Lesson 5 FNSACC402 Budgeting PowerPoint Slides · Used as a planning tool ! Can quantify expected...
Transcript of Lesson 5 FNSACC402 Budgeting PowerPoint Slides · Used as a planning tool ! Can quantify expected...
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 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 organisation’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
overcome what has caused the variance in the first place
NOTE: If a change is made, the effect that it would have on 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
original 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 of 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 BudgetedVARIABLE COSTS X activity + FIXEDper activity unit units COSTS
Budgeted budgeted variable costsVARIABLE COSTS = budgeted units soldper 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 the last lesson. Thank you for participating in my class this semester.