Reference no: EM133164607

Question: Delight Ltd is an established company which specialises in making celebration cakes for large events, birthdays, weddings and other celebrations. In the past they have grown steadily and have always achieved their budgeted sales targets. They have a good reputation, using fresh, high quality ingredients. However, during the year 2020, the global Covid-19 pandemic prevented many large celebrations from taking place, and the company's cake sales dropped significantly.

The Managing Director, Susan Thornton, wants to know which areas of her business have performed well in 2020 and has heard that using a flexed budget will help to identify this. She has asked you to review the 2020 financial results and advise her on actions which she could take to improve the company's performance in the coming year.

The results for 2020 are presented in the following table:

	Actual	Budget
Sales units (Cakes)	85,000 units	110,000 units
	£	£
Selling price per cake	35	40
Sales revenue	2,975,000	4,400,000
Direct materials	935,000	1,100,000
Direct labour	510,000	550,000
Gas (variable)	89,250	110,000
Electricity (fixed)	42,750	50,000
Production overhead	670,000	640,000
Selling & admin overhead	980,000	950,000
Total Costs	3,227,000	3,400,000
Profit / (loss)	(252,000)	1,000,000

The following notes are relevant:
• Direct materials include eggs, sugar and flour. These were in short supply in 2020, with eggs particularly difficult to obtain from their usual suppliers.
• The company kept all its staff working during the pandemic, but also needed to use some less experienced temporary staff to cover for employees who were unable to work due to Covid-19 infection or self-isolation.
• The gas is only used in the bakery ovens and normally costs £1 per cake baked.
• Electricity is budgeted at £50,000 per year. The charge covers head office electricity as well as general light and heat of buildings.
• Production overhead and selling& admin overhead are fixed costs.
• Production overhead includes depreciation, machine maintenance and production manager salaries. Some temporary staff have been used to cover sickness during the year.
• Selling and admin overhead includes advertising costs, finance, sales team and other management salaries. Some temporary staff have been used to cover sickness during the year.
• Some Head Office employees worked from home during the year.

Budget process
The company has always previously used an incremental budgeting methodology to calculate its budget for the coming year. An external consultant has proposed that they change to use zero based budgeting for the future. Susan is not sure what this means or whether it will make their budgeting more accurate. She has asked you to advise her.

Required:

a) For each category of the 2020 results, calculate a flexed budget and a variance to the flexed budget. (The variance to the flexed budget is the variance between the Actual results and the flexed budget results).

b) Based on your calculations in part (a), and the additional relevant information provided in the question, state for each category of the results what the possible causes could be of the flexed variance to budget, and a possible action management could take.

c) Critically analyse both zero based budgeting and incremental budgeting methodologies, with specific reference to Delight Ltd, and the current and future economic situation of their industry. Advise Susan, the Managing Director, on whether zero based budgeting is an appropriate methodology for her business, giving your reasoning.