Accounting of Narnia Ltd - Case Study Example

Accounting Coursework Name: Students ID: Unit Code: Instructor: Part 1: Variance Analysis Narnia Ltd. Budgeted Income Statement for the Month Ended 31 March 20XX Amount (£) Amount (£) Sales (200 * 10000) 2000000 Variable Cost of Goods Sold Direct materials (90 * 10000) 900000 Direct labour (50 * 10000) 500000 1400000 Budgeted contribution 600000 Fixed production overheads 20000 Fixed non-production overheads 12000 Budgeted profit 568000 Reconciliation Statement Amount (£) Amount (£) Budgeted profit 568000 Sales variance Sales price variance 60000A Sales volume variance 113600F 53600F Material cost variance Material price variance 12000A Material volume variance 0 12000A Labour cost variance Labour rate variance 12000A Labour efficiency variance 50000A 62000A Fixed overhead variance Fixed production overhead variance 5000A Fixed non-production overhead variance 2000F 3000A Actual Profit 513400 Part 2: Importance of Budgeting Budgets According to the Chartered Institute of Management Accountants, a budget is “A financial and/or quantitative statement, prepared and approved prior to define period of time, of the policy to be pursued during that period for the purpose of attaining a given objective.” From a managerial perspective, it is a “predetermined statement of managerial policy during the given period which provides a standard for comparison with the results actually achieved.” It is a key tool in management for planning, controlling, and monitoring the funds of an organisation or a project. From these definitions, it is clear that a budget is essentially; (i) a statement prepared for a definite future period of time in advance; (ii) monetary and/or quantitative statement of policy; and (iii) a pre-set statement and it is intended to accomplish a particular objective. Therefore, it can be taken as a document that is closely knit to both accounting as well as managerial functions of an organisation. A budget estimates the income and expenditures for a fixed period of time for a project or organisation. Therefore, it must reflect the income (various sources of revenue, such as sales or contributions) and expenditures (itemised expenses, such as fees, purchases). Other important components to be considered when preparing a budget include: the currency, notes (to record the budgeting process), and contingency funds (to allow for fluctuations and abrupt expenses), among others. Classification of Budgets Budgeting plays an important role which is best understood when related to the particular basis for which it is prepared. This leads to various classifications of budgets based on: (1) Time; (2) Capacity; and Function. On the basis of time, long-term budgets are prepared bearing in mind a longer period of over five years. Long-term budgets sum up the over-all plan of operations plus the expected consequences and it mainly targeted to the top-level management of an organisation. The cover important activities, such as the like composition of the organisation’s capital expenditure, and new product development and research. On the other hand, short-term budgets are ordinarily prepared for a period of one year or for shorter period like quarterly or half-yearly. Their scope of budgeting varies greatly among different organisations, such as team activities and meetings, trips. Current budgets are prepared for the current business operations and cover a planning period of months or weeks. The current budgets are established for use over a short period of time and are associated with current conditions (Hope & Fraser, 2003). Fixed budgets and flexible Budgets are prepared based on the capacity. A fixed budget, just as the name suggests, is designed to stay unchanged notwithstanding the level of activity essentially accomplished. However, a flexible budget can accommodate changes depending on the various level of activity actually reached. The flexible budget also takes into account both fixed, variable and semi-fixed manufacturing expenditures (Hope & Fraser, 2003). Based on function, there are functional budget and master budget. A functional budget is relates to a particular function of an organisation. The number of functional budgets depend upon the size and nature of business. The commonly used functional budgets are: (1) purchases budget, (2) sales budget, (3) production budget, (4) labour cost budget, (5) selling and distribution cost budget, (6) cash budget, and (7) capital expenditure budget. A master budget is a summary budget incorporating all the functional budgets into one harmonious unit. It has to be finally approved, accepted and employed. Figure 1: Types of Budgets Importance of Budgeting The above chart indicates that a budget can serve several essential purposes. Most people appreciate the significance of stepping up and running through to a home budget. It offers the best way to ensure that domestic expenses do not overrun the income, compelling families and individuals to use credit cards or borrow money so as to meet their expenses. Financiers also need a budget as a vital tool providing an understanding of the work to be financed. The financiers are mainly interested in local costs, other sources of funds, the link between expenditures and activities, as well as the percentage of overheads, among other considerations (Libby & Lindsay, 2010). The same tenets apply to managing business finances. It is imperative that managers work together with other key members of the management team to set up a business budget that defines the organisation’s basic financial structure and cash management systems within this structure. Through business budgeting organisations are able to cut down the uncertainty that often goes with expense and cash flow forecasting. It also provides executives with a financial framework for all of the company’s business decisions. Budgeting is mainly beneficial in giving the managers the freedom of making decisions and still stick within the budgets. It makes it easy for the managers to delegate and limit authority and responsibility. Budgets make the top management feel that they are in control of the several business activities of the company. Budgeting also promotes continuous improvement by doing away with non-value adding undertakings. New or improved processes are designed to boost productivity (Hope & Fraser, 2003). A budget makes it possible for a company to set performance standards and activity level for different departments and functions within the company. This pushes the various departments and functions to work within the outline of a common inclusive plan. Budgeting can as well be used to evaluate the performance of different managers and functions within the organisation. Budgeting is one of the most noticeable tools to give managers more freedom to manage their performance (Hope & Fraser, 2003). Result-based or performance budgeting is a “form of budgeting that relates funds allocated to measurable results” (Libby & Lindsay, 2010). In a move from ex-ante to ex-post controls the attention changes from inputs to outputs or even outcomes. “Input controls are relaxed and managers and/or organizations are given flexibility to improve performance. In return they are held accountable for results measured in the form of outputs and/or outcomes” (Libby & Lindsay, 2010). In a bid to achieve this aim, various legislative bodies switched a line itemised budget with a budget, in which a net sum of expenditures is decentralised to the administrative entities in combination with performance objectives. These consolidated appropriations might be applicable to the entire budget or be limited to operational costs. Brookson (2000) indicates that if performance budgets take account of consolidated appropriations, the efficiency and flexibility of administrations will improve. This is because the administrators will be able to distribute resources that match current needs instead of relying on past expectations that are symbolised in the estimates. Budgeting can also boost employee motivation through increased responsibility (Moynihan 2008), which is articulated by way of slogans like “let the managers manage!” Brookson (2000) points out that the improved flexibility of lump-sum type consolidated appropriations can be acknowledged as an empowering model: “By giving people the power to make decisions, individuals are motivated and use their initiative and innovate, to the good of the organisation.” Limitations of Budgeting Budgeting is not a panacea. It faces various challenges. Traditional budgeting focuses mainly on expenses and does not sufficiently consider the results gained as a result of the expenses sustained. For example, a marketing manager possibly will not cash on a prospect to sell more by increasing the travelling of his sales-persons given that it will result in travel expenditure that exceeds the budget. Also, the emphasis on input cost to the inclusion of the deliberation of results achieved makes budgeting somewhat worthless when the level of operations keep fluctuating. A case in point is when the production cost in any company is closely linked to the level of production. And so, a fixed budget that fails to take into account the level of production can turn out to be quite unsuitable as a planning or controlling tool (Jensen, 2001). Budgeting is also affected by the manner in budgets are finalised. In a lot of organisations, budgets are often set on the basis of past performance instead of the future needs. This is disposed to generate a wrong feeling of planned working, when in reality the organisation is merely wandering along with the flow of past trends. Budgeting also demotivates employees, especially when they feel that targets set for them are hard to achieve. Budgeting can as well carry a real opportunity cost if a lot of employees are embroiled in the budgeting process meaning that they will not be able to carry out other duties (Hope & Fraser, 2003). Budgeting is always open to mistakes and inaccuracies given that future predictions are hard to make. External forces, such as fluctuating interest rates, exchange rates and prices of commodities may well interfere with the whole process. This will also create room for managers to pad the budget or create budgetary slack so as to inflate figures for the top management not to rebuke them. Budgeting involves and affects people and may, therefore, cause conflict. Difficult choices have to be made due to limited funds. Those departments with tight budgets possibly will feel forced (Hope & Fraser, 2003). Conclusion Budgets are a necessary evil. They help to plan for the future, control and monitor individual as well as organisational activities. However, they face a number of setbacks. Even though recent developments such as zero-based budgeting and performance budgeting help to overcome some of the challenges there still remains a void. But in the whole, budgeting is a vital management tool (Jensen, 2001). References Brookson, S. 2000. Managing Budgets, New York, Dorling Kindersley. Hope, J. and R. Fraser. 2003. Who needs budgets? Harvard Business Review, 81(2): 108-115. Jensen, M. 2001. Corporate budgeting is broken – let’s fix it. Harvard Business Review, 79(10): 94-101. Libby, T. and M. Lindsay. 2010. Beyond budgeting or budgeting reconsidered? A survey of North-American budgeting practice. Management Accounting Research, 21:56-75. Read More