Session 3

Cash: the lifeblood of the

organizations

1
 Session 3

Cash: the lifeblood of

the organisations

2
 Internal Control

 Establishing and maintaining an appropriate

and integrated system of accounts and records
 Financial supervision and control by
management, including budgetary control,
management accounting reports and interim
accounts. –

3
Internal Control

 Safeguarding and if necessary duplicating

records.
 Engaging, training and allocating staff, who are
capable of fulfilling their responsibilities, to
specific duties; rotation of duties and cover for
absences.
Internal Control Aims

 To ensure that activities are orderly and

secure.
 To prevent the organisation being defrauded
or things belonging to the organisation being
mislaid, misappropriated or stolen, or to
detect such occurrences.
 To record transactions with as few errors as
possible.
Operating information

 Recording transactions provide Operating

information (OI) reliable and valid for day to
day tasks.
 OI is processed, analysed and aggregated to
provide information for strategy
implementation and strategic planning and to
provide information for statutory or legal
reporting purposes.
Control

 Strategic implementation resembles tasks

control in a systematic way with a fair level of
routine but also requires people in
managerial roles to analyse, evaluate and
interact.
 Control

 Diagnostic and interactive control contrast

with other form of control, namely, belief
systems and boundary systems.

 The volume of activities that constitute task

control exceeds those in the other

88 categories.
The importance of money

 Money dominates as the unit of

measurement in accounting and finance.

 For daily purposes, people need to measure

things in units other than money.
 Budgeting

 Establishing a planned level of expenditures,

usually at a fairly detailed level. A company may
plan and maintain a budget on either an accrual
or a cash basis.
 Process of expressing quantified resources
requirements (amount of capital, amount of
material, number of people) into time-phased
goals and milestones.
10
 The purpose of budgeting is to

 Provide a forecast of revenues and expenditures

i.e. construct a model of how our business might
perform financially speaking if certain strategies,
events and plans are carried out .
 Enable the actual financial operation of the
business to be measured against the forecast .

11
 Budgets

 The most effective financial budget includes both a

short-range, month-to-month plan for at least one
calendar year and a long-range, quarter-to-quarter plan
you use for financial statement reporting.
 It should be prepared during the two months
preceding the fiscal year-end to allow ample time for
sufficient information-gathering.
12
 Budgets

 The long-range plan should cover a period of

at least three years (some go up to five
years) on a quarterly basis, or even an
annual basis.

 The long-term budget should be updated

when the short-range plan is prepared.
13
 Budgetary control

A control technique whereby actual results are

compared with budgets.

 Any differences (variances) are made the

responsibility of key individuals who can
either exercise control action or revise the
original budgets.

14
 The Budget Process
Identify organization objectives and
short- term goals

Planning Develop long-term strategy and

short-term plans

Develop master budget

Measure and assess performance

Control against budget

Reevaluate objectives, goals,

strategy, and plans
The Cash Cycle

Sales
Inventory
RM Accounts
WIP Receivable
Finished Goods

Investment Collection

Cash
 The Master Budget

Two major types of budgets make up the master

budget
1- Operating budget: summarize the level of
activities such as: sales, purchasing budget,
and production.
2- Financial budgets, such as balance sheets,
income statements, and cash flow statements

17
 Master Budget
E xh ibit 1 0- 3
The Master Budget
3. spendin
plan
Capital g
I. Organization goals
--
- - --- -----
- ---- --- --- ---~
- - --
- -
2. Sales
plan
I

. '
5 Prodc:ction plan
6. Productive capacity
plan
.
'
•' I I

' f
A
8. Labor bring and trainingand
I
9. Administrative
'
plan I discretionary spending
plan

' .i->
HJ. Expected finzncial
results

12. Projectedincome statement

andbalance
!beet

18
 Operating budget:

1- Sales plan
2- Capital spending plan
3- production plan
4- Materials purchasing plan
5- labor hiring and training plan
6- administrative spending plan

19
 The Budgeting process illustrated

Review this comprehensive exercise page 450

Management accounting book

20
 Characteristics of a good budget
 Participation: involve as many people as possible in
drawing up a budget.
 Comprehensiveness: embrace the whole organization.
 Standards: base it on established standards of
performance.
 Flexibility: allow for changing circumstances.

 Feedback: constantly monitor performance.

 Analysis of costs and revenues: this can be done on
21 the basis of product lines, departments or cost centers.
 Advantages of budgeting and
budgetary control (1)

 Compels management to think about the future, which is

probably the most important feature of a budgetary planning
and control system. Forces management to look ahead, to
set out detailed plans for achieving the targets for each
department, operation and (ideally) each manager, to
anticipate and give the organization purpose and direction.
 Promotes coordination and communication.
22
 Advantages of budgeting and
budgetary control (1)

 Clearly defines areas of responsibility. Requires

managers of budget centers to be made responsible for
the achievement of budget targets for the operations
under their personal control.
 Provides a basis for performance appraisal (variance
analysis). A budget is basically a target against which
actual performance is measured and assessed.
 Control is provided by comparisons of actual results
against budget plan.
 Departures from budget can then be investigated and the
reasons for the differences can be divided into
23 controllable and non-controllable factors.
 Advantages of budgeting and
budgetary control (2)

 Enables corrective action to be taken as variances

occur.
 Motivates employees by participating in the setting
of budgets.
 Improves the allocation of scarce resources.
 Economizes management time by using the

24 management by exception principle.

 Problems in budgeting (1)

 Whilst budgets may be an essential part of any

marketing activity they do have a number of
disadvantages, particularly in perception terms.
 Budgets can be seen as pressure devices imposed
by management, thus resulting in:
– bad labor relations.
– inaccurate record-keeping. ·
25
 Problems in budgeting (1)

 Departmental conflict arises due to:

– disputes over resource allocation
– departments blaming each other if targets are
not attained.
 It is difficult to reconcile personal/individual and
corporate goals.
 Waste may arise as managers adopt the view, "we
had better spend it or we will lose it". This is
often coupled with "empire building" in order to
26 enhance the prestige of a department.
 Problems in budgeting (2)

 Responsibility versus controlling, i.e. some costs

are under the influence of more than one person,
e.g. power costs.
 Managers may overestimate costs so that they
will not be blamed in the future should they
overspend.
27
 Cash Budget

 An estimate of the expected cash inflows

and cash outflows for a company or
individual for a given period of time.
 A cash budget is vitally important because
it measures the liquidity of a company (or
individual) and therefore how much one can
spend before beginning to have financial
difficulties.
28
 Some of the Advantages and
disadvantages of Cash Budgets
Advantages:
1. Planned use of cash
2. Provision for Capital Expenditure
3. Investment of Surplus Funds
4. Dividend Policy
5. Profitable Use of Cash
6. Timely Payment of Debts
7. Arrangement for Obtaining Funds
8. Useful for Control
9. Helps Co-ordination
29 10.Easy to Obtain Funds
 Some of the Advantages and
disadvantages of Cash Budgets

Disadvantages:
The disadvantages of cash flow are that :
 Accurate figures are needed as an input to get
the same quality of output.
 Also it doesn't account to variable change so
damage costs aren't included.
30
 Comparing actual and planned results.

:
.

Actual amount= actual price per unit × Actual Quantity

Budgeted amount= Standard price per unit × Budgeted Quantity
31
 Basic Concepts

 Favorable variance (F): Variances are

favorable when actual revenues exceed
budgeted revenues and when actual
costs are less than budgeted costs.

 Favorable variance (F) has the effect of

increasing operating income relative to
the budget amount.
32
 Basic Concepts

 Unfavorable variance (U): Variances are

unfavorable when actual revenues less
than budgeted revenues and when
actual costs are more than budgeted
costs.
 Unfavorable variance (U)has the effect
of decreasing operating income relative
to the budget amount
33
 Comparing actual and planned results.

Budgeted Come from three sources:

1- Standards established by industrial
engineers.
2- previous period’s performance.
3- A performance level achieved by a
competitor
34
Material Quantity and Price variance:
 Quantity variance formula:

={ }X
Qua Actual Standar Standa
ntity
Varia Quntit
y
- d rd Price
nce Quntity
Price variance formula: 

Pri Actu Standar Actua

ce
Var ={ al - d Price }X l us
ian Price Quant
ed
ce ity
Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.
Material Quantity and Price variance:
 Quantity variance = 0

Qua 1,100, 2
={ }X
1,10
ntit
Vari 0,00 000- 5
y
anc 0
e Price variance = 2,200,000 Unfavorable
Pri 2 2 1,10
ce
Vari ={ 7 - 5 }X 0,00
anc 0
e Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.
 •bit 10-21
e,chl·als
Maten
Flexible .
dget
BU . PQ XAP PQ XSP
Analysis
Variance 1,100,0 X 27 1,100,000 X
00 25

Price
variance
2,200,000
U
AQ X SP SQ
X SP
1,100,000 X 25 1,100,000 X
25

Quantity
variance
0

37
 . ··-o-·-- ·,- ....... J -· ••••

Material Ouant·t ,
Materia l Quan tit y a n d Price Variance
T lte material quantit
I Y a nd p ·
r~ce Var ianc es
y vanance c b
QlJ ant,.ty v · an e calculated from the following relationship:
anance - (AO
- - SQ) x SP
"'(l,100,000 - units x €25 per unit
where = 1,100,000)
o
AQ == actual
SQ_ · quantity of materials
- standard q
used · .
uant,ty of materials allowed for the
production level
SP== achieved
estim t
d a e or standard price of materials
TI1e material price vari f .
relationship: ance ct·
or irect matenals
. IS calculated using the following

Price variance == (AP_ SP) x AO

= (€27 - €25) per unit x 1, 100,000
units
where = €2,200,000 (Unfavorable)

AP == actual price of materials

SP = estimated or standard price of materials
AQ == actual quantity of materials used

We have now decomposed the total variance for the cost of the welcoming pack•
age, which is the direct material in this example, into a material quantity variance
and a material price variance. When we add these two third-level variances together
(€0 + €2,200,000 U), we obtain the total flexible budget variance for direct materials
(€2,200,000 U).

Chapter 10 Using Budgets to Organizational Objectives 473

Achieve
38
 yvv\ v UUUll\.\..v ic ~w
..U lVUV" u,

Sumo! variances= OuantiW

decom~os variance t ~rice variance
ed = S x S~ t SP)
[(A Q [(AP- x AO]
= S) (SQ x
Q-
(AQ P) SP)
+ (APX
xAQ)-- (SPX
= (AP x AO)
AQ) -
(SQ x SP)
= Budget
Actual ed cost
= rlexiDle
cost-
Dudget
39 variance
Efficiency and wage rate variance of Direct Labor cost:
 Efficincy variance formula:

={ }X
Effici Actual Standar Standard
ency
Varia Hours - d Hours W Rate
nce
Labor rate variance formula: 

Labo Actu Standar Actua

rW
Vari ={ al - d Rate }X l
Rat
anc Rate Hour
e s
Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.
Efficiency and wage rate variance of Direct Labor cost:
 Efficiency variance = 1,375,000 Favorable

={ }X
Effici 495, 550,0 2
ency
Varia 000 - 00 5
nce
 Labor rate variance = 2,475,000 Unfavorable

Lab 3 2 4950
or
Vari ={ 0 - 5 }X 00 H
Rate
anc
e Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.
 Efficiency and
W The labor cost ::~
1~ce
Rate Variances for Direct
material
Laborquantity
Costs s are determined in a way similar to that for
and pnce Variances.
described The formulas are as
follows:
Labor efficiency variance = lAH - SH) x
SR Labor rate variance = (AR -
SR) x AH
wher
e
AH = actual number of direct tabor hours
AR = actual wage rate
SH = number of direct labor hours allowed given the \eve\
of output achieved
SR = standard wage rate
Note that whileit is commonto use the terms price and quantity
for thematerialvari•
ances, it is common to use the terms rate and efficiency forthe
comparablelaborvariances.
Chapter Using Budgets to Achieve 47
10 Organizational Ob1ectives 5

42
 The total cost variance for is computed as
labor follows:
Efficiency variance + Rate variance = (AH - SH) x SR + (AR
- SR)=X(AH
AH SR) - ( SH x SR) + (AR X AH) - (
x (AR xSR
= x -AH)
AH) (SR x SH)
= cost - Budgeted
Actual cost
=Flexible budget variance
To compute the efficiency and rate variance for the sales staff, the
total hours of sales staff used is 495,000 (0.45 x 1,100,000 hours), and
the total budgeted level of hours, given the achieved level of production,
is 550,000 (0.5 X 1,100,000 hours).
Therefore, the efficiency variance for sales staff labor cost is as
follows:
Efficiency variance = (AH - SH) x SR
= (495,000 - 550,000) x €25
= -€1,375,000
(Favorable)
The efficiency efforts commissioned by Sharon evidently paid off in
terms of fewer hours used of sales staff time than planned for the achieved
level of income, resulting in cost savings of €1,375,000.
The price or rate variance for sales staff labor is as follows:
Rate variance = (AR - SR) x AH
43 = (€30 - €25) per hour x 495,000 hours
 e,chibit 1 0-23
oecornposing
the Direct Labor
Cost variance ARARr----------
Labor rate
---------~---
SRr---------------------
variance
----------------
Rate -------~---l.----------
----------~---l.
-. Labor
efficienc
y
variance

Hours AH
SH
I

Exhibit 10-24
Direct Labor
Flexible AHXAR AHXSR
Varianc
Budget Analysi SH x SR
e s 495,000 x 30 495.000 x 25
550,000 x 25

Rate variance Efficiency variance

2,475,000 U 1,375,000 F

44 ri.. .., .... ~or 1 I Icino R11itvpt_s

n Obie
to Achieve Ornanizational
 Sales VARIANCES

Selling price variance =

( Actual selling price – Budgeted selling price ) ×
Actual units sold
= ( 125 – 120 ) × 10,000 units = $ 50,000 F,
which increases operating income.
Sales Volume variance =
( Actual Quantity – Budgeted Quantity ) ×
Actual Price
45 = ( 10,000 – 10,200 ) × 125 = $ 25,000 U
 Session 3 case study

 The diner

 Palmer Limited

46
47