1. Paper F2 Management Accounting
2018/9/22

2. Chapter 15 Budgeting
2018/9/22

3. Budgeting Chapter Preview Planning and control
Fixed and flexible budgets
Responsibility centres
Preparing flexible budgets
Controllable costs
Spreadsheets
2018/9/22
Ji Weili, JXUFE

4. Planning and control Planning and control cycle Determine objectives
Control - variances
Planning – set budget
Actual operations
2018/9/22
Ji Weili, JXUFE

5. The planning and control cycle
Identify objectives
Implement the long-term plan
Identify potential strategies
Measure actual results and compare with plan
Control process
Planning process
Respond to divergences from plan
Evaluate strategies
Choose alternative courses of action
2018/9/22
Ji Weili, JXUFE

6. Objectives of a budgetary systems
Ensure the organization’s objectives are achieved
Compel planning
Communicate ideas and plans
Co-ordinate activities
Provide a framework for responsibility accounting
Establish a system of control
Motivate employees to improve their performance
2018/9/22
Ji Weili, JXUFE

7. Responsibility centres
A responsibility centres is a sub-unit of an organisation where the manager is held accountable for the sub-unit’s activities and performance
Investment centre
Profit centre
Cost centre
Revenue centre
2018/9/22
Ji Weili, JXUFE

8. Responsibility centres
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9. Controllable costs Traceable cost VS. controllable cost
The managers of responsibility centres should only be accountable for costs which they have some influence.
Sometimes it is hard to distinguish controllable cost and uncontrollable cost. e.g. apportioned costs
2018/9/22
Ji Weili, JXUFE

10. Fixed and flexible budgets
Fixed budget = Master (original) budget
Prepared before the start of the budget period
Flexible budget = ‘scenario planning’
Prepared at the start of the year
What if? analysis
Flexed budget is a flexible budget prepared at the end of the year using the actual volumes
2018/9/22
Ji Weili, JXUFE

11. Budgetary Control and Reporting
Develop the budget from planned objectives.
Revise objectives and prepare a new budget.
Compare actual with budget and analyze any differences.
Management uses budgets to monitor and control operations.
Budgets are an important cost control tool. Actual results are compared with budgets and differences are investigated and analyzed. This process may result in corrective action to restore progress toward budgeted objectives. If the operating environment has changed the investigation and analysis may lead to budget revisions.
Take corrective and strategic actions.
2018/9/22
Ji Weili, JXUFE

12. Fixed Budget Performance Report
Fixed budgets are prepared for a single, predicted level of activity.
Performance evaluation is difficult when actual activity differs from the predicted level of activity.
Hmm! Comparing fixed budgets with actual costs is like comparing apples with oranges.
One of the major problems with fixed budgets is that they’re prepared for a single planned level of activity. Performance valuations can be very difficult when the actual level of activity differs from the planned level.
2018/9/22
Ji Weili, JXUFE

13. Fixed Budget Performance Report
Hmm! Comparing fixed budgets with actual costs is like comparing apples with oranges.
Consider the following condensed example from the Optel Company . . .
To illustrate the difficulty involved with performance evaluation when comparing actual results at one activity with a fixed budget at another activity, let’s look at an example.
2018/9/22
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14. Fixed Budget Performance Report
Optel’s fixed budget was prepared for January at an expected sales level of ten thousand units. However, Optel actually sold twelve thousand units during the month.
2018/9/22
Ji Weili, JXUFE

15. Fixed Budget Performance Report
U = Unfavorable variance Actual cost is greater than budgeted cost.
All of the expense variances are unfavorable because actual expenses are greater than budgeted expenses.
2018/9/22
Ji Weili, JXUFE

16. Fixed Budget Performance Report
F = Favorable variance Actual revenue and income are greater than budgeted revenue and income.
As a result, of the favorable increase in sales, variances for sales and income are favorable.
2018/9/22
Ji Weili, JXUFE

17. Fixed Budget Performance Report
If unit sales are higher, should we expect costs to be higher?
How much of the higher costs are because of higher unit sales?
If unit sales are higher, should we expect costs to be higher?
How much of the higher costs are because of higher unit sales?
Since the cost variances are unfavorable, has Optel done a poor job controlling costs? But wait, if sales volume is greater than expected, shouldn’t we expect Optel’s costs to be higher? If so, what portion of the higher costs is due to activity and what portion is due to poor cost control?
2018/9/22
Ji Weili, JXUFE

18. Fixed Budget Performance Report
How much of the unfavorable cost variance is due to higher activity, and how much is due to poor cost control?
I don’t think I can answer the question using a fixed budget.
I really don’t think we can answer that question using a fixed budget. The sales level was higher than the budgeted level, so it follows that variable expenses should be higher to support the higher level of sales. We actually don’t have a grip on cost control.
2018/9/22
Ji Weili, JXUFE

19. Fixed Budget Performance Report
How much of the unfavorable cost variance is due to higher activity, and how much is due to poor cost control?
I don’t think I can answer the question using a fixed budget.
One of the ways we can answer the question about the effectiveness of cost control is to use flexible budgeting. We will prepare a budget at the actual level of activity. In other words, we will flex Optel’s fixed budget up to the actual level of sales.
To answer the questions, we must
the budget to the actual level of activity.
2018/9/22
Ji Weili, JXUFE

20. 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.
The central concept behind flexible budgeting is that if you can tell me what your activity was during the period, I can tell you what your revenue and expenses should have been at that level of activity.
2018/9/22
Ji Weili, JXUFE

21. Purpose 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.
A flexible budget shows us the revenue and expenses that should have been incurred at the actual level of activity rather than just the budgeted level of activity. One of the real strengths of flexible budgeting is that it helps us get a firm grasp on cost control. In addition, performance evaluation is improved using flexible budgeting.
Improve performance evaluation.
2018/9/22
Ji Weili, JXUFE

22. Preparing Flexible Budgets
To a budget for different activity levels, we must know how costs behave with changes in activity levels.
Total variable costs change in direct proportion to changes in activity.
Total fixed costs remain unchanged within the relevant range.
Fixed
Variable
In order to prepare an effective flexible budget, we have to know that total variable costs change directly and proportionately with the level of activity, and that total fixed costs remain unchanged as long as we stay within the relevant range of activity. Recall that in Chapter 20, we studied fixed and variable costs along with methods to determine the fixed and variable components of mixed costs.
2018/9/22
Ji Weili, JXUFE

23. Preparing Flexible Budgets
Let’s prepare
budgets for Optel.
We are now ready to prepare flexible budgets for Optel. We will prepare flexible budgets at three levels of activity to illustrate the process.
2018/9/22
Ji Weili, JXUFE

24. Preparing Flexible Budgets
Let’s see how flexible budgeting works by preparing budgets for ten thousand units, twelve thousand units, and fourteen thousand units. Notice that Optel’s costs have been classified by behavior, either variable or fixed in the flexible budget. The first thing we do is express the variable costs in per unit amounts. For example, we divide the fifty seven thousand, six hundred dollars variable cost by ten thousand units to obtain a unit variable cost of four dollars and eighty cents. Optel’s forty thousand dollars fixed cost will remain the same at all three levels of budgeted activity.
Variable costs are expressed as a constant amount per unit.
2018/9/22
Ji Weili, JXUFE

25. Preparing Flexible Budgets
Next we multiply the four dollars and eighty cents unit variable cost times each of the budgeted levels of activity to get the total variable costs at each activity level. For example, at fourteen thousand units of activity, the budgeted variable cost of sixty seven thousand, two hundred dollars is computed by multiplying four dollars and eighty cents per unit times fourteen thousand units.
Total variable cost = $4.80 per unit × budget level in units
2018/9/22
Ji Weili, JXUFE

26. Preparing Flexible Budgets
Total fixed costs remain unchanged in the budgeting process as long as we operate within the relevant range of activity.
Fixed costs are expressed as a total amount that does not change within the relevant range of activity.
2018/9/22
Ji Weili, JXUFE

27. Flexible Budget Performance Report
Now let’s prepare a budget performance report at 12,000 actual units for Optel.
Now let’s compare the flexible budget for twelve thousand units with the actual costs at twelve thousand units.
2018/9/22
Ji Weili, JXUFE

28. Flexible Budget Performance Report
At twelve thousand units, we would expect sales revenue to be one hundred twenty thousand dollars. Since the actual sales revenue was one hundred twenty five thousand dollars, we conclude that Optel’s average selling price was greater than ten dollars. Now we can begin to analyze cost control.
Favorable sales variance indicates that the average selling price was greater than $10.00.
2018/9/22
Ji Weili, JXUFE

29. Flexible Budget Performance Report
Comparing actual costs at twelve thousand units with a flexible budget prepared at twelve thousand units reveals that Optel has unfavorable cost variances. These variances are due to cost control issues because we have removed the activity differences by flexing the fixed budget from ten thousand units up to the actual activity of twelve thousand units.
Unfavorable cost variances indicate costs that are greater than expected.
2018/9/22
Ji Weili, JXUFE

30. Flexible Budget Performance Report
The favorable variances for contribution margin and income indicate that the favorable sales variance is larger than the unfavorable cost variances.
Favorable variances because favorable sales variance overcomes unfavorable cost variances.
2018/9/22
Ji Weili, JXUFE

31. Spreadsheets
A very useful tool for calculating, analysing and manipulating numerical data.
Use of spreadsheets is an essential part of the daily work of an accountant.
2018/9/22
Ji Weili, JXUFE

32. This organization has entirely too much overhead!
End of Chapter 15
This organization has entirely too much overhead!
2018/9/22
Ji Weili, JXUFE