chapter 13 cost analysis for planning and control
TRANSCRIPT
CHAPTER 13
Cost Analysis for Planning and Control
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Overview
• Budgeting in general• Cost classifications• The budgeting process• The sales budget and other operating budgets• Standard costs• Performance reports• The flexible budget• Reporting for segments of an organisation• Residual income• The balanced scorecard
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Control
Steps taken by management to
ensure that objectives are
attained.
Planning
Developing objectives for
acquisitionand use of resources.
A budget is a comprehensive financialplan for achieving the financial and
operational goals of an organisation.
A budget is a comprehensive financialplan for achieving the financial and
operational goals of an organisation.
Budgeting
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BudgetingManagement philosophy is reflected in how the
budget is prepared and used:
• Top down• Highly structured
(carved in stone)
• Top down• Highly structured
(carved in stone)
• Participative• Flexible
• Participative• Flexible
The budget should be seen as a
guide that reflects management’s
best thinking at the time of
preparation. It may have to change
if circumstances change.
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Budgeting
Financial accounting concepts, as the results of an organisation’s activities are reported via financial statements
Financial accounting concepts, as the results of an organisation’s activities are reported via financial statements
Management accounting techniques, especially knowledge about cost behaviour patterns.
Management accounting techniques, especially knowledge about cost behaviour patterns.
A budget involves the use of:
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Cost classifications
Variable costs -- change with the volume of activity -- unit costs constant.
Variable costs -- change with the volume of activity -- unit costs constant.
Fixed costs-- do not change within a relevant range.
Fixed costs-- do not change within a relevant range.
Recap of cost behaviour patterns:
Mixed costs-- a certain amount of cost can be expected regardless of activity.
Mixed costs-- a certain amount of cost can be expected regardless of activity.
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Cost ClassificationsAccording to time frame perspective
Committed
Incurred to carry out long range policy decisions to which
the firm is committed
Discretionary
Costs that can be adjusted in the short run after evaluation
of resources
In the long run, every cost is controllable.
Fixed costsFixed costs
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The Budget Time Frame
Single period budget – prepared in the months
preceding the beginning of the year, but estimates must
be made more than a year in advance.
Rolling budget – planning for segments of a year on a
repeat basis.
Continuous budget – the final budget for any quarter
should be much more accurate as it has been prepared
more recently, but time, effort and money are required.
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The Budgeting Process
1. Develop and communicate a set of broad
assumptions about the economy, industry and
organisational strategy.
2. Prepare operating (master) budget made up of a
number of detailed budgets:
• Prepare sales budget -- estimated unit prices
and unit sales. All other budgets are a function of
sales activity.
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The Budgeting Process
DirectMaterialsBudget
Production Budget
Operating ExpenseBudget
DirectLabor
Budget
Manufacturing
OverheadBudget
Sales Budget
Cost of GoodsSold Budget
Budgeted Balance Sheet
Budgeted Income Statement
Budgeted Statement of Cash Flows
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The Production or Purchases Budget
The basic inventory flow model is usedfor production and purchases budgets.The basic inventory flow model is usedfor production and purchases budgets.
Goods available for sale
Goods available for sale
Beginninginventory
Beginninginventory
+Purchases
or productio
n
Purchases or
production
Cost (or quantity) of goods sold
Cost (or quantity) of goods sold
=
EndinginventoryEnding
inventory-
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The Production or Purchases Budget
Production or purchases must be adequate to meet budgeted sales and to provide
sufficient ending inventory.
Production or purchases must be adequate to meet budgeted sales and to provide
sufficient ending inventory.
Budgeted sales in units
+ Desired units in ending inventory
= Total product units needed
– Beginning inventory
= Units to produce or purchase
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The Production or Purchases Budget
Once quantities have been determined,
they can be converted to dollars.
Once quantities have been determined,
they can be converted to dollars.
When the number of units to be produced is known, the quantity of
each raw material input to be purchased can be forecast using the
same model.
When the number of units to be produced is known, the quantity of
each raw material input to be purchased can be forecast using the
same model.
Raw materials
Direct labour
Manufacturing
overhead
Determining these budgeted
amounts often involves the
use of a standard cost
system.
Determining these budgeted
amounts often involves the
use of a standard cost
system.
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The Cost of Goods Sold Budget
Summarises changes in inventory accounts,
as indicated by:
• sales budget
• purchases and production budget
• required ending inventory levels as
determined by management.
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Operating Expense Budget
The cost behaviour patterns of selling,
general, administrative and other operating
expenses are determined
May be a function of sales or influenced by
management strategy
Budget slack or ‘padding the budget’
Tendency of managers to submit budget estimates
that are slightly higher than expected costs
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Budgeted Income Statement
Production Budget
Operating ExpenseBudget
Sales Budget
Cost of GoodsSold Budget
Budgeted Income Statement
May be prepared after completion of other budgets
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The Cash Budget
Similar to a budgeted statement of cash flows, but with shorter time frame.
Cash collections from customers?
How long does it take the firm to collect its receivables?
Short-term borrowing requirements?
Cash payments to suppliers?
What credit terms is the firm subject to?
How often does the firm pay its employees?
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Budgeted Balance SheetMay be prepared after completion of other budgets
Operating ExpenseBudget
Depreciation and
amortisation
Budgeted Balance Sheet
Budgeted Income Statement
Production Budget
Sales Budget
Cost of GoodsSold Budget
Budgeted Statement of Cash Flows
Inventory balances
Retained earning balance
Accounts receivable, accounts payable, equipment, dividends
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Standard
costs are:
based on carefullypredetermined amounts
used in planning and control phases of the management process, particularly budgeting
used in financial accounting to value inventory
benchmarks formeasuring performance.
Standard Costs
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Standard CostsA standard cost has two elements:
1. Quantity of input (weight, volume, hours)2. Cost per unit of input
Standard Unit budget
Used extensively in the budget preparation process
Used to plan for input that will be needed to make the product
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Performance Reporting
The performance report compares actual results to budgeted amounts.
Those activities that are
performing differently from
expectations are highlighted
and variances investigated.
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Performance Report Characteristics
Activity
Favourable
•Actual revenues > Budget revenues
•Actual costs < Budget costs
Unfavourable
•Actual revenues < Budget revenues
•Actual costs > Budget costs
Favourable
•Actual revenues > Budget revenues
•Actual costs < Budget costs
Unfavourable
•Actual revenues < Budget revenues
•Actual costs > Budget costs
BudgetAmount
ActualAmount– = Variance
Explanation ?
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Responsibility ReportingAmount of detail varies according
to level in organisation.
Responsibility ReportingAmount of detail varies according
to level in organisation.
Performance Report Characteristics
Involves successive degrees of summarisation.
Each layer of management receives detailed reports
for their layer, but summarised reports for
lower layers.
Involves successive degrees of summarisation.
Each layer of management receives detailed reports
for their layer, but summarised reports for
lower layers.
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Management by exception:
Management concentrate their
attention on only those
activities that are not
performing according to plan.
Usually only those variances
in excess of a certain
percentages (say 10%) are
investigated.
Performance Report Characteristics
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The Flexible Budget
improve performance evaluation.
may be prepared for any activity level in the relevant range
adjusts the original budget to reflect budgeted amounts for actual activity
reveal variances due to good cost control or lack of cost control
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To a budget for different activity levels, we must know how costs behave with changes in activity levels (variable costs and fixed costs).
FixedVaria
ble
The Flexible Budget
Variable costs / unit
Actual level of activity
Actual costs
x
Flexible budget
Compared with
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Reporting for Segmentsof an Organisation
A segment of an
organisation is a division,
product line, sales
territory or other
organisational unit.
A segment of an
organisation is a division,
product line, sales
territory or other
organisational unit.
For management reports, total company results may be
reported by segment.For management reports, total company results may be
reported by segment.
Segment income statements
should reflect the
contribution to the common
fixed expenses and company
profit.
Segment income statements
should reflect the
contribution to the common
fixed expenses and company
profit.
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Reporting for Segmentsof an Organisation
Profit Centre A part of the business
that has control over both costs and revenues,
but no control over investment funds.
Profit Centre A part of the business
that has control over both costs and revenues,
but no control over investment funds.
Investment Centre A profit centre where management also has autonomy for investing in assets to
conduct operations.
Investment Centre A profit centre where management also has autonomy for investing in assets to
conduct operations.
Cost CentreA business section
that has control over the
incurrence of costs, but does not generate revenue.
Cost CentreA business section
that has control over the
incurrence of costs, but does not generate revenue.
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Methods of Evaluating Segments
CostCentre
Actual costs compared to budgeted costs
ProfitCentre
InvestmentCentre
Actual return on assetscompared to budgetedreturn on assets
Evaluation Measures
Actual segment margincompared to budgetedsegment margin
SegmentSegment
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Analysis of Investment Centres
Return on investment (ROA) is the ratio of
segment EBIT to the investment used to generate the
segment EBIT.
ROA = Segment EBIT Divisional operating assets
As investment centre managers have a much higher
level of responsibility, appropriate measures of
performance are important.
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Analysis of Investment Centres
SalesOperating assets
ROA = Segment EBIT
Operating assets
ROA = Segment EBIT
Sales ×
MarginMargin TurnoverTurnover
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As division manager,I wouldn’t invest in
that project becauseit would lower my pay!
Gee . . .I thought we were
supposed to do what was best for the
company!
ROA and Dysfunctional Behavior
A performance evaluation system needs to be carefully designed so that it doesn’t lead to dysfunctional behaviour.
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Residual income encourages managers to make profitable investments that would be rejected by managers using ROA.
Residual Income
ROA should not be the sole measure of investment centre performance.
Managers should be evaluated on their ability to generate a minimum ROA and to maximise theamount of earnings above that minimum ROA.
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An integrated set of performance measures that highlight and communicate an organisation’s strategy, goals
and priorities.
EmployeeEmployeestakeholderstakeholder
groupgroup
InvestorInvestorstakeholderstakeholder
groupgroup
The Balanced Scorecard
This approach shows an organisation’s performance in meeting its responsibilities to
various stakeholders.
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Financial PerspectiveHow do we look
to the firm’s owners?
Learning and Growth Perspective
How can we continuallyimprove and create value?
Internal BusinessProcess Perspective
In which activities must we excel?
Customer PerspectiveHow do our
customers see us?
Integratedmeasures
The Balanced Scorecard