CHAPTER 13 Cost Analysis for Planning and Control.

CHAPTER 13

Cost Analysis for Planning and Control

PowerPoint Slides t/a Accounting: What the Numbers MeanMarshall, McCartney, van Rhyn, McManus, VieleSlides prepared by Sandra Chapple Copyright 2005 McGraw-Hill Australia Pty Ltd

13-2

Overview

• Budgeting in general• Cost classifications• The budgeting process• The sales budget and other operating budgets• Standard costs• Performance reports• The flexible budget• Reporting for segments of an organisation• Residual income• The balanced scorecard


13-3

Control

Steps taken by management to

ensure that objectives are

attained.

Planning

Developing objectives for

acquisitionand use of resources.

A budget is a comprehensive financialplan for achieving the financial and

operational goals of an organisation.

A budget is a comprehensive financialplan for achieving the financial and

operational goals of an organisation.

Budgeting


13-4

BudgetingManagement philosophy is reflected in how the

budget is prepared and used:

• Top down• Highly structured

(carved in stone)

• Top down• Highly structured

(carved in stone)

• Participative• Flexible

• Participative• Flexible

The budget should be seen as a

guide that reflects management’s

best thinking at the time of

preparation. It may have to change

if circumstances change.


13-5

Budgeting

Financial accounting concepts, as the results of an organisation’s activities are reported via financial statements

Financial accounting concepts, as the results of an organisation’s activities are reported via financial statements

Management accounting techniques, especially knowledge about cost behaviour patterns.

Management accounting techniques, especially knowledge about cost behaviour patterns.

A budget involves the use of:


13-6

Cost classifications

Variable costs -- change with the volume of activity -- unit costs constant.

Variable costs -- change with the volume of activity -- unit costs constant.

Fixed costs-- do not change within a relevant range.

Fixed costs-- do not change within a relevant range.

Recap of cost behaviour patterns:

Mixed costs-- a certain amount of cost can be expected regardless of activity.

Mixed costs-- a certain amount of cost can be expected regardless of activity.


13-7

Cost ClassificationsAccording to time frame perspective

Committed

Incurred to carry out long range policy decisions to which

the firm is committed

Discretionary

Costs that can be adjusted in the short run after evaluation

of resources

In the long run, every cost is controllable.

Fixed costsFixed costs


13-8

The Budget Time Frame

Single period budget – prepared in the months

preceding the beginning of the year, but estimates must

be made more than a year in advance.

Rolling budget – planning for segments of a year on a

repeat basis.

Continuous budget – the final budget for any quarter

should be much more accurate as it has been prepared

more recently, but time, effort and money are required.


13-9

The Budgeting Process

1. Develop and communicate a set of broad

assumptions about the economy, industry and

organisational strategy.

2. Prepare operating (master) budget made up of a

number of detailed budgets:

• Prepare sales budget -- estimated unit prices

and unit sales. All other budgets are a function of

sales activity.


13-10

The Budgeting Process

DirectMaterialsBudget

Production Budget

Operating ExpenseBudget

DirectLabor

Budget

Manufacturing

OverheadBudget

Sales Budget

Cost of GoodsSold Budget

Budgeted Balance Sheet

Budgeted Income Statement

Budgeted Statement of Cash Flows


13-11

The Production or Purchases Budget

The basic inventory flow model is usedfor production and purchases budgets.The basic inventory flow model is usedfor production and purchases budgets.

Goods available for sale

Goods available for sale

Beginninginventory

Beginninginventory

+Purchases

or productio

n

Purchases or

production

Cost (or quantity) of goods sold

Cost (or quantity) of goods sold

=

EndinginventoryEnding

inventory-


13-12


Production or purchases must be adequate to meet budgeted sales and to provide

sufficient ending inventory.

Production or purchases must be adequate to meet budgeted sales and to provide

sufficient ending inventory.

Budgeted sales in units

+ Desired units in ending inventory

= Total product units needed

– Beginning inventory

= Units to produce or purchase


13-13


Once quantities have been determined,

they can be converted to dollars.

Once quantities have been determined,

they can be converted to dollars.

When the number of units to be produced is known, the quantity of

each raw material input to be purchased can be forecast using the

same model.

When the number of units to be produced is known, the quantity of

each raw material input to be purchased can be forecast using the

same model.

Raw materials

Direct labour

Manufacturing

overhead

Determining these budgeted

amounts often involves the

use of a standard cost

system.

Determining these budgeted

amounts often involves the

use of a standard cost

system.


13-14

The Cost of Goods Sold Budget

Summarises changes in inventory accounts,

as indicated by:

• sales budget

• purchases and production budget

• required ending inventory levels as

determined by management.


13-15

Operating Expense Budget

The cost behaviour patterns of selling,

general, administrative and other operating

expenses are determined

May be a function of sales or influenced by

management strategy

Budget slack or ‘padding the budget’

Tendency of managers to submit budget estimates

that are slightly higher than expected costs


13-16


Production Budget


Sales Budget



May be prepared after completion of other budgets


13-17

The Cash Budget

Similar to a budgeted statement of cash flows, but with shorter time frame.

Cash collections from customers?

How long does it take the firm to collect its receivables?

Short-term borrowing requirements?

Cash payments to suppliers?

What credit terms is the firm subject to?

How often does the firm pay its employees?


13-18

Budgeted Balance SheetMay be prepared after completion of other budgets


Depreciation and

amortisation

Budgeted Balance Sheet


Production Budget

Sales Budget


Budgeted Statement of Cash Flows

Inventory balances

Retained earning balance

Accounts receivable, accounts payable, equipment, dividends


13-19

Standard

costs are:

based on carefullypredetermined amounts

used in planning and control phases of the management process, particularly budgeting

used in financial accounting to value inventory

benchmarks formeasuring performance.

Standard Costs


13-20

Standard CostsA standard cost has two elements:

1. Quantity of input (weight, volume, hours)2. Cost per unit of input

Standard Unit budget

Used extensively in the budget preparation process

Used to plan for input that will be needed to make the product


13-21

Performance Reporting

The performance report compares actual results to budgeted amounts.

Those activities that are

performing differently from

expectations are highlighted

and variances investigated.


13-22

Performance Report Characteristics

Activity

Favourable

•Actual revenues > Budget revenues

•Actual costs < Budget costs

Unfavourable

•Actual revenues < Budget revenues

•Actual costs > Budget costs

Favourable

•Actual revenues > Budget revenues

•Actual costs < Budget costs

Unfavourable

•Actual revenues < Budget revenues

•Actual costs > Budget costs

BudgetAmount

ActualAmount– = Variance

Explanation ?


13-23

Responsibility ReportingAmount of detail varies according

to level in organisation.

Responsibility ReportingAmount of detail varies according

to level in organisation.


Involves successive degrees of summarisation.

Each layer of management receives detailed reports

for their layer, but summarised reports for

lower layers.

Involves successive degrees of summarisation.

Each layer of management receives detailed reports

for their layer, but summarised reports for

lower layers.


13-24

Management by exception:

Management concentrate their

attention on only those

activities that are not

performing according to plan.

Usually only those variances

in excess of a certain

percentages (say 10%) are

investigated.



13-25

The Flexible Budget

improve performance evaluation.

may be prepared for any activity level in the relevant range

adjusts the original budget to reflect budgeted amounts for actual activity

reveal variances due to good cost control or lack of cost control


13-26

To a budget for different activity levels, we must know how costs behave with changes in activity levels (variable costs and fixed costs).

FixedVaria

ble

The Flexible Budget

Variable costs / unit

Actual level of activity

Actual costs

x

Flexible budget

Compared with


13-27

Reporting for Segmentsof an Organisation

A segment of an

organisation is a division,

product line, sales

territory or other

organisational unit.

A segment of an

organisation is a division,

product line, sales

territory or other

organisational unit.

For management reports, total company results may be

reported by segment.For management reports, total company results may be

reported by segment.

Segment income statements

should reflect the

contribution to the common

fixed expenses and company

profit.

Segment income statements

should reflect the

contribution to the common

fixed expenses and company

profit.


13-28

Reporting for Segmentsof an Organisation

Profit Centre A part of the business

that has control over both costs and revenues,

but no control over investment funds.

Profit Centre A part of the business

that has control over both costs and revenues,

but no control over investment funds.

Investment Centre A profit centre where management also has autonomy for investing in assets to

conduct operations.

Investment Centre A profit centre where management also has autonomy for investing in assets to

conduct operations.

Cost CentreA business section

that has control over the

incurrence of costs, but does not generate revenue.

Cost CentreA business section

that has control over the

incurrence of costs, but does not generate revenue.


13-29

Methods of Evaluating Segments

CostCentre

Actual costs compared to budgeted costs

ProfitCentre

InvestmentCentre

Actual return on assetscompared to budgetedreturn on assets

Evaluation Measures

Actual segment margincompared to budgetedsegment margin

SegmentSegment


13-30

Analysis of Investment Centres

Return on investment (ROA) is the ratio of

segment EBIT to the investment used to generate the

segment EBIT.

ROA = Segment EBIT Divisional operating assets

As investment centre managers have a much higher

level of responsibility, appropriate measures of

performance are important.


13-31

Analysis of Investment Centres

SalesOperating assets

ROA = Segment EBIT

Operating assets

ROA = Segment EBIT

Sales ×

MarginMargin TurnoverTurnover


13-32

As division manager,I wouldn’t invest in

that project becauseit would lower my pay!

Gee . . .I thought we were

supposed to do what was best for the

company!

ROA and Dysfunctional Behavior

A performance evaluation system needs to be carefully designed so that it doesn’t lead to dysfunctional behaviour.


13-33

Residual income encourages managers to make profitable investments that would be rejected by managers using ROA.

Residual Income

ROA should not be the sole measure of investment centre performance.

Managers should be evaluated on their ability to generate a minimum ROA and to maximise theamount of earnings above that minimum ROA.


13-34

An integrated set of performance measures that highlight and communicate an organisation’s strategy, goals

and priorities.

EmployeeEmployeestakeholderstakeholder

groupgroup

InvestorInvestorstakeholderstakeholder

groupgroup

The Balanced Scorecard

This approach shows an organisation’s performance in meeting its responsibilities to

various stakeholders.


13-35

Financial PerspectiveHow do we look

to the firm’s owners?

Learning and Growth Perspective

How can we continuallyimprove and create value?

Internal BusinessProcess Perspective

In which activities must we excel?

Customer PerspectiveHow do our

customers see us?

Integratedmeasures

The Balanced Scorecard

CHAPTER 13 Cost Analysis for Planning and Control.

Documents

Transcript of CHAPTER 13 Cost Analysis for Planning and Control.