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Lecture 6 (Purpose of Management Accounting:
To provide information to…
Lecture 6
Purpose of Management Accounting:
- To provide information to help make decisions
- Setting objectives
- Planning
- Controlling
- Monitoring
- Reporting
**- Right info at right time
- Accurate and relevant info is essential**
What is a budget
It is not a forecast, however forecasts are used
Types:
FINANCIAL:
- Master
- Capital
- Revenue
- Expenses
- Cash Flow
NON FINANCIAL:
- Employees
- Operating Hours
- Mileage
Budget Objectives:
- To ensure achievement of firms objectives
- To compel planning
- To communicate ideas and plans
- Coordinate activities
- Provide framework for responsibility accounting
- Establish system of control
- Motivate employees to improve performance
Budget Setting:
- AIms
- Objectives
- Key/Limiting factor - what determines the maximum volume of sales, capacity etc
- Levels of service
- Resources (5 M's)
- Quantification - work out what our statements will look like at the end of the year with this plan
- Express in financial terms
- Get agreement - easier when there is a team approach
Key Limiting factor
This constrains what can be done. In many companies this is sales or ability to sell. It could be production capacity. It could be labour resource
Types of Budgets
- Operating Budgets (ie Sales and production) Sales will estimate the amount of cash coming in which will also affect expenditure budget. Consider what ifs
- Cash Budget (receipts and payments) What ifs? Need to ensure cash flow and overdrafts etc are maintained. These contribute to capital budgets
- Master Budget (P&L and Balance Sheet)
- Capital Budget (Fixed Assets)
Approaches to budgeting:
- Top down or bottom up? (Or hybrid)
- Fixed/Periodic/Incremental
- Flexible/Rolling
- Zero Based (ZBB) or Activity Based (ABB). These expect spending to be authorised by the budget holder
- Whichever is used the budget targets need to be SMART
Fixed and Flexible Budgets:
Fixed - BAsed on level of output. When variances are computed at the end of the period, no adjustment is made to the budgeted amounts
Flexible - Developed using budgeted revenues or cost amounts when variances are computed, the bidget amounts are flexed to recognise the actual levels of output and the actual quantities of revenue and cost drivers
A flexible budget is calculated at the end of the period when the actual output is known
Deficiencies of fixed budgets:
- Fixed Budget variance confuses control over
activities and costs
- Variances caused b changes in output cannot be separated from variances caused by changes in cost
- Flex budgets are based on actual output, tehreby output variances can be separated from costs variances
5 Steps on flexing a budget
1) Determine what the budget would have been if outputs had been at the planned level
2) For control purpose flex the budget for the actual output
3) Make sure to distinguish between fixed costs and those variable in relation to output
4) It is safe to assume that sales revenue, Material costs and labour costs vary strictly with volume
5) Fixed overheads can be fixed within the relevant range
Variance analysis:
Th analysis of difference between plan and actual
Only effective if used!
Adverse or Favourable
Sales variance - volume and price.
Materials variances - Usage and price
Labour variances - rate and efficiency
Budgetary control is the feedback of performance against budget
Monitoring is not enough and we must take action based on analysis
dvanttages:
- Guides and regulates
-Better coordiantiona nd communication
- Provides a taret
Better sue of resources
- Better cost control
- Performance measirement
- Centralised contrl
- Highlights areas of risk
Disadvantages:
- Time consuming and costly to prep
- Rigid operation
May demotiveate if imposed or unrealistrinc
Manipultion
Uncontrolled spending
Budgets are based on standards
- how wel is the company performaning?
- Sets standards
Benchmarks or normsTargets need to be achievable to motivate
Ambitious - only attainable in optimal circumstances
Reasons for variances:
Value chain explanations
- poor design
-purchase of poor materials
- manufacturing poorly carried out
-Trade off between price and efficiency
Performance evaluation is a key element of variance analysis
2 attributes commonly used are Effectiveness and Efficiency
BUT we need to be careful to understand the causes of a variance before we use it as a performance measure
Interdepdencencies should be considered - do not interpret variances in isolation
DANGER - potential adverse effect on management behaviour
What you measure is what you get
Limitations of VA
Calcs are easy but only useful if we invetigate significant variances
- whch are significant?
- Is significance related to size only?
- Should favourable receiev the same interest as adverse?
- Are variances the result of poor planning or standards?
- Are records accurate?
- Are inter- relations recognised
- Will assignment of responsibility have the right effect on staff?
Disadvantages of budgetary controlRIgid operation
- May demotivate if imposed or unrealistic
- Manipulation and concealment
- uncontrolled spending
Criticisms:
- Time consuming and costly
- Poorly linked to strategy
- Infelxible - esp if not update regularly
- Reactive - focuses on cost reduction, not value creation
Sub optimal - Setting easily achievable targets
Prootection of costs
-