XEA 202: INTRODUCTION TO MANAGEMENT ACCOUNTING
CHAPTER I
INTRODUCTION
Definition
Various definition have been advanced by different authorities
1. It is the application of appropriate techniques and concepts in processing historical
and projected. Economic data of an entity to assist management in establishing plans
for reasonable economic objectives and in the making of rational decisions with a
view to achieving those objectives. (American Association of Accountants, AAA).
2. It is the application of professional knowledge and skill in the preparation of
accounting information in such a way as to assist management in the formulation of
policies and in the planning and control of the operations of the undertaking
(ICMAL- Institute of Chartered Management Accountants of London).
3. (ICMA)-It is the presentation of accounting information in such a way as to assist the
management in the creation of policies and the day to day operations of the
undertaking. (Institute of Chartered Management Accountants of England and
Wales).
From the above definitions the following conclusions can be reached.
i). Management accounting is concerned with providing information to mangers.
ii). Management accounting builds on the principle of financial accounting to satisfy the
reporting needs of financial managers.
iii). Any study of management accounting must be preceded by some understanding of
the management process and the organizations in which manager’s work.
SCOPE OF MANAGEMENT ACCOUNTING
i). Financial accounting
ii). Cost accounting ’ mechanics of preparing the costing information
iii). Tax accounting
iv). Auditing
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v). Office services
vi). Financial analysis and interpretation ’ providing highly summarized information
from the basic financial statements.
vii). Management reporting
viii). Forecasting and budgeting
Functions of Management
The manager carries out four broad functions in an organization i.e.
a) Planning
b) Organizing and directing
c) Controlling
d) Decision making
Planning
Managers outline the steps to be followed or taken in achieving the organizations
objectives. The plans of the management are expressed formally as budgets such are
typically prepared on an annual basis and express the desires and goals of management in
specific qualitative terms.
Organizing and directing
In organizing managers decide how best to put together the organizations human and other
resources in such a way as to most efficiently carry out established plans.
In directing managers oversee day to day activities and keep the organization functioning.
Therefore to meet these functions managers have a constant need for cost accounting
information in the routine conduct of the organization eg sales volumes, inventory control
levels , prices etc.
Controlling
Managers take those steps necessary to ensure that each part of the organization in
following the plan that was outlined for it at the planning stage.
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Accounting information thus assists in the controlling function by supplying performance
reports that help focus the manager’s attention to problems or opportunities that might go
unnoticed.
A performance report is a detailed report to management comparing budgeted data to actual
data for a specific time period. If the performance report of a particular department
indicates that problems exist then the manager will need to find out the course of the
problem and take corrective action.
Decision making
Manager attempt to make rational choices among alternatives (rational and informed
decisions). All decision are based on information and accounting information is often a key
factor in analyzing alternative methods of solving a problem. This is because various
alternatives usually have specific costs and benefits that can be measured and used as an
input in deciding which alternatives is the best. Accounting is generally responsible for
gathering available cost and benefit data and for communicating it in a usable form to the
appropriate manager.
Differences between management accounting and financial accounting
i). Management accounting focuses on providing data for internal uses by the manager
who must direct day to day operations, plan for the future, solve problems and make
several routine and non-routine decisions all of which require special information
inputs. However, financial accounting on the other hand focuses on providing data for
external users.
ii). Management accounting places move emphasis on the future, since a large part of the
overall responsibilities of the manger have to do with planning a managers information
needs i.e. has a strong future orientation. As such the mangers planning framework in
built largely on established data that may or may not be reflective of past experience. In
contrast financial accounting records the financial history of an organization and has
little to do with estimates and projections of the future.
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iii). Management accounting emphasizes the relevance and flexibility of data. Information
is considered to be relevant if it is pertinent to be the problem at hand. Information is
flexible if it can be used in a variety of decision making situations.
Financial accounting however, emphasizes on objectivity and verifiability.
iv).Financial accounting is primarily concerned with the reporting of business activities for
a company as a whole. Management accounting however focuses on the segments of an
organization e.g. divisions, departments product lines etc.
v).Financial accounting statement are prepare in accordance with the GAAPs.
Management accounting on the other hand is not governed by the GAAPs it managers
can set their own ground rules on the content and form of information that is to be used
internally.
vi).Management accounting places less emphasis on accuracy and more emphasis on nonmonetary data qualitative in nature. Financial accounting emphasizes on monetary and
qualitative data.
vii).Financial accounting is mandatory ie financial records must be kept so that sufficient
information will be available to satisfy the requirements of various interested parties.
Management accounting on the other hand is not mandatory. There are no regulatory
bodies or other outside agencies that specify what is to be done or prepared.
viii).Managerial accounting draws heavily from other disciplines while financial accounting
relies on its own conceptual framework and regulation.
COST OBJECTIVES AND CLASSIFICATION
In financial accounting a cost is defined as the sacrifices made to obtain some good or
service e.g. sacrifice for materials, labour etc
In management accounting, cost is used in many different ways. The reason is that there
are many different types of cost and these costs are classified differently according to the
immediate needs of management.
The methods of classifying costs include;a) By way of manufacturing i.e. manufacturing and manufacturing costs

Manufacturing costs
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These includes direct materials, direct labour and manufacturing overheads

Direct materials
Are those materials that become an integral part of a company’s finished product
and that can be conveniently traced into it.
NB: Not all Raw materials are direct materials

Direct labour
Refers to those labour costs that can be physically traced to the creation of products
without undue cost or inconvenience.

Manufacturing overheads
These includes all costs of manufacturing other than direct materials and direct
labour. Example of manufacturing overheads include;
i). Indirect labour i.e. labour costs that cannot be physically traced in the products or
involve a lot of expenses in tracing them eg janitor supervisors etc.
ii). Indirect materials ie they can only be traced in the products at great
cost/inconvenience eg paint.
iii). Other costs of operating the factory eg electricity, insurance, maintenance and all
other costs incurred to operate the manufacturing division of a company.
Non-manufacturing costs
These can be sub-classified into two categories
i). Marketing and selling costs
This group includes all cost necessary to secure customer orders and get the finished
product or services into the hands of the customer. They include sales commissions,
sales travel, salaries of salesmen, advertising etc.
ii). Administrative costs
These include all executive, organizational and clerical costs that cannot logically be
included under either manufacturing or marketing. Examples include executive salaries,
general accounting, secretarial public relations and similar costs having to do with the
overall general administration of the organization as a whole.
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b) Classifying costs according to cost behaviour
Cost can be classified according to how they react to changes in the level of business
activities ie how they react to number of units sold, member of hours worked etc.
As the activity level rises and falls a particular cost may rise and fall as well or may
remain constant. Thus, we have fixed costs and variable costs.

Fixed costs
Are those costs that remain constant in total regardless of the changes in the level of
business activity within the relevant range. However, beyond some range these costs may
cease to be fixed.
COST
ft
Activity
COST/init
Activity
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
Variable costs
These vary in total in direct proportion to changes in the level of activity but within the
relevant.
v-c
Cost
0
Activity
Cost/
unit
V-c
0
Activity
NB: There are neither pure variable costs nor pure fixed costs
Semi variable costs: These are component of fixed and variable costs
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Cost
0
Activity
c) Classifying costs as period costs and product costs

Product costs
These consists of the cost involved in the purchases or manufacture of goods. These
product costs are also called inventionable costs. This is because they are first classified
in the inventory stage until they are expensed. This is only treated as expenses (cost of
good sold) in the time period in which the related products are sold.

Period costs
Are those costs that are matched against revenues on a time period basis and are therefore
not included as part of the cost of the product. They are treated as expense and deducted
from revenues in the time period in which they are incurred.
d) Classifying costs as direct and indirect costs

Direct cost
A direct cost is a cost that can be obviously and physically traced to the particular
segment under consideration ie can be traced to a particular cost object
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
Indirect costs
Is the cost that must be allocated in order to be assigned to the segment under
consideration. They are also known as commons costs eg manufacturing overhead costs.
e) Classifying costs as controllable and non-controllable.
A cost is considered to be controllable at a particular level of management if that level
has the power to authorize its incurrence.
On the other hand, where no power to authorize its incurrence exists that cost is a noncontrollable.
f) Classifying costs according to time
Under this classification we can either talk of predetermined costs or historical costs.
Predetermined costs are established costs which are computed in advance of the
production process taking into consideration the previous periods and factors affecting
such costs.
Historical costs are those ascertain after they have been incurred and are available only
when the production is complete.
g) Classifying costs according to planning and control.
This classification identifies costs as either budgeted costs or standard costs.

Budgeted costs
These are estimates of expenditure for different phases of business operations such as
manufacturing, administrative, sales, research and development coordinated in a wellconceived framework.

Standard costs
These are budgeted costs which are translated into actual operation. They are
scientifically predetermined costs of every aspect of business activity and are control
tools (used for control purposes).
h) Other costs

Opportunity costs

Sunk costs

Differential costs
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i) Opportunity costs
Is the potential benefit i.e. cost or sacrifice when the selection of one course of action
makes it necessary to give up another course of action. It is the cost of foregone
alternative. It is therefore the maximum positive alternative earnings that might have
been achieved if the productive capacity or service had been put into alternative use.
ii) Differential costs
Is any cost that is present under one alternative but is absent in the other alternative.
Differential costs are changes in costs due to changes in the level of activity or method of
production.
iii) Sunk costs ’ is a cost that has already been incurred and cannot be changed by any
decision made now or in the future. It is an irrecoverable cost.
Sunk costs are not relevant in decision making.
It is therefore only opportunity costs and differential costs which are relevant in decision
making.
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COST ESTIMATION
The analysis of mixed costs into fixed and variable cost is very important in planning and
control of operations. The fixed portion of a mixed cost represents the basic, minimum
charge for just having a good or service ready and available for use. The variable portion
represents the charge made for actual consumption of the service. There is therefore need
to break do costs into fixed and variable elements. There are several methods of
estimating costs.
I. The Industrial Engineering Approach
This method involves an estimation of the required production inputs for certain output
by the engineers. The engineers would calculate the raw material inputs based on the
estimated material content of the product specification; labour inputs may be based on
time and motion studies; and an estimate of the capital equipment needed for production.
A thorough observation and measurement by expert engineers of relationships between
inputs and outputs can lead to very accurate predictions of future costs, and may yield
results which benefit the overall planning system of the firm.
The main disadvantage of this method is its cost line. If the production process is
Complex the preparation of a full specification of inputs will require much expert work,
entailing large cost which will be worthwhile only if the additional net benefits it creates
surpass the costs involved. However the industrial Engineering Approach or at least some
variation of it may be used if there are no past records on which to base an analysis.
2. The High-Low or Range Method
The high-low method is the cheapest and easiest to use. It attempts to segregate total past
costs by examinin2 only two observations i.e. those representing the highest and lowest
past activity over the relevant range. The difference in cost observed at the two extremes
is divided by the change in activity in order to determine the amount of variable cost
involved
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Example
Assume that the maintenance costs for HACO Ltd. Have been observed as follows within
the relevant range of 5,000 to 8,000 direct labour hours:
Month
D.L.Hs
Maintenance Cost (sh)
January
5,500
745
February
7,000
850
March
5,000
700
April
6,500
820
May
7,500
960
June
8,000
1,000
July
6,000
825
Required
Determine the fixed and variable cost elements of the mixed costs?
Solution:
D.L.Hs
Maintenance cost (shs)
High point observed
8,000
1,000
Low point observed
5,000
700
Change observed
3,000
300
Variable cost = ∆ in cost
=
∆ in activity
shs 300___
3000 D.L.Hs
= shs. 0.10 Per D.L.H
Fixed cost = Total cost – variable cost element
At the highest point = 1,000 – (0.10*8,000)
= shs 200
The cost formula is therefore:
Total cost = shs 200 fixed cost - shs. 0.10 Per K.L.H or
Y = 200 = 0.10x
3. The visual inspection method or scatter graph method.
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This method entails plotting all the relevant observations on a scatter graph and then
fitting a line to the data by visual inspection. This is a more accurate way of estimating
costs than the high-low method since it includes all points of observed cost data in the
analysis through use of a graph. Cost is shown on the vertical axis and the volume or rate
of activity is shown on the horizontal axis. The line fitted to the plotted points is known
as a regression line. The regression line, in effect, is a line of averages, with the average
variable cost per unit of activity represented by the slope of the line and the average fixed
cost represented by the point where the regression line intersects the cost axis.
Cost
Y=a+bx
Activity
4. The Least-Squares Method or Linear Regression Analysis
Linear regression analysis refers to the measurement of the average amount of change in
one variable (e.g. manufacturing costs) which is associated with unit increases in the
amounts of one or more other variables (e.g. output, labour hours). It is a method of
regressing Y (the dependent variable) on X (the independent or predictor variable).
The regression analysis fits a line f best fit to the data so as to minimize the sum of the
square of the vertical distances from the regression line to the plots of the actual
observations, so that the sum of the squares of these deviations is less than the sum of the
squared deviations from any other line. Thus it is a method of line fitting which is free
from subjectivity.
The least-squares method is based on computations that find their foundation in the
equation for a straight line i.e. Y= a+ bx
Where;
Y is the dependent variable
a is the fixed element
b is the degree of variability1variable element slope of the line
x is the independent or predictor variable
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From this basic equation, and a given set of observation , n, two mathematical equations
known as normal equations which must be solved simultaneously to derive values for a
and b for inclusion in the total cost function can be developed.
1.............y  na  bx
2.............xy  ax bx 2
Where;
x = activity measure
Y = total mixed cost observed
a = fixed cost
b = variable rate
n = number of observation
Example
The following data relates to J.J. Kamotho’s business for the period January to June
2002;
Month
Output
Total manufacturing
(Units)
costs (shs)
January
80
10,200
February
90
10,900
March
100
12,100
April
80
10,800
May
120
13,700
June
110
12,500
Required
Determine the business fixed and variable costs for its manufacturing costs.
Solution:
Normal equations:
1y  na  bx...............1
xy  ax  bx 2 .........2
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Month
Output
x
Total mfg costs
(y)
xy
x2
January
80
10,200
816,000
6,400
February
90
10,900
981,000
8,100
March
100
12,100
1,210,000
10,000
April
80
10,800
864,000
6,400
May
120
13,700
1,644,000
14,400
June
110
12,500
1,375,000
12,100
Totals
x  580
y  70,200
xy  6,890,000
x 2  57,400
Substituting in the normal equations
70,200 = 6a+ 580b ’’’’’.1
6,890,000 = 580a + 57,400b’’’.2
Multiplying equation (1) by 580; and equation (2) by 6;
40,716,000 = 348a + 336,400b
41,340,000 = 348a + 344,400b
- 624,000 =
-8,000b
Therefore b = 78
Substituting 78 for b in (1)
70,200 = 6a + 580 (78)
70,200 = 6a + 45,240
70,200 ’ 45,240 = 6a
24,960 = 6a
A = 4,160
Therefore fixed mfg cost = shs 4,160 and
Variable mfg cost = shs. 78
Our equation will be
Y = 4,160 + 78x
5. Account classification method
-Reading assignment
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CHAPTER III
PRODUCTION COSTING SYSTEMS
The basic purpose of any costing system is to accumulate cost data for managerial use.
Managers need unit cost data for several reasons:
1. Unit costs are needed to cost inventories and to determine the net income of a
period.
2. Unit costs are needed to assist the management in planning and controlling
operations. Budgets must be prepared as expected costs at various operating levels
And reports must be generated to provide feedback on where operations can be
improved. The usefulness of these budgets and reports depend on the accuracy of
the unit cost data.
3. Unit costs are needed to assist management in a broad range of decision making
situations e.g. setting selling prices for products and services, deciding whether to
add or drop a production line or whether to make or buy production components
and whether to accept special orders at special prices or not.
Cost accounting system
A cost accounting system consists of the techniques, forms and accounting records used
to develop timely information about the cost of manufacturing specific products or of
performing specific functions.
Types of cost accounting systems
There are two major cost accounting systems
 Job-Order costing system
 - Process-costing system
1. Job-Order Costing System
A job order costing system is used in those manufacturing companies where many
different products or jobs are produced each period. In such a system, the cost of
materials used, direct labour and manufacturing overheads arc accumulated separately for
each job. Examples of industries that use job-order system include; printing, furniture,
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equipment manufacturing, construction firms and in services such as hospitals. Law
firms, audit firms etc.
2. Process Costing System
This is employed in situations where manufacturing involves a single homogenous
product that is produced for long periods of time. The cost of raw materials used, direct
labour and overhead applicable are accumulated by department or process. The focal
point is therefore the department. Examples of industries that use process costing include
cement brick manufacturing, utilities like electricity, gas etc. The product is homogenous
and goes through a process. Costs are accumulated in a particular operation or department
for the entire period and this is then divided by the number of units produced during the
period hence getting unit cost.
JOB ORDER COSTING SYSTEM
The basic document used in this system is the job cost sheet. This is a form prepared for
each separate job initiated into production and it serves two purposes:
1. Serves as a means of accumulating material, labour and overhead costs chargeable
to a particular job.
2. Serves as a means for computing unit cost.
Application of manufacturing overheads
Manufacturing overheads are assigned to unit products through an allocation process
where the manager selects an activity base which is common to all the products that the
company manufactures to all services that the company renders. By means of this base,
an appropriate am ant o overhead cost is assigned to each product or service. This is done
after computing the pre-determined overheads rate.
Pre-determined = Estimated Total Manufacturing 0/H
0/H rate
Estimated number of units in the activity base
Example:
Assume that a firm has estimated its total manufacturing overhead cost for the year to be
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sh.400, 000 and has estimated 20.000 total direct labour hours for the year. A particular
job requires 40 direct labour hours to complete.
Required -- Compute:
(a) The predetermined 0/H rate
(b) The manufacturing 0/H cost assigned to the job.
Solution
(a) predetermined 0/H rate =sh. 400,000
20,000 hrs
=sh. 20 per D.L.H.
(b) Manufacturing 0/H cost assigned = 40 x20
=sh. 800 to its completion
Illustration
King’eero Company employs a job order system. The company uses predetermined
overhead rates in applying manufacturing overhead cost to individual jobs. The
predetermined overhead rate in department A is based on machine hours and the rate in
department B is based on direct materials cost. At the beginning of the year 2001, the
company management made the ff estimates for the year.
Department A
Department B
Machine hours
80,000
21,000
Direct labour hours
35,000
65,000
Direct material cost
shs. 190,000
shs. 400,000
Direct labour cost
shs. 280,000
shs. 400,000
Manufacturing O/H cost
shs. 416,000
shs. 720,000
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A particular job no. 400 was initiated into production on 1st January 2008 and was
completed on 14th May 2008. The company’s records show the ff information on the
job;
Department A
Machine hours
Department. B
250
70
Direct labour hours
80
130
Direct material cost
shs. 940
shs. 1,200
Direct labour cost
shs. 710
shs.
980
Required
(a) Compute the predetermined O/H rates that should be used during the year in
departments A and B.
(b) Computer the total O/H cost applied to job no. 400
(c) Compute the total cost of job no. 400
Solution
(a) For dept. A; application rate will be determined by:
Estimated total mfg O/H cost A = shs. 416, 000
80,000 M.Hs
= shs. 5.20 Per machine hour
For dept. B; application rate will be determined by:
Estimated total mfg O/H cost B = shs. 720, 000 x 100
Shs. 400,000
= 180% of D.M.C
(b) Total O/H cost applied for job no. 400;
350* 5.20
1,200* 180%
A
B
shs. 1,820
-
Shs. 1,820
shs. 2,160
shs. 2,160
Total O/H cost applied = 1,820 + 2,160 = shs. 3,980
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(c) Total cost for job no. 400
Total O/H cost applied
Direct material cost
Direct labour cost
shs 3,980
A
940
B
1,200
A
710
B
980
7,810
Or
Direct material cost
Direct labour cost
Total O/H cost applied
A
B
Total
shs. 940
shs. 1,200
shs. 2,140
710
980
1,690
1,820
2,160
3,980
3,470
4,340
7,810
Illustration 2:
Grogon Company is highly automated and uses computers to control manufacturing
operations. The company has a job order system in use and applies manufacturing
O/H cost to products on the basis of computer hours of activities. The following
estimates were used in preparing a predetermined O/H rate for the year 2007:
Computer hours
85,000
Manufacturing O/H cost shs. 1,530,000
The company’s cost records revealed the following actual cost and operating data for
the year:
Computer hours
60,000
Manufacturing O/H cost
shs. 1,350,000
Inventories at year end:
Raw materials
shs. 400,000
Work in progress
shs. 160,000
Finished goods
shs. 1,040,000
20
Cost of good sold
shs. 2,800,000
Required
i) Compute the company’s predetermined O/H rate for 2007
ii) Compute the under/over applied O/Hs for 2007
iii) Prepare the appropriate journal entries to close out the under/over applied O/Hs
Solution
i) Predetermined O/H rate = shs. 1,530,000
85,000 C.Hrs
= shs. 18 per computer hour
ii) Applied O/Hs (60,000*18
1,080,000
Actual O/Hs as per records
(1,350,000)
Under applied O/Hs
(270,000)
iii) Closing off under/over applied O/Hs balances:
Generally, any balance in this account is treated in one of two ways:
(a) It can be closed out to cost of goods sold
(b) It can be allocated between work in progress, finished goods and cost of goods sold in
proportion to the ending balances in these accounts.
NB: The greater the amount of O/Hs the more likely a company is to choose alternative
2.
Alternative 1:
For under applied:
Dr. Cost of goods sold a/c
XX
Cr. Manufacturing O/H control a/c
XX
For over applied:
Dr. Manufacturing O/H control a/c
Cr. Cost of goods sold a/c
XX
XX
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Alternative 2:
For under applied;
Dr. Cost of goods sold a/c
XX
Finished goods a/c
XX
Work in progress a/c
XX
Cr. Manufacturing O/H Control a/c XX
For over applied
Dr. Manufacturing O/H control a/c
XX
Cr. Cost of goods sold a/c
XX
Finished goods a/c
XX
Work in progress a/c
XX
In our case this is an under application
1. By using alternative 1
Dr. cost of goods sold a/c
sh. 270,000
Cr. Manufacturing O/H control a/c
sh. 270,000
2. By using alternative 2:
Apportionments:
% rate
amount
Work in progress
160,000
4
10,800
Finished goods
1,040,000
26
70,200
Cost of goods sold
2,800,000
70
189,000
4,000,000
100%
270,000
Journal entries
Dr. cost of goods sold A/C
sh. 189,000
Finished goods a/c/
70,200
Working in progress a/c
10,800
Cr. Manufacturing O/H control a/c
sh. 270,000
PROCESS COSTING SYSTEM
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(a) Similarities between job order and process costing methods
1) The same basic purpose exists in both systems which is to assign
materials, labour and overhead costs into products.
2) Both systems provide a mechanism for computing unit costs.
3) Both systems maintain and use the same basic manufacturing accounts
e.g. manufacturing O/Hs, raw materials, work in progress and finished
goods.
(b) Differences between jobs order and process costing methods
(a) Nature and scope
In a job order costing system many different jobs are worked or done during each
period with each job having different production requirements while in process
costing a single product is produced either on a continuous basis or over a long period
of time and all units of the product are identical.
(b) Accumulation of costs
In a job order costing system, costs are accumulated by individual jobs while in a process
costing system costs are accumulated by departments
(c) Documents used
In a job order costing system the job sheet/card is the key document controlling the
accumulation of costs by a job while in a process costing system, the production report is
the key document showing the accumulation of costs.
Steps of coming up with unit cost using process costing method:
1. Summarize the flow of physical units
2. Compute output in terms of equivalent units
3. Summarize the total costs and compute unit costs
4. Apply total costs to unit completed and to units in ending WIP inventory
Equivalent units of production
Equivalent units can be defined as the number of units that would have been produced
during a period if all of a department’s effort had resulted in completed units of a
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product. These are computed by taking the completed units and adjusting them for
partially completed units in the WIP inventory.
Example: Assume that a company has 5,000 units in its ending WIP inventory that are
60% complete
Required:
Determine its equivalent units of production
Solution :
The EU will be given by;
5,000* 60%= 3,000 completed units (EU)
Reasons for computing equivalent units
Completed units alone will not accurately measure output in a department since part of
the departments effort during a period will have been expended on units that are only
partially complete. These partially completed units must be considered in the
computation of output. This is done by mathematically converting the partially completed
units into fully completed equivalent units and then adjusting the output figure
accordingly.
There are two ways of computing a department’s equivalent units i.e
1. weighted average method (WAM)
2. FIFO method.
Example:
Fabisch company manufactures a product that goes through two processes i.e mixing and
firming. During the year 2004, the following activities took place in the mixing
department:
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Percentage of completion
Units
Materials
Conversion costs
Beginning WIP inventory
10,000
100%
70%
Units started into production
150,000
60%
25%
During the year
Units completed during the year
140,000
& transferred to firming dept.
Ending WIP inventory
20,000
Required
a) Compute EU using WAM
b) Compute EU using FIFO method.
a. Computation of EU using WAM
The EU is for the work done to date including earlier work done in the current period and
work done in the ending WIP inventory.
The units in the beginning WIP inventory are always treated as if they were started and
completed during the current period, thus no adjustment is made for these units regardless
of how much work was done on them before the period started.
Physical
Units completed & transferred out
140,000
Ending WIP inventory
20,000
materials
140,000
12,000(60%)
160,000
Equivalent units of production
conversion costs
_
152,000
140,000
5,000(25%)
_
145,000
b. Computation of EU using FIFO method
This differs from the computation under WAM in two ways:
25
1. the units transferred out figure is divided into two ways:
a) units from the beginning WIP inventory that were completed and
transferred out.
b) The units that were both started and completed during the current period.
2. Full consideration is given to the amount of work expended during the current period
for units in the beginning WIP inventory as the units in the ending WIP inventory
For beginning WIP inventory, the EU represent the work done to complete the units and
for the ending WIP inventory, EU represent the work done to bring the units to a stage of
partial completion at the end of the period.
Therefore, the EU figure under the FIFO method consists of three amounts:
1) The work needed to complete the units in the beginning WIP inventory
2) The work expended on the units started and completed during the period.
3) The work expended on partially completed units in the ending WIP inventory.
Solution:
Physical units
materials
10,000
0
Beginning WIP inventory
conversion
3,000(30%)
Units started & completed during
The period(140,000-10,000)
Ending WIP inventory
Equivalent units of production
130,000
20,000
160,000
130,000
130,000
12,000(60%)
5,000(25%)
142,000
138,000
Illustration
XYZ company uses two processes, for mixing in department A and firing in department
B to produce a particular product. Direct materials are introduced at the beginning of the
process in department. A and additional materials are added at the end of the process in
department. B conversion costs are applied evenly throughout both processes.
26
As the process in department A is completed, goods are transferred to department B and
as goods are completed in department B, they are transferred to finished goods inventory.
Data for the mixing department for the month of November 2004 was provided as
follows:
Beginning WIP inventory
Direct materials
10,000units (40%)*
sh
Conversion costs
4,000
1,110
Sh. 5,110
Units started into production during November
40,000
Units completed & transferred out to firing department
48,000
Cost added during the month:
Direct materials
shs.
22,000
Conversion costs
18,000
Shs.
Ending WIP inventory

40,000
2,000 ( 50%) *
Means each unit in the WIP inventory is regarded as being 40% or 50% complete
with respect to conversion costs.
Required:
a) Determine the cost of goods transferred out of department A.
b) Determine the cost of the ending WIP inventory (use both WAM& FIFO
methods)
27
CHAPTER IV
COST VOLUME - PROFIT ABNALYSTS (C-V-P)
C-V-P analysis is a managerial techniques used to determine how costs and profits are
affected by changes in the level of business activity. It is a deterministic analysis. It seeks
to evaluate the relationship between investment outlays, activity volumes and
profitabi1ity of particular interest is the point where sales revenues are able to cover all
costs i.e. Break- even point, since this shows minimum scale of operation so as to stay in
business.
Assumptions of C-V-P Analysis
i. The unit sales price and unit cost remains constant in the review period
ii. All costs can be neatly classified and identified as either fixed or variable with a
reasonable amount of accuracy.
iii. Variable costs will change proportionately with volume
iv. The fixed costs will remain constant
v. The relationship between revenue, costs. Volume and profits and linear over the
relevant range.
vi. The volume of production equals the volume of sales or changes in beginning and
ending inventory levels are insignificant in amount.
vii. Volume is the only relevant factor affecting cost.
viii. Whenever, more than one product is sold, total ales will be in some predictable
proportion or sales mix
Therefore C-V-P analysis is used by management to evaluate the interrelationships of
selling price, sales volume, sales mix and costs and profits so that acceptable profits can
be achieved.
In order to plan for profits, managers must estimate the selling price of each product, the
variable costs required to produce and sell it, and the fixed costs expected for a given
period. This information is combined with estimates concerning the expected sales
volume and sales mix to arrive at a good profit plan.
28
BREAK- EVEN POINT (B.E.P)
The B.E.P is the sales volume at which revenues and total costs are equal. At this level
both the variable costs and fixed costs are covered by the sales revenue. It defines
minimum production and sales level to stay in business. It also allows us to evaluate
profitability associated with various output levels. In new markets. We are able to
compare the volume demanded in the market (through market survey with the breakeven qua’hty4om this comparison we determine whether it is worthwhile to venture into
such a market.
Graphical analysis of the Break- even point
TR
Cost of revenues
P
TC
Losses
B.E.P
FC
B.E.F
Units of product
i.e. TR-T.C=0
Mathematical determination of the B.E.P
Profit=T.R-T.C I.E Q.SP-(Q.V.C)-F.C
At B.E.P; profits=0
QSP-(QVC)-F.C=0
Q (S.P-V.C) =FC
Q=F.C
S.P-V.C
Where S.P=selling price
V.C-variable cost per unit.
29
F.C-fixed costs
And S-P-V.C=contribution margin per unit.
Contribution margin ratio=C.M/unit
S.P
To get the B.EP in revenue (sales) =F.C
CM ratio
N/B while the B.E.P is not a derived performance target because of the lack of profit it
does indicate the level of activity necessary to avoid incurring a loss. As such the B.E.P
represents a target of the minimum sales volume that must be achieved by a business.
Example
A summarized income statement of XYZ co.LTD for the first year operation is given
below. XYZ CO.LTD.
Income statement for the year ended Dec 31; 2008
Sales (8,000 units@sh.50 each)
400,000
Variable cost
280,000
Contribution margin
Fixed cost
120,000
(150,000)
Net income/loss
(30,000)
Required
i.
B.E.P in units
ii.
B.E.P in revenue
Solution:
I. B.E.P (units) =F.C
C.M /units
=150,000 - 150,000
50-35
15
30
=10,000 units
ii B.E.P (sales) = F.C
CM ratio
CM ratio =15
= 0.3
50
Hence, B.E.P =150,000 =Sh. 500,000
0.3
Margin of safety
Margin of safety is the excess of actual sales over the break ’ even sales. It shows the
amount by which sales revenue can decline before the firms makes losses.
Ms =Actual Sales-B.E.sales
The margin of safety is useful for a firm facing a declining market share. It shows the
extent to which revenue can fall before contemplating a shut-down decision.
The B.E.P gives an indication of the level of sales that is required below which the form
would face the risk of insoluency i.e. if sales are below the B.E.P revenue then the firm is
facing the risk of insoluency.
In such situation
Units to attain for cash B.E.P =F.C less non ’cash expenses
C.M per unit
Non cash expenses include:
Depreciation
Amortization
Deferred expenses ’ arise from timing differences between incurrence and actual
payment.
In revenue (actual cash) F.C-Non cash expenses
C.M ratio
Examples:
Assume that the manager of XYZ co.Ltd expects sales of shs. 800,000 in the year 2000
without any change in its B.E.P compute its margin of safety.
31
Ms=Expected sales- B.E sales
=800,000 -500,000
= sh. 300,000
As a percentage of sales=300,000x100=37.5%
800,000
Target net income
C-V-P analysis can be used to determine the sales volume required to meet a target net
profit figure
Where management is targeting a given level of profits;
Q = F.C+Target Profit
Contribution margin/unit
Example:
Assume that the manager of XYZ co. Ltd wants to earn a net profit before tax of sh.
200,000 in the year 2,000 and expects the same selling price and costs as those
experienced in 1999 required.
What sales volume would achieve this target profit?
Q = 150,000+200,000 = 23,333 Units
15
Using equation: T.R- T.V.C-F.C = 200,000
50Q-35Q-150,000=200,000
15Q=350,000
Q=23,333 Units.
Illustration
ABC Company produces and sells a certain product at shs. 800 each with variable
manufacturing costs of shs 380 per unit and fixed manufacturing costs of shs 1,000,000
per year.
32
In addition, the company incurs selling and administrative costs of 2.5 %of sales revenue
and fixed selling costs of sh 200,000 per year
Required
i.
Determine the B.E.P in units and in shillings
ii.
Determine the units that should be sold to earn a net income of shs. 500,000
iii.
If the company was in the 35% tax bracket, how many units would have to be
sold to earn the sh. 500,000 targeted?
iv.
Management in considering a policy which would increase the fixed
manufacturing costs by sh. 400,000 but cut down on the variab1e manufacturing
costs by 20% .
a) What is the B.E.P in units and in revenue under this policy?
b) Taking into account the 35% tax level, how many units have to be sold to earn
the target income of shs.500,000 under this policy?
v.
At what sales level would management be indifferent among the two policies.
vi.
Assuming that the maximum possible demand is 8,000 units, determine the range
of sales in which each policy will be more financially beneficial?
Read sensitivity analysis
1. Changes in the variable cost.
2. Changes in selling prices.
3. Changing in fixed costs and sales volume.
4. Change in fixed and variable cost.
Solution
i.
B.EP in units = fixed cost
Contribution margin /unit.
Fixed cost =1,000,000+ 200,000=1,200,000
Variable cost = 380+(2.5% of sh. 800)
33
= 380+(0.025x800)
= shs. 400
Contribution margin/unit = 800-400
= Shs. 400
B.EP (units) 1,200,000 = 3000 units
400
B.E.P in shillings = fixed cost
Contribution margin ratio.
Contribution margin ratio= C.M/unit
Selling price
= 400
=
0.5
800
B.EP in shillings =1,200, 000
0.5
= Shs. 2,400,000
ii.
Units to be sold to earn a net income of shs. 500,000
Q=
F.C + X __
= 1,200,000 + 500,000
C.M / unit
400
= 4250 units
iii.
Considering tax of 35% and profit target of shs. 500,000
Q = F.C + I-T
C.M/Unit
= 1,200,000 + 500,000
= 1,200,000 + 769, 231
0.65
400
400
iv.
= 4, 923 Units
New fixed cost = 1,200,000 + 400,000
= Shs. 1,600,000
New variable cost = 380 (0.8) + 20 = shs. 324
34
New contribution margin = 800 ’ 324 = shs. 476
a) B.E.P in units = 1,600, 000
476
= 3,361 units
B.E.P in shillings = 1,600, 000
0.595
= shs. 2,689, 075.6
b) Q = 1,600,000 + 500,000 = 1,600,000 + 769,231
0.65
476
= 2,368,231 = 4977 units
476
v.
Let the sales level be denoted by x
Policy 1 (PI) Profit function = 400 x ’ 1,200,000
Policy 2 (P2) Profit function = 476 x -1,600,000
At equilibrium (point of indifference)
 of P1   of P 2
Hence, 400 x ’ 1,200,000 = 476x - 1,600,000
400 x ’ 476x = -1,600,000 + 1,200,000
-76x = -400,000
X = -400,000
-76
x = 5,263 units
SALES MIX
The term sales mix refers to the relative combination in which a company’s products are
sold or the relative combination of quantities of products that comprise total sales
.Managers will always use the sales that mix that yields the greatest amount of profits.
Profits will be greater when high margin items make up a relatively large proportion of
total sales and less if sales consist mostly of low margin items.
35
Illustration
ABC Company produces two products A and B and has the following budgets
A
Sales (Units)
B
Total
240,000
80,000
320,000
1,200,000
800,000
2,000,000
Variable costs @ shs. 3 (A) shs (B)
720,000
480,000
1,200,000
Contribution Margin
480,000
320,000
800,000
Sales @ shs. 5 (A) shs. 10 (B)
Fixed cost
(500,000)
Net Income
(300,000)
Required:
Compute the Break even point.
Solution:
The sales mix = 240,000: 80,000 = 3:1 (A: B)
Let X be the number of units of B sold: then
3x will be the number of units of A sold.
At break even; sales-v.c-F,c =0
Hence :(3x*5)+(x*10) ’ (3x*3)+(x*6) -500,000=0
(15x+10x)- (9x+6x) = 500,000
10x = 500,000
X = 500,000 = 50,000 units for B
10
Units of A =3x hence: 50,000/*3=150000 units of A
Total no. of units = 50,000+150,000 = 200,000 units
36
CHAPTER V
PRODUCT COSTING METHODS
There are only two known methods to product costing
a) Absorption costing method/Full costing method/Traditional costing.
b) Direct costing/Variable costing/ marginal/ Contribution costing method.
Absorption Costing Method
This method treats all costs of manufactured as product costs regardless of whether they
are variable of fixed in nature. All the costs of Manu faction are treated in this method as
part of the cost of the product.
It allocates a portion of the fixed manufacturing overheads to each unit of the product
along with the variable manufacturing costs. The cost of the unit of a product under this
method therefore costing of direct materials, Direct labour, variable overheads and an
applied overheads.
Direct Costing Approach
Under this method, only those costs of manufacture that vary directly with activity are
treated as product costs. If therefore includes only the variable costs of manufacturing.
The cost of the unit of a product therefore consists of direct materials, direct labour and
the variable portion of manufacturing overheads. Fixed manufacturing overhead is treated
a period cost and like selling and administrative expenses is charged off against the
revenue for each period.
Illustration
37
ABC Company produces and sells a single product selected costs from the operating data
relating to the product for a recent year are given below.
Beginning inventory (unit)
0
Units produced during the year
10,000
Units sold during the year
8,000
Ending inventory (units)
2,000
Selling price per unit
shs. 50
Selling and administration cost:
Variable per unit
shs. 5
Fixed per year
shs. 70,000
Manufacturing costs
Variable per unit - Direct materials
shs. 11
Direct labour
shs. 6
Variable overheads
shs. 3
Fixed per year
shs. 100,000
Required
a) Prepare income statements under the two methods.
b) Reconcile the direct costing and absorption costing net income figures.
Solution;
A) Absorption costing approach
Unit Manufacturing cost of product:
Direct materials
Sh. 11
Direct labour
6
Variable overhead
3
Fixed manufacturing cost/unit 100.00
10
10,000
30
ABC Company income statement sales
Sales (8,000 @ shs. 50)
400,000
38
Cost of goods sold :
Opening Inventory
Nil
Cost of goods manufactured
(10,000 units shs 30)
300,000
Cost of goods available for sale
300,000
Less: Ending inventory (2,000 x 30)
60,000
Cost of goods sold
(240,000)
Gross profit
160,000
Less: Selling and Administration expenses
Variable (8,000 @ shs. 5)
40,000
Fixed
70,000
Net income
(110,000)
50,000
b) Direct Costing Approach
ABC @ income statement
Sales (8,000 @ shs. 50)
400,000
Less: Variable costs:
Variable cost of goods sold (8,000 x 20)
160,000
Variable Selling and Adm. cost (8000 x 5)
40,000
Total variable cost
(200,000)
Contribution margin
200,000
Less; fixed cost:
Selling and administration
Manufacturing
70,000
100,000
Total fixed cost
Net income
(170,000)
30,000
Note: the difference in profit between the two methods in due to the fixed manufacturing
overhead costs that are differed in closing inventory under absorption costing, to the
period when the related units of the product are sold.
i)
Reconciliation of income figures
39
Direct costing net income
30,000
Add: Fixed O/H cost differed in ending
Inventory under absorption costing (2,000 @ shs. 10)
20,000
Absorption costing net income
50,000
Illustration 2:
Selling and administration cost (all fixed)
shs. 30,000 per annum
Normal production volume
shs. 25,000 units
Basic data only :
Sales price per unit
shs.20
Variable manufacturing cost per unit
shs. 11
Fixed manufacturing overheads
shs 150,000
Additional data:
Year 1
Year 2
Year 3
Beginning inventory (units)
Nil
Nil
5,000
No. of units produced
25,000
25,000
25,000
No. of units sold
25,000
20,000
30,000
Ending Inventory (units)
Nil
5,000
Nil
Required
Income statement under both absorption costing and direct costing for each of the three
years.
Solution;
a) Direct costing Approach
Income statement
Year 1
Year 2
Year 3
Sales @ shs. 20 per unit
500,000
400,000
600,000
Less; Variable costs @ shs 11
275,000
220,000
330,000
Contribution margin
225,000
180,000
270,000
40
Less: Fixed Costs: Fixed manufacturing
150,000
150,000
150,000
Fixed selling and Administration
30,000
30,000
30,000
Net Income / Loss
45,000
Nil
90,000
b) Absorption Costing Approach
Income Statement
Year 1
Year 2
Year 3
500,000
400,000
600,000
Beginning inventory @ shs 17 per unit
Nil
Nil
85,000
Cost of goods manufactured (25,000 x 17)
425,000
425,000
425,000
Cost of goods offered for sale
425,000
425,000
510,000
Less: Ending inventory @ shs 17 per unit
Nil
85,000
Nil
Cost of goods sold
(425,000)
(340,000)
(510,000)
Gross profit
75,000
60,000
90,000
Less: Selling and Admin costs
(30,000)
(30,000)
(30,000)
Net income/loss
45,000
30,000
60,000
Sales @ shs. 20 per unit
Less: Cost of goods sold
Working unit cost: Variable cost = shs. 11
Manufacturing O/H 150,000 =
Shs. 6
25,000
Total shs. 17
Conclusion
1) When production and sales are equal, the same net income will be realized regardless
of whether direct or absorption costing is used, because there is no chance for the fixed
overhead costs to be deferred in inventory or realized from inventory under absorption
costing.
2) When production exceeds sales, the net income reported under absorption costing will
41
generally be greater than the net income reported under direct costing. The reason is
that when more is produced than sold, part of the fixed overhead costs of the current
period are deferred in the inventory to the next period under absorption costing
3) When sales exceed production, the net income reported under absorption costing
approach will generally be less than the net income reported under direct costing
approach. The reason is that, when more is sold inventories are drawn and fixed overhead
costs that were previously deferred in inventory under absorption costing are released and
charged against income
42
PRODUCT COSTING METHODS
There are two major methods of product costing i.e.
(a) Direct costing
(b) Absorption costing
However, these methods differ in only one conceptual respect. The fixed manufacturing
overhead is excluded from the cost of products under direct costing but included in the
cost of products under absorption costing.
Direct/Variab1e/marginal/Contribution Costing.
This method signifies that fixed manufacturing overhead (fixed factory overhead) is not
inventoried. The fixed manufacturing overhead is regarded as an expired cost to be
immediately charged against sales. Fixed manufacturing costs are not applied to any
products but are regarded as expenses as actually incurred.
The cost of the product under this method will therefore consist of direct materials, direct
labour and the indirect cost known as variable manufacturing overhead. The costs of the
product are therefore accounted for by applying all variable manufacturing costs to the
goods produced. This method is widely used for internal reporting in performance
measurement and cost analysis.
Absorption Costing
This method signifies that fixed manufacturing overhead (fixed factory overhead) is
inventoried. Fixed manufacturing overhead is treated as an un-expired cost to be held
back on inventory and changed against sales later as part of cost of goods sold.\
The cost of the product under this method therefore consists of direct materials, direct
labour, variable manufacturing overhead and an applied amount of the fixed
manufacturing overhead.
43
Example
ABC co. had the following operating data in 2006 and 2007
Basic production date standard cost
Direct material
Direct labour
Variable manufacturing overhead
Standard variable costs per unit
sh. 1.30
1.50
.20
sh 3.00
The fixed manufacturing overhead (fixed factory overhead) was sh. 150,000. expected
production in each year was 150,000 units. Sales price was sh 5 per unit. Selling and
administrative expenses were all fixed at sh 65,000 annually except for sales commission
at 5% of sales.
In units
2006
2007
Opening inventory
-
30,000
Production
170,000
140,000
Sales
140,000
160,000
Ending inventory
30,000
10,000
Less: closing inventory
120,000
40,000
There were no variances from the standard variable manufacturing costs and fixed
manufacturing overhead incurred was exactly sh 150,000 per year.
Required
(a) Prepare income statements for 2006 and 2007 under direct costing
(b) Prepare income statements for 2006 and 2007 under absorption costing
(c) Prepare a reconciliation of the direct costing and abosorption costing net profit
figures
44
Solution
(a)
Direct costing
2006
2007
Sales 140,000 and 160,000 units respectively
700,000
800,000
Opening inventory
-
90,000
(170,000 & 140,000)
510,000
420,000
Cost of goods available for sale
510,000
510,000
Less ending inventory
90,000
30,000
Variable manufacturing costs of goods sold
420,000
480,000
Variable selling expense @ 5% of sales
35,000
40,000
Total variable cost
(455,000)
(520,000)
Contribution margin
245,000
280,000
Fixed factory overhead
150,000
150,000
Fixed selling & administrative expenses
65,000
65,000
Total fixed expenses
(215,000)
(215,000)
Operating profit/income
30,000
65,000
Absorption costing
2006
2007
Sales
700,000
800,000
Opening inventory (sh 4)
-
120,000
Cost of goods manufactured
680,000
560,000
Cost of goods available for sale
680,000
680,000
Less: closing inventory
120,000
40,000
Cost of goods sold
(560,000)
(640,000)
Gross profit at standard
140,000
160,000
Production volume variance
20,000
(10,000)
Gross profit at standard
160,000
150,000
35,000
40,000
Add costs of goods manufactured
(b)
Selling and administrative expenses:
Variable
45
Fixed
65,000
65,000
Total selling & administrative expenses
(100,000)
(105,000)
Net income
60,000
45,000
Workings
Production volume variance
2006
sh 20,000 F(170,000 ’ 150,000) X sh 1
2007
sh 10,000 U (140,000 ’ 150,000) x sh 1
(c)
Reconciliation: 2006 only
Net income under direct costing
sh 30,000
Add: fixed manufacturing overhead cost differed in
Closing inventory under absorption costing 30,000
Net income under absorption costing
60,000
46
CHAPTER V
BUDGETING
Definitions
1. A budget is a quantitative expression of a plan of action of a specified period of time.
2. A budget is a financial and/or a quantitative statement prepared prior to a defined
time period to serve as a basis for the implementation of a policy to be followed
during that period for the purpose of attaining a given objective.
The main purpose of a budget is to implement the policies formulated by management for
attaining the company’s objectives.
The budget can be independent for a particular unit in the organization or for the entire
organization
THE MASTER BUDGET
The master budget is prepared for the entire organization. It is a summary of all phases of
the company’s plans and goals for the future. It sets specific targets, for all the sub-units
of the organization e.g. production, Distribution, finance e.t.c.
FUNCTIONS OF BUDGETS
1. Planning:
Budgeting requires managers to give planning top priority among their duties. Planning
involves the development of future objectives and the preparation of various budgets to
achieve these objectives
. The budget brings out the firm’s requirements and expectations in terms of inputs and
outputs and in this way many unforeseen contingencies may be anticipated in
advance.
2. Communication
47
Budgets are devices for communication. The plans summarized in budgets are read and
interpreted through out the firm. Thus budgets are an important channel of
communicating certain types of information that will enable managers in different
parts of the organization to o- ordinate their activities more efficiently.
3. Motivation
Budget often serve as a means of motivating managers to strive towards the achievement
of the organizational objectives. They do this by acting as an external standard the may
be accepted by a manager as his own target, thus providing a motivational force.
Extensic rewards and penalties .ay also be attached to budget achievement to increase its
motivational effect e.g. bonuses performance awards etc.
4. Controlling
Budget serves as standard against which managerial performance is evaluated. The
budget offers the only available quantitative reference point against which performance
can be assessed.
A danger in this situation is that performance which is relatively reported can become the
dominant measure of overall performance yet the budget itself represents only an
imperfect standard. A strong stress on budget attainment is likely to lead to budgets that
are met but at the expenses of worse long- run performance with various harmful sideeffects.
Nevertheless, properly used budgets can be vial tool in monitoring and controlling
managerial and business unit performance.
5. Co-Ordination
A budget is important for effective co- ordination.
The various departmental managers will be expected to co- ordinate one another so as to
be able to determine man-power needs, facilities, raw materials and other resources in the
organization. This can be done using the relevant budget.
48
LIMITATION OF BUDGETS
1. The budget plan is based on estimates and therefore absolute accuracy is not
possible in budgeting. The strength and weakness of a budgeting system depends
to a 1are extent on the accuracy’ with which the estimates are made.
2. Danger of rigidity
The budget program must be dynamic and continuously deal with the changing
business conditions. Budgets reduce much of their usefulness if they acquire
rigidity and are not revised with the changing circumstances.
3. Budgeting is only a tool of management but cannot take the place of management.
Execution of budgets will not occur automatically. i is therefore necessary that the
entire organization participates in the budget programme if the budgeting goals
are to be achieved.
TECHNIQUES FOR MAKING BUDGETING MORE EFFECTIVE
1. Continuous Budgets
In a dynamic environment, a particular budget may become unrealistic later in the year.
At that point a firm may revise its budget in reflect move current conditions. Some firms
establish procedures for updating their budgets on a regular basis in order to incorporate
managements latest planning and control decisions. These updated budgets are usually
referred to as ’continuous budgets’ or Frothing Budgets’
However, some firms will not use continuous budgets because budgets that are
automatically revised downwards to accommodate some informal set of external
circumstances may weaken employees’ motivation. Once the budget for a department or
division has been discussed and agreed on, the manager of that department is deemed to
have made a commitment to achieve the results reflected in the budget. If conditions
49
change, the manager is expected to exert extra effort and develop new strategies to
achieve the expected results.
2. Participative Budgets.
The behavioral studies of the budgeting process indicate that managers usually feel a
great commitment to achieving the budgeting goals if they have played a part in
construction of the budget.
The participative approach to budgeting emphasizes the active involvements of managers
who will subsequently be evaluated on the basis of budgeted goals. One approach of
participative budgeting is to give subordinates on opportunity to construct the first round
(initial) budgets which is then revived and modified by the subordinates’ superior. This
approach gives the lower level manager a large creative role.
Another approach is to review the initial budget with the subordinates in a group which
collectively arrives at a final budget decision through a consensus. Effective use of the
approach requires special skills on the part of the superior who managers
the group in the decision making process.
3. Zero Base Budgeting
In zero- base budgeting managers are required to start at zero- budget level every year
and should justify all costs as if the programmes involved were being initiated for the
first time. The manager must start at the ground level each year and present justification
for all costs in the proposed budget.
This is done in a series of decision packages in which the manager ranks all of the
activities in the department according to relative importance ranging from those that he
considers essential to those that he considers least important.
This allows the top management to evaluate each decision package independently and to
rule out those that appear less critical or that do not appear to be justified in terms of costs
involved.
50
TYPES OF BUDGETS
1. Sales Budget.
The sales budget is the starting point in preparing the master budget. The sales budget
is constructed by multiplying the expected sales in units by the selling price.
Example: ABC Co. manufactures two products A and B
The sales forcast for ABC co’s products for the coming year has been made as
follows:
Products
Sales (Units
A
1000,000
B
20.000
Selling price is sh.20 for A and sh. 10 for B
Required:
Prepare the sales budget for ABC Co.
Solution
ABC Co’s sales budgets
Products
Total
A
B
Units
100,000
20,000
Selling price(s)
20
10
Sales (sh)
2,000,000
200,000
120,000
2,200,000
2. PRODUCTION BUDGETS
This follows the sales budget. It is used to determine the number of units to be produced.
The units to be produced will be made up as follows:
51
Desired inventory of finished goods (in units) + budgeted sales in units ’ Beginning
inventory of finished goods in units.
The production required of the forthcoming budget period is determined and organized in
the form of production budgets.
Sufficient goods will have to be available to meet sales needs and provide for the desired
ending inventory. The remainder will have to be produced.
Sufficient goods will have to be available to meet sales needs and provide for the desired
ending inventory ’ A portion of these goods will already exist in the form of beginning
inventory. The reminder will have to be produced.
Example: ABC Co. Production budget
A
B
Total
Expected sales (units)
100,000
2,000
102,000
Add: desired ending monthly
20,000
200
20,200
Total nets
120,000
2,200
122,200
Less beginning inventory
1,000
100
1,100
Units to be produced
119,000
2,100
121,100
3. DIRECT MATERIALS PURCHASE BUDGET
This budget is prepared to show the materials that will be required in the production
process. Sufficient raw materials will have to be available to meet production needs and
to provide for the desired ending raw materials inventory for the budget period. Part of
this raw materials requirement will already exist in the form of beginning raw materials
inventory. The remainder will have to be purchased from suppliers.
Example
ABC Co. has the following data:
Direct materials:
unit cost
input requirement per unit
A
B
Material x
sh. 4 per kg
10 kg
10 kg
Material y
sh 10 per kg
7 kg
9kg
52
Direct labour
sh 5/hour
20 hrs
25hrs
Additional information:
X
Y
Beginning inventory (kg)
10,000
10,000
Desired ending inventory (kg)
8,000
2,000
Required:
(i)
The direct material purchases budget
(ii)
Direct labour cost budget
Solution
(i) Direct material usage
A
B
C
Units to be produced
119,000
2,100
121,100
Material X
119,000
21,000
1,211,000
833,000
18,900
851,900
Y
ABC CO’s DIRECT MATERIALS PURCHASE BUDGET
Materials
X
Y
Amount needed for production
1,211,000
851,900
Add: desired ending inventory
8,000
2,000
Total needs
1,219,000
853,900
Less: Beginning inventory
10,000
10,000
Amount to be purchased
1,209,000
843,900
Price per kg
sh. 4
sh. 10
Direct material purchase cost
4,836,000
8,439,000
Total
13,275,000
4. Direct labour cost budget
This shows the direct labour requirement for the company. By knowing in advance
what will be needed in terms of labour time through out the budget period, The
53
Company can develop plans to adjust the labour force as the situation may require. To
compute direct labour requirement, the number of units of the finished product to be
produced each period is multiplied by the number of direct labour hours required to
produce a single unit.
SOLUTION
(ii)ABC Co’s labour budget
A
B
Units to be produced
119,000
21,000
Labour requirement per units (hrs)
20
25
Total labour required (hrs)
2,380,000
52,500
Labour rate per hour (sh)
5
5
11,900,000
262,500
Total
12,162,500
5. CASH BUDGET
A cash budget is used to plan for an adequate but not excessive cash balances. The goal
of a cash budget is to ensure that the business has sufficient liquidity to pay its bills as
they fall due.
A cash budget has three section i.e.
i.
The cash receipts section
-
ii.
-
opening balance is also included plus all cash receipts
The ending balance section
consists of the difference between the receipts total and the disbursements total.
The difference either show a deficit or a surplus
ILLUSTRATION:
ABC co. has the following data from which a master budget has to be prepared for the
coming year.
2006
2007
2008
Current year
coming year
year after
4th Q
1ST Q2nd Q3rd Q4th Q
1st Q
54
Sales (Units)
1800
1000 2000 1500 2000
1000
Expected selling is shs. 200 per unit
Inputs
requirement
cost/unit
Material
2kg
sh.5/kg
Labour hour’s
3hrs
sh.10/hr.
Beginning inventory of finished goods for each quarter must be equal to 10% of sales for
the previous quarter. Raw material inventory at the end of any quarter must be equal to
the requirements to produce units for sale in the next quarter. Variable manufacturing
overheads are based on direct labour costs at the rate of 80% of direct labour cost. In
addition, fixed manufacturing overheads of sh. 20,000 will be incurred each quarter
including depreciation sh. 2,000 per quarter.
Required
Prepare the Sales budget, Production budget, Raw materials purchase budget, Direct
labour cost budget and Manufacturing overheads budget for the year on the basis of
quarters.
SOLUTION
(a) Sales Budget
Quarters
1
2
3
4
Expected sales in units
1,000
2,000
1,500
2,000
Selling price per unit (shs)
200
200
200
200
400,000
300,000
Expected sales revenue (shs) 200,000
400,000
(b) Production budget
Quarters
1
2
3
4
Expected sales in units
1,000
2,000
1,500
2,000
Add: Required ending inventory
100
200
150
200
55
Total requirements
1,100
2,200
1,650
2,200
Less: Required beginning inventory 180
100
200
150
Units to be produced
2,100
1,450
2,050
920
Raw materials purchase budget
Quarters
1
2
3
4
Units to be produced
920
2,100
1,450
2,050
Requirements per units (kg)
2
2
2
2
Materials for production (kg)
1,840
4,200
900
4,100
Add: Closing inventory required (kg) 4,000
3,000
4,000
2,000
Total requirements
5,840
7,200
6,900
6,100
Less: Required opening inventory
2,000
4,000
3,000
4,000
Price per unit (sh)
5
5
5
5
Budgeted R Material cost (sh)
19,200
16,000
19,500
10,500
c) Direct labour cost budget
Quarters
1
2
3
4
Units to be produced
920
2,100
1,450
2,050
Requirement per unit
3
3
3
3
Hours required
2,760
6,300
4,300
6,150
Cost per hour (sh)
10
10
10
10
Budgeted labour cost (sh)
27,600
63,000
43,500
61,500
d) Manufacturing overheads budgets
Quarters
1
2
3
4
Budgeted direct labour (shs)
27,600
63,000
43,500
61,500
Variable o/H applicant rate
0.8
0.8
0.8
0.8
Budgeted variable 0/H
22,000
50,400
34,800
49,200
56
Add: Budgeted fixed overheads
20,000
20,000
20,000
20,000
42,080
70,400
54,800
69,200
e) Compute the manufacturing cost per unit (Assume the variable cost approach)
Input item
Quantity
Cost/unit
Total
Direct materials
2kg
sh.5
10
Direct labour
3 hours
sh. 10
30
Variable overhead
3 hours
sh. 8
24
Sh. 64
Additional data:
In addition to the manufacturing costs selling and administrative costs of sh.32,000 are
incurred per month sales are made on cash and credit terms as follows:
In any quarter:
30% cash sales
70% credits sales
Credit sales are collectable in the quarter following the quarter of sales and 2% of the
credit sales are considered uncollectable. Raw materials are paid for in the month of
purchase. Wages, overheads and administrative expenses are paid for in the month they
are incurred. Equipment worth, shs. 380,000 will be bought in the fourth quarter of the
coming year. The company requires a minimum cash balance of sh. 25.00 and the cash
balance at the beginning of the first quarter in expected to be sh. 27,000.
Required
(a) Prepare projected income statements
(b) The cash budget for the company for the year on quarterly basis.
Solution:
a) Project income statement for the quarters to 31st Dec
1
2
3
4
Sales (shs)
200,000
400,000
300,000
400,000
Less: variable costs
64,000
128,000
96,000
128,000
57
Contribution margin
136,000
272,000
204,000
272,000
Less: Fixed mfg. costs
20,000
20,000
20,000
20,000
Selling & adm. Costs 96,000
96,000
96,000
96,000
156,000
88,000
156,000
1
2
3
4
60,000
120,000
90,000
120,000
137,200
274,400
205,800
257,200
364,400
325,800
4
Project net income/less
20,000
b) Cash from sales
Quarters
Cash sales (Shs)
Add: Collection from credit 249, 960
Sales customers
Cash from sales
306,960
Cash budget for the quarters to 31st December
1
2
3
Opening balance (shs)
27,000
11,080
164,880
Add cash from sales
306,960
257,200
364,400
205,800
Total cash
333,960
408,280
529,280
643,208
Raw materials
19,200
16,000
19,500
10,500
Wages for D/Labour
27,600
63,000
43,500
61,500
Overheads (less deprn.)
40,080
68,400
52,800
67,200
Selling adm. Expenses
96,000
96,000
96,000
96,000
Equipment
-
-
-
380,000
182,880
243,400
211,800
615,200
Closing balance
151,080
164,880
317,480
28,080
Less: minimum balances
25,000
25,000
25,000
25,000
Surplus/deficit
126,080
139,880
292,480
3,080
Disbursement:
58
CHAPTER 8
RELEVANT COST FOR DECISION MAKING
A relevant cost can be defined as a cost that is applicable to a particular decision making
situation in the sense that it will have a bearing on which alternative(s) the manager
selects. Any cost that is avoidable is relevant for decision making purposes. An
avoidable cost is any cost that can be eliminated completely or partially as a result of
choosing an alternative over another alternative in a decision making situation.
All costs are considered to be avoidable except for:
i) Sunk costs
ii) Future costs that do not differ between the alternatives at hand.
TYPES OF DECISIONS
1) Make or buy decisions
A decision which will produce a component part internally rather than buy the part
externally is called a make or buy decision.
Example:
Assume that XYZ Co. is now producing a small sub assembly, that is used in the
production of the company’s main production lines. The company’s accounting
department reports the following costs of production the sub assembly internally
Per unit
8000 units
sh. 6
sh. 48,000
Direct labour
4
32,000
Variable O/H
1
8,000
Supervisor’s salaries
3
24,000
Deprn. Of special equipment
2
16,000 sunk cost
Allocated general O/H
5
40,000 irrelevant
Direct materials
Total cost
sh. 21
sh. 168,000
59
XYZ Co. has just received an offer from an outside supplier who will provide 8,000 units
of sub assemble per year at a price of sh. 19 each.
Required:
Should XYZ Co. stop producing the sub-assemblies internally and start purchasing them
from the outside supplier or not?
Solution:
Check on the relevant cost only
Make
Direct materials
sh. 6
Direct labour
4
Variable 0/H
1
Supervisor’s salary
3
Total cost
Buy
sh. 14
Outside purchase
sh. 19
The difference is in favour of the making of sub-assembly i.e. sh. 5 saving per unit or sh.
5 * 8000 = sh. 40,000 can be saved
Decision: The company should therefore reject the outside offer.
Example 2:
Assume that the space now being used to produce sub-assemblies will be used to produce
a new product line that would segment a product margin of sh. 50,000 per year should
XYZ Co. accept the supplier’s offer or not?
Make
Buy
Differential costs
sh. 14
sh. 19
No of units needed annually
8000
8000
sh. 112,000
sh. 152,000
Total annual cost
60
The difference of sh. 10,000 is in favour of purchasing from the outside supplier.
Decision: The company should therefore accept the suppliers offer and use the available
space to produce the new product.
2) Sell or Process ’ further decisions
Under these decisions joint products are considered joint products: - These are two or
more product from a common input.
Joint cost; - Are manufacturing costs that are incurred in producing joint products up to
split-off-points
Split ’ off: - This is that point in the manufacturing process at which the products can be
recognized as individual units of output
This join costs are irrelevant in decision making: As a general guide it will always be
profitable to continue processing a joint product after the split off point so long as the
incremental revenue from such processing exceeds the incremental processing costs.
Example: 2) Utilization of scarce resources
Cost and revenue data relating to three products are as follows
Sales value at the split off point
A
120,000
B
150,000
C
60,000
Sales value after further processing
160,000
240,000
90,000
Allocated joint product costs
80,000
100,000
40,000
Costs of further processing
50,000
60,000
10,000
B
C
90,000
30,000
REQUIRED
Which product (s) should be processed further
A
Incremental Revenue
shs. 40,000
Cost of further processing
(50,000) (60,000)
(10,000)
Profit/Loss for further processing
(10,000)
20,000
30,000
Therefore B&F should be processed further
61
A should be sold after split off point
Firms are always faced with problem of deciding how scarce resource can be utilized eg
limited number of machine hours/ D.C.Hs, floor space etc
The firm should select the course of action that will maximize its total contribution
margin. Total contribution margin will be maximized by promoting those products or
accepting those order that promise the highest contribution margin relation to the scarce
resources of the firm.
Example:
Assume that a firm has two products A&B. Cost and revenue characteristics of the two
product lines are as follows;
A
B
Sales price per unit
shs. 25
sh. 30
Variable cost per unit
shs. 10
shs 18
Contribution Margin per unit shs 15
shs 12
It takes two machine hours to produce one unit of product A and only one machine hour
to produce one unit of product B. The firm has only 18,000 machine hours of capacity
available in the factory per period
Required:
If demand becomes strong which orders should the firm accept
Solution:
A
B
Contribution margin per unit
shs 15
shs. 12
Machine hours required to produce/Unit
2hrs
1hrs
62
Contribution margin per machine hrs
shs 7.50
shs 12
Total machine hrs available
shs. 18,000
shs. 18,000
Total contribution margin
shs 135,000
shs. 216,000
VARIANCE ANALYSIS
Variance analysis is typically performed for the production costs of manufactured goods.
However, conventional procedures for decomposing a cost variance into its quantity and
price components can be extended to explain deviations of actual from planned
profitability.
Standard costs
A standard can be defined as a benchmark or ’norm’ for measuring performance. In
management accounting the standards used relate to the quantity and cost of inputs used
in manufacturing goods or providing services. Managers, set standards for the three
elements of cost input i.e. direct materials, direct labour and manufacturing overheads.
Quantity standards indicate how much of a cost element, such as labour time or raw
materials should be used in manufacturing a unit of a product or in providing a unit of a
service.
Cost standards indicate what the cot of the input i.e. labour time or raw materials should
be. By comparing actual quantities and actual costs of inputs with these standards we can
be able to tell whether operations are proceeding within the limits set by management.
A general model for variance analysis
Actual quantity of inputs,
Actual quantity of inputs,
Standard quatity
At actual price
at standard price
Allowed for outputs,
At std price
Price variance
Quantity variance
Material price variance
Materials quantity variance
63
Labour rate variances
Labour efficiency variance
Variance O/H spending variance
Variance O/H efficiency variance
TOTAL VARIANCE
This model provides a base for variance analysis. It deals with variable costs, isolates
price variances from quantity variances and shows how each of these variances is
computed.
Reasons for separating standards into price and quantity
1. Control decisions relating to price paid and quantity used will generally fall at
different points in time e.g. for raw materials, control over price paid comes at the
time of purchase while control over quantity used does not arise until raw materials
are used in production.
2. Control over price paid and quantity used will generally be the responsibility of two
different managers and will therefore need to be assessed independently.
Price and quantity variances
A variance is the difference between standard prices and quantities, and actual prices and
quantities. A price variance and a quantity variance can be computed for each of the three
variable cost elements i.e. direct materials, direct labour and variable manufacturing
overheads.
Standard Quantity allowed or Standard hours allowed
This refers to the amount of direct materials, direct labour or variable manufacturing
overhead that should have been used to produce what was produced during the period.
Material price variance
This measures the difference between what is paid for a given quantity of materials and
what should have been paid according to the standard that had been set.
64
(A.Q * AP)-(A.Q * S.P)
=A.Q (A.P- S.P)
Or A.Q (S.P ’A.P) to automatically name the variance.
Ordinary, the responsibility for any price variance is with the purchasing agent. However,
this may not hold in all circumstances e.g. when production schedules have been changed
to affect methods of delivery (air freight instead of truck then-prod-mgr is responsible).
Causes of material price variances.
1. Size of lots purchased.
2. Delivery method used.
3. quantity discounts available
4. rush orders
5. quantity of materials purchased e.t.c
Material quantity variance.
This measures the difference between the quantity of materials used in production and the
quantity that should have been used according to the standard that had been set.
i.e.
(A.Q * SP) ’ (S.Q * S.P)
=S.P (A.Q-S.Q)
Or S.P (S.Q-A.Q)
This variance is best isolated at the time that materials are placed into production.
Ordinary, the responsibility of any material quantity variance is with the production
manager.
Causes
1. Faulty machines
2. Inferior quality of materials.
3. Untrained workers.
4. poor supervision
Labour rate variance
This measures any deviation from standard in the average hourly rate paid to direct
labour workers i.e.
65
(A.H * AR) ’ (A.H * SR)
=A.H (A.R-S.R)
Or A.H (S.R-A.R)
Rate variances in terms of amounts paid to direct labour workers tend to be almost nonexistent because in many firms the rates paid to workers are set by union contracts
(CBA). Rate variances can arise through the way labour is used i.e Skilled and unskilled
labour, overtime premium e.t.c.
Labour Efficiency Variance
This measures the productivity of labour time. i.e.
(A.H * S.R) ’ (S.H * S.R)
=S.R(A.H ’ S.H)
Or S.R(S.H ’ A.H)
Causes.
1. Poorly trained workers
2. Poor quality materials
3. faulty equipment
4. Poor supervision e.t.c.
Variable Overhead Spending Variance
This measures deviations in amounts spent for overhead inputs such as lubricants and
utilities. i.e.
(AH * AR) ’ (AH * SR)
=AH (AR ’ SR)
Or AH (SR ’ AR).
Variable Overhead Efficiency Variance.
This is a measure of the difference between the actual activity of a period and the
standard activity allowed, multiplied by the variable part of the predetermined overhead
rate. i.e.
66
(AH * SR) ’ (SH * SR)
=SR (AH ’ SH)
Or SR (SH ’ AH).
Illustration:
XYZ co. Ltd manufactures a product called Fruta. The company uses a standard cost
system and has established the following standards for one unit of Fruta:
Std Qty
Std price/Rate
Std cost
Direct materials
1.5 pounds
sh. 6 per pound
sh. 9.00
Direct labour
0.6 hours
sh. 12 per hour
7.20
Variable overhead
0.6 hours
sh. 2.50 per hour
1.50
Sh. 17.70
During June 2008, the following activity was recorded by the company relative to
production of Fruta:
1. The company produced 3,000 units during the month.
2. A total of 8,000 pounds of material were purchased at a cost of sh. 46,000.
3. there was no beginning inventory of materials on hand to start the month;
at the end of the month , 2,000 pounds of material remained in the
warehouse unused.
4. The company employs 10 persons to work on the production of Fruta.
During June, each worked an average of 160 hours at an average rate of
sh. 12.50 per hour.
5. Variable overhead is assigned to Fruta on a basis of direct labour hours.
Variable overhead costs during June totaled sh. 3,600.
The company’s management is anxious to determine the efficiency of the activities
surrounding the production of Fruta.
Required:
a) Compute the price and quantity variances.
b) Compute the rate and efficiency variances.
c) Compute the Variable overhead spending and efficiency variances.
67
BUDGETING
Definitions.
A budget is a detailed plan outlining the acquisition and use of financial and other
resources over some given time period. It represents a plan for the future expressed in
formal quantitive terms.
Budgeting is very critical for effective profit planning since it focuses on those steps to
be taken by a business organization to achieve certain desired levels of profits.
When several budgets are prepared, they form an integrated business plan known as the
master budget. Usually, the data going into the preparation of the master budget forms
heavily on the future, rather than the past.
The main purpose of a budget is to implement the policies formulated by management in
order to attain a company’s objectives.
Functions of budgets
The reasons for producing budgets are as follows:
i.
to aid the planning of annual operations
ii.
to coordinate the activities of the various parts of the organization and to ensure
that the parts are in harmony with each other.
iii.
To communicate plans to various responsibility centre managers.
iv.
To motivate managers to strive to achieve the organizational goals
v.
To control activities
vi.
To evaluate the performance of managers.
Planning
Planning involves the development of future objectives and the preparation of various
budgets to achieve these objectives. The budgeting process ensures that managers do plan
for future operations, and that they consider to conditions are likely to change in the
68
future, and when steps they should take now to respond to such changed conditions. This
process encourages managers to anticipate problems before they arise, and hasty
decisions that are made on the spur of the moment, based on expediency rather than
reasoned judgment, will be minimized.
Coordination:
The budget serves as a vehicle through which the actions of the different parts of an
organization can be brought together and reconciled into a common plan.
Without any guidance, managers may each make their own decisions believing that they
are working in the best interests of the organisations and end up creating problems of
conflict of interest e.g the purchasing manager may prefer to place large orders so as to
obtain large discounts; the production manager will be concerned with avoiding high
stock levels while the accountant will be concerned with the impact of the decisions on
the cash resources of the business. Hence budgeting reconciles all these differences for
the good of the organization as a whole.
Communication
The budget effectively defines lines of communication so that all parts of the
organization are kept fully informed of the plans and the policies, and constraints, to
which it is expected to conform. It ensures that everyone in the organization has a clear
understanding of the part he or she is expected to play in achieving the organizational
objectives. This process ensures that the appropriate individuals are made accountable for
implementing the budget.
Motivation
Budgets can be useful devices for influencing managerial behaviour and motivating
managers to perform in hire with the organizational objectives. Budgets often provide
standards that under certain circumstances, managers must be motivated to strive to
achieve. However budgets can also encourage inefficiency and conflict between
managers.
69
If individual have actively participated in preparing the budget (bottom-up strategy) and
it is used as a tool to assist managers in managing their respective units, it can act as a
strong motivational device. However, if the budget is dictated from the top, and imposes
a threat rather than a challenge, it maybe resisted and do more harm than good.
Control
Budgets assist managers in managing and controlling the activities for which they are
responsible. Managers can compare actual results with budgeted results and can ascertain
which items do not conform to the original plan, and thus require their attention.
Deviations identified should be investigated to identify inefficiencies and take
appropriate control actions to remedy the situation
Performance evaluation
The budget provides a useful means of uniforming managers of how well they are
performing in meeting targets that they have previously helped to set. e.g. in some
companies bonuses or promotion may be partly dependent upon a manager’s budget
record. Hence, a manager’s performance may be evaluated by measuring his or her
success in meeting the budgets. Furthermore, the manager may be the budget to evaluate
his or her own performance.
Administration of the annual budget.
A firm should ensure that procedures are established for approving the budgets and that
the appropriate staff supports support is available for assisting managers in preparing
their budgets. In practice, the procedures should be tailor made to the requirements of the
organization.
The budget committee
This should consist of high level executives who represent the major limits of the
business. Its major role is to ensure that budgets are realistically established and that they
are coordinated satisfactionaley.
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The budget committee should apprint a budget officer, who will coordinate the individual
budgets into the master budget.
Accounting staff:
These will normally assist managers in the preparation of their budgets and ensure that
managers submit their budgets on time. However, the accounting staff do not determine
the content of the various budgets but they do provide valuable advising and clerical
service for the hire managers.
Budget manual
This is usually prepared by the accountant describing the objectives and procedures
involved in the budgeting process. It provides a useful reference source for managers
responsible for budget preparation. The manual may include a timetable specifying the
order in which the budgets should be prepared and the dates when they should be
presented to the budget committee stages in the budgeting process.
1) Communicating details of budget policy and guidelines
to those people
responsible for the preparation of budgets.
2) Determining the factor that restricts performance.
3) Preparation of the sales budget.
4) Initial preparation of various budgets
5) Negotiation of budgets with superiors.
6) Coordination and review of budgets.
7) Final acceptance of budgets
8) Ongoing review of budgets.
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