FNSACC402 Prepare Operational Budgets By the end of PART 1 of this - - PowerPoint PPT Presentation

Lesson ¡5 ¡| ¡Part ¡1 ¡

FNSACC402 Prepare Operational Budgets

By the end of PART 1 of this lesson, you will be able to…

1.

Explain the term ‘goal congruence’.

2.

Prepare a basic performance report

3.

Explain the term ‘management by exception’

4.

Explain the importance of monitoring the performance of an organisation on a regular basis

5.

Describe options for corrective action

The planning cycle (budgetary control)

PERFORMANCE ¡REPORT ¡ BUDGET ¡ Comparison ¡of ¡ACTUAL ¡results ¡to ¡BUDGET ¡à à ¡VARIANCE ¡

Goal congruence

Employee ¡ goals ¡ Department ¡ goals ¡

SAME ¡

(align) ¡

Company ¡ goals ¡

Goal congruence

— The likelihood of individuals acting in their OWN best

interests (rather than the organisation’s) à HIGH

— What tool or technique can we use to measure and

monitor GOAL CONGRUENCE?

It’s ¡all ¡about ¡ me! ¡

Performance reports

— Used to:

Highlight any variances that may arise when actual results achieved are compared to the budget

Performance reports

Essential features:

• 1. Timely
• 2. Accurate
• 3. Provide information (level of detail; format)

that enables management to analyse performance and identify responsibility

What is a variance?

A VARIANCE represents the difference between the budgeted figure and the actual figure. Variances indicate areas that require further investigation. There may or may not be a problem that needs to be fixed.

Types of variances

You get two (2) types of variances:

Favourable variances (F)

J à increase in profits

Unfavourable variances (U)

L à decrease in profits

Variances

— Both NATURE and SIZE of variance should be taken

into account.

— Any LARGE or UNUSUAL variances should be

investigated and appropriate remedial action taken.

— What is considered material or significant varies from

business to business.

Reasons for variances

— Are numerous, but fall into two main groups:

— à due to external factors (no control) — à due to internal factors (may be able to

change)

What does a performance report look like?

Example : performance report

Item Budget ($) Actual ($) Variance ($) Variance (%) U or F Salaries $21,000 $22,620 Stationery $750 $690 Telephone $840 $864 Electricity $1,020 $960 Rates $500 $520 Depreciation $750 $750 Total $24,860 $26,404 This column shows the ABSOLUTE size of the variance i.e. positive values only

Formula for calculating variances (%)

Formula for calculating variance %:

(Variance $ / Budget $) x 100

Formula for calculating variances (%)

Example : performance report

Item Budget ($) Actual ($) Variance ($) Variance (%) U or F Salaries $21,000 $22,620 Stationery $750 $690 Telephone $840 $864 Electricity $1,020 $960 Rates $500 $520 Depreciation $750 $750 Total $24,860 $26,404

Required: Prepare a performance report showing the variance in dollars ($) and expressed as a percentage (%). Please also state whether the variance is FAVOURABLE (F) or UNFAVOURABLE (U).

Example : performance report

Item Budget ($) Actual ($) Variance ($) Variance (%) U or F Salaries $21,000 $22,620 $1,620 7.7% U Stationery $750 $690 $60 8.0% F Telephone $840 $864 $24 2.9% U Electricity $1,020 $960 $60 5.9% F Rates $500 $520 $20 4.0% U Depreciation $750 $750 $0 0% Total $24,860 $26,404 $1,544 6.2% U Formula for calculating variance %: (Variance in $ / Budget in $) x 100 e.g. Salaries variance % = ($1,620 / $21,000) x 100 = 7.7% Note that TOTAL variance % is NOT the sum of the figures in the ‘variance (%)’ column.

Management by exception

— Focus on the THINGS THAT MATTER à don’t waste time

investigating areas of responsibility already performing at or above an acceptable standard of performance.

— Focus on the EXCEPTIONS i.e. those areas that are

performing below a given standard e.g. a variance of 5% either way.

Importance of monitoring ¡

— Often overlooked and poorly executed L — Effective monitoring enables those responsible for

budget outcomes to track their progress and come up with countermeasure plans to improve performance by flagging any issues or problems early on.

Following on from the performance report… ¡

• 1. Identify
• 2. Analyse / investigate further
• 3. Take action

What do we do now…? ¡

— If circumstances change, a new budget

needs to be prepared.

— In practice, the original budget is left

unchanged and a new forecast is prepared.

What do we do now…? ¡

Sometimes the situation can be fixed and sometimes it can’t The reason for the variance may be one for which corrective action can be taken, but sometimes certain external factors beyond the control of management can impact on the

• rganisation’s ability to stick to its budget.

What do we do now…? ¡

— Options for action may include:

— Revising the budget — Investigating alternatives and developing strategies to

• vercome what has caused the variance in the first

place

NOTE: If a change is made, the effect that it would have

• n the organisation as a whole needs to be taken into

account i.e. quick fixes for a particular area of the business should be avoided.

PART 2

Lesson ¡5 ¡| ¡Part ¡2

FNSACC402 Prepare Operational Budgets

By the end of PART 2 of this lesson, you will be able to…

• 1. Prepare a performance report that discloses

contribution margin.

• 2. State the flexible budget formula.
• 3. Prepare a basic flexible budget.

Flexible budgets

STATIC budget:

à prepared for one level of planned activity. What is the limitation of static budgeting?

Flexible budgets

To make an accurate evaluation of expenditure and revenue, you need to compare actual expenditure against a budget based on the same level of activity (sales) achieved. In other words, a FLEXIBLE BUDGET is required based on the actual volume of activity achieved.

Flexible budgets

FLEXIBLE budget:

à gives different budget allowances for various levels of output i.e. it shows what costs should have been incurred at the actual level of activity.

Flexible budgets

— Used as a planning tool

— Can quantify expected results at different activity

levels.

— Used as a control tool

— Can evaluate actual results by restating the

• riginal static budget figures based on the actual

level of activity achieved.

Flexible budgets

e.g. The Simms Card Company

The Simms Card Company manufactures inexpensive greeting cards, which are sold in packs of ten (10) at discount stores. The Simms Card Company has prepared its budgets on the assumption that it will sell 200,000 packs

• f cards during the year.

How could the company’s performance be accurately assessed if 190,000 packs of cards were sold instead? (see next slide)

Flexible budgets

e.g. The Simms Card Company (STATIC)

BUDGET ACTUAL

• VAR. F /

U Sales 200,000 190,000 10,000 U Less: Variable costs* 20,000 18,000 2,000 F Contribution margin 180,000 172,000 8,000 U Less: Fixed costs 10,000 10,000

• Net profit

170,000 162,000 8,000 U * Budgeted for at 10c per sales dollar

Flexible budgets

e.g. The Simms Card Company (FLEXIBLE)

BUDGET (level 1) BUDGET (level 2) BUDGET (level 3) Sales 190,000 200,000 210,000 Less: Variable costs* 19,000 20,000 21,000 Contribution margin 171,000 180,000 189,000 Less: Fixed costs 10,000 10,000 10,000 Net profit 161,000 170,000 179,000 * Budgeted for at 10c per sales dollar

Flexible budgets

e.g. The Simms Card Company (FLEXIBLE)

BUDGET ACTUAL VAR. F / U Sales 190,000 190,000

• Less: Variable costs*

19,000 18,000 1,000 F Contribution margin 171,000 172,000 1,000 F Less: Fixed costs 10,000 10,000

• Net profit

161,000 162,000 1,000 F * Budgeted for at 10c per sales dollar

BUDGET ACTUAL VAR. F / U Sales 190,000 190,000

• Less: Variable costs*

19,000 18,000 1,000 F Contribution margin 171,000 172,000 1,000 F Less: Fixed costs 10,000 10,000

• Net profit

161,000 162,000 1,000 F * Budgeted for at 10c per sales dollar BUDGET ACTUAL VAR. F / U Sales 200,000 190,000 10,000 U Less: Variable costs* 20,000 18,000 2,000 F Contribution margin 180,000 172,000 8,000 U Less: Fixed costs 10,000 10,000

• Net profit

170,000 162,000 8,000 U * Budgeted for at 10c per sales dollar

STATIC ¡BUDGET ¡ FLEXIBLE ¡BUDGET ¡#1 ¡

HOW to prepare a flexible budget

— Start by:

— Forecasting all fixed costs — Forecasting all variable costs

— Then:

— Calculate COST PER UNIT for all variable costs

Important concepts

that you need to understand before going any further

• 1. Fixed costs
• 2. Variable costs
• 3. Contribution margin
• 4. Contribution margin ratio

Cost behavior:

The more knowledge we have about how our costs behave, the more accurate our budgeting process can be.

Fixed costs: remain the same (in the short run) with changing levels of activity.

— The cost per unit decreases as activity increases. — This relationship is constant within the relevant

range of activity.

— e.g. factory rent

Fixed Costs

Cost behavior:

The more knowledge we have about how our costs behave, the more accurate our budgeting process can be.

Variable costs: in total vary (in the short run) with changing levels of activity.

— Remain the same per unit over the relevant

range.

— e.g. direct labour

Variable Costs

The contribution concept ¡

Definition: Contribution margin

The amount left over after deducting variable costs from sales to cover or contribute to all fixed costs and profit.

The contribution concept ¡

Contribution Margin (per unit) = Selling Price (per unit) - Variable Cost (per unit)

The contribution concept ¡

Contribution Margin Ratio (expressed as a %) = Contribution Margin / Sales

The contribution concept ¡

The contribution concept ¡

The contribution concept ¡

Let’s have a go at preparing a FLEXIBLE BUDGET for Jellybeans Inc.

Jellybeans Inc.

Performance report for the year ended 30 June

Budget Actual Variance U or F Units sold 80,000 75,000 5,000 U $ $ $ Sales 700,000 630,000 70,000 U Less: COGS 542,500 511,000 31,500 F Gross profit 157,500 119,000 38,500 U Less: Operating expenses 80,500 74,270 6,230 F Net profit 77,000 44,730 32,270 U

Jellybeans Inc.

Performance report for the year ended 30 June

Budget Actual Variance U or F Units sold 80,000 75,000 5,000 U $ $ $ Sales 700,000 630,000 70,000 U Less: VARIABLE COSTS 518,000 476,000 42,000 F Contribution margin 182,000 154,000 28,000 U Less: FIXED COSTS 105,000 109,270 4,270 U Net profit 77,000 44,730 32,270 U

Having identified the fixed and variable costs:

• a. the company’s performance report can be restated as follows; and
• b. The relationship between activity and total expenses 


can be expressed as a formula…this is known as the FLEXIBLE BUDGET EQUATION.

Flexible budget equation

Total budgeted expenses = Budgeted Total Budgeted VARIABLE COSTS X activity + FIXED per activity unit units COSTS Budgeted budgeted variable costs VARIABLE COSTS = budgeted units sold per activity unit

The Flexible Budget Equation

Budget Units sold 80,000 $ Sales 700,000 Less: VARIABLE COSTS 518,000 Contribution margin 182,000 Less: FIXED COSTS 105,000 Net profit 77,000

Budgeted variable costs per activity unit 
 = Budgeted variable costs / Budgeted units sold = $518,000 / 80,000 
 = $6.475 per unit Therefore, Jellybean Inc.’s flexible 
 budget formula is: Total budgeted expenses = (Budgeted VC per activity unit x 
 number of units sold) + Budgeted FC
 = ($6.475 x number of units sold) 
 + $105,000 The average budgeted sales price 
 per unit is $8.75
 (i.e. $700,000 / 80,000 units)

Level 1 Level 2 Level 3 Level 4 Units sold 70,000 75,000 80,000 85,000 $ $ $ $ Sales 612,500 656,250 700,000 743,750 Less: VARIABLE COSTS 453,250 485,625 518,000 550,375 Contribution margin 159,250 170,625 182,000 193,375 Less: FIXED COSTS 105,000 105,000 105,000 105,000 Net profit 54,250 65,625 77,000 88,375

Using the flexible budget equation, you can prepare a flexible budget to see what the effect of other likely activity levels might be on profits.

MASTER BUDGET

Flexible budget calculations

(shown below for LEVEL 1 only as an example)

SALES: $8.75 x number of units sold

e.g. $8.75 x 70,000 = $612,500

VARIABLE COSTS:

$6.475 x number of units sold e.g. $6.475 x 70,000 = $453,250

FIXED COSTS: REMAIN THE SAME

(it is assumed that activity levels are within the relevant range)

Jellybeans Inc.

Performance report for the year ended 30 June

FLEXIBLE budget Actual Variance U or F Units sold 75,000 75,000

• $

$ $ Sales 656,250 630,000 26,250 U Less: VARIABLE COSTS 485,625 476,000 9,625 F Contribution margin 170,625 154,000 16,625 U Less: FIXED COSTS 105,000 109,270 4,270 U Net profit 65,625 44,730 20,895 U

By comparing actual performance to a budget prepared using the actual activity level as a reference point… …management are now in a better position to understand whether any cost variances are in fact due to increases or decreases in sales activity or due to better (or poor) cost control.

This week’s homework

— Go through the SLIDES and CASE

STUDY from today’s lesson.

— Complete ASSESSMENT 2.

This is the end of

• f the last lesson
• n.

Thank you

• u for
• r pa

participa pating in my y class this semester. ¡