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Therefore, for e. Having identified cost centres, the next step will be to make a quantitative calculation of the resources to be used, and to further break this down to shorter periods, say, one month or three months. The length of period chosen is important in that the shorter it is, the greater the control that can be exercised by the budget but the greater the expense in preparation of the budget and reporting of any variances. The quantitative budget for harvesting may be calculated as shown in figure 4. Once the budget in quantitative terms has been prepared, unit costs can then be allocated to the individual items to arrive at a budget for harvesting in financial terms as shown in table 4.

Charge out costs In table 4. Some of the costs are fixed, e. Other costs such as repairs are unpredictable and may be very high or low - an estimated figure based on past experience. If the tractor is used for more than 1, hours then there will be an over-recovery on its operational costs and if used for less than 1, hours there will be under-recovery, i.

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The budget represents an overall objective for the farm for the whole year ahead, expressed in financial terms. Table 4. Balance sheet at the end of the year. Cash flow budget which shows the amount of cash necessary to support the operating budget. It is of great importance that the business has sufficient funds to support the planned operational budget.


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Reporting back During the year the management accountant will prepare statements, as quickly as possible after each operating period, in our example, each quarter, setting out the actual operating costs against the budgeted costs. This statement will calculate the difference between the 'budgeted' and the 'actual' cost, which is called the 'variance'.

There are many ways in which management accounts can be prepared. To continue with our example of harvesting on the sugar cane farm, management accounts at the end of the third quarter can be presented as shown in figure 4. It appears that actual costs are less than budgeted costs, so the harvesting operations are proceeding within the budget set and satisfactory. However, a further look may reveal that this may not be the case.


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The budget was based on a cane tonnage cut of 16, tonnes in the 3rd quarter and a cumulative tonnage of 25, If these tonnages have been achieved then the statement will be satisfactory. If the actual production was much higher than budgeted then these costs represent a very considerable saving, even though only a marginal saving is shown by the variance.


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  8. Similarly, if the actual tonnage was significantly less than budgeted, then what is indicated as a marginal saving in the variance may, in fact, be a considerable overspending. Price and quantity variances Just to state that there is a variance on a particular item of expenditure does not really mean a lot.

    Most costs are composed of two elements - the quantity used and the price per unit. A variance between the actual cost of an item and its budgeted cost may be due to one or both of these factors. Apparent similarity between budgeted and actual costs may hide significant compensating variances between price and usage. Management may therefore need to investigate some significant variances revealed by further analysis, which a comparison of the total costs would not have revealed.

    Price and usage variances for major items of expense are discussed below. Labour The difference between actual labour costs and budgeted or standard labour costs is known as direct wages variance.

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    This variance may arise due to a difference in the amount of labour used or the price per unit of labour, i. The direct wages variance can be split into: i Wage rate variance: the wage rate was higher or lower than budgeted, e. Materials The variance for materials cost could also be split into price and usage elements: i Material price variance: arises when the actual unit price is greater or lower than budgeted.

    Could be due to inflation, discounts, alternative suppliers etc. Overheads Again, overhead variance can be split into: i Overhead volume variance: where overheads are taken into the cost centres, a production higher or lower than budgeted will cause an over-or under-absorption of overheads. Calculate: i Price variance ii Usage variance Comment briefly on the results of your calculation. Management action and cost control Producing information in management accounting form is expensive in terms of the time and effort involved.

    It will be very wasteful if the information once produced is not put into effective use. There are five parts to an effective cost control system. These are: a preparation of budgets b communicating and agreeing budgets with all concerned c having an accounting system that will record all actual costs d preparing statements that will compare actual costs with budgets, showing any variances and disclosing the reasons for them, and e taking any appropriate action based on the analysis of the variances in d above.

    Action s that can be taken when a significant variance has been revealed will depend on the nature of the variance itself. Some variances can be identified to a specific department and it is within that department's control to take corrective action. Other variances might prove to be much more difficult, and sometimes impossible, to control.

    Variances revealed are historic. They show what happened last month or last quarter and no amount of analysis and discussion can alter that.

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    However, they can be used to influence managerial action in future periods. Zero base budgeting ZBB After a budgeting system has been in operation for some time, there is a tendency for next year's budget to be justified by reference to the actual levels being achieved at present. In fact this is part of the financial analysis discussed so far, but the proper analysis process takes into account all the changes which should affect the future activities of the company.

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