INDEX

Introduction..........................................................................................................................11

Task 1

The purpose and nature of the budgeting process..................................................................11

Appropriate budgeting methods for the Sefton Limited and the preparation for budgets according

to the chosen budgeting method..............................................................................................14

Task 2

Operating statement reconciling budgeted and actual results, the calculation of variances, the

identifying causes and recommendation for corrective action.................................................21

Report findings to management in accordance with identified responsibility centers.............27

Conclusion...............................................................................................................................

Reference list...........................................................................................................................

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Introduction

The purpose of management accounting in any organizations is to support competitive decision

making by collecting, processing, and communicating information that helps management plan,

control, and evaluate business processes and company strategy. A management system, therefore

supplies reliable, accurate information to the management team of a company. These figures are

used for planning for future goals of the company.

Assigned as Management Accountant of Sefton Ltd, this paper has been prepared to analyze in

two parts

Part 1: The purpose and nature of budgeting process, budgeting methods and preparation for

budgets through Budgeted Income Statement, Cash Budget, and Budgeted balance sheet

Part 2: The calculation variances, the operating statement, possible causes in variances with

recommendation, and report to identify responsibility centers

Based on the information, Managing Director of Sefton can improve the budget through

appropriate budgeting methods, and the standard costing system

Task 1

The purpose and nature of the budgeting process

A. Purpose of budgeting process

In a business, making decisions, which affect the

profitability of the company, are occurred every day. To

make effective decisions and coordinate the decisions

and actions of the various departments, a business needs

to have a plan for its operations. Planning the financial

operations of a business is called budgeting. (Purpose

of budget, no date)

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A budget is ‘A quantitative statement, for a defined period of time, which may include planned

revenues, expenses, assets, liabilities, and cash flows’ [1]

A budget has five main purposes:

Communication In the budgeting process, managers in every department justify the resources

to achieve their goals. They explain to their superiors the scope and volume

of their activities as well as how their tasks will be performed.

Thus, this communication between superiors and subordinates will help to

ensure the achievement of company’s goals

Coordination Different units in the company must also coordinate the many different tasks

they perform to maximize integration of effort toward common goals

Planning A budget is ultimately the plan for the operations of an organization for a

period of time. Many decisions are involved, and many questions must be

answered. And the managers will decide the most effective ways to achieve

the budget target for the operation under personal control

Control Spending within the budget and having responsibility to achieve revenues

specified within the budget are very important. Budgets and actual revenues

and expenditures are monitored constantly for variations and to determine

whether the organization is on target. If performance does not meet the

budget, action can be taken immediately to adjust activities.

Evaluation Evaluation can be provided by comparing the budget with actual

performance. It is a part of controlling budget, and also provides an

incentive for improving future performance.

(Purpose of budget, no date)

B. Nature of budgeting process

The nature of budgeting process can be summarised by this graph:

12

However, to prepare the budget effectively as a useful financial tool, business must implement

the proper steps:

Step 1: Identification of the principal budget factor

Determining the principal budget factor is also the first task in the budgetary process of any

businesses. This is also known as the key budget factor or limiting budget factor and is the factor

which will limit the activities of an undertaking. This limits output, e.g. sales, material or labour.

(Budgetary control, no date)

Step 2: Preparation of sales budget

Step 3: Preparation of finished goods stock budget

Step 4: Preparation of a production budget

Step 5: Preparation of budgets of resources for production

Step 6: Preparation of overhead cost budgets

Step 7: Co-ordinate and preview of budgets

Step 8: Preparation of a master budget

For example, if sales volumes are the principal budget factor, the stages involved in budget

preparation can be:

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Preparing sales budget and the finished good stock budget firstly to decide the planned

increase or decrease in finished goods stock level.

Then, according to the information of sales, and stock budgets, the production budget can

be prepared

Next, preparing the budget of production resources, which relate to materials usage

budget, machine usage budget, and labour budget.

After that, the managers will prepare their draft budgets for the department overhead

costs, which include maintenance, stores, administration, selling, research, and develop

From the above information, a budgeted profit and loss account can be produced

Besides, several other budgets must be prepared to arrive at the budget balance sheet

( capital expenditure budget, working capital budget)

Appropriate budgeting methods for the Sefton Limited and the preparation

for budgets according to the chosen budgeting method

A. Budgeting methods

A sales budget is a detailed schedule showing the expected sales for the budget period.

Typically, it is expressed in both dollars and units of production. An accurate sales budget is the

key to the entire budgeting in some way, because it helps determine how many units will have to

be produced. (Sales budget, no date)

Besides, it gives a direction to a company with regard to its targeted sales, and improves the

profitability. Moreover, it can be called a financial plan with regard to the amount of goods and

services that it plans to sell in a year and the price at which the goods and services are to be sold.

By the way, it brings lots of detailed benefits for company such as:

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Helps company achieve its sales targets

Prevents sales losses and provides a basis for sales evaluation

Helps to integrate all departments in a company because achieving a sales target is the

secret of making profits

Helps each department to assess their performance and correct any mistakes in function

Distributes goods and services in a cost effective way

Keeps company’s marketing expenditure within affordable limits

(What is sales budget, no date)

Therefore, sales budget can be chosen as appropriate budgeting methods for Sefton Ltd.

B. Preparation for budgets

I. Budgeted Income Statement

This is the calculation for the Budgeted Income Statement for the year ended 31/12/year3

a) Sales revenue

b) Material purchase value

15

c) Closing inventory of raw material

d) Direct wages

e) Closing inventory of finished goods

16

This is the Budgeted Income Statement of Sefton Ltd for the year ended 31/12/year3,

according to the calculation above

SEFTON

Income Statement

For the year ended 31 December, Year 3

Revenues $1,071,000

Opening inventory of raw materials $20,000

Purchases of raw materials $ 253,700

Less: Closing inventory of raw materials $ 14,000

Material costs used for production $ 259,700

Direct wages $ 448,500

Production overhead (given) $ 200,000

Production cost of goods completed $ 908,200

Opening inventory of finished goods $ 15,000

Finished goods available for sales $ 923,200

Less: Closing inventory of finished goods $ 50,370

Production cost of goods sold $ 872,830

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Gross profit $ 198,170

Selling and administration overhead $ 75,000

Net profit before taxation $ 123,170

Taxation (33, 33% of net profit before tax) $ 36,951

Net profit after taxation $ 86,219

Retained earnings b/f (opening) $ 81,000

Retained earnings c/f $ 167,219

II. Cash budget

This is the Cash budget of Sefton Ltd for the year ended 31/12/year3

III. Budgeted Balance sheet

This is the calculation for the Budgeted Balance sheet at 31/12/year3

Non-current assets

Buildings and Equipment

Opening cost $ 400,000

Machinery purchase $ 120,000

Total $ 520,000

Less: Opening depreciation balance $ 75,000

Production depreciation $ 25,000

18

Selling depreciation $ 5,000

Total depreciation $105,000

Buildings and Equipment $415,000

Current assets

Inventories

Raw materials

Material M (4000 units*$2) $8,000

Material N (2000units *$3) $6,000

Total $14,000

Finished goods

→ Inventories = Finished goods + Raw materials = $64,370

Receivables

Opening balance $ 25,000

Sales $ 1,071,000

Less: Receipts (cash budget) $ 994,000

Total receivables $102,000

19

Current liabilities

Payables

Closing payables balance

Opening balance of payables $ 9,000

Material purchases from budget $ 253,700

Over head production $ 175,000 ($200,000 - $25,000)

Over head Selling & Administration $ 70,000 ($75,000 - $ 5,000) Total $507,700

Less: Material payments (cash budget) $159,000

Overhead payments (cash budget) $230,000

Total payments $389,000

Total payables $118,700

Taxation

Opening taxation $ 5,000

Less: Taxation Payment $ 5,000

Taxation occurred $ 36,951

Total taxation $36,951

Basing on this calculation above, this is the balance sheet of Sefton Ltd at 31 December,

year 3

SEFTON

Balance sheet

31 December, Year 3

Assets

Non-current assets

Land $50,000

Buildings and Equipment $ 415,000

Total non-current assets $465,000

Current assets

Inventories $ 64,370

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Receivables $ 102,000

Cash at bank (cash budget) $ 41,500

Total current assets $207,870

Liabilities

Current liabilities

Payables $ 118,700

Taxation $ 36,951

Total current liabilities $155,651

Net assets $517,219

Financed by Equity

Share capital $ 350,000

Retained earnings (income statement) $ 167,219

Total financed by Equity $517,219

Task 2

Operating statement reconciling budgeted and actual results, the calculation

of variances, the identifying causes and recommendation for corrective action

Calculation of Variances : (A)= Adverse; (F) Favorable

$

a) 2,300 kg of material should cost (x $4) 9,200

But did cost 9.800

Material price variance 600 (A)

b) 4,800 units should uses 2,425 kg

But did use 2,300 kg

Material usage variance in kgs 125 kg (F)

X standard cost per kg x $4

Material use in variance $ 500 (F)

$

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c) 8,500 hours of labour should cost (x $2) 17,000

But did cost 16,800

Labour rate variance 200 (F)

d) 4,850 units should take (x 2hrs) 9,700 hrs

But did take (active hours) 8,000 hrs

Labour efficiency variance in hours 1,700 hrs (F)

X standard cost per hour x $2

Labour efficiency variance in $ $3,400 (F)

e) Idea time variance 500 hours (A) x $2 $1,000 (A)

$

f) 8,000 hours incurring o/hd expenditure should cost (x $0.03) 2,400

But did cost 2,600

Variable overhead expenditure variance 200 (A)

g) Variable overhead efficiency variance in hours is the same as the labour efficiency

variance: 1,700 hours (F) x $0.03 per hour$510 (F)

$

h) Budgeted fixed overhead (5,100 units x 2hrs x $3.70) 37,740

Actual fixed overhead 42,300

Fixed overhead expenditure variance 4,560 (A)

i) Actual production volume 4,850 units

Budgeted production volume 5,100 units

Fixed overhead volume variance in units 250 units (A)

x Standard hours x standard fixed overhead absorption rate x 2hours

Fixed overhead volume variance x $3.70

1,850 (A)

j) Fixed overhead efficiency variance in hours is the same as the labour efficiency

variance: 1,700 hrs (F) x $3.70 per hour $6,290 (F)

k) Budgeted capacity (5,100 units x 2hrs) 10,200 hrs

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Actual hours of work 8,000 hrs

Capacity variance in hours 2,200 hrs (A)

x standard fixed overhead absorption rate per hour x $3.70

Fixed overhead capacity variance $8,140 (A)

l) Revenue from 4,850 units should be (x $20) 97,000

But was 95,600

Selling price variance 1,400 (A)

m) Budgeted sales volume 5,100 units

Actual sales volume 4,850 units

Sale volume profit variance in units 250 units

x standard profit per unit x $6 (A)

Sales volume profit variance in $ $1,500 (A)

Reconciling budgeted & actual income statement

SEFTON LTD – OPERATING STATEMENT 30th April 2010

$ $

Budgeted profit before sales and administration cost 30,600(5,100 units x $6)

Sales volume variance 1,500 (A)

Budgeted profit from actual sales 29,100

Selling price variance 1,400 (A)

Actual sales minus the standard cost of sales 27,700

(F) (A)

$ $

Material price 600

Material usage 500

Labour rate 200

Labour efficiency 3,400

Labour ideal time 1000

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Variable overhead expenditure 200

Variable overhead efficiency 510

Fixed overhead expenditure 4,560

Fixed overhead efficiency 6,290

Fixed overhead capacity 8,140

10,900 14,500 3,600 (A)

Actual profit before sales and admin costs 24,100

Less: Sales and administration costs 18,000

Actual profit, April 2010 6,100

Check $ $

Sales 95,600

Materials 9,800

Labour 16,800

Variable overhead 2,600

Fixed overhead 42,300

Sales and administration 18,000

89,500

Actual profit 6,100

Identifying causes and recommendation for corrective action

In budgeting, a variance is the difference between a budgeted, planned or standard amount and

the actual amount incurred/sold. Variances can be computed for both costs and revenues to

know whether it is favorable (F) or adverse (A). [2]

- Favorable variance (F) shows that standard cost is less than actual cost or standard

revenue is more than actual revenue.

- Adverse variance (A) shows that actual cost is more than standard cost or actual revenue

is less than standard revenue

(Types of variance, no date)

The classification of variance can be shown by this graph:

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According to the Calculation of Variances of Sefton above, the possible reasons for the

occurrence of the variances and the recommendation for corrective action can be seen through this

table below:

Variance Favorable Adverse Corrective action

Material

price

Careless purchasing Prepare a detail material schedule

planning of purchasing raw materials

in accordance scope of work to avoid

the redundancy

Material

usage

Storing good

materials in

warehouse

Maintain and develop more and more

good storage system conform to

warehouse standards for material

storing

Labour

rate

Use of apprentices

or other workers at a

rate of pay lower

than standard

Continue hiring apprentices or other

workers with acceptable wages, and

providing the standard entitlements

(e.g. sick, annual, parental, leave,

overtime etc) to not only make them

satisfied but also maintaining the

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savings for company

Labour

efficiency

Output produced

more quickly than

expected because of

work motivation,

better quality of

equipment or

materials

Maintain and invest in the best

equipments to improve overall

efficiency.

Develop better work environment and

motivation activities (rewards, bonus,

…) to make sure all employees feel

satisfied

Ideal time Machine breakdown Identify the machine’s errors

occurring frequently and provide

faster electronics repair service to

reduce machine breakdown time as

well as diagnosis for the failure and

guidance to avoid such failures in

future.

Variable

overhead

expenditure

Changing in type of

services used

Find and chose the suitable type of

services, but need to consider about

the standard variable overhead

expenditure to avoid increasing too

much in actual variable overhead

expenditure

Fixed

overhead

expenditure

Changing in type of

services used

Find and chose the suitable type of

services, but need to consider about

the budgeted fixed overhead to avoid

increasing too much in actual fixed

overhead

Sales price Price increase

following increased

demand

Increase in selling price but still

provide the best quality’s products for

customers.

Sales

volume

Increased sales

resulting from new

Create and develop lots of new

advertising campaigns to attract lots of

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advertisements customers

Report findings to management in accordance with identified responsibility centers

To: Managing Director

From: Management Accountant

Date: 12 Dec 2011

REPORT ON IDENTIFYING RESPONSIBILITY CENTERS

1. Executive summary2. Methods of research3. Findings4. Recommendation

EXECUTIVE SUMMARY

This report highlights the responsibility accounting through controlling profit and cost centers.

METHOD OF RESEARCH

This report has been compiled from research findings designed to show:

Cost center Revenue Profit center

FINDINGS

Cost center

Cost center is a division that adds to the cost of an organization, but only indirectly adds to its profit. In Sefton, the cost center include the

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REFRENCE LIST

Budgetary control, no date, 6th Dec 2011, < http://www.fao.org/docrep/W4343E/w4343e05.htm>

Purpose of budget, no date, 6th Dec 2011, < http://accmana3d.tripod.com/id2.html>

Sales budget, no date, 6th Dec 2011, <

http://www.accountingformanagement.com/sales_budget.htm>

Types of variance, no date. 6th Dec 2011, < http://www.svtuition.org/2011/06/types-of-

variance.html>

What is sales budget, no date, 6th Dec 2011, < http://www.ehow.com/about_4699902_what-

sales-budget.html>

[1]: Management Accounting: Costing & Budgeting Course book, 2007, 1st edition, Great Britain:

BPP Professional Education, chapter 8, section 1, page 178

[2]: http://en.wikipedia.org/wiki/Variance_(accounting), viewed 6th Dec 2011

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