UNIVERSITY OF CAPE TOWN - COLLEGE OF ACCOUNTING

MANAGEMENT ACCOUNTING II ACC3023W

CONTROL FUNCTION AND BUDGETING

CONTENTS

1. INTRODUCTION ...................................................................................................................... 2
2. LEARNING OBJECTIVES .......................................................................................................... 2
[Link] COMPETENCY AND DEFINITIONS ............................................................................... 5
4. PRE-READING INFORMATION ............................................................................................... 9
[Link] LECTURE NOTES ...................................................................................... 9
[Link] EXAMPLES ............................................................................................................ 15
[Link] OF THE WEEK.......................................................................................... 21
8. TUTORIALS ......................................................................................................................... .22

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 INTRODUCTION

This module covers the control function and budgeting which forms part of the
organisation framework for planning and control. Budgeting is primarily a tool for planning
and strategic purposes. This builds on your knowledge of budgeting from Management
Accounting 1 and as such it is expected that students are comfortable with the concepts
covered in Management Accounting 1. The control function is extremely important as it
covers the entire planning and control pillar in management accounting. We will use the
control function in Budgeting as well as further sections such as Standard costing, transfer
pricing and performance evaluation.

LEARNING OBJECTIVES

Key learning objective(s) are:

On completion of this module, you should be able to:

The control function:

a) Describe the three different types of control used in organisations

b) Distinguish between feedback and feed-forward controls
c) Explain the potential harmful side-effects of results controls
d) Define the four different types of responsibility centres
e) Explain the different elements of management accounting control systems
f) Describe the controllability principle and the methods of implementing it
g) Discuss how the level of difficulty of targets impacts on
motivation and performance
h) Describe the influence of participation in the budgeting process
i) Distinguish between the different approaches that managers
use to evaluate budgetees’ performance

Budgeting:

j) Understand and be able to explain how budgeting fits into an organisation

k) Identify and describe the purposes of budgeting
l) Identify and describe the various stages in the budgeting process
m) Discuss the importance of assumptions and predictions in budgeting
n) Prepare a budget, or adjust an existing budget
o) Be able to explain what a flexible budget is and where it might be used
p) Understand and discuss zero-based, incremental and activity- based budgeting
q) Discuss the limitations of budgeting

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 The focus of this section is not to teach the preparation of a Master Budget,
or any other subsidiary budgets, but the focus is rather on the
“soft”/qualitative issues inherent in the budgeting process. The numerical
preparation of budgets is considered to be prior knowledge gained from
previous management accounting courses.

SAICA COMPETENCY AND DEFINITIONS

SAICA COMPETENCY LEVEL

C1.2 Decision-making based on budgeting and expenditure forecasting

Level Learning Outcomes Minimum content
2 a) Understand the budgeting and expenditure • Corporate strategy and long-term planning (as it
forecasting processes which translate the relates to budgeting)
organisation’s business strategy into financial targets • Budgeting
and tactical plans and that can be executed in a risk- o relevant costing
controlled manner o operating budgets (sales, production, procurement,
b) Use effective and consistent modelling, planning and and general and administrative) over an appropriate
forecasting processes across business unit(s) to period of time
benchmark performance and trends for decision- o financial budgets (capital expenditures, working
making capital) over an appropriate period of time
c) Analyse the organisation’s actual performance (using o special project budgets to be included in business
financial and non-financial information) against the plans
budgeting and expenditure forecasting information o forecasts
to interpret variances for decision-making o short-term cash flow projections
o long-term cash flow forecasts, identifying the need
for financing
• Variance analysis
• Balance scorecard, including key performance
indicators (KPIs)

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PRE-READING INFORMATION

DEFINITIONS OF KEY TERMS:

Activity Based
An approach to budgeting that takes cost objects as the starting point,
Budgeting
determines the necessary activities and then estimates the resources that are
(ABB)
required for the budget period.

Budget A financial plan for implementing management decisions.

bBudgeting The implementation of the long-term plan for the year ahead through the
development of detailed financial plans.
Cash budget A budget that aims to ensure that sufficient cash is available at all times to meet
the level of operations that are outlined in all other budgets.
Control The process of comparing actual and planned outcomes and responding to any
process deviations from the plan.
Discretionary Costs such as advertising and research where management has some discretion
costs as to the amount it will budget.
Incremental An approach to budgeting in which existing operations and the current
budgeting budgeted allowance for existing activities are taken as the starting point for
preparing the next annual budget and are then adjusted for anticipated
changes.
Incremental Budgets in which expenses for an item within the budget are based on the
budgets previous budgeted allowance plus an increase to cover higher prices caused by
inflation.
Master budget A document that brings together and summarizes all lower-level budgets and
which consists of a budgeted profit and loss account, a balance sheet and cash
flow statement.
Rolling An approach to budgeting in which the annual budget is broken down into
budget months for the first three months and into quarters for the rest of the year,
with a new quarter being added as each quarter ends, also known as
continuous budgeting.
Strategic plan
A top-level plan that sets out the objectives that an organization's future
activities will be directed towards, also known as a long-term plan.

Strategy The courses of action that must be taken to achieve an organization's overall
objectives.
Unit Specific, measurable statements, often expressed in financial terms, of what
objectives individual units within an organization wish to achieve.
Vision A statement that clarifies the beliefs and governing principles of an
statement organization, what it wants to be in the future or how it wants the world in
which it operates to be.

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Z ero-based budgeting An approach to budgeting in which projected
expenditure for existing activities starts from base zero rather than last
year's budget, forcing managers to justify all budget expenditure, also
known as priority-based budgeting.

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Behavioural Controls that involve observing the actions of individuals as they go about their
controls work, also known as action controls.

Bottom-up budget Allowing individuals to participate in the setting of budgets and targets.
setting
Continuous An approach to budgeting in which the annual budget is broken down into
budgeting months for the first three months and into quarters for the rest of the year,
with a new quarter being added as each quarter ends, also known as rolling
budgeting.
Control The process of ensuring that a firm's activities conform to its plan and that its
objectives are achieved.
Controllability The principle that it is appropriate to charge to an area of responsibility only
principle those costs that are significantly influenced by the manager of that
responsibility centre.
Controls Measurement and information used to help determine what control action
needs to be taken.
Discretionary
Cost centres where output cannot be measured in quantitative terms and
expense centres
there are no clearly observable relationships between inputs and outputs.

Expense centres
Responsibility centres whose managers are normally accountable for only
those costs that are under their control, also known as cost centres.

Flexible budgets Budgets in which the uncontrollable volume effects on cost behaviour are
removed from the manager's performance reports.
Goal congruence The situation that exists when controls motivate employees to behave in a way
that is in tune with the organization's goals.
Historical targets Targets derived directly from the results of previous periods.
Investment Responsibility centres whose managers are responsible for both sales
centres revenues and costs and also have responsibility and authority to make capital
investment decisions.
Managerial The extent to which each manager perceives his or her work-related activities
interdependency to require the joint or cooperative effort of other managers within the
organization.
Negotiated targets
Targets based on negotiations between superiors and subordinates.

Participation The extent that individuals are able to influence the figures that are
incorporated in their budgets or targets.
Profit centre A division or part of an organization in which the manager does not control the
investment and is responsible only for the profits obtained from operating the
assets assigned by corporate headquarters.

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Revenue centres Responsibility centres where managers are mainly accountable for financial
outputs in the form of generating sales revenues.
Standard cost Cost centres where output can be measured, and the input required to
centres produce each unit of output can be specified.

Strategic control Control that focuses outside the organization, looking at how a firm can
compete with other firms in the same industry.
Top-down budget Imposing budgets and targets from above, without the participation of the
setting individuals involved.

Variance The difference between the actual cost and the standard cost.
Variance analysis The analysis of factors that cause the actual results to differ from
predetermined budgeted targets.

Source: Drury 10th Edition.

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 SUPPLEMENTARY LECTURE NOTES

KEY CONCEPTS AND TECHNIQUES

PLANNING

Timeframe
The budget is a short-term plan. It must be consistent with, and support, the long-term
plan and strategic goals of the organisation. Short term and long-term goals can be in
conflict with one another. The organisation’s long-term goals are expressed in the
organisation’s mission and vision statements.

Uncertainty
Budgets are based on uncertain forecasts, and actual circumstances may differ from
those circumstances the budget was prepared under. The question often raised is:
Should the budget be revised for changed circumstances? The answer would depend on
nature of the change, and may also differ depending on the perspective (planning,
control or measurement perspective.) How and when the budget is adjusted should
also be considered. Uncertainty can be taken into account in the following ways:

Planning & co-ordinating perspective:

Instead of a traditional annual budget cycle, producing a 12-month budget that is set in
advance, a rolling budget can be used, whereby: the annual budget is broken into
months for the first 3 months, and into quarters for the remaining 9 months. The
quarterly budgets are reviewed and developed on a monthly basis as the year
proceeds. The quarterly budget can be updated for new information. A 12-month
budget can exist at any stage during the year, as, as 1 quarter elapses, another is
added on in the future. Instead of planning being an annual consideration,
management is continually thinking ahead, and errors or decisions can be adjusted for
within a short time frame. A rolling budget system prevents the budget from
becoming irrelevant and thus no longer useful for control and measurement
purposes.

Motivation perspective:
A continually changing budget can be very unsettling and create uncertainty for
managers. Care must be taken not to manage revenue/profit targets downwards
purely because unfavourable conditions become explicit and short term, as opposed
to general, unknown, and long-term.

Performance evaluation:
It is often desirable for the budget to be revised for the purposes of performance
evaluation, but only as regards factors that were not controllable by the person
/entity being evaluated.

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 Flexible budgeting and controllability are discussed more extensively under
“Performance measurement”.

3 – Basis for determining the numbers

There are 3 different approaches to determining the numbers to be reflected in the

budget: Incremental, Activity Based Budgeting (ABB) and Zero-Based budgeting.

Incremental budgeting:
This involves using the previous year’s budget (perhaps adjusted for known changes)
and adjusting it on an incremental basis to arrive at the new budget. The major
disadvantage is that inefficiencies may be perpetuated as future expenditure is
justified based on “that is what was spent last year so it must have been necessary”
thinking, as opposed to considering whether the expenditure is value-added or
wasteful.

Activity Based Costing and Activity Based Budgeting:

ABB involves determining costs with reference to anticipated levels of activities and
resource utilisation (rather than output volumes), and the budget is often structured
around activities, rather than cost types. (Discussed further under “control”). By
focusing on activities, an organisation is more likely to develop a budget that is
more accurate and complete than a volume-driven approach is able to achieve.

Zero-Based budgeting:
This form of budgeting is extremely time consuming and requires substantial
commitment from the organisation. It means very simply that each year the
budgeting process is started from a ZERO BASE and every process and activity is
consideredafresh.

A comparison of incremental budgeting and zero-based budgeting follows:

TRADITIONAL BUDGETING ZERO BASED BUDGETING

♦ Starts with last year’s ♦ Starts with a minimum (or zero
funding requirements figure) for funding

♦ Focus on money  Focus on goals and objectives

♦ Does not systematically ♦ Directly examines alternative
consider alternatives to approaches to achieve similar
currentoperations results
♦ Produces a single level ♦ Produces alternative levels of
of appropriation for funding based on the availability of
anactivity funds and desired results

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 Zero-based budgeting is particularly important to not-for-profit organisations. Why?

A) COMMUNICATION

Both the preparation of the budget, and the budget itself, facilitate knowledge sharing within an
organisation. The budget is a formal communication / expression of the
financial role that each responsibility centre has, in supporting the organisation to
achieve its strategic, financial and operational targets.

B) MOTIVATION

Motivation can be affected by various factors, financial reward being one such
consideration. In this regard the motivation and performance evaluation aspects of
budgeting overlap. Financial reward will be discussed under “performance
evaluation”.

Targets:
Can either be easy, ideal or tough but attainable. The latter is usually found to be the most
effective in terms of motivating managers to achieve the targets set.

Style:
The manner in which the budget is communicated and implemented has
motivational consequences – managers are more motivated to meet targets that
they have “bought into”, than targets which they consider to be imposed. Two
opposing implementation styles are:

a. Top-Down / Imposed – the budget originates from and is handed down by top
management.
b. Bottom-Up / Negotiated – this approach emphasises participation and
acceptance. The budget originates from those who will be responsible for
ensuring the budget is achieved. The budget is escalated up for approval and
feedback. Co-ordination of budgets is considered at budget committee level.

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PERFORMANCE EVALUATION

Arguably, the most effective way of motivating managers to try to achieve the
budget, is to relate their own financial reward to their performance against budget
(performance evaluation). The key principle as regards performance evaluation is
that managers should only be evaluated on items that they can control.

Implementing this principle requires the following two numerical adjustments to be

made when evaluating actual results against budgeted.

1) Management should not be evaluated on uncontrollable line items (e.g.

allocated administrative costs).
2) Likewise, flexible performance standards should be applied by adjusting targets
to reflect variations in uncontrollable factors arising from circumstances not
envisaged when targets were set. Uncontrollable volume effects on cost
behaviour are removed from the manager’s performance report by restating the
original budget at the actual level of activity (volumes) experienced. This
technique is termed “Flexible Budgeting”.

Qualitative considerations should also be taken into account when interpreting the
numerical results, especially the interrelationship of variances (the possibility that
another centre has the ability to affect the results of the responsibility centre under
evaluation), and the performance of the division/centre relative to that of other similar
divisions or companies.

An interesting dilemma arises in the area of motivation and performance evaluation,

concerning budget surpluses and deficits. Should divisions be allowed to retain
surpluses generated for future use?

C) CONTROL

Controllable and non-controllable items:

One of the purposes of budgeting is to achieve control over revenue and costs – and
often control of costs in particular. Departmental managers are usually held
responsible for ensuring that the budget for their department is achieved. Which
raises the question: Can a manager control all the costs on their department’s
budget? And should budgets comprise either controllable income and expenses
only, or both controllable and non-controllable items? By including non-controllable
expenditure in budgets management is made aware of the greater operating and
administrative cost base that they need to contribute to. However, the inclusion of
non-controllable items in the budget complicates performance evaluation.

Overheads:
One category of costs that are particularly difficult to control is overheads, as
overheads are indirect, rather than direct, costs. Activity Based Budgeting (ABB) has
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 been developed as a tool to improve an organisation’s control over overhead costs,
by effectively turning indirect costs into direct.

Activity Based Costing and Activity Based Budgeting:

The conventional approach to budgeting works fine where the consumption of resources
varies proportionately with the volume of final output of products or services.
However, for those indirect costs and support activities where there are no clearly
defined input-output relationships and the consumption of resources does not vary
with the final output of products or services, conventional budgets only serve to
authorise certain levels of spending for each budgeted item of expense. Budgets
that are not based on well-understood relationships between activities and costs are
poor indicators of performance and performance reporting normally implies little
more than checking whether the budget has been exceeded. Conventional budgets
therefore provide little relevant information for managing costs of support activities.
To manage costs more effectively Activity Based Costing and Activity Based
Budgeting can be employed, whereby overhead costs are related to activities, rather
than volumes.

An article extract: Activity-Based Budgeting Focuses on Work, Not Costs

(Raiborn (1999) adapted)

A budget should be based on knowledge of how good the organization can

be and should be. Developing an achievable budget is often difficult
because most managers develop a budget on what they spend, not on
what they do (activities) that consumes the budgeted costs. Many
organizations (in the US), such as Johnson & Johnson and Chrysler
Corporation, are looking to their existing activity- based cost systems as the
basis for re-engineering their budgeting process. Unlike conventional
budgeting that focuses on resource cost, the re-engineered budget
process should assume that the focus will centre on activities and
business processes. Activity-based budgeting (ABB) is a process of planning
and controlling the expected activities of an organization. ABB links work
(activity) with the strategic cost, time, and quality objectives of the
organization. ABB focuses on activities. Costs are determined after the
activity workload is defined.

Activity-based budgets require an analysis of cost drivers and the

relating of budget line items to activities performed.

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 LECTURE EXAMPLES

Lecture example 1 part a is a recap from MA1 and is self-study.

LECTURE EXAMPLE 1-THERE LIMITED (SELF STUDY)

There Limited manufactures and sells a product called Q1. On 1 November 2018, the company had a
favourable bank balance of R35 540.

40% of all sales are cash sales. There Limited allows credit subject to a discount of 5% if payment is
received within 5 days after the date of the statement - the remaining amount is payable within 30 days.
If accounts are paid after that, interest of 24% per annum (2% per month) is charged on the outstanding
balance. Statements are sent to debtors on the last day of each month.

Experience has shown that 30% of credit sales are paid within the discount period and that 50% of credit
sales within the rest of the 30 days. During the followingmonth, 15% of the credit sales, together with the
interest thereon, are recovered and the remaining 5% are written off as bad debts.

The actual and budgeted sales are as follows:

Units
August 2018 14 000
September 2018 16 000
October 2018 10 000
November 2018 18 000

The budgeted information per unit of Q1 is as follows:

R
Selling price 80
Materials (6kg @ R6) 36
Labour (2 hours @ R10) 20
Variable overheads 7

Fixed overheads (including depreciation of R10 000) were budgeted at R40 000 per month until
October 2018. After this a once-off increase of 5% is expected in the fixed overheads per month,
excluding the depreciation. All overheads are paid in the month that follows the month in which the
overheads were incurred.

Materials are purchased on credit. The suppliers allow 60 days credit after the date of the statement.
Assume that There Limited makes use of the maximum credit period. Labour is paid in the month during
which the work was done.

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Due to a JIT system being in use, no opening or closing stock finished goods or materials should be on
hand.

REQUIRED

a) Present a cash budget for November 2018. (15 Marks)

Lecture example 1: Suggested solution

Workings Rands
a) Opening Balance 35,540

Cash Receipts:
Cash Sales 18,000 x 80 x 40% 576,000
Credit Sales
October 10,000 x 80 x 60% x 30% x 95% 136,800
10,000 x 80 x 60% x 50% 240,000
September 16,000 x 80 x 60% x 15% x 102% 117,504

Payments:
Fixed Overheads -30,000
Labour 18,000 x 20 -360,000
Variable Overheads 10,000 x 7 -70,000
Raw Materials 16,000 x 36 -576,000

Closing Balance 69,844

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 LECTURE EXAMPLE 2 - Rockingham Private Patients Hospital (Source Drury 10th Edition IM 1
6.21)

A new private hospital of 100 beds was opened to receive patients on 2 January though many senior
staff members including the supervisor of the laundry department had been in situ for some time
previously. The first three months were expected to be a settling-in period; the hospital facilities being
used to full capacity only in the second and subsequent quarters.

In May the supervisor of the laundry department received her first quarterly performance report from
the hospital administrator, together with an explanatory memorandum. Copies of both documents
are set out below. The supervisor had never seen the original budget, nor had she been informed that
there would be a quarterly performance report. She knew she was responsible for her department and
had made every endeavour to run it as efficiently as possible. It had been made clear to her that
there would be a slow build up in the number of patients accepted by the hospital and so she would
need only 3 members of staff, but she had had to take on a fourth during the quarter due to the extra
work. This extra hiring had been anticipated for May, not late February.

Rockingham Private Patients hospital Ltd MEMORANDUM 30 April To: All Department

Heads/Supervisors

From: Hospital Administrator

Attached is the Quarterly Performance Report for your department. The hospital has adopted a
responsibility accounting system so you will be receiving one of these reports quarterly.
Responsibility accounting means that you are accountable for ensuring that the expenses of running
your department are kept in line with the budget. Each report compares the actual expenses of
running your department
for the quarter with our budget for the same period. The difference between the actual and forecast will
be highlighted so that you can identify the important variations from budget and take corrective
action to get back on budget. Any variation in excess of 5% from budget should be investigated and
an explanatory memo sent to me giving reasons for the variations and the proposed corrective
actions.

Comment: We need to have a discussion about the over-expenditure of the department.

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 Performance report – laundry department:

3 months to 31 March

Actual Budget Variation %

(Over)Under Variation
Patient days 8 000 6 500 (1 500) (23)
Kg of laundry processed 101 170 81 250 (19 920) (24.5)
Department expenses (£) (£) (£)
Wages 4 125 3 450 (675) (19.5)
Supervisor salary 1 490 1 495 5 -
Washing materials 920 770 (150) (19.5)
Heating and power 560 510 (50) (10)
Equipment depreciation 250 250 - -
Allocated administration costs 2 460 2 000 (460) (23)
Equipment maintenance 10 45 35 78
9 815 8 520 (1 295) (15)

You are required to:

1) Critically evaluate the process above; and

2) Re-draft the performance report in a way which, in your opinion,
would make it a more effective management tool.

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Lecture example - Suggested solution:

Performance report – laundry department:

3 months to 31 March

Actual Flexed Variation %

Budget (Over)Under Variation
Patient days 8 000 8 000
Kg of laundry processed 101 170 101 170
Department expenses (£) (£) (£)
Wages 4 125 4 246 121 2.8%
Supervisor salary 1 490 1 495 5
Washing materials 920 958 38 4.0%
Heating and power 560 635 75 11.8%
Equipment depreciation 250 250 - -
Allocated administration costs 2 460 2 000 (460)
Equipment maintenance 10 56 46 82.1%
9 815 9 584

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KEY TAKEWAYS FROM LECTURE EXAMPLE 2:

• Make sure that you flex line items to the appropriate driver (and this may
mean flexing different things)

• Exclude those factors that are beyond the control of the person you are evaluating
(e.g. the laundry manager cannot control the allocation of admin costs to his/her
department)

• When interpreting the variances, remember there could be both price and usage
reasons for good/bad performance

• The correct answer is ‘’it depends’’. A positive variance can be good or bad and
may be related to other variances.

TIPS AND EXAM TECHNIQUE FOR BUDGETING QUESTIONS:

In the event of a budgeting question remember:

- Any potential budgeting question will require an analysis based on the information
contained in the particular question. Pay careful attention to the possible reasons for
variances in a budget and the way in which line items could be connected to each
other.
- Be aware of the qualitative factors that can lead to budgets not being implemented successfully.

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 MANAGEMENT ACCOUNTING II -ACC3023W
Control function and budgeting
Tutorial Questions

Tutorials
BU01: Cold Chain fleet
BU02: Electrified Fencing
BU03- Horizon
BU04: HyperTec Motors*
BU05: SA Wholesalers

* Unseen tutorial to be completed before your tutorial session.

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BU01 Unseen (30 MARKS : 36 MINUTES)

The recently appointed operations manager of the Cold Chain division of a large, listed
logistics and transport company was somewhat perplexed by a budget review meeting
with the manager of the Express Cold Chain fleet, who reports to her.

She requested the assistance of the group management accountant in clarifying certain
matters pertaining to the company’s budget procedures generally, and the Express Cold
Chain fleet’s most recent monthly operating statement in particular.

During the meeting with the group management accountant, she pointed out that,
according to her reading of the budget manual, which had been in operation for a
number of years, cost centre managers were responsible for keeping costs within budget
levels. Budgets were set by head office on the basis ofits assessment of operational
requirements in the forthcoming year, and departmental managers were evaluated on the
basis of their performance against budgets. In terms of the company’s remuneration
policy, managers are given a bonus of one month’s salary for meeting budget, and a
further formula related bonus based on the extent to which they are able to keep actual
costs below budget.

The management accountant confirmed the operation managers understanding of the

budget policy. He stated that the policy had always worked well. The company had been
stable for a number of years and costs were well controlled.

The operations manager mentioned that as regards the question of stability, this might
better be described as stagnation. She had been hired because of her track record in
implementing leading- edge supply chain measures in order to increase the company’s
competitiveness and increase its market share. She believed that the current budget
procedures would in fact hamper theseefforts significantly.

Moreover, she said that she believed that the budget procedures might even have been
contributing to the problems that the company had been having recently. The
management accountant was somewhat taken aback. He stressed that good budgetary
control could not be a problem, and that good management was all about planning and
control. How could this be a problem he asked?

The operations manager then went on to the issue of her recent budget meeting with the
manager of the Express Cold Chain fleet. The fleet manager was distraught because
according to him, despite having done everything the operations manager asked, and
more, he was being penalized because of poor performance against budget. The Cold
Chain fleet had increased its output in terms of deliveries, and customers had expressed
a greater degree of satisfaction with the overall service levels.

However, the manager was called to account for the unfavourable variance of R13 549
being the difference between the budgeted departmental expenses of R144 741 (original
budget set six months ago) and the actual expenses for September of R159 290. The
operations manager stated that the situation simply did not make sense. She has requested
the management accountant to look into the matter, because she believes that the existing
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 performance evaluation process is unsuitable and needs to be revised urgently.
The September operating statement for the Cold Chain fleet is as follows:

Department: Cold Chain Fleet

Operating report for the month of: September 2003 (Note:
– “ = variance is unfavourable) Actual Budget Variance

Kilometres travelled 90,000 76,500 -13,500

Number of vehicles 10 10
R R R
Fuel costs 41,580 36,720 -4,860
Wages 31,578 26,000 -5,578
- Normal time 27,000 26,000 -1,000
- Overtime 4,578 - -4,578
¶
Rental allocation 4,300 4,000 -300
Depreciation 37,000 35,000 -2,000
Repairs and maintenance 16,000 14,688 -1,312
Administration costs 19,000 20,000 1,000
Insurance premiums 9,000 8,333 -667

Total expenses 158,458 144,741 -13,717

Relevant facts regarding the items contained in the operating report are as follows:

a) Fuel consumption was budgeted at 15 litres per 100 kilometers, and the price of diesel
was budgeted at R3.20 per litre. The actual average consumption turned out to be 14
litres per 100 km’s.

b) Wages (normal time) are fixed costs, which vary, by driver according to level of
experience (which impacts on service levels and efficiency). The fleet manager is
responsible for the hiring and training of drivers in his fleet. There are 173.36 standard
working hours per driver in a month. 196 overtime hours were worked in September.
Overtime is payable at 1.5 times the normal hourly rate for each hour of overtime
worked.

c) Rental costs relate to the parking of vehicles and comprise an apportionment of the
overall divisional rental for parking facilities.

d) The increased depreciation charge is as a result of the replacement of a vehicle earlier

than expected. Decisions regarding vehicle additions and replacements are taken by
head office in consultation with the divisional manager.

e) Repairs and maintenance costs are influenced by a number of factors, including the driver
skill and training, the age of vehicles and distance travelled. Repairs and
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 maintenance costs have been observed to average 40% of fuel costs, and the budget
amount is calculated accordingly.

f) Administration costs comprise an allocation of the divisional administration expenses.

g) Insurance premiums comprise a flat fee and are significantly influenced by passed claims.

REQUIRED

1. Comment briefly on the shortcomings of the current budget policy and whether the
operations manager’s concerns in this regard are valid. (5 marks)

2. Redraft the September operating report for the Cold Chain fleet in a manner that you
believe would be more appropriate for purposes of measuring the performance of the
fleet manager. Comment on the reasons for the inclusion or exclusion of items in your
redrafted report and explain what impact the revised might be expected to have on the
behaviour of the fleet manager. (18 marks)

3. Provide an analysis of the fuel variance included in your redrafted September

operating report that would be useful in understanding the relative effects of price and
volume. (7 marks)

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

BU02 (30 MARKS : 36 MINUTES)

Electrified Fencing (Pty) Ltd is a Cape Town based company specialising in securing the
perimeter of residential properties through the installation of electric fencing. The company is
100% owned and managed by Grant Wallenall who left the busy commercial world to pursue a
career with more outdoor appeal.

To ensure maximum efficiency within his business, Grant has split his company into two
divisions – an Installation division and a Sales division. This allows the Installation division to
focus on performing installations and ensuring the customer receives a quality product while the
Sales division can concurrently liaise with the customers and win new business. Therefore, the
Installation division is responsible for the majority of the variable costs of the installation
process whilst the Sales division is responsible for generating the revenue.

Grant employs a single senior manager, Hector Strate, to manage the Installation division. He
has incentivised Hector by offering him a profit share of 10% provided the actual profits of the
company exceed the budgeted profits. At the end of the 2012 financial year, Hector was upset
to hear that the company had not generated a profit. Hector believed that both he and the
Installation division performed well throughout the year and wonders whether there is
something wrong with the performance incentive system. He has asked you to review the
performance report and provide him with feedback regarding whether his concerns around
the incentive system are correct.

Budgeted and Actual Income Statement for year ended 31 October 2012

Note Budget Actual Variance

Number of Installations 1 180 190 10
Number of Meters of Perimeter 2 18,000 21,850 3,850
Covered
R's R's R's
Installation Revenue 1 1,836,000 1,999,750 163,75
0
Variable Costs
Stainless Steel Wiring 2 -55,350 -77,677 -22,327
Brackets 2 -36,000 -35,755 245
Energisers and Sirens 1 -450,000 -456,000 -6,000
Fixed Costs
Salaries 3 -636,000 -893,200 -257,200
Vehicle Rental 4 -96,000 -96,000 -
Diesel 5 -21,600 -22,800 -1,200
Impairment of Equipment 6 -10,000 -11,000 -1,000
Administrative Expenses 7 -480,000 -480,000 -

Net Profit Before Tax 51,050 -72,682 -123,732

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

Notes:

1. The Sales division drives the number of installations that take place as they are
responsible for winning business. Budgeted revenue is a function of the number of
installations that take place and the distance of perimeter covered. In terms of the
budget, each customer is quoted a fixed fee of R6,000 for an installation plus a variable
rate of R42 per meter of perimeter. Customers were actually charged a fixed fee of
R6,500 and R35 per meter. One energiser and siren are required per installation.

2. Each installation requires stainless steel wiring and brackets to be erected around the
perimeter of the property. Grant budgeted for each installation to cover an average
perimeter distance of 100 meters. The average distance actually covered was 115
meters per property. This distance affects the amount of stainless steel wiring used and
the number of brackets that support it. The budget is based on an anticipated wastage
of 5% of wiring as well as the usage of one bracket for every 5 meters of perimeter
distance. The actual purchase price of these items did not differ from budget and
amounted to R2.93 per meter of perimeter distance covered by wiring and R10 per
bracket.

3. Budgeted salaries consists of the following:

• R6,000 per month each for two Installation technicians;
• R21,000 per month for Hector as the senior manager of the Installation division;
• R10,000 per month each for two sales reps who make up the Sales
division. Actual salaries includes the following:
• The Installation technicians negotiated a R300 increase in their salaries
(each) at the beginning of the year which did not form part of the original
budget;
• On 1 January 2012, Grant employed an additional senior manager in the Sales
division to assist in managing the sales reps at a cost of R25,000 per month;
• There were no deviations from budget other than indicated above.
Hector is not part of the hiring process, nor salary negotiations, of any of the staff members.

4. Grant hires a Kia K2700 diesel bakkie at a cost of R4,000 per month as well as two Opel
Corsa Bakkies at a cost of R4,000 per month each. Hector has some input over which
vehicles the company chooses to hire, but this is more of an informal arrangement where
Grant makes the final decision.

5. The amount of diesel used is a function of how far the Installation and Sales divisions
travel to perform their duties but based on past experience varies with the number of
installations performed.

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

 6. Impairment of Equipment relates to the writing off of the tools used in the installation
process such as drills, hammers, pliers, etc. These are largely hand tools that are used
solely by the Installation division. Due to variability in the quality of these tools and the
intensity of their usage, these tools are not depreciated but rather impaired when they
fail or are lost or stolen. Hector is in charge of sourcing and replacing tools as necessary.

7. Administrative expenses relate to the salaries of Grant and his personal assistant, who
email orders to customers, process invoices and manage payment collection.

You have ascertained that Hector is responsible for sourcing materials for the installation
process as well as the usage thereof during the installation process.

REQUIRED:

1) Redraft the performance report in a manner that is more meaningful for analysis of the
performance of Hector and his Installation team. Indicate which items should or should
not form part of the performance analysis and why. (13
Marks)

2) Comment on the performance of Hector and his Installation team with reference to
the revised performance report calculated above. (10
Marks)

3) Do you regard the current performance evaluation system as appropriate, or not? Explain.
(2 Marks)

4) How can qualitative performance evaluation methods assist in effective performance

evaluation and control of Hector as a senior manager? (2
Marks)

Professional communication, presentation, and layout (3 Marks)

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

BU03

Jacob Madonsela is the manager of Horizon Ltd (hereafter referred to as Horizon). Horizon
manufactures and sells high quality soccer balls to Premier Soccer League teams (for training
purposes).

Mr. Madonsela would like your assistance in order to solve a number of issues. The company
currently only produces a cash budget, because ‘cash is king’. Budgets are currently drawn up
by top level management with no participation from other managers nor workers. Only top
level management has access to budgets as they are worried that employees may leak
confidential financial information to competitors.
In order to assist some of the smaller clubs in terms of cash flow management, a portion of sales
are done on credit. Cash to credit sales are in the ratio 1:4. None of the credit sales are
collected in the month in which the sale occurred. 5% of total sales is uncollectible as teams in
the relegation zone (bottom 3 of the league) tend to be unable to afford to pay their debts. 50%
of total sales is collected in the month following the month of the sale. The remainder is
collected in the 2nd month after sale.

Sales and Inventory

Selling prices and units sold for January, February and March (the first quarter) 2016 are as follows:

Month Selling price (R) Soccer Balls sold

January 300 1,000
February 320 900
March 320 1,000

An increase in selling price was effective as of 1 February 2016. Taxation paid amounts to
R50,000 for the month of March.

Factory

Horizon’s current factory has a practical capacity of 1,000 soccer balls. Horizon is able to
obtain additional factory space if needed (at a cost) and market demand is sufficient for any
additional balls produced to be sold. The annual lease payments on the current factory are
R600,000. Lease payments are made at the end of each month.

Accounts Payable

Accounts payable (relating to February purchases of raw materials) as at 29 February was

R30,000. 20% of purchases made within the month are paid for in the following month. The
balance is paid for in the month to which it relates. Accounts payable at the end of March
(March 31) is R60,000.
ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.
 Insurance for the factory which is included in overheads, is paid at the end of every quarter.
One twelfth (1/12) is recognised each month as an accounting expense. This expense
amounted to R6,000 for March.

The company has 12 employees (including the manager, Jacob). The sales representative is
paid 20% of cash sales. The other 10 employees involved in the manufacturing process are
paid R10,000 each per month. The manager is paid R20,000, and a cash bonus of 10% of
the portion of sales above R200,000 for the month. Based on current operations, the
company has more direct labour hours than needed to reach full production based on
practical capacity.

Machinery and Overheads

Overheads expense per the accounting records equate to R50,000 for March. This
amount includes depreciation relating to machinery. The machinery has a
useful life of 5 years, R110,000 cost and a residual value of 10,000. The machine
is depreciated on the straight line basis.

Opening balances

The company must maintain a minimum cash balance of R100,000. If the cash
balance falls below this amount, the company will issue equity to obtain
additional financing, at R15 per share, before flotation costs. The flotation
costs amount to 10% of the capital raised. The opening cash balance as at 1
March 2016 is R150,000.

REQUIRED

1. Prepare the cash collections schedule for the month ending 31st March 2016. 3

2. Prepare the cash budget for the month ended 31st March 2016. 13

Professional Communication - Presentation and 1

3. Mr. Madonsela is unsure as to how he can improve Horizon’s current liquidity

position and needs your advice. Prepare a memorandum to him in which you
answer the questions below:

a) What recommendations would you make to improve future cashflows? 6

b) How can the company improve upon its process of drawing up budgets? 4

Professional Communication - Presentation and 1

Total 28

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

BU04 Unseen (35 MARKS; 42 MINUTES)

HyperTec Motors is a privately owned South African Motor dealership which distributes,
services and repairs motor vehicles on behalf of a leading international vehicle manufacturer.

The international vehicle manufacturer has a significant presence in South Africa, and arguably
represents the most trusted vehicle brand in South Africa, due to their reputation for producing
vehicles that are built to last, of high quality, but also good value for money. The manufacturer
believes that the after sales service that their customers receive is instrumental in preserving
the relationship of trust between the manufacturer and the motoring public. Customers want
the peace of mind that comes from knowing that at every service their vehicle is properly
maintained and thoroughly inspected to ensure it will remain reliable until the next service
interval. Customers also expect dealers to “go the extra mile” – e.g., a complementary wash
and vacuum with every service.

HyperTec is one of a number of independent dealerships used by this international

manufacturer. HyperTec operates through 27 branches, spread throughout South Africa. Each
branch consists of three departments: vehicle sales, workshop and administration. The
workshop is responsible for both services and repairs. The performance report for the
workshop at the Cape Town branch is presented on the following page. Information regarding
the operations of the workshop is presented below.

Services

Two kinds of services are carried out: minor and major. All services carried out must conform
to the manufacturers specifications, which specify the various inspections and replacements that
must be carried out for each service type (a list of 35 items). The price that customers are
charged for each kind of service is fixed by HyperTec head office (and based on the
manufacturer’s specifications). Customers are charged a standard amount of R500 for a minor
service, and R900 for a major service. It is possible to have standard charges, as these services
must be carried out in accordance with the standard check lists and the number of labour hours
and consumables and parts that should be required for each type of service is known. As a
courtesy to customers, all vehicles worked on are cleaned, and all customers receive a follow up
phone call to check to see whether they are satisfied with the servicereceived.

Standard requirements (per service): Minor Service Major Service

Total Labour Time(including cleaning) 2 hours 6 hours

Consumables (oil, grease,air-filters etc.) R60 R300

The budget has been based on the assumption that 70% of services will be carried out on
vehicles that are under a Motorplan. This means that the manufacturer, instead of the
customer, pays HyperTec for the service under Motorplan. (Customers pay the manufacturer
for the Motorplan upfront, when the vehicle is purchased.) HyperTec gives the manufacturer a
discount of 10% on the standard price of the service.

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 Repairs

All repairs are charged to customers based on actual labour hours worked, plus parts at a
mark- up. This formula is set by head office. The budget traditionally shows only the profit on
repairs. The relationship between the number of services performed and the number of hours
of repairs has been very consistent in the past, as at the end of each service mechanics should
inspect the vehicle (as per the standard service list) for any other items that might need to be
repaired, that are not covered by the service.

The Budgeting Process

The budgets for all branches and departments therein are set by HyperTec Head office.
Hypertec uses the prior period’s operating results in establishing the budget in the
currentyear.

Any known changes are adjusted for (for example, targeted market share, increase in fees,
inflation etc.). Department managers receive a bonus based on their performance against
budget. The budget for the workshop at the Cape Town Branch is presentedbelow:

Performance report for the workshop for the year ended 30 September 2005
Notes Budget Actual Variance
Quantitative information

Number of services: 12,800 12,850

Minor 8,320 8,640
Major 4,480 4,210

Labour hours - services 43,520 36,558

Minor 16,640 13,824
Major 26,880 22,734

Number of repair hours 20,000 16,000

R's R's R's

Services - Revenues and Costs

Revenue - Services 1 8,192,000 8,109,220 -82,780

Minor 4,160,000 4,328,640
Major 4,032,000 3,780,580

10% Discount on Motorplan 2 -573,440 -527,099 46,341

Labour cost - services 3 -1,740,800 -1,504,101 236,699

Minor -665,600 -568,759
Major -1,075,200 -935,342

Consumables and Parts 4 -1,843,200 -1,888,850 -45,650

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

 Minor -499,200 -604,800
Major -1,344,000 -1,284,050

Net Profit on Repairs 3,400,000 2,800,000 -600,000

Other (General revenue and
expenses)
5 - 52,000 52,000
Profit on disposal of engine winch
Supervisors’ salaries 3 -420,000 -432,000 -12,000
Maintenance 6 -640,000 -400,000 240,000
Depreciation 5 -390,000 -400,000 -10,000
Administrative charges 7 -158,000 -100,000 58,000
Rent, Marketing and Development 8 -1,130,000 -1,060,000 70,000

Profit 4,696,560 4,649,170 -47,390

Notes

1 The standard charges (see services above) apply to all branches. Workshops have a policy
of never turning customers away, and cannot control the number of minor/major
services performed.

2 Only 65% of each type of service was carried out under a Motorplan, not the 70% originally assumed.

3 The standard labour hours (see services above) apply to all workshops. Workshops are
responsible for their own hiring and firing, but hourly rates are set by head office. The
original budget was based on an anticipated wage increase of 5% on the prior year’s rates
(R40/hour after the 5% increase). After industrial action, an increase of 8% was awarded
to all staff (R41.143/hour). The department managers receive a fixed salary and are not
paid overtime. They were also awarded the 8% increase.

4 See services information above.

5 The winch used to lift engines out of cars had to be replaced after the winch seized and
broke. The seizure was due to a lack of lubrication. HyperTec had only intended to
replace the winch in the following year, as the winch still had one year of its estimated 5
year useful life remaining. The replacement of the winch is the reason for the actual
depreciation charge exceeding budgeted. All asset purchase and replacement decisions
are made at headoffice.

6 Each workshop is responsible for maintaining its own equipment. Maintenance is driven
by labour hours plus repair hours - the more machine hours are used, the more
maintenance they require.

7 30% of the administrative charges incurred by the branch admin department are
allocated to the workshop.

8 Rent, Marketing and Development expenditure represents the portion of head office
spending on brand development and business sustainability that the workshop is
expected to contribute to. This amount is allocated based on revenue earned.

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

The workshop at the Cape Town Branch believes they have performed well against budget –
and has provided the following commentary on the workshop’s performance for the year
under review:

“Once again the workshop has turned in a good performance against a really challenging
budget. As you know, we have a policy of never turning customers away, and that fact that
fact that we have slightly exceeded our service targets is due to the workshop team performing
services super-efficiently, especially considering that 52% of the workshop staff were newly
hired thisyear!”

REQUIRED:

1. Identify and briefly explain 4 or 5 potential shortcomings in HyperTec’s budgeting

process in general and/or relating to the performance report presented above, in
particular. (6
Marks)

2. Redraft the performance report presented above in order to better analyse the
performance of the workshop department. Indicate any items omitted. Show your
workings clearly. (14 marks)

3. Comment on the performance of the workshop, based on your interpretation of each

variance calculated in the revised performance report and the information provided in
the question. If you believe that their performance could be improved by introducing
other measures, then you should suggest some measures (at least 3 or 4) that you feel
would be beneficial. (15 Marks)

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

BU05 (31 MARKS: 37 MINUTES)

SA Wholesalers is a divisionalised company that manufactures and retails a wide range of wood,
electrical and hardware products to tradesmen, as well as the generalpublic.

DIY Cupboard Pieces (DCP) is one division within this company. DCP produces wooden panels
(doors, shelving etc.) for kitchen and bedroom cupboards from boards of wood, as per
customers’ specifications.

DCP’s Production and sales process for wood panels

Sales staff assist customers with the design of the customer’s kitchen and bedroom
cupboards, if the customer has not already finalised this themselves. Then, the customer,
assisted by the sales staff if they require some help, determines how many wooden panels and
doors are required to build the desired cupboards. Standard panel sizes are available, but
panels can also be custom designed to the last metre in accordance with customer
specifications. A customer places an order with the sales staff, and pays for the order upfront.
The order is usually ready for collection or delivery anywhere between 1 and 3 weeks after the
order is placed. Customers do complain about the long lead times, especially the tradesmen
and kitchen installation companies that DCP supplies, but seem to accept that the long lead times
are as a result of DCP being very busy, and bottlenecks developing in the production process
(and particularly the cutting department) at peak times.

The customer’s order is then passed on to the production departments. The wood that the
customer requires is taken out of the warehouse and delivered to the cutting department to
be cut to size. (Note that DCP does not produce wood, but instead purchases in a wide variety
of plain wooden boards in a standard size of 2.4m2 per board. All wood types are always held
in stock in order to prevent stock-outs and reduce lead times.) Once the wood has been cut
into the size panels as per the customer’s order, the panels are then routered (machine-
carved), heat-edged (a coloured strip is heat glued to exposed edges) and then insets and cut-
outs are drilled for hinges, draw-runnersetc.

Performance Evaluation

SA Wholesalers uses a variety of financial performance measures as a basis for incentivising

the various grades of management. The senior management of a division (e.g. DCP) is evaluated
on the basis of Return on Investment (ROI), while managers of the individual departments
within the division (e.g. the cutting department) are evaluated on the basis of actual results
compared to budget.

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

 Cutting Department

A comparison of the actual results compared to budget for the cutting department (one of the
many departments of DCP) for 2007, together with some additional information, is presented
be

Performance Report for the Cutting Department

Budget Actual Variance

Number of boards cut*: 320,000 366,080 46,080
R’s R’s R’s
Supervisors' salaries 460,000 460,000 0
Wages 960,000 1,032,000 (72,000)
Parts (Blades, labels, etc) 384,000 496,896 (112,896)
Power 384,000 440,320 (56,320)
Maintenance 230,000 140,000 90,000
Depreciation 600,000 770,000 (170,000)
Allocated Divisional Overheads 150,000 160,000 (10,000)
Total Costs 3,168,000 3,499,216 (331,216)

2
*All panels that are sold require boards to be cut. The standard size of a board is 2.4m .
Wastage is inevitable an cutting department is not responsible for the invoicing of panels.
This is done upfront when the order is placed by the customer and is the responsibility of the
sales department. The sales department then passes the order on to the operational
departments, who are responsible for following the instructions received from the sales
department.

DCP has a very efficient budgeting system in place: Since the operating requirements of the
cutting department are determined by the number of boards that need to be cut, the budget
for the cutting department for the forthcoming year is determined by grossing up the actual
costs for the last year for the increase in the number of boards that need to be cut, and for
inflation.

DCP has the policy that although budgets are set and should be adhered to as far as reasonably
possible, divisional management is also aware that actual sales levels can be very different from
estimated volumes and that some flexibility is required. Should any of the departments wish to
alter their capacity to cut, edge or package boards, divisional management is very supportive
and signs off on the requests of the departmental managers.

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

REQUIRED

1. Comment on the performance of the cutting department. Your answer should be supported by:
 a re-draft of the performance report (justifying the adjustments made);
 an analytical, insightful, and applied discussion of the variances
calculated, which considers possible reasons for each of the variances;
and
 any further calculations necessary to support your analysis. (21 marks)

2. SA Wholesalers is currently using ROI as a basis for incentivising divisional management. Do

you agree that it is preferable to incentivise divisional management (e.g., the senior
management team of DCP) on the basis of ROI rather than on the basis of a comparison of
actual net profit to budget (similar to the manner in which departmental managers are
evaluated)? Your answer should include a consideration of the behavioural consequences of
the two measures.(6 marks)
3. Briefly identify any areas of concern you may have with the budgeting process and
suggest any key improvements you would like to see implemented. (4 marks)

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

 MANAGEMENT ACCOUNTING II -ACC3023W
Control function and budgeting
Tutorial Solutions

Tutorials

Tutorials
BU01: Cold Chain fleet
BU02: Electrified Fencing
BU03- Horizon
BU04: HyperTec Motors*
BU05: SA Wholesalers

*Unseen solution will be worked through in your tutorial sessions.

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

BU01 EXPRESS COLD CHAIN
SUGGESTED SOLUTION

1. Current budget policy and procedures:

The operations manager is correct in her assessment:

• The company is in effect following a system of imposed budgets. The process is non-
participative and is unlikely to be successful in motivating managers towards superior
performance.
• Managerial performance is likely to be constrained by the budget. This is evident from the fact
that the company appears to have been stagnating.
• Managers are much less likely to explore innovative ways to add value in the present
circumstances as they would be under a participative budget approach.
• Managers will tend to more concerned with keeping costs at or below budget than with
contributing to ways to increase market share. Assuming an increase in market share is a
goal of the company, there will be a lack of alignment between the goals of the company and
the goals of managers.
• The business is measuring cost center performance against original budget. This further
exacerbates the problem. Not only is it inappropriate to measure costs that will vary with
output against a fixed budget, but this will result in behaviour aimed at ensuring that the
output is restricted, as managers believe that they are penalized for increasing output!
• Managers are being held accountable for costs that they have no control over. Moreover,
this affects their bonuses! This will lead to cynicism regarding the budget process.

2) Redrafted operating report

Department: Cold Chain Fleet
Operating report for the month of: September 2003 Flexible
Actual Budget Variance

Kilometres travelled 90,000 90,000 -

Number of vehicles 10 10
R R R
Fuel costs 41,580 44,550 2,970
Wages 31,578 30,410 -1,168
- Normal time 27,000 26,000 -1,000
- Overtime 4,578 4,410 -168

Repairs and maintenance 16,000 17,280 1,280

Insurance 9,000 8,333 -667

Controllable expenses 98,158 99,223 1,065

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

 Calculations and comments
Fuel costs
Controllable item. Include in flexible budget. However
the price element of the fuel costs are not controllable
and therefore remove that.
Flexible budget amount is R36 720 X 90000/76500 = R43 200 R43
200/ R3.2 * R3.3 = R44 550
Wages
Wages are controllable by the manager and should be included in the flexible budget.
As normal time wages do not vary with the level of activity the budget amount is not
adjusted.
Overtime arises as a direct result of the increase in the level of activity and the flexible
budget should be adjusted to include overtime. The calculation above has been determined
as follows:
Budgeted rate per hour = 26 000/173.36 hrs per driver/10 drivers = R15 per hour.
Flexible budget o/time is therefore R15 x 1.5 x 196 hours = R4410
Rent
Allocated expense over which the manager has no control. Hence exclude for performance
measurement.
Depreciation
Vehicle acquisitions and replacement are not controlled by the manager and should be
excluded.
Repairs and maintenance
Controllable, therefore include in flexible budget.
Flex. budget amount is R14 688 x 90000/76500
Admin. expenses
Allocated expense over which the manager has no control. Hence exclude for performance
measurement.
Insurance
This could be debated. However the manager can be considered to have significant
influence over insurance costs as the are directly impacted by the past claims arising
in the department. Hence, include for performance measurement.

3) Explanation of fuel variance against flexible budget

Flexible budget no. of litres : 90000/100 x 15 = 13 500
Actual no. of litres : 90000/100 x 14 = 12 600
Budgeted cost per litre = R3.20 (given)
Actual cost per litre (must be calculated)
Actual fuel costs= 90000/100 x 14 litres per 100 km x X = 41 580
Solving for X gives an actual cost per litre of R3.30

Price variance= (Actual price - Budgeted price) x Actual qty

(3.30 - 3.20) x (12 600) = 1260U

Volume variance = (Actual qty - Flexible Budget qty) x Budgeted price

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

(12600 -13500) x 3.20 = 2880 F
Total variance per above : 1260U + 2880F = 1620F

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

 BU02 Suggested Solution
1 Redraft the performance
report
Note Budget Flexible Budget Actual Variance
Number of Installations 1 180 190 190 10
Number of Meters or 2 18,000 21,850 21,850 3,850
Perimeter Covered
R's R's R's
Installation Revenue 1 1,836,000 Not controllable 1,999,750 Not
controllable
Variable Costs
Stainless Steel Wire 2 -55,350 - -77,677 -10,488
67,189
Brackets 2 -36,000 - -35,755 7,945
43,700
Energisers and Sirens 1 -450,000 -475,000 -456,000 19,000
Fixed Costs
Salaries of Installation 3 -636,000 Not controllable -893,200 Not
controllable
Vehicle Rental 4 -96,000 Not controllable -96,000 Not
controllable
Diesel 5 -21,600 - -22,800 -
22,800
Impairment of 6 -10,000 - -11,000 -444
Equipment 10,556
Administrative Expenses 7 -480,000 Not controllable -480,000 Not
controllable
Profit 51,050 -72,681

2 Discussion of Performance

Installation revenue not controllable by Hector or the Installation team, therefore should be
evaluated on controllable costs only.

Unfair to base Hector's performance on profits as he has no control over revenue line item as well
as the majority of the costs including salaries, rental, admin expenses.

Increased impairment an indication of improper tool usage, loss of tools (easy to leave on site / to
steal), or the purchase of poor quality tools which have a shorter usefullife.

Diesel usage is as anticipated, this however could still include perpetuated inefficiencies.

Increased usage of stainless steel wire could be indicative once again of inefficiencies in the
installation process, stolen by employees or simply due to increased complexity in the
installation process. Multiple steps in the wall height used a greater length ofwire.

Calculating the efficiency of the usage of the stainless steel and the brackets, planned
wastage of 5%, actual just over 20%.Usage of brackets more efficient - greater distance
ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.
between each bracket. This does make the increase in usage of wire due to steps in the
fence height unlikely as steps are associated with increased bracket usage.

Hector did perform well in sourcing more cost effective energiser and siren combos - the only
difference can be price as they cannot use less than one energiser and siren per installation

3 Current performance system appropriate?

No - Hector has no control over the revenue line item therefore little influence over the
entire process. He is also being held to account for expenses over which Hector has no
decision making power.
4 Qualitative performance evaluation?

Non-financial measures such as customer feedback / complaints will give insight into quality
of products and service. Non-financial measures allow for more effective control over non-
financial aspects such as quality that affect future profits.

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BU03- Solution

Question 1: Budgeting

1
W0: Sales
Selling price Units Sales
January 300 1 000 300 000
February 320 900 288 000
March 320 1 000 320 000

Cash Collections
Cash Sales Credit Sales
From January From February From March Totals
January 45 000 - - - 45 000
February 57 600 120 000 - - 177 600
March 64 000 108 000 115 200 - 287 200
509 800
w1 300000*0.05 (amount uncollectible) 15000 Amount collected
45000 Alternative: If total
sales interpreted to include credit & cash

Cash Collections

Cash Sales Credit Sales

From January From February From March Totals
January 45 000 - - - 45 000
February 57 600 150 000 - - 207 600
March 64 000 75000 144000 - 283 000
535 600

2 Cash Budget March 2016)

(31st
Ref/Working R
Cash receipts: Alternative
Cash from customers Part 1 287 200 283 000
Cash payments for:
Lease payment W1 -50 000
Raw materials W2 -270 000
Insurance W3 -18 000
Employee Salaries W4 -144 800
Overheads W5 -42 333
Taxation -50 000

Net cash flows -287 933 -292 133

Opening Cash Balance 150 000
Cash flow before borrowings -137 933 -142 133
Cash from share issue W6 237 938 242 136
Closing Cash Balance 100 004 100 003
ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.
 Workings
W1 50 000 (600,000/12)
W2 270 000 60,000*(80/20)+30,000
W3 18 000
W4 144 800 (0.2*64000 +10*10000 +20000 +0.1 *(320000-
W5 42 333 50,000-((110000-10000)/5)/12-6000
237 933 242 133
13.50 15*0.9
17 624.7 17 935.80 237933/13.50 or 242133/1

237 937.50 242 136.00 13.50*17625 or 17936

ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.

3a) TO: Mr.
Madonsela FROM:
A Student
SUBJECT: The Budgeting
Process DATE: 06 June 2016

This memorandum serves as a response to your queries on how to improve cash

flow and how to go about the budgeting process in the
future.

Increase selling price

Take up the new lease
option Cut down on
staff
Sell only on a cash basis/change their credit policy (sell
less on credit) Find alternative, cheaper forms of
financing
Targets for bonuses should be harder to reach, the manager receives a bonus
in each of the 3 months system. He recieves a bonus in
March despite making cash flow losses.
Factor debtors
Use shares to pay
employees Sale and
leaseback
Negotiate better terms with suppliers

3b) Budgeting Process

Obtain input from all levels of management as well as workers
This will allow management to obtain valuable input that can assist in setting
reasonable, attainable targ Hold management to be accountable for budgets set
Obtain seasonal reports on sales
Employees need to be given access to the budget information that is relevant to their function
so they
they are being measured up against
Management should consider drawing up a Budgeted Statement of Financial Position as well
as a Bud
Comprehensive Income

d thefore would not be a true reflection of what caused the variance.

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 Number of boards cut: 366,080 366,080 C1
46,080
14%
R’s R’s R’s
Supervisors' salaries 460,000 460,000 - 0%
Wages 1,098,240 1,032,000 C2 66,240 6%
Parts (Blades, labels, etc) 439,296 496,896 C3 -57,600 (13%)
Power 439,296 438,272 C4 1,024 0%
Maintenance 263,120 140,000 C5 123,120 47%
Depreciation 686,400 770,000 C6 -83,600 -12%
Allocated Divisional Overheads C7

Net Profit 3,386,352 3,337,168 49,184

Commentary on the variances:

Firstly, the original variance report compares the actual costs incurred on 1 level of activity to
budgeted costs based on a different level of activity. As most of the costs included in the report
will increase either in a direct proportion, or step wise manner, with an increase in activity, a
portion of the total variances calculated will reflect the additional cost that is attributable to
the increase in activity. This portion of the variance is to a large extent beyond the control of
management, as it is a result of an increase in sales levels beyond budgeted. The original budget
has been restated to reflect the actual number of boards cut, in order to isolate efficiency, or lack
thereof, in the cutting process itself.

Secondly, it should be noted that the actual number of boards cut, exceeds the standard
allowance of 10%. For the 768,000 m2 of panels that were sold, 352,000 boards should have
been cut (768,000 m2 / 2.4m2 ) x 110%). The actual number of boards cut (366,080) exceeds
the standard, by 4%. This could be due to a number of reasons:

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 1) Inefficiency and errors in the cutting department, resulting in new board having to
be cut, at the company’s expense (additional boards would have to be purchased).
The cost of the wasted boards is not reflected in the department’s performance
report, but would be between R281,600 [R20 x (366,080 – 352,000)] and
R844,800 [R60 x (366,080 – 352,000)] depending on
the proportion of chip / super-wood wasted.
2) A second explanation could be that the excessive wastage, is actually a
reflection of unrecorded sales, and internal controls and reconciliation over the sales
process should be investigated. This may be fraud (free supply of panels to friends and
family of sales staff) or could merely be a cut off problem between the recording of sales
and cutting of the wood (were there large orders at
the end of the previous financial year that were only supplied this year?) There is an
indication that long lead times are not uncommon.
3) Thirdly, the cutting department may be cutting wood either for their own
private use (indication of theft?) or for DCP showroom.

C2 Wages increased by less than the increase in wood cut. This either reflects efficient
utilization of staff, or unwillingness to incur costs (cost constrained mentality) due to
being held accountable for the variance. The budget may have intentionally made
allowance for sufficient spare capacity to ensure that bottlenecks do not incur too
frequently. Despite being able to increase capacity easily, long lead times exist. The long
leads times resulting from under spending in this area may result in undermining the
company’s ability to compete and draw sales, especially from tradesmen.

C3 Parts are significantly over budget – this either relates to not taking adequate care of the
machines (rough usage), in which case parts may break, or may relate to the reduced
maintenance spend. Alternately, theft of parts may be possible, or closing stock may be
incomplete, with the result that usage appears higher than it actually was (if the quantity used is
determined by purchases + change in stock levels).
C4 The power variance is very small, indicating that this has probably been well controlled.

C5 Maintenance costs are well below budgeted

– Unless this is due to timing (maintenance may be a lumpy cost, occurring at infrequent
intervals, but smoothed in the budget, but given that the budget is for a whole year, this
is not likely)
– It seems likely adequate levels of maintenance are not taking place.
– Either this was the result of an effort to reduce the overall cost overrun that
occurred the department during the year (many costs increased
automatically in response to
increased activity levels) or

– A result of the department being busier than anticipated, which means that in an
ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.
 effort to keep acquisitions of additional equipment to a minimum, down time for
scheduled maintenance was reduced in order to increase the number of operating
hours available from existing machinery.
– Alternately, under-spending on maintenance may have prompted earlier than expected
replacement of machinery, explaining the depreciation charge that is higher than
originally anticipated, and increased at a rate in excess of the increase in activity (i.e. the
level of investment in assets increased relative to the increase in cutting activity).

C6 Although this department is unlikely to be able to exercise autonomy in the purchase of new
assets, their use of and care for the assets will affect the life of the asset, and it would be this
department that initiates a nd motivates for the acquisition and replacement of assets. The
information provided indicates that cutting capacity can easily be expanded. Which implies that if
the cutting department indicates that it needs additional resources, it receives these as a matter
of course. Further, asset replacement would be affected by the extent to which maintenance of

the existing assets has been carried out, which is the responsibility of this department, and the
efficiency with which existing assets are used – i.e. could bottle necks be solved by improved
planning, rather than asset acquisitions?
Including the depreciation charge in the measurable profit will encourage the
department managers to not be unnecessarily extravagant as regards acquisition of
assets.

C7 Unless the allocation method considers the specific resource utilization of the Cutting
department, and allocates the divisional costs in accordance with cost causation, this line item
reflects an arbitrary allocation over which the department managers cannot exercise any sort of
control, and is ignored for the purposes of performance evaluation.

Other valid observations or interpretation will also attract marks, but the majority of marks will be
awarded for key issues, and application to and development of the factspresented.

Note: there are 60 marks available in this solution above. It is not anticipated that most
students at this level will identify all practical reasons explaining the variances. A full range
of reasons is included to provide for a variety of possible answers. Marks can be capped
per variance.

2 Key points would be the following:

Control

Managers should be evaluated on that which they can control. A department may not
have control over the decision to invest in asset for that department. If that
responsibility does not lie with the department, then it is appropriate to use a measure
that does not include assets. The same applies to working capital, the cutting department
ACC3023W – Management Accounting II – Budgeting ©2023 UCT, All Rights Reserved.
does not have any working capital – no debtors to manage, no inventories to manage.
However, other departments such as the purchasing department, would have
responsibility for inventories, and a comparison of actual to budgeted costs, or profits
would not be appropriate.

Divisional managers would be expected to exercise control over every aspect of the
divisions operations, and so it is appropriate to use a performance measure that
considers operating performance relative to the investment in assets.

Short term focus (both measures)

Both measures will encourage managers to have a short term focus, on accounting
profits. ROI encourages the manager to focus maximise the short term accounting
figures, and discourages management from focusing on items that are of strategic
importance, that are important for the long term growth and profitability of the
company, as the immediate financial effect would be an increase in costs in the current
financial year, for benefit only to be received in subsequent financial years.

Consistency with NPV and DCF (Value creation)

Evaluating division managers on net profit would encourage growth, but not encourage
managers to seek returns in excess of WACC. Any investment opportunity that had a
positive return would be accepted, regardless of whether it had a positive NPV or not.

Using net profit to incentivise divisional management would be inappropriate, especially

given the significance of managing of assets, given the nature of the operations of DCP
(equipment dependent, possibly large inventory holdings as a result of importing, etc).

General shortcomings of ROI

(Key points – not encourage managers to pursue growth, and inappropriate investment
decision making as a result of using existing ROI as hurdle rate for new (and existing)
investment.)

Unfortunately ROI has its own negative behaviour consequences by virtue of being a relative
performance measure, rather than a measure of value in absolute terms.
Managers tend to use the existing ROI as the hurdle rate when evaluating new projects, with the
result that any new investment that may have positive NPV’s, but not offer a return
exceeding the average return of the division in the first year is unlikely to be accepted.
Consequently, maximum growth is not encouraged. It is unlikely that most new
investment will beat the divisions current ROI in the 1st year, due to numerous factors,
including typically poorer cash flows in the initial year, and highest asset base in that year
(as opposed to depreciated asset base in the division).
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3.

Solution to be fleshed out – key points are:

Incremental budgeting (perpetuate past inefficiencies – detail, budgeting system does
not encourage critical thinking about cost control.)
Input from departmental managers seems non-existent.
For planning purposes the budget may be prone to becoming outdated and irrelevant.

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