MBA 122 Managerial Accounting for Decision Making

:Lecture 5
Profit-planning and Control

)ARaboshuk@su.edu.om( Course coordinator: Dr. Alina Raboshuk

Academic Year: 2022-2023
Semester: II
 Course Learning Outcomes
1. Summarize knowledge on recent practices related to businesses and critically
assess in evaluating strategic options
2. Acquire knowledge on profit-planning and apply on all types of budgets
3. Analyze costing systems and their implications on the decision-making process and
managing businesses through analyzing costs and profits
4. Evaluate operational and strategic alternatives of businesses operating in
competitive environments
5. Choose appropriate and effective controlling concepts to evaluate performance
6. Integrate knowledge on advanced management accounting practices
7. Apply CVP and marginal analysis for making short-term managerial decisions
8. Construct various budgets and undertake variance analysis for effective system of
budgetary control design
Controlling is the last step in the decision-making process.
This step includes:

• Preparing budgets.
• Perform and collect information on actual performance.
• Identify variances between budgeted and actual performance.
• Respond to variances and exercise control.
• Revise plans and budgets if needed.

Can you think why most businesses prepare detailed budgets for a year
ahead, rather than for a shorter or longer period???
Advantages of Budgeting:

1. Benchmarking approach.
2. A tool for internal communication.
3. Plan for future activities.
4. A method to help in allocating resources.
5. A method to coordinate activities towards achieving goals.
6. A method to discover bottlenecks.

Budget Period:
How managers should determine the budget period?
Human Factor:
How companies should prepare its budgets?
Responsibility Accounting?
Types of Budgets:

Periodic Budget: is prepared for a particular period (usually one year).

Continual Budget (rolling budget): is continually updated. A continual

budget will add a new month to replace the month that has just
passed, thereby ensuring that a budget for a full planning period is
available.

??? Which method do you consider to be more costly and which

method is likely to be more beneficial for forwarding planning???
Types of Budgets:

Zero-Based Budget: is a method for building the budget with zero prior
bases. It focuses on identifying a task and then funding these expenses
irrespective of the current expenditure structure.

Advantages:
• Accuracy.
• Efficiency.
• Reduction in redundant activities.

Disadvantages:
• Time-Consuming.
• High HR Requirement.
• Lack of Experience staff.
Activity-Based Budget: Budgets prepared according to cost-driving
activity rather than function can provide.

Advantages:
• Accuracy.
• Closer links between costs and management responsibilities.

Master Budget: Company’s budget is prepared according to

departments or functions. All these sub-budgets are the master budget
for the company.
Trade receivables Cash Trade payables
budget budget budget

Sales Overheads Capital Direct Raw materials

expenditure labour purchases
budget Budget budget budget budget

Finished goods Production Raw materials

inventories budget budget inventories budget

The interrelationship of operating budgets

Benefits of Budgets:

• Budgets promote forward thinking and the identification of short-

term problems.
• Budgets can help co-ordination between the various sections of the
business .
• Budgets can motivate managers to better performance.
• Budgets can provide a basis for a system of control (management by
exception).
• Budgets can provide a system of authorization for managers to pend
up to a particular limit
The budget-setting process:

 Establish who will take responsibility

 Communicate guidelines
 Identify key factors
 Prepare budget for key factor area
 Prepare draft budgets for all areas
 Review and coordinate
 Prepare master budgets (incomes statement and statement of financial
position)
 Communicate the budgets to interested parties
 Monitor the performance relative to budget
The traditional planning model versus the “beyond budgeting” planning model
Criticism of budgets:

 Cannot deal with rapid change

 Focus on short-term financial targets, rather than on value creation
 Encourage “top-down” management style
 Can be time-consuming
 Based around traditional business functions and do not cross boundaries
 Encourage increment thinking (las year’s figure, plus x per cent)
 Protect rather than lower costs
 Promote “sharp” practice among managers
 Budgeting is still widely regarded as useful and extensively practiced
despite the criticism and the costliness of a traditional budgeting system
Accounting for Control:

Companies should design an effective system of budgetary control.

Companies should undertake variance analysis and analyze possible

reasons for the variances.

Companies should consider the standard costing system.

The Budgetary Control Process

1. Prepare budgets
2. Perform and collect information on actual performance.
3. Identify variances between planned (budgeted) and actual
performance.
4. Respond to variances between planned and actual performance
and exercise control

Two types of control are available to managers:

5. Feedback Control.
6. Feedforward Control.
Feedback Control Steps (remedial):

1. Prepare budget.
2. Perform.
3. Collect information on actual performance.
4. Compare actual performance with budget and take action on
deviations.

Adjusting the budget in this type of control will be after comparing the
actual performance with the planned.

Steps are taken to get operations back on track as soon as there is a

signal that they have gone wrong.
Feedforward Control Steps (preventive):

1. Prepare budget.
2. Prepare forecast of actual outcome.
3. Identify deviations between budget and forecast actual outcome.
4. Evaluate results and take action on deviations

Here predictions are made as to what can go wrong and steps are then
taken to avoid any undesirable outcome.

It should be recognized at the outset that studying and analyzing

variances would help companies in:

5. Achieve their objectives.

6. Control business activities.
7. Evaluate performance.
8. Planning for future.
Behavioral Aspects of Budgetary Control:

1. Budgets can improve job satisfaction and performance.

2. Demanding, yet achievable, budget targets can motivate more

than less demanding ones.

3. Unrealistically demanding targets can adversely effect managers’

performance.

4. Participation of managers in setting their targets can improve

motivation and performance.
Variance Analysis:
A method used by companies to evaluate performance. This method
helps companies to follow the management by exception approach
through analyzing the reasons for the variance and make corrective
actions in the future.

One application of variance analysis is the Standard Costs approach.

Standard Costs approach

Standards are benchmarks or “norms” for measuring performance and

for controlling costs. Two types of standards are commonly used.
1. Cost/Price standards.
2. Quantity standards
• Cost (price) standards specify how much should be paid for each
unit of the input.

• Quantity standards specify how much of an input should be used to

make a product or provide a service.

Types of Standards:

Ideal standards can be attained only under perfect circumstances. No

breakdowns or interruptions.

Practical standards are standards that are tight but attainable. They
allow for normal breakdowns.
Example 1:

The standards for product “X” call for 7.5 kilogram of a raw material that costs
18.10 OMR per kilo.
Last month, 1,400 kilogram of the raw material were purchased for 24,990
OMR.
The actual output of the month was 160 units of product “X”.
A total of 1,300 kilogram of the raw material were used to produce this output.

Required:

Determine the materials price variance and the materials quantity variance for
the month.
Answer:

Materials price variance = (AQ × AP) − (AQ × SP)

= 24,990 OMR − (1,400 × 18.10 OMR) = 350 Favorable

Materials quantity variance = SP(AQ − SQ*)

= 18.10 OMR (1,300 − 1,200) = 1,810 Unfavorable

*SQ = Standard quantity per unit × Actual output = 7.5 × 160 = 1,200
Example 2:

The standards for product “X” specify 6.5 direct labor-hours per unit at 12.90
OMR per direct labor-hour.
Last month 1,240 units of product “X” were produced using 8,200 direct labor-
hours at a total direct labor wage cost of 100,040 OMR.

Required:

Determine the labor rate variance and the labor efficiency variance for the
month?
Answer:

Labor rate variance = (AH × AR) − (AH × SR)

= 100,040 OMR − (8,200 × 12.90 OMR) = 5,740 F

Labor efficiency variance = SR(AH − SH*)

= 12.90 OMR (8,200 − 8,060) = 1,806 U

*SH = Standard hours per unit × Actual output = 6.5 × 1,240 = 8,060
Example 3:

The following standards for variable manufacturing overhead have been

established for a company that makes only one product:
• Standard hours per unit of output 6.2 hours
• Standard variable overhead rate 13.25 OMR per hour

The following data pertain to operations for the last month:

• Actual hours: 8,200 hours
• Actual total variable overhead cost: 109,470 OMR
• Actual output: 1,300 units

Required:
Determine the variable overhead spending variance and the variable overhead
efficiency variance for the month?
Answer:

Variable overhead spending variance = (AH × AR) − (AH × SR)

= 109,470 OMR – (8,200 × 13.25 OMR) = 820 U

SH = Standard hours per unit × Actual output = 6.2 × 1,300 = 8,060

Variable overhead efficiency variance = SR(AH − SH)

= 13.25 OMR (8,200 – 8,060) = 1,855 U
Static and Flexible Budgets:

Static Budget

Prepared at the beginning of the budgeting period and is valid for a

single, planned (fixed) level of activity.
In static budgets, control & performance evaluation is difficult when
actual activity differs from the planned level of activity. Therefore,
static budgets are suitable for planning purposes.

Flexible Budget

May be prepared for any activity level within a specified range. Reveal
variances related to cost control, and improve performance evaluation.
Example 4:

A manufacturing company presented the static budget and actual results for one
its functions at the end of 2020. As a senior manager you are required to analyze
variance and performance

Variance Actual Static Budget Items

2,000 ? 8,000 hour 10,000 hour Machine hours

6,000 F 34,000 OMR 40,000 OMR Variable indirect labor
4,500 F 25,500 OMR 30,000 OMR Variable indirect
materials
1,200 ? 3,800 OMR 5,000 OMR Power
0 12,000 OMR 12,000 OMR Fixed depreciation
50 U 2,050 OMR 2,000 OMR Fixed Insurance
11,650 F 77,350 OMR 89,000 OMR Total OH
Variance Actual Flexible budget Items

0 8,000 hour 8,000 hour Machine hours

2,000 U 34,000 OMR 32,000 OMR Variable indirect labor (4 per hour)

1,500 U 25,500 OMR 24,000 OMR Variable indirect materials (3 per hour)

200 F 3,800 OMR 4,000 OMR Power (0.5 per hour)

0 12,000 OMR 12,000 OMR Fixed depreciation

50 U 2,050 OMR 2,000 OMR Fixed Insurance

3,350 U 77,350 OMR 74,000 OMR Total OH

 Flexible Budget Performance Report
Actual performance at Flexible budget at Static Budget at
8,000 hour 8,000 hour 10,000 hour

77,350 OMR 74,000 OMR 89,000 OMR

89,000 OMR – 74,000 OMR = 15,000 F Variance from Activity

74,000 OOMR – 77,350 OMR = 3,350 U Cost Control Variance

• The 15,000 OMR favorable variance is due to decline in the level of activity.
• The 3,350 OMR unfavorable variance is due poor cost control.
Standard costing:

• Standards are budgeted physical quantities and financial values for

one unit of inputs and outputs.
• There are two types of standards (ideal standards and practical
standards).
• There tends to be a learning-curve effect: routine tasks are performed
more quickly with experience.
• Standards can be useful in providing data for income measurement,
pricing decisions, product sourcing and efficiency measurement.
• Standards have their limitations, particularly in modern
manufacturing environments, however they are still widely used.
 :References

Atrill, P. and McLaney, E. (2018). Management Accounting for Decision Makers (8th .1
ed.), Pearson Education Limited, London. E-book weblink:
quest.com/lib/soharuni/detail.action?docID=5481312&query=
unting
(Chapter 4, 5)

2. Drury, C. (2006). Management and Cost Accounting. 6th Edition. Publisher: Thomson.
 Contact Us
Dr. Alina Raboshuk
araboshuk@su.edu.om