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

Lesson ¡5 ¡| ¡Part ¡1 ¡ FNSACC402 Prepare Operational Budgets

By the end of PART 1 of this lesson, you will be able to … Explain the term ‘ goal congruence ’. 1. Prepare a basic performance report 2. Explain the term ‘ management by exception ’ 3. Explain the importance of monitoring the performance of 4. an organisation on a regular basis Describe options for corrective action 5.

The planning cycle (budgetary control) BUDGET ¡ PERFORMANCE ¡REPORT ¡ Comparison ¡of ¡ACTUAL ¡results ¡to ¡BUDGET ¡ à à ¡VARIANCE ¡

Goal congruence Employee ¡ goals ¡ SAME ¡ (align) ¡ Department ¡ Company ¡ goals ¡ goals ¡

Goal congruence — The likelihood of individuals acting in their OWN best interests (rather than the organisation’s) à HIGH — What tool or technique can we use to measure and monitor GOAL CONGRUENCE ? It’s ¡all ¡about ¡ me! ¡

Performance reports — Used to: Highlight any variances that may arise when actual results achieved are compared to the budget

Performance reports Essential features: 1. Timely 2. Accurate 3. Provide information (level of detail; format) that enables management to analyse performance and identify responsibility

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

Types of variances You get two (2) types of variances: Favourable variances (F) J à increase in profits Unfavourable variances (U) L à decrease in profits

Variances — Both NATURE and SIZE of variance should be taken into account. — Any LARGE or UNUSUAL variances should be investigated and appropriate remedial action taken. — What is considered material or significant varies from business to business.

Reasons for variances — Are numerous, but fall into two main groups: — à due to external factors (no control) — à due to internal factors (may be able to change)

What does a performance report look like?

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

Formula for calculating variances (%)

Formula for calculating variances (%) Formula for calculating variance %: ( V ariance $ / B udget $ ) x 100

Example : performance report Item Budget ($) Actual ($) Variance Variance U or F ($) (%) Salaries $21,000 $22,620 Stationery $750 $690 Telephone $840 $864 Electricity $1,020 $960 Rates $500 $520 Depreciation $750 $750 Total $24,860 $26,404 Required: Prepare a performance report showing the variance in dollars ($) and expressed as a percentage (%). Please also state whether the variance is FAVOURABLE (F) or UNFAVOURABLE (U).

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

Management by exception — Focus on the THINGS THAT MATTER à don’t waste time investigating areas of responsibility already performing at or above an acceptable standard of performance. — Focus on the EXCEPTIONS i.e. those areas that are performing below a given standard e.g. a variance of 5% either way.

¡ Importance of monitoring — Often overlooked and poorly executed L — Effective monitoring enables those responsible for budget outcomes to track their progress and come up with countermeasure plans to improve performance by flagging any issues or problems early on.

Following on from the performance report … ¡ 1. Identify 2. Analyse / investigate further 3. Take action

¡ What do we do now … ? — If circumstances change, a new budget needs to be prepared. — In practice, the original budget is left unchanged and a new forecast is prepared.

¡ What do we do now … ? Sometimes the situation can be fixed and sometimes it can’t The reason for the variance may be one for which corrective action can be taken, but sometimes certain external factors beyond the control of management can impact on the organisation’s ability to stick to its budget.

¡ What do we do now … ? — Options for action may include: — Revising the budget — Investigating alternatives and developing strategies to overcome what has caused the variance in the first place NOTE: If a change is made, the effect that it would have on the organisation as a whole needs to be taken into account i.e. quick fixes for a particular area of the business should be avoided.

PART 2 Lesson ¡5 ¡| ¡Part ¡2 FNSACC402 Prepare Operational Budgets

By the end of PART 2 of this lesson, you will be able to … 1. Prepare a performance report that discloses contribution margin. 2. State the flexible budget formula . 3. Prepare a basic flexible budget .

Flexible budgets STATIC budget: à prepared for one level of planned activity. What is the limitation of static budgeting?

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

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

Flexible budgets — Used as a planning tool — Can quantify expected results at different activity levels. — Used as a control tool — Can evaluate actual results by restating the original static budget figures based on the actual level of activity achieved.

Flexible budgets e.g. The Simms Card Company The Simms Card Company manufactures inexpensive greeting cards, which are sold in packs of ten (10) at discount stores. The Simms Card Company has prepared its budgets on the assumption that it will sell 200,000 packs of cards during the year. How could the company’s performance be accurately assessed if 190,000 packs of cards were sold instead? (see next slide)

Flexible budgets e.g. The Simms Card Company (STATIC) BUDGET ACTUAL VAR. F / U Sales 200,000 190,000 10,000 U Less: Variable 20,000 18,000 2,000 F costs* Contribution 180,000 172,000 8,000 U margin Less: Fixed costs 10,000 10,000 - - Net profit 170,000 162,000 8,000 U * Budgeted for at 10c per sales dollar

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

Flexible budgets e.g. The Simms Card Company (FLEXIBLE) BUDGET ACTUAL VAR. F / U Sales 190,000 190,000 - - Less: Variable costs* 19,000 18,000 1,000 F Contribution margin 171,000 172,000 1,000 F Less: Fixed costs 10,000 10,000 - - Net profit 161,000 162,000 1,000 F * Budgeted for at 10c per sales dollar

BUDGET ACTUAL VAR. F / U Sales 200,000 190,000 10,000 U Less: Variable costs* 20,000 18,000 2,000 F STATIC ¡BUDGET ¡ Contribution margin 180,000 172,000 8,000 U Less: Fixed costs 10,000 10,000 - - Net profit 170,000 162,000 8,000 U * Budgeted for at 10c per sales dollar BUDGET ACTUAL VAR. F / U Sales 190,000 190,000 - - Less: Variable costs* 19,000 18,000 1,000 F Contribution margin 171,000 172,000 1,000 F FLEXIBLE ¡BUDGET ¡#1 ¡ Less: Fixed costs 10,000 10,000 - - Net profit 161,000 162,000 1,000 F * Budgeted for at 10c per sales dollar

HOW to prepare a flexible budget — Start by: — Forecasting all fixed costs — Forecasting all variable costs — Then: — Calculate COST PER UNIT for all variable costs

Important concepts that you need to understand before going any further 1. Fixed costs 2. Variable costs 3. Contribution margin 4. Contribution margin ratio

Cost behavior: The more knowledge we have about how our costs behave, the more accurate our budgeting process can be. Fixed costs: remain the same (in the short run) with changing levels of activity. — The cost per unit decreases as activity increases. — This relationship is constant within the relevant range of activity. — e.g. factory rent

Fixed Costs