TBS 901

Module 7

Budgetary
Control and
Planning

7-1
ACCY211. 1-1
 Definition

A budget is
a detailed plan,
expressed in quantitative terms,
that specifies how resources will be acquired
and used during a specified period of time.

7-2
ACCY211. 1-2
 Purposes of Budgeting Systems

  Planning
  Facilitating communication & coordination
  Allocating resources
  Controlling profit & operations
  Evaluating performance & providing
incentives

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ACCY211. 1-3
 Planning and Control

  Planning -- involves   Control -- involves

developing the steps taken by
objectives and mgt that attempt to
preparing various ensure the objectives
budgets to achieve are attained.
these objectives.

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ACCY211. 1-4
 Responsibility Accounting

Managers should be evaluated by how well they

manage those items — and only those items —
under their control.

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ACCY211. 1-5
 Types of Budgets

Detail
Budget
Detail

Materials
Budget
Detail

Production
Budget
Master
Budget
Covering all Sales
phases of
a company’s
operations.

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ACCY211. 1-6
 Sales of Services or Goods

Ending Production
Inventory Budget
Budget

DM DL OH Selling &
Budget Budget Budget Admin Budget

Cash Budget

Budgeted Financial Statements

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ACCY211. 1-7
 Types of Budgets cont’d

Capital budgets
  deal with acquisition of building & equipment
  normally cover several years.

Long -Range Budgets

2005 2006 2007 2008

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ACCY211. 1-8
 Types of Budgets cont’d
Continuous or rolling budgets
  usually cover 12 mths
AND
  roll forward one mth as current mth
is completed.

2005 2006 2007 2008

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ACCY211. 1-9
 Types of Budgets

The annual operating budget may be

divided into quarterly or monthly budgets.

Operating Budget

2005 2006 2007 2008

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 Attention Directing
  A budgetary control system does this by
 setting budgetary standards
 collecting actual cost and revenue info
 reporting accounting variances on a
regular and routine basis

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ACCY211. 1-11
 Budgets and
... objectives

 Budget makers need relatively clear view of

objectives
 Budget may help represent and communicate
broad objectives
OR
 Budget process may shape definitions or
objectives

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ACCY211. 1-12
 Budgets and
... choice of strategies

 Help measure inputs & outputs in

financial terms
 Allow comparison and evaluation of
different strategies

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ACCY211. 1-13
 Budgets and
... predictive models

 express estimated input/output

relationships

 identify critical success factors

budgets?

 sensitivity to changes

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ACCY211. 1-14
 Budgets and
... feedback

 budget targets express desired level of

performance
 responsibility for target achievement can
be assigned
 responsibility accounting
- tracks performance on a regular basis
- enables corrective action

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 Use of Budgetary Information
Potential conflicts
 forecast of future events
 motivational targets
 performance evaluation

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ACCY211. 1-16
 Management Styles
Authoritarian Mgt

 Mgt role to instruct worker exactly how to

perform tasks
 Top-down authority
 Sometimes causes resistance to develop
 Top-down budgets (imposed)
 Budgets used to force employees to meet
expectations of top mgt
 Sometimes causes dysfunctional behaviour.

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ACCY211. 1-17
 Budgetary Slack

 Developed by subordinate managers

and workers to provide protection

- underestimate revenues

- overestimate expenses

- deceive mgt about task time

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ACCY211. 1-18
 Participative Budgeting
  Allows individuals responsible for
performance under budget to participate
in establishment of budget
  Managers (all levels) and workers should
be in accord with goals of firm
  Goal congruence is key objective
  Humans are highly diverse
  Behaviour influenced by many factors

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ACCY211. 1-19
 Advantages
¤  Motivates by providing challenge and sense
of responsibility
¤  Aims to create higher morale and positive
employee attitudes towards firm
¤  Increases likelihood of goal congruence
¤  Can bring greater satisfaction and self-
esteem through job enlargement
¤  Better plan: combined knowledge
¤  Awareness of how particular fn fits into total
operational picture
¤  Increases interdepartmental cooperation
¤  Junior mgt more aware of future
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ACCY211. 1-20
 Budget Cycle

 objectives
 success factors
 sales/revenue budget
 operating activities’ budgets
 negotiation of budget targets
 coordination and review
 acceptance and communication
 continuous monitoring

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ACCY211. 1-21
 Budget Setting Process
  Iterative process
  Involves dialogue
  Budget holders must be part of the budget
setting process
  This ensures ownership of the plan

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ACCY211. 1-22
 Monitoring Budgets
  Compare actual to budget on a timely
basis
  Analyse variances to:
-allocate responsibility
-take corrective action
-revise continuing budget
-feed into new forecasts

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ACCY211. 1-23
 Flexing a budget
  Helps to determine why variances have
occurred
  Take budgeted volume and replace with
actual volume
  Calculate revised variances between
flexed figures and actual
  Fixed costs remain the same

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ACCY211. 1-24
 Budget Administration
The Budget Committee is a standing committee
responsible for . . .
  overall policy matters relating to the budget.

  coordinating preparation of the budget.

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ACCY211. 1-25
 International Aspects of
Budgeting

Firms with international operations face

special problems when preparing a budget.

 Fluctuations in foreign currency exchange

rates.
 High inflation rates in some foreign
countries.
 Differences in local economic conditions.

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ACCY211. 1-26
 Budgeting Product Life-Cycle Costs
Product planning
and concept
design

Distribution
Preliminary
and customer
design
service

Detailed design
Production
and testing

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ACCY211. 1-27
 Controlling Costs
Standard Actual
performance performance
level level

Comparison between
standard and actual
performance
level

Cost
variance
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ACCY211. 1-28
 Management by Exception
Managers focus on quantities and costs
that exceed standards, a practice known as
management by exception.

Standard
Amount

Direct
Material
Direct
Labour

Type of Product Cost

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ACCY211. 1-29
 Variance Analysis Cycle

Take
Identify Receive
corrective
questions explanations
actions

Conduct next
Analyse
period’s
variances
operations

Prepare
standard cost
performance
7-30
report
ACCY211. 1-30
 Participation in Setting Standards

  Accountants, engineers, personnel

administrators, and production
managers combine efforts to set
standards based on experience and
expectations.

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ACCY211. 1-31
 Perfection vs Practical Stds:
A Behavioural Issue
Practical stds should I agree.
be set at levels that are Perfection stds
currently attainable are unattainable
with reasonable and and therefore
efficient effort. discouraging to
most employees.
Should we use
practical stds or
perfection stds?

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ACCY211. 1-32
 Use of Stds by
Service Organisations

v  Std cost analysis

may be used in any
organisation with
repetitive tasks.
v  A relnship between
tasks and output
measures must be
established.

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 Budget holders in the health
system are not necessarily able
to control the amount of
activity that passes through
their section

Why not?

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ACCY211. 1-34
 Cost Variance Analysis

Std Cost Variances

Price Variance Quantity Variance

Difference between Difference between

actual price and actual quantity and
std price std quantity
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 A General Std quantity is the quantity
Model for allowed for actual good output.
Variance
Analysis
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

Std price is the amt that should have been

paid for the resources acquired.
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ACCY211. 1-36
 A General Model for Variance
Analysis
Actual Quantity Actual Quantity Standard Quantity
× × ×
Actual Price Standard Price Standard Price

Price Variance Quantity Variance

AQ(AP - SP) SP(AQ - SQ)

AQ = Actual Quantity SP = Standard Price
AP = Actual Price SQ = Standard Quantity

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ACCY211. 1-37
 Material Variances Zippy
Example

  Hanson Ltd has the following DM standard to

manufacture one Zippy:
1.5 kg per Zippy at $4.00 per kg
  Last week 1,700 kg of material were purchased
and used to make 1,000 Zippies. The material
cost a total of $6,630.

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ACCY211. 1-38
 Material Variances Question 1 Zippy

What is the actual price per kg paid for the

material?

a. $4.00 per kg
b. $4.10 per kg
AP = $6,630 ÷ 1,700 kg
c. $3.90 per kg
AP = $3.90 per kg
d. $6.63 per kg

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ACCY211. 1-39
 Material Variances Question 2 Zippy

Hanson’s material price variance (MPV) for the

week was:

a. $170 unfavourable
b. $170 favourable
c. $800 unfavourable
d. $800 favourable
MPV = AQ (AP - SP)
MPV = 1700 kg x ($3.90 - $4.00)
MPV = $170 favourable
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ACCY211. 1-40
 Material Variances Question 3 Zippy

The standard quantity of material that

should have been used to produce 1,000
Zippies is:
SQ = 1000 units × 1.5 kg per unit
SQ = 1500 kg
a. 1,700 kg
b. 1,500 kg
c. 2,550 kg
d. 2,000 kg

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ACCY211. 1-41
 Material Variances Question 4 Zippy

Hanson’s material quantity variance (MQV)

for the week was:

a. $170 unfavourable
b. $170 favourable
c. $800 unfavourable
d. $800 favourable
MQV = SP(AQ - SQ)
MQV = $4.00 (1700 kg - 1500 kg)
MQV = $800 unfavourable
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ACCY211. 1-42
 Material Variances Zippy
Summary

Actual Quantity Actual Quantity Std Quantity

× × ×
Actual Price Std Price Std Price
1,700 kg 1,700 kg 1,500 kg
× × ×
$3.90 per kg $4.00 per kg $4.00 per kg
$6,630 $ 6,800 $6,000

Price variance Quantity variance

$170 favourable $800 unfavourable
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ACCY211. 1-43
 Material Variances Zippy

Hanson purchased The price variance is

and used 1,700 kg. computed on the entire
quantity purchased.
How are the variances
computed if amt The quantity variance is
purchased differs computed only on the
from amount used? quantity used.

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ACCY211. 1-44
 Material Variances Cont’d Zippy

  Hanson Ltd has the following material std to

manufacture one Zippy:
1.5 kg per Zippy at $4.00 per kg
  Last week 2,800 kg of material were purchased
at a total cost of $10,920, and 1,700 kg were
used to make 1,000 Zippies.

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ACCY211. 1-45
 Material Variances Cont’d Zippy

Actual Quantity Actual Quantity

Purchased Purchased
× ×
Actual Price Std Price
2,800 kg 2,800 kg
× ×
$3.90 per kg $4.00 per kg
$10,920 $11,200
Price variance
Price variance increases because
$280 favourable quantity purchased
7-46
increases.
ACCY211. 1-46
 Material Variances Cont’d
Zippy

Actual Quantity Std Quantity

Used
× ×
Std Price Std Price
1,700 kg 1,500 kg
× ×
$4.00 per kg $4.00 per kg.

Quantity variance is $6,800 $6,000

unchanged because
actual and standard
quantities are Quantity variance
unchanged. $800 unfavourable
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ACCY211. 1-47
 Responsibility for Material
Variances
You used too much
material because of poorly
I am not responsible for
trained workers and poorly
this unfavourable material
maintained equipment.
quantity variance.
Also, your poor scheduling
You purchased cheap sometimes requires me to
material, so my people rush order material at a
had to use more of it. higher price, causing
unfavourable price
variances.

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 Labour Variances Example Zippy

 Hanson Ltd has the following DL std to

manufacture one Zippy:
1.5 std hours per Zippy at $6.00 per DLH
 Last week 1,550 DLH were worked at a total
DL cost of $9,610 to make 1,000 Zippies.

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ACCY211. 1-49
 Labour Variances Question 1 Zippy

What was Hanson’s actual rate (AR) for

labour for the week?

a. $6.20 per hour AR = $9,610 ÷ 1,550 hrs

AR = $6.20 per hr
b. $6.00 per hour
c. $5.80 per hour
d. $5.60 per hour

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ACCY211. 1-50
 Labour Variances Question 2 Zippy

Hanson’s labour rate variance (LRV) for the

week was:

a. $310 unfavourable
b. $310 favourable
c. $300 unfavourable
d. $300 favourable
LRV = AH (AR - SR)
LRV = 1,550 hrs($6.20 - $6.00)
7-51 LRV = $310 unfavourable
ACCY211. 1-51
 Labour Variances Question 3 Zippy

The std hours (SH) of DL that should have

been worked to produce 1,000 Zippies is:

a. 1,550 hours
b. 1,500 hours
c. 1,700 hours
d. 1,800 hours
SH = 1000 units × 1.5 hrs per unit
SH = 1500 hrs
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ACCY211. 1-52
 Labour Variances Question 4 Zippy

Hanson’s labour efficiency variance (LEV)

for the week was:
a. $290 unfavourable
b. $290 favourable
c. $300 unfavourable
d. $300 favourable
LEV = SR(AH - SH)
LEV = $6.00 (1,550 hrs - 1,500 hrs)
LEV = $300 unfavourable
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ACCY211. 1-53
 Labour Variances Summary Zippy

Actual Hours Actual Hours Standard Hours

× × ×
Actual Rate Standard Rate Standard Rate
1,550 hours 1,550 hours 1,500 hours
× × ×
$6.20 per hour $6.00 per hour $6.00 per hour
$9,610 $9,300 $9,000

Rate variance Efficiency variance

$310 unfavourable $300 unfavourable
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ACCY211. 1-54
 Labour Rate Variance –
A Closer Look
Using highly paid skilled workers
to perform unskilled tasks results
in an unfavourable rate variance.

High skill, Low skill,

high rate low rate

Production managers who make work assignments

are generally responsible for rate variances.

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ACCY211. 1-55
 Labour Efficiency Variance –
A Closer Look
Poorly Poor
trained quality
workers materials

Unfavourable
Efficiency
Variance
Poor Poorly
supervision maintained
of workers equipment
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ACCY211. 1-56
 Responsibility for Labour Variances
I am not responsible for You used too much time
the unfavourable labour because of poorly
efficiency variance! trained workers and
You purchased cheap poor supervision.
material, so it took more
time to process it.

Maybe I can attribute the labour

and material variances to personnel
for hiring the wrong people
and training them poorly.
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ACCY211. 1-57
 Significance of Cost Variances
v  Size of variance
l  Dollar amount
l  Percentage of
standard
v  Recurring variances
v  Trends
v  Controllability
What clues help me
to determine the v  Favourable variances
variances that I v  Costs and benefits of
should investigate? investigation
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 Advantages of Std Costing

Sensible Cost Management by

Comparisons Exception

Advantages

Performance Employee
Evaluation Motivation

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 Criticisms of Std Costing

  Std costing may be inappropriate in some

modern manufacturing environments.
  Undue concern for variances and cost
minimisation may lead to lower quality.
  Automation reduces labour costs and the
significance of labour variances.
  Std costing may not be applicable in flexible
manufacturing operations with short life-
cycle products.

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ACCY211. 1-60
 Flexible Budgets
Static budgets are Hmm! Comparing
prepared for a single, static budgets
planned level of with actual costs
activity. is like comparing
Performance apples and oranges.
evaluation is difficult
when actual activity
differs from the
planned level of
activity.

Consider the following

example from the Cheese
7-61
ACCY211.
Company . . . 1-61
Static Budgets
and
Performance
Reports Static Actual Variance
Budget .
Machine hours 10 000 8 000 2 000 U
Variable cost
Indirect labour $40 000
Cheese Company
Indirect materials 30 000 was unable to
Power 5 000 achieve the budgeted
Fixed costs level of activity.
Depreciation 12 000
Insurance 2 000
Total overhead costs $89 000
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ACCY211. 1-62
 Since cost variances
Static Budgets are favourable, have
and we done a good job
Performance controlling costs?
Reports Static Actual Variance
Budget .
Machine hours 10 000 8 000 2 000 U
Variable cost
Indirect labour $40 000 $34 000
6 000 F
Indirect materials 30 000 25 500
4 500 F
Power 5 000 3 800
Fixed costs 1 200 F
Depreciation 12 000 12 000 0
Insurance 2 000 2 000 0
Total overhead costs $89 000 $77 300 $11 700 F
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ACCY211. 1-63
 Static Budgets and
Performance Reports

I do know that
I don’t think I can actual activity is below
answer this question budgeted activity which
using a static budget. is unfavourable.
But shouldn’t variable costs
be lower if actual activity
is below budgeted activity?

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ACCY211. 1-64
 Static Budgets and
Performance Reports
v  The relevant question is . . .
“How much of the favourable cost variance
is due to lower activity, and how much is
due to good cost control?”

v To answer the question,

we must
the budget to the
actual level of activity.

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ACCY211. 1-65
 Flexible Budgets

Central Concept

If you can tell me what your activity was

for the period, I will tell you what your costs
and revenue should have been.

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ACCY211. 1-66
 Preparing a Flexible Budget

To a budget for different activity

levels, we must know how costs behave
with changes in activity levels.
l  Total variable costs change
in direct proportion to
changes in activity
l  Total fixed costs remain
unchanged within the
relevant range Fixed

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ACCY211. 1-67
 Advantages of Flexible Budgets
Show revenues and expenses
that should have occurred at the
actual level of activity.

May be prepared for any activity

level in the relevant range.

Reveal variances due to good

cost control or lack of cost
control.

Improve performance evaluation.

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ACCY211. 1-68
 Example

  Suppose it has been determined by a hospital

that treatment for a particular medical
condition has a standard requirement of 1
treatment pack per patient at a standard cost
of $50 per pack
  Last month 105 patients were treated and the
cost of treatment packs was $5562,
representing actual usage of 108 packs at a
charge of $51.50 each

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ACCY211. 1-69
 Example

  Overall variance is

$5562 (108 @ $51.50)

- $5250 (105 @ $50)
= $ 312

However, this overspend is not due entirely to

the treatment team

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ACCY211. 1-70
 Example

  Firstly, the treatment packs are costing more

than was allowed for in the budget
  The price variance is:
($51.50 - $50) x 108 = $162

However, 3 additional treatment packs were

used
The efficiency variance is:
(108-105) x $50 = $150

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ACCY211. 1-71
 Example

  Both variances are adverse (actual exceeds

standard)
  The adverse price variance would be the
concern of the supplies officer
  Internal enquiries would need to be undertaken
to see why 3 additional treatment packs were
used

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ACCY211. 1-72
 Preparing a Flexible Budget

Let’s prepare
budgets for the
Cheese Company.

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ACCY211. 1-73
 Preparing a Flexible Budget
Flexible Budgets .
VC Total 8 000 10 000 12 000
per hr FC hrs hrs hrs .
Machine hours 8 000 10 000 12 000
Variable cost Using an input activity measure as
Indirect lab $4.00 units of output may not be
Indirect mats 3.00 meaningful in a multiproduct firm.
Power 0.50
Total VC $7.50 VC expressed as constant amt
per hr
Fixed costs
Depreciation $12 000
Insurance 2 000
Total FC FC expressed as total amt that
does not change within
Total OH costs
7-74
ACCY211. relevant range of activity. 1-74
 Preparing a Flexible Budget
Flexible Budgets .
VC Total 8 000 10 000 12 000
per hr FC hrs hrs hrs .
Machine hours 8 000 10 000 12 000
Variable cost
Indirect lab $4.00 $32 000 $40 000 $ 48 000
Indirect mats 3.00 24 000 30 000 36 000
Power 0.50 4 000 5 000 6 000
Total VC $7.50 $60 000 $75 000 $ 90 000
Fixed costs
Depreciation $12 000 $12 000 $12 000 $ 12 000
Insurance 2 000 2 000 2 000 2 000
Total FC $14 000 $14 000 $ 14 000
NB: No $74 000 $89 000 $104 000
Total OH costs
7-75
ACCY211.
flex in FC 1-75
 Flexible Budget
Performance Report

Now let’s prepare a

budget performance report
at 8 000 actual machine
hours for the Cheese Co.

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ACCY211. 1-76
Flexible Budget Performance
Report
VC Total Flexible Actual Variance
per hr FC Budget Results .
Machine hours 8 000 8 000 0 .
Variable cost Flexible budget is
Indirect lab $4.00
prepared for the $34 000
Indirect mats same
3.00 activity level 25 500
Power (8,000
0.50 hours) as 3 800
actually achieved.
Total VC $7.50 $63 300
Fixed costs
Original actual
Depreciation results$12for000
Cheese $12 000
Insurance Company 2 000
that we 2 000
Total FC saw earlier. $14 000
Total OH costs $77 300
7-77
ACCY211. 1-77
Flexible Budget Performance
Report
VC Total Flexible Actual Variance
per hr FC Budget Results .
Machine hours 8 000 8 000 0 .
Variable cost
Indirect lab $4.00 $32 000 $34 000 $ 2 000 U
Indirect mats 3.00 24 000 25 500 1 500 U
Power 0.50 4 000 3 800 200 F
Total VC $7.50 $60 000 $63 300 $ 3 300 U
Fixed costs
Depreciation $12 000 $12 000 $12 000 0
Insurance 2 000 2 000 2 000 0 .
Total FC $14 000 $14 000 0 .
Total OH costs $74 000 $77 300 $ 3 300 U
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ACCY211. 1-78
Flexible Budget Performance
Report
Indirect labourVCand Total Flexible Actual Variance
perhave
indirect material hr FC Budget Results .
Machine hours variances
unfavourable 8 000 8 000 0 .
because
Variable costactual costs
are more
Indirect lab than the
$4.00 $32 000 $34 000 $ 2 000 U
flexible budget costs.
Indirect mats 3.00 24 000 25 500 1 500 U
Power Power has0.50 a 4 000 3 800 200 F
Totalfavourable
VC $7.50
variance $60 000 $63 300 $ 3 300 U
Fixedbecause
costs the actual
cost is less than the
Depreciation $12 000 $12 000 $12 000 0
flexible budget cost.
Insurance 2 000 2 000 2 000 0 .
Total FC $14 000 $14 000 0 .
Total OH costs $74 000 $77 300 $ 3 300
7-79
U
ACCY211. 1-79
Activity Based Flexible Budgets
Flexible Budgets .
VC Total 8 000 10 000 12 000
per hr FC hrs hrs hrs .
Machine hours 8 000 10 000 12 000
Variable cost
Indirect lab $4.00 The$32
Cheese Co.000
000 $40 flexible
$ 48 000
Indirect mats 3.00 budget 24is000
based30on000a single
36 000
Power 0.50 cost driver,
4 000 machine
5 000 hours6 000
Total VC $7.50 $60 000 $75 000 $ 90 000
Fixed costs
If different cost$12
Depreciation drivers are000
000 $12 identified
$12 000for$ the
12 000
different variable costs,
Insurance 2 000 an2activity
000 based
2 000 flexible
2 000
Totalbudget
FC should be prepared with$14
$14 000 different cost
000 $ 14 000
Total OH formulae
costs based on the
$74 different
000 $89 drivers.
000 $104 000
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ACCY211. 1-80
 Effective Budgeting Systems

 Aspiration level is level of performance a

person accepts as achievable and is prepared
to act towards
 Difficult to generalise because of diverse
behaviour
Attainable goals
Participation
Feedback

7-81
ACCY211. 1-81
 TBS 901
Module 7

Budgetary
Control and
Planning

7-82
ACCY211. 1-82