginal costing the effect of sales volume on contribution and expenditure and efficiency on contribution is clearly shown.
Conclusion
A clear reconciliation of budgeted and actual costs and revenues is important to help focus management attention on important variances. In practice the format of the above statements may vary, but whatever the layout is chosen, it is vital that they are laid out in a logical manner and distinguish between the sales volume and the rate and efficiency causes of deviations from budget. In the case of marginal costing it is important to separate the effects on contribution, fixed and variable costs.
Period: most recent | $ | | Budgeted cost (50,000 units × $12 per unit standard cost) | 600,000 | | Cost volume variance (10,000 units × $12 per unit standard cost) | 120,000 | favourable | Standard cost of actual production (40,000 units × $12 per unit standard cost) | 480,000 | | Variances | (F) (A) | | | $ $ | | Direct material price | (6,000) | | Direct material usage | 2,000 | | Direct labour rate | (8,000) | | Direct labour efficiency | (3,000) | | Variable overhead expenditure | 6,000 | | Variable overhead efficiency | (4,000) | | Fixed overhead expenditure | 12,000 | | | 20,000 (28,000) | (8,000) | Actual total cost | | 488,000 | | | |
Period: most recent | | $ | Budgeted variable cost (50,000 units × $11.30 per unit standard cost) | | 565,000favourable | Cost volume variance (10,000 units × $11.30 per unit standard variable cost) | | 113,000 favourable | Standard variable cost of actual production | | 452,000 favourable | Variances | (F) (A) | | | $ $ | | Direct material price | (6,000) | | Direct material usage | 2,000 | | Direct labour rate | (8,000) | | Direct labour efficiency | 6,000 | | Variable overhead efficiency | (4,000) | | | 8,000 (21,000) | (13,000) | Actual variable cost | | 465,000 | Fixed costs | $ | | Budget | 35,000 | | Expenditure variance | (12,000) favourable | | Actual fixed overhead | | 23,000 | Actual total cost | | 488,000 | * * * Task 14 * 4.3 Report findings to management in accordance with identified responsibilities centres. * You are required to ： (a) Comment on the department’s performances of the company in Task 12 inrelation to favourable or adverse variances you indicated. * * * Particulars | * Budget | * Actual | * Flexed | * Variance | * F /UF | * Output (production and sale) | * 1,000 unit | * 1200 unit | * 1200 unit | * 200 units | * F | * Sales revenue | * $20,000 | * $22,880 | * $24,000 | * ($1,120) | * UF | * Raw materials | * $9,000 (3000 units) | * $12,932 (3180 units) | * $9,540 (3180 units) | * ($3,392) | * UF | * Fixed overheads | * $8,000 | * $9,000 | * $8,000 | * ($1,000) | * UF | * Operating profit | * $3,000 | * $3848 | * $6,460 | * ($2,612) | * UF | * * The budget plan is unfavorable in all sense the sales revenue variance is (22,800-24,00=$1,120). * The raw materials variance is significant in this budget it is ($3,392) it is very clear that is a huge difference may be because of inefficient management of spending, also its seen a difference in overhead that is ($1000) so that the profit variance is ($2612). * (b) Provide suggestions to improve the company’s performance. * * In view of the above, the management must undergone training to control the cost or reducing business expenses. * * It can look for ways to cut costs through methods such as cutting back, moving to less expensive plan or changing service providers. * * The cost-control process seeks to manage expenses ranging from phone, internet and utility bills to employee payroll and outside professional services in addition to the above-mentioned particulars. * * * Reference： * Finance： Management Accounting FinancialReportingJuly2015 edition BPP LearningMedia 