APPENDIX 1.1 |
81
➤ Question A1.3
Twinkle Toes Ltd is a company that makes and sells shoes for women. A new shoe made from
recycled materials is being considered, and the following estimates have been made:
Expected selling price: $220 per pair of shoes
•
800 grams of raw material that costs $50 per kilogram;
•
direct labour of two hours, at $17 per hour; and
•
variable overhead of $24.
Expected unit sales for the second half of 20Y1 are as follows:
July
August
September
October
November
December
1300
1900
2200
2300
2500
3200
To ensure there are no shortages of stock or production bottlenecks, the following are required:
•
Finished goods (FG) inventory at the end of each month should be 20 per cent of the following
month’s estimated sales. Note that Twinkle Toes will require inventory to be built up in June
for July sales.
•
Raw materials inventory at the end of each month should be 35 per cent of the following
month’s estimated raw material usage needed to meet the production requirements.
Prepare the following for Twinkle Toes Ltd for the period July–September 20Y1:
(a) sales budget
(b) production budget
(c) direct labour budget
(d) raw materials budget.
Notes: The production budget will need to include October so that raw materials purchases for
September are identified, and ending June inventory for both raw material and finished goods
is required to determine July starting balances.
Evaluating and controlling with variance analysis
Variance analysis is conducted to ensure budgets are being achieved and to help with control.
The variance that is analysed is the difference between the actual costs and quantity used
(of direct materials, labour and overhead) and the amounts budgeted for at the start of
the period.
The first type of variance examined is the difference between a budgeted level of activity and the
actual level. The second type of variance is the difference between the consumption of resources
that should be incurred for a ‘given level of activity’ as compared to what is actually consumed.
For example, if production of 1500 units is budgeted but, because of a large sales order,
2000 units are actually produced and sold during the period, there are two variance issues.
The first issue revolves around why there is a 500 unit variance in units produced. The second
issue relates to the amount of resources used to produce 2000 units. The actual resources used
must be compared with the budgeted estimates to ensure resources are being used effectively.
MODULE 1
To make each pair of shoes, the following items are required:
APPENDIX 1.1 |
79
A short-term master budget is required to help turn long-term strategic objectives into
operational short-term plans. The master budget may be for a period of weeks, months,
quarters or even a year and combines the relevant information into a short-term operational
plan. The budgeting process helps management to allocate resources (time, people and money)
to a coherent set of financial and numerical plans. The starting point of the budgeting process
is the organisational goals and strategic plan. These are combined with a detailed assessment
of the financial position and integrated with external and internal projections about how the
organisation will operate in the future environment. Information required will include sales
forecasts, production capacity and costs, and employee data.
A series of short-term budgets not only assists in planning, but is also useful for coordinating and
integrating the variety of activities within an organisation. It also communicates to staff what is
expected to be achieved, and the allocation of resources to key areas informs employees about
the relative importance of activities and areas.
Important budgets include:
• sales budgets;
• production budgets;
• stock/merchandise budgets;
• material purchases and usage budgets;
• direct labour budgets;
• overhead budgets;
• capital expenditure budgets;
• cash flow budgets;
• income statement (profit and loss) budget; and
• balance sheet budget.
There are many different approaches to budgeting, some of which are more flexible than others.
Flexible budgets are commonly used and are updated during a period based on changing
events. Another popular method is the use of a rolling forecast. This is where, instead of an
organisation forecasting in calendar or financial year blocks, new budgets or forecasts are
continuously created, and the organisation continues to look 12 to 18 months ahead at all times.
For example, as a three- or six-month period passes, that period drops off the budget and
another three- or six-month period is then added.
Forecasts, or dynamic budgets, are now common in most organisations and allow for increased
control over costs and short-term planning. These forecasts use actual costs incurred during
the financial period to date, in addition to the remaining budget for the period, to enable
more accurate forecasts of revenues, expenditures and cash flows for the full financial period.
These forecasts do not take the place of the original budget, but provide an additional tool that
may be used to adjust or refocus planning where variations to budgets occur.
Planning activity and resources
The main types of budgets are similar for most organisations, although differences do exist
between service, trading and manufacturing organisations. Although the examples reproduced
below are very simple, the conceptual structure is unchanged even when there are hundreds
of product lines.
Sales budget
Forecast sales (units)
× Unit sale price
= Revenue
July
August
September
MODULE 1
Budgeting
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| INTRODUCTION TO STRATEGIC MANAGEMENT ACCOUNTING
MODULE 1
Important things to consider when creating a sales budget include external factors such as
market demand at different price levels and internal factors such as production and storage
capacity. Failure to integrate these factors may create unachievable budgets and, in turn,
lead to decreases in employee motivation. The cash collections from the sales budget will be
incorporated into the cash budget.
To determine the amount of goods to be produced in a particular period, first determine the
level of sales and then consider the current and required levels of inventory. Setting sales and
production budgets is usually an iterative process in which the sales and production teams need
to communicate to ensure that the number of units expected to be sold can be produced.
Production budget
July
August
September
Forecast sales
+ Finished goods inventory required at the end of the period
– Finished goods inventory from the start of the period
= Production requirements (units)
If goods or services are being produced, a direct labour budget and a raw materials purchases/
usage budget are required. The final data from the production budget (production requirements)
becomes the starting point for both of these budgets.
Direct labour budget
July
August
September
Production requirements (units)
× Direct labour hours per unit of production
× Direct labour cost per hour
= Total direct labour cost
A raw materials budget is created by combining the production requirements identified earlier
with the required levels of raw materials inventory. From this, the amount of raw materials to
purchase as well as the cost can be calculated. The cost information from the direct labour
budget and raw materials budget will be fed into the cash budget, which will project when
payments will be required.
Raw materials (RM) purchases and usage budget
Production requirements (units)
× Volume of RM required per unit of production
= Usage of RM
+ RM inventory required at the end of the period
– RM inventory from the start of the period
= RM purchases volume
× RM cost
= Total RM cost
July
August
September