Total PS TG. Budgeted production levels can be calculated as follows:

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1 U. ;' cn '.:. \.' >>.:---"--^ '-.'" * i--.'. * ::-;.v>"--:'i.-^ =../.-' "-. " '.:.' Ill all it.;? s Solution Total PS TG Sales units 6,000 5,000 1,000 Sales value $605,000 $475,000 $130,000 Workings Sales - PS = 5,000 x $95 = $475,000 Sales -TG = 1,000 x $130 = $130,000 chapter 13 '.': ^.-' -.,.' -'* : - - ;*: :* *; i- "-. :-- Test your understanding 1 A copany akes two products - A and B. The products are sold in the ratio 1:1. Planned selling prices are $100 and $200 per unit respectively. The copany needs to earn $900,000 revenue in the coing year. Required: Prepare the sales budget for the coing year. -;: Production budgets -..-.VvA.'i ^"J r ~- F j Budgeted production levels can be calculated as follows: Budgeted production = Forecast sales + Closing inventory of finished goods - Opening inventory of finished goods Illustration 3 - Production budgets A copany akes two products, PS and TG. Forecast sales for the coing year are 5,000 and 1,000 units repectively. 9 ;-ft:fi 5W.:.-..;.'.." ' «;?o-;; ;» -.-vv, V'-- i The copany has the following opening and required closing inventory levels..- : : ^ :w-.;?':' Opening inventory Required closing inventory PS units TG units , Required: is plfl Prepare the production budget for the coing year. 317

2 Budgeting Solution I] Production budget PS units TG units Sales budget 5,000 1,000 + Closing inventory 1, ' :' - Opening inventory (100) (50) o\-v;:; r-.-'-.v i:t>!; Budgeted production in units 6,000 1,000 Test your understanding 2,:/: Newton Ltd anufactures three products. The expected sales for each product are shown below. Product 1 Product 2 Product 3 Sales in units 3,000 4,500 3,000-3 :.!" : '' ' ;*; J Opening inventory is expected to be: Product units Product units Product units Manageent have stated their desire to reduce inventory levels, and closing inventory is bud 3d as: : Product 1 Product 2 Product units 300 units 300 units Required: Coplete the following: '... '; : ;f> V-.-.- (a) The nuber of units of product 1 to be produced is (b) The nuber of units of product 2 to be produced is (c) The nuber of units of product 3 to be produced is ' '-." '.., * 318

3 -.:" -. chapterj3 ';/ I I : "V,. ij 5 Material budgets There are two types of aterial budget that you need to be able to calculate, the usage budget and the purchases budget. The aterial usage budget is siply the budgeted production for each product ultiplied by the quantity (e.g. ) required to produce one unit of the product. The aterial purchases budget is ade up ofthe following eleents. Material purchases budget =Material usage budget +Closing inventory - Opening inventory Illustration 4 - Material budgets A copany produces Products PS and TG and has budgeted to produce 6,000 units of Product PS and 1,000 units of Product TG in the coing year. The data about the aterials required to produce Products PS and TG is given as follows. Finished products: PS per unit TG per unit Kg of raw aterial X Kg of raw aterial Y Direct aterials: Raw aterial X Y.y.vV;j:j:.-.:; Desired closing inventory Opening inventory 6,000 1,000 5,000 5,000 Standard rates and prices: Raw aterial X Raw aterial Y $0.72 per $1.56 per 319

4 Budgeting Required: Prepare the following: (a) The aterial usage budget. (b) The aterial purchase budget. Solution Material budgets For production of PS (W1) For production of TG (W2) Material X Material Y 72,000 36,000 12,000 8,000 Material usage budget + Closing inventory - Opening inventory 84,000 6,000 5,000 44,000 1,000 5,000 Material purchases budget (units) 85,000 40,000 $ Material purchases budget ($) X $0.72 per x 85,000 61,200 Y $1.56 per x 40,000 62,400 Workings (W1) Budgeted production of Product PS = 6,000 units Therefore: 6,000 x 12 perunit =72,000 of Material Xrequired. Therefore: 6,000 x 6 per unit =36,000 ofmaterial Yrequired. (W2) Budgeted production ofproduct TG = 1,000 units Therefore: 1,000 x 12 per unit = 12,000 of Material Xrequired. Therefore: 1,000 x 8 per unit =8,000 ofmaterial Yrequired. 320 RH MiMHUniUKMi wwwiuiawin

5 -' -. chapter 13 Test your understanding 3 - " :,, H -.-.." ' '/ " ^ :Wffl Newton Ltd anufactures three products. The expected production levels for each product are shown below. Product 1 Product 2 Product 3 Budgeted production in units 2,700 '4,100 2,800 ii > I Three types of aterial are used in varying aounts in the anufacture of the three products. Material requireents are shown below: Material M1 Material M2 Material M3 Product Product Product The opening inventory of aterial is expected to be: Material M1 Material M2 Material M3 4,300 3,700 4,400 I $1 Manageent are keen to reduce inventory levels for aterials, and closing inventory levels are to be uch lower. Expected levels are shown below: Material M1 2,200 Material M2 1,300 Material M3 2,000 Material prices are expected to be 10% higher than this year and current prices are $1.10/ for aterial M1, $3.00/ for aterial M2 and $2.50/ for aterial M3. 321

6 Budgeting Required: Coplete the following. (a) (i) The quantity of aterial M1 to be used is (ii) The quantity of aterial M2 to be used is (iii)the quantity of aterial M3 to be used is (b) (i) The quantity of aterial M1 to be purchased is These purchases have a value of $ (ii) The quantity of aterial M2 to be purchased is These purchases have a value of $ (iii) The quantity of aterial M3 to be purchased is These purchases have a value of $ 6 Labour budgets '':' '' Eg ' :: : ' Labour budgets are siply the nuber of hours ultiplied by the labour rate per hour as the following illustration shows. Illustration 5 - Labour budgets _..- < '- A copany produces Products PS and TG and has budgeted to produce 6,000 units of Product PS and 1,000 units of Product TG in the coing year. The data about the labour hours required to produce TG is given as follows. Finished products: Products PS and i PS perunit TG per unit Direct labour hours 8 12 Standard rate for direct labour = $5.20 per hour 322

7 BMWMiBMi tu chapter 13 Required: Prepare the labour budget for the coing year. '.-." ipi Solution Hours For Product PS 6,000 x 8 hrs 48,000 ^ ' '^.'"'V For Product TG 1,000 x 12 hrs 12,000 n-: 312, ,C-r' Test your understanding 4 '..V Newton Ltd anufactures three products. The expected production levels for each product are shown below. i Product 1 Product 2 Product 3 Budgeted production in units 2,700 4,100 2,800 r.",-v-*-'"i Two types of labour are used in producing the three products. Standard ties per unit and expected wage rates for the forthcoing year are shown below: Product 1 Product 2 Pi.... ; Hours per unit Skilled labour Sei-skilled labour turn :- Skilled labour is to be paid at the rate of $9/hour and sei-skilled labour at the rate of $6/hour : 323

8 Budgeting Required: Coplete the following. (a)the nuber of hours of skilled labour required is The cost of this labour is $ (b)the nuber of hours of sei-skilled labour required is The cost of this labour is $ n Test your understanding 5 A contract cleaning fir estiates that it will take 2,520 actual cleaning hours to clean an office block. Unavoidable interruptions and lost tie are estiated to take 10% of the workers' tie. Ifthe wage rate is $8.50 per hour, the budgeted labour cost will be: A $19,278 B $21,420 :,"...:. ;. C $23,562 i. ; ' : D $23,800 If! 324

9 nafi in -! ;: >' ':-i «;& ;,.;::,.; chapter 13 >.;' ' :' : -;': ' " '. :' W- ::,', -'. ' :.: --. ; ;:. : -V: 7 Overhead budgets The following illustration deonstrates the calculation of overhead budgets. Illustration 6 - Overhead budgets Acopany produces Products PS and TG and has budgeted to produce 6,000 units of Product PS and 1,000 units of Product TG in the coing year. The following data about the achine hours required to produce Products PS and TG and the standard production overheads per achine hour is relevant to the coing year. PS per unit TG per unit Machine hours 8 12 fs, :, 1;-' V- '.hi :Q - ; ".. - '-::.-:':;/."' Production overheads per achine hour Variable $1.54 per achine hour Fixed ' $0.54 per achine hour Required: Calculate the overhead budget for the coing year. :. :. 3 7;^ '-'. I'.;:-'X >; ;'i;i ;, : >;.;:; ; '' -' : r, ; >- Solution Overhead budget Variable costs 60,000 hours x $1.54 Fixed costs 60,000 hours x $0.54 $ 92,400 32, ,800 Workings ;.7.";>'.--. a'-'j---'^'; : Machine hours - Product PS = 6,000 units x 8 hours = 48,000 achine hours Machine hours - Product TG = 1,000 units x 12 hours = 12,000 achine hours Total achine hours = 48, ,000 = 60,

10 Budgeting Test your understanding 6 Newton Ltd anufactures three products. The expected production levels for each product are shown below. Budgeted production in units Product 1 Product.2 Product 3 2,700 4,100 2,800 Two types of labourare used in producing the three products. Standard ties per unit and expected wage rates for the forthcoing year are shown below: Product 1 Product 2 Product 3 Skilled labour Sei-skilled labour Production overheads per labour hour are as follows: Variable $3.50 per labour hour Fixed $5.50 per labour hour Required: Calculate the overhead budget. 8 Fixed, flexible and flexed budgets Budgetary control cycle At the beginning of this chapter we listed the ain purposes of budgeting, one of which was 'controlling costs - by coparing the plan of the budget with the actual results and investigating any significant differences between the two' - this is known as budgetary control. r"i: ".. ' :> /' '.. -.:. 326

11 chapter 13 : The budgetary control cycle can be illustrated as follows..-i Budget agreed. ' I I i M i-v;-.:.--;--,!- :'.-: B8 v:-.r..:' : -. ".' Feedback for revision of next budget Expenditure incurred Differences between budget and actual analysed } Feedback for revision of perforance ;-n!j--:::v;-;: Reasons for differences sought and obtained, followed by appropriate anageent action '. :' ' J 1^1 Fixed budgets i^ws The siplest for of budget report copares the original budget against actual results and is known as a fixed budget. sis. -'..-, : ' ''.'':.i:- Any differences arising between the original budget and actual results are known as variances. Variances ay be either adverse or favourable. Adverse variances (Adv) or (A) decrease profits. ' ' Favourable variances (Fav) or (F) increase profits. An exaple of a budget report is shown below. Budget Actual Sales units 1,000 1,200 W Production units 1,300 1,250 ifiib'i: 327

12 Budgeting > Variance Sales revenue $10,000 $11,500 $1,500 Fav Less : labour costs $2,600 $2,125 $475 Fav Less : aterials costs $1,300. $1,040' $260 Fav Less : overheads $1,950 $2,200 $250 Adv Cost of sales $5,850 $5,365 $485 Fav Profit $4,150 $6,135 $1,985 Fav The fixed budget shown above is not particularly useful because we are not really coparing like with like. For exaple, the budgeted sales were 1,000 units but the actual sales volue was 1,200 units. The overall sales variance isfavourable, butfro the report shown we don't know how uch of this variance is due to the fact that actual sales were 200 units higher than budgeted sales (or whether there was an increase in the sales price). Siilarly, actual production volue was 50 units less than the budgeted production volue, sowe are not really aking a very useful coparison. It is ore useful to copare actual results with a budget that reflects the actual activity level. Such a budget is known as a flexed budget. Flexed budgets, Aflexed budget is a budget which recognises different cost behaviour patterns and is designed to change as the volue of activity changes. When preparing flexed budgets it will be necessary to identify the cost behaviour of the different ites in the original budget. In soe cases you ay have to use the high/low ethod in order to deterine the fixed and variable eleents of sei-variable costs. 5'. *:.',.. -".;*.-. :. :. i^ r 328

13 ' iilhuiini»i Kg Illustration 7-Fixed, flexible and flexed budgets Wye Ltd anufactures one product and when operating at 100% capacity can produce 5,000 units per period, but for the last few periods has been operating below capacity. penoas Below is the flexible budget prepared at the start of last period for three levels of activity at below capacity: chapter 13 ;--? * ;i- I. 1 ig! '* - ' I..- a.. " : Level of activity Direct aterials Direct labour Production overheads Adinistration, selling and distribution overheads 70% 80% 90% $ $ $ 7,000 8,000 9,000 28,000 32,000 36,000 34,000 36,000 38,000 15,000 15,000 15,000 Total cost 84,000 91,000 98,000 I.'-..-- V--' tsgiii ::." : -?.;. I p ' '.- In the event, the last period turned out to be even worse than expected with production of only 2,500 units. The following costs were incurred: ' ' :.'/ - ' "' fe-ffi; : :. - -a ".;. Direct aterials Direct labour Production overheads Adinistration, selling and distribution overheads Total cost Required: Use the inforation given above to prepare the following. $ 4,500 22,000 28,000 16,500 71,000 (a) Aflexed budget for 2,500 units. (b) A budgetary control stateent. ; ; 329

14 Budgeting Solution (a) Flexed budget for 2,500 units Direct aterials (W1) (2,500 x $2) Direct labour (W2) (2,500 x $8) Production overheads (W3) Adinistration, selling and distribution overheads (W4) $ 5,000 20,000 30,000 15,000 Total cost 70,000 Workings -; 1 Material is a variable cost - $2 per unit Variable aterial cost = $7,000 70% x 5,000 $2 per unit 2 Labour is a variable cost - $8 per unit. Variable labour cost = $28,000 70% x 5,000 = $8 per unit 3 Production overheads are sei-variable. Using the high/low ethod, the variable cost is $4 per unit, the fixed cost is $20,000. The cost for 2,500 units therefore = $20,000 + (2,500 x $4) = $30, % activity = 70% x 5,000 = 3,500 90% activity = 90% x 5,000 = 4,500 Variable cost per unit: $(38,000-34,000) 4,500-3,500 $4 per unit Total fixed cost by substituting at high activity level: 330

15 chapter 13 Total cost = $38,000 Total variable cost = 4,500 x $4 $18,000 Fixed cost = $20,000 4 Other overheads are fixed. (b) Budget for 2,500 units Actual Variance Production (units) Indirect labour Consuables Other variable Fixed Flexed Actual Expenditure budget budget results Variances 20,000 17,600 17,600 $ $ $ $ 20,000 17,600 19,540 (1,940) (A) ,000 (296) (A) 4,200 3,696 3,660 36(F), Depreciation Other fixed 25,000 22,000 24,200 (2,200) (A) 10,000 10,000 10,000-5,000 5,000 5,400 (400) (A) Direct aterials Direct labour Production overheads $ $ $ 5,000 4, (F) 20,000 22,000 2,000 (A) 30,000 28,000 2,000 (F) Total cost 70,000 71,000 1,000 (A) 331

16 : Budgeting 9 Chapter suary The purposes of budgeting Planning Counication Control Co-ordination Authorisation Motivation Evaluation BUDGETING ^ The stages of budget preparation 1. Budget coittee fored 2. Budget anual produced 3- Liiting factor identified and its corresponding budget prepared 4- Initial functional budgets prepared 5- Initial budgets reviewed and integrated into coplete budget syste 6. Top anageent give final approval 7- Budgets reviewed regulary and variances arising are investigated v! I w Fixed, flexible and flexed budgets Original budget = fixed Flexed budget recognises different cost behaviour patterns and is designed to change volue of activity changes J SALES BUDGETS PRODUCTION BUDGETS MATERIAL BUDGETS LABOUR BUDGETS OVERHEAD BUDGETS Note that ifsales is the liiting factor (principal budget factor) then sales deand is what liits the activitiesof an organisation and so the sales budget ust be prepared first. Once the sales budget has been prepared, the production budget can be prepared, followed by the aterial, labour and overhead budgets. ; :-::: M i I 332

17 chapter Standard costi Chapter learning objectives Upon copletion of this chapter you will be able to: explain, for a anufacturing business, the purpose and principles of standard costing: targets, feedback/variances, ease of ' accounting establish, fro inforation supplied, the standard cost per unit under arginal costing establish, fro inforation supplied, the standard cost per unit under absorption costing calculate, fro inforation supplied, the sales price and volue variances for given or calculated sales variances, interpret and explain possible causes, including possible interrelationships between the calculate, fro inforation supplied, the aterials total, price and usage variances for given or calculated aterials variances, interpret and explain possible causes, including possible interrelationships between the calculate, fro inforation supplied, the labour total, price and efficiency variances for given or calculated labour variances, interpret and explain possible causes, including possible interrelationships between the calculate, fro inforation supplied, the variable overhead total, expenditure and efficiency variances for given or calculated variable overhead variances, interpret and explain possible causes, including possible interrelationships between the calculate, fro inforation supplied, fixed overhead total and expenditure variances 339

18 Standard costing. calculate, fro inforation supplied, where appropriate, fixed overhead volue, capacity and efficiency variances for given or calculated fixed overhead variances, interpret and explain possible causes, including possible interrelationships between the using given variances and standard figures, calculate actual figures using given variances and actual figures, calculate standard figures using given or derived variances, produce an operating stateent to reconcile budgeted profit with actual profit under standard absorption costing using given or derived variances, produce an operating stateent to reconcile budgeted profit or contribution with actual profit or contribution under standard arginal costing. i ;.->< 34O

19 chapter 14 (? THE PURPOSE OF STANDARD COSTING "-'^ :'-- - : - ;v-:.; ;- STANDARD COSTING %^ fc.v-r.?.-;. :r? "- ^?- STANDARD COSTING PER UNIT lo.'v.':',"'; :-J (-&.} ::?. : VARIANCE CALCULATION AND ANALYSIS i-v :.; --:. -.. :-; ---. t?r:- \- :. iv, ;-'.«- ''# ^V«-- '...- ;T: y'-'.: BS SALES VARIANCES MATERIAL COST VARIANCES LABOUR COST VARIANCES VARIABLE OVERHEAD VARIANCES FIXED OVERHEAD VARIANCES r. :: ".'. --;" :.---! 'V P^ iv-. : - ;-:, -.: ;;.--: ~ OPERATING STATEMENTS a ;. : - ; y:.-' ':;. ;.- 1 The purposes of standard costing Introduction to standard costing A standard cost is the planned unit cost of a product or service..',.;, :: :---vv : :, ':-: V ;4 '. '-. ;'-v!i:- * : -. - In order to prepare budgets we need to know what an individual unit of a product or service is expected to cost. Standard costs represent 'target' costs and they are therefore useful for planning, control and otivation. As well as being the basis for preparing budgets, standard costs are also essential for calculating and analysing variances. Variances provide 'feedback' to anageent indicating how well, or otherwise, the copany is doing. Standard costs also provide an easier ethodl^i^couniigg since it enables siplified records to be kept.. -T^^ Astandard cost ay be coputecy?ni either%^rfs^^^^^^bs\s, including only variable costs, or u'rjder absoj^t[4n:'costu\g. fcfc. r-' -'< 341

20 Standard costing Types of cost standards There are four ain types of cost standards. Basic standards. Ideal standards. Attainable standards. Current standards. Basic standards - these are long-ter standards which reain unchanged over a period of years. Their sole use is to show trends over tie for ites such as aterial prices, labour rates, and labour efficiency. They are also used to show the effect of using different ethods over tie. Basic standards are the least used and the least useful type of standard. Ideal standards - these standards are based upon perfect operating conditions. Perfect operating conditions include: no wastage; no scrap; no breakdowns; no stoppages; no idle tie. In their search for perfect quality, Japanese copanies use ideal standards for pinpointing areas where close exaination ay result in large cost savings. Ideal standards ay have an adverse otivational ipact because they are unlikely to be achieved. Attainable standards - these standards are the ost frequently encountered type of standard. They are based upon efficient (but not perfect) operating conditions. These standards include allowances for the following: noral or expected aterial losses; fatigue; achine breakdowns. Attainable standards ust be based on a high perforance level so that with a certain aount of hard work they are achievable (unlike ideal standards). Current standards - these standards are based on current levels of efficiency in ters of allowances for breakdowns, wastage, losses and so on. The ain disadvantage of using current standards is that they do not provide any incentive to iprove on the current level of perforance. 2 Standard costs per unit Standard cost cards Once estiated, standard costs are usually collected on a standard cost card. 342