Kaplan 8: Preparing Budgets; Control phase Flashcards
A cost centre is
A location; Function; Item of Equipment
In respect of which costs may be accumulated & related to cost units.
For control purposes.
Examples:
Production: Assembly line or Packing machine.
Service dept: Stores; Canteen, QC
Service: Tax dept (accountants); ward (hosp)
A profit centre is
A location; function; Item of equipment
In respect of which costs & revenues may be ascertained for the purpose of controlling the resultant Profit
Prime cost =
Total of direct costs
Production cost =
Prime cost (direct costs) + Indirect PRODUCTION costs
Total cost =
Production cost + Indirect NON-PRODUCTION costs
How would you classify costs for :
Cost control
By nature, materials , OHs labour etc
How would you classify costs for :
Cost accounting purposes
By relationship to cost units - direct, indirect costs etc.
Prime cost, production cost.
How would you classify costs for :
Budgeting, contribution analysis
By behaviour. fixed, variable etc
Think about budgeting electricity - need to know fixed & var costs in order to budget changes
How would you classify costs for :
Decision making
Relevant, non-relevant
How would you classify costs for :
Responsibility accounting
Controllable & uncontrollable
Direct costs are..
costs which can be related directly to one cost unit.
Direct materials
Direct labour
Direct expenses
Another term for Indirect costs
Overheads.
These cannot be identified directly with a cost unit
For inventory valuation purposes need to distinguish between overheads which ..
Are incurred in the production process:
(Factory rent, rates, power)
Are non-production costs involved in converting finished goods to revenue:
(Exec salaries, office costs, marketing, selling & dist)
Fixed costs are also known as … ? costs (why?)
Period costs
They accrue with the passage of time (eg rent)
Hi Lo method remember
Use highest & lowest OUTPUT (not necessarily smae as Highest & lowest cost)
‘Activity’ Variance & ‘Controllable’ varience
This relates to flexed budgeting.
The flexed budget eliminates the activity variance and highlights the controllable variance element
Budgetory control statement
Its the statement with columns for Original Budget/ Flexed budget/ Actuals/ Variances (F or A)
4 situations where an imposed budget might be preferable
- Managers objectives may not be those of the organisations as a whole
- Managers do not have the training, skill or technical knowledge to set budgets
- Managers would prefer not to set their own budgets
- Time constraint whereby full participation is not practical
Discuss whether an imposed requirement to reduce material costs be reduced would have motivated managers
- Setting budget targets that are not achievable can be demotivating. If managers recognise might not even try
- Impossible targets can bring the whole planning process into disrepute and managers may question the validity and usefuless of the budgetary process
- Need to consider whether it is a controllable cost. If there are no ther suppliers it may not be in managers power to reduce this cost. (Maybe even some contract in place?)
The boss thinks the results PROVE that his imposed budget motivated the managers.
Name 3 ways which could have increased profit without additional effort by the managers
1) There may have been increased DEMAND.
2) The only cost less than budget was heat/light… this could be due to INACCURATE FORECAST
3) The reduction in cost could also be due to better weather conditions
What do you use to reconcile the budgeted costs to actua costs
A cost analysis
What to remember when flexing a budget about fixed costs
You flex them also (should be a OAR * units).
Need to work on the Fixed OH variances..
Fairly ok with Ependiture & volume variance.
But volume variance can be broke into efficiency & capacity !!!
.
When working out price var for FO due to indexing
- Work out the price var and usage var as usual and make sure they match the overall variance.
- Work out the per unit price actually paid.
- Work out what the indexed per unit price was.
- Work out the difference between the indexed ppu and the actual ppu and multiply by the ACTUAL usage.
- Work out the difference between the standard ppu and the indexed ppu and multiply by the ACtual usage.
- Results form 4 & 5 should add up to the same as the PRICE variance (not the overall variance.
- You now have the Usage variance and the Price variance … with the Price variance now split into the change due to the index (uncontrollable) and due to other factors (maybe controllable)
Reviewing performance from a budget report:
Direct costs
- Naturally higher when sales are higher.
- Check consistent? Is the DC/SR% cumulative to date budget % the same as the % for the whole year? If its lower I think this means a rise in DCs in the latter part of the year.
- Admin - remember these can be influenced by random occurences like a large purchase of stationery or an overseas trip for the MD..
Why do we use flexed budget and not compare results to fixed budget (5 comments)
- We use 2 types of budget.
- A Fixed budget is essentially a PLANNING DEVICE.
It sets a target to which management are in the short-term committed - A flexible budget is however a CONTROL DEVICE.
It is principally a revision of the original plan..
..whereby allowances are given for both Cost & Rev..
..to MATCH the level of activity actually achieved. - This enables a ‘like for like’ comparison,
- From this comparison meaningful varianced can be reported, on which a measure of control can focus.
Factors to take into account before investigating variances (7 comments)
- It is not practicable to investigate all variances.
- Because of this, exception tecniques are used.
- Apply both a minimum absolute val and min % before investigation is recommended
- A variance may be investigated if it is an element of a continuing trend.
- Variance would not be investigated if the cause is a factor of which management are aware.
- Also not worth investigating if the cause is a factor that is not controlable.
- Essential that the benefits of the investigation, outweigh the costs of investigating
What are the limitations of linear regression techniques
- Assumption of linearity - This may not be the case. Sales may not follow that pattern.
- Use of historic data - Past performance is not always a good guide to the future.
- LR does not account for the effects of a product life cycle
Reasons for variances - 4 headings
- Planning errors.
- Measurement errors
- Random factors
- Operational causes
Variances - Planning errors
Could be carelessness, not taking account of known changes in the production process or expected price rises.
Or could be unexpected external changes (eg market shortage)
Variances - Measurement errors
Inaccurate completion of timesheets or jobcards. Inaccurate measurement of quantities issued from stores. Incorrect coding of invoices!!
Rectification of these errors will probably not give rise to any cost savings
Variances - Random errors
By definition uncontrolable but need careful monitoring to ensure they are not one of the other types of variance
Variances - operational causes
NB: Nearly always useful to consult staff working in operational departments to resolve any queries in the data as they will have ‘local’ knowledge of the day to day operations
- MATERIALS PRICE:
i. Bulk discounts
ii. Different suppliers/materials
iii. Unexpected delivery costs
iv. Different buying procedures - MATERIALS USAGE:
i. Different quality/mix material
ii. Theft, obsolescence, deterioration.
iii. Different grade of staff
iv. Different batch sizes and trim loss - LABOUR RATE:
i. Different class of labour
ii. Excessive OT
iii. Productivity bonuses
iv. National wage negs. - LABOUR EFFICIENCY:
i. Different level of skill
ii. The learning effect
iii. Machine breakdowns
iv. Work to rule
5 OVERHEAD PRICE:
i. Change in nature of OH
ii. Unforseen price changes
- OVERHEAD VOLUME:
i. Excess idle time
ii. Increase in workforce (more mgrs)
NPV & DCF
The NPV compares the value of the investment amount today to its value in the future.
The DCF assists in analysing an investment and determining its value—and how valuable it would be—in the future. … The DCF method makes it clear how long it would take to get returns
A Kaplan scenario analysing an adverse usage variance of £50K in a month gave lots of info and possible solutions.
The appreach was…
- Break up the info given into rows with the adverse amount that related to that piece of info.
a) Theft 3000x£10 ………….. 30,000
b) Bad measurement ……… 20,000
.
e) Other Op factors (bal)…..(30,000)
Total……………………………………50,000 - Insert ‘balancing’ row named ‘other operational factors’ (In this case favourable)
- Analyse each row in turn including the balancing figure. Dont forget the balancing figure may need further investigation even though it’s favourable.. if the var affects the quality for instance.
Fixed OH variances
- Volume variance is a product of TAC (Total absorption costin) system and represents the adjustment for over/under absorption of fixed costs due to actual production being higher/lower than budgeted.
- Unlike the other variances it does not actually represent a cost saving or overspend.
- However it’s still a problem needing investigated because decisions (eg Pricing of the product) may be based on this. (Price too high may have lost sales; too ow profit margin eroded)
- Therefore regular reviews should be conducted so that the OAR can be adjusted if appropriate.
How does variance analysis fit in…
Using variance analysis to improve budgeting practices means that budget planning and control has been used to create a cycle of CONTINUOUS IMPROVEMENT.
A Continuous Improvement culture will help ensure that the internal budget process is efficient and affective and remains relevant to the organisations needs & priorities..
Tricky variances where working out what is due to exchange rate (or other index) change (‘planning’ variance’) and what is ‘operational’
- Work out the total variance:
Standard price * Actual qty - Actual price * Actual qty. - The work out what the ‘indexed’ standard price would be by multiplying the standard price by ‘NEW /OLD’ and use that to isolate the var due to indexing using the same method as above:
Standard price * Actual qty - Indexed price * Actual qty. - Finally do diff between ‘indexed’ and ‘actual’ price… again same method as above (ie. using Actual qty …PAUS)
Indexed price * Actual qty - Actual price * Actual qty. - Check 2 & 3 add up to 1 !!!!!!!!!!!!
FO Volume variance can be split into 2 sub variances
FO efficiciency variance:
St. hrs for act. prod. - Act. hrs for act prod. (*AR)
FO capacity variance:
Actual hours worked - budgeted hrs for the period (*AR)
