Reference no: EM132339232

Assessment - Costing and Budgeting

1 Analyse cost information within a business

2 Propose methods to reduce costs and enhance value within a business

3 Prepare forecasts and budgets for a business

4 Monitor performance against budgets within a business

Assignment brief

You are a trainee manager in a manufacturing business which has a number of different businesses and initiatives. At present it has several issues which need to be addressed and you have been tasked to examine some of these matters. Following a recruitment campaign a number of new trainees have been appointed and are to take part in a short induction course.

The course is designed to introduce the new trainees to the business and to its various procedures.

The induction course will concentrate on a number of key issues within the organization and some of the tasks within this assessment will require you to focus on preparing suitable materials to assist trainees on the induction course.

Task 1a)

You have been asked to prepare some briefing notes, suitable for the new recruits to the business, which briefly explains the kinds of manufacturing and operating costs likely to be encountered within the business. The notes should give examples of manufacturing costs and the way these costs may be classified.

Your notes will need to explain what is meant by:

'direct’ and ‘indirect’ indicating examples of „direct? and „indirect?  costs, and

‘Fixed’, ‘Variable’ and ‘Semi-variable’ costs, again, indicating which of your chosen examples fall into these categories.

Task 1 b)

The new trainees will also experience of a range of different costing methods which take place within the organisation. You should also write brief notes to explain what is meant by:

Job Costing 1.2

Process Costing 1.2

Task 1 c)

The organisation uses traditional absorption costing and marginal costing techniques in the course of its business. The following case study, Unified Models (UM) Ltd., has been designed to help the new trainees understand how these techniques may be applied within the business. UM Ltd has 2 products, Alpha and Beta. It operates from premises with two separate production factories, X and Y.

In the forthcoming budget year the following information is relevant:

Unified Models	Annual
	Production
	Items
Product Alpha	600
Product Beta	1,500

Unified Models
				Labour	Labour	Machine	Machine
	Labour	Material	Annual	hours in	hours in	hours in	hours in
	Cost per	Cost per	Production	Factory X	Factory Y	Factory X	Factory Y
	item	item	Items	per item	per item	per item	per item
	£	£
Product Alpha	160	300	600	5.0	5.0	1.0	1.0
Product Beta	39	60	1500	1.5	1.5	2.5	2.5

The annual fixed operating costs, £9m are to be shared between the two factories using a traditional absorption costing methodology which has resulted in the following overhead analysis. The calculations have been „rounded?.

Unified Models	Store	Administration	Distribution	Factory X	Factory Y	Total
	£	£	£	£	£	£
Annual Fixed Operating costs	200,000	2,400,000	3,200,000	2,200,000	1,000,000
Allocation of Store	(200,000)	40,000		100,000	60,000
	-	2,440,000	3,200,000	2,300,000	1,060,000
Allocation of Administration		(2,440,000)	244,000	976,000	1,220,000
		-	3,444,000	3,276,000	2,280,000
Allocation of Distribution			(3,444,000)	1,377,600	2,066,400
Total Fixed Operating Costs			-	4,653,600	4,346,400	9,000,000
Labour Hours taken:
Product Alpha				3,000	3,000
Product Beta				2,250	2,250
				5,250	5,250
Fixed overhead per labour hour				£          886.40	£     827.89
Machine Hours taken:
Product Alpha				600	600
Product Beta				3,750	3,750
Total				4,350	4,350
Fixed overhead per machine hour				£       1,069.79	£     999.17

UM Ltd absorbs the fixed overheads into the product costs on the basis of machine hours.

The following information has been prepared in respect of product Alpha on the assumption that the unit cost is to be marked up by 75% in order to arrive at the selling price. For this purpose Value Added Tax (VAT) can be ignored.

Unified Models	Machine	Unit Cost
Product Alpha	Hours per	Product Alpha
	item	£
Direct Labour per item produced		160.00
Direct Materials per item produced		300.00
		460.00
Fixed overhead Factory X	1.0	1,069.79
Fixed overhead Factory Y	1.0	999.17
Total Unit Cost		2,528.98
Mark up on cost	75%	1,897.02
Selling Price		4,426.00
Profit per item		1,897.02

Required:

Produce the information required to establish the selling price of product Beta assuming the unit cost is marked up by 45% in order to arrive at the selling price. You may, if you wish, present it in a similar format to that shown for product Alpha, above. Your analysis should show a selling price, rounded to the nearest £ of £7,644.

Task 1 d)

The trainees need to have some understanding of aspects of marginal costing. The UM Ltd Case includes a simple „break-even? case study as follows.

UM Ltd has a works restaurant which provides snacks and cooked meals during 6 hours of each working day, 6 days a week for 48 weeks of the year. The restaurant area can accommodate up to 25 customers at any one time and it is considered, on average, that each diner would spend 1 hour in the restaurant.

The facility is operated as a profit centre which is expected to generate a small profit for the organisation. It has the following annual fixed costs.

Unified Models		£
Restaurant rent and local taxes		25,000
Chef and cooks		150,000
Kitchen staff		50,000
Depreciation of equipment		10,000
Heating, Light and Cleaning		10,000
Repairs and maintenance		5,000
Licences etc		2,000
Loan Interest on borrowings		4,000
		256,000

A typical cooked meal is sold for £8 and the variable costs of the ingredients and power etc for this meal are £2.00.

You are required to:

• Calculate how many meals are needed to break even and to briefly state your opinion about the financial viability of the restaurant in terms of its ability to make a profit for UM Ltd.

• Produce a simple pie chart using the annual fixed cost information, above. Briefly describe the main message portrayed by your chart.   

Task 1 e)

The recruits will be required to understand the rationale for simple data sampling (not data collection) and to be able to present data in a variety of forms.

You are required to:

• Write brief notes which explain to the recruits the meaning of the terms „random sampling? and „stratified sampling? and which discuss why such techniques are used.

Task 2

One of your organisation?s small manufacturers Folkestone plc has been in operation for 3 months since October 2013. Your organisation had originally invested £16 million of assets (capital) into the company. The overall market for the product for the 3 months period ending December 2013 had been estimated to be around £25 million of sales.

At the end of the trading period in December 2013 the actual overall market for the product for the period had been around £22 million of sales.

The directors of Folkestone plc had been required to achieve the following performance ratios as part of their own performance targets:

• The Marketing director had been required to achieve around 25% penetration of the market and net asset turnover of 0.39 times

• The Production director had been tasked with achieving a gross profit margin of 55%, an operating profit margin of 6.8% and customer complaints to be 50 or less in the period, and

• The Finance director had been required to ensure that the current ratio was maintained at 2.0:1

• The Distribution director had been required to ensure that at least 90% of deliveries to customers were on time.

A summary of various performance indicators and the actual outcomes for the 3 month period was as follows:

Folkestone plc	October	October
	December	December
	2013	2013
	Budget /	Actual
	Target
Assets Invested (£)	16,000,000	16,000,000
Market (£)	25,000,000	22,000,000
Market Penetration	25.0%	27.0%
Quality
Customer complaints	50	80
On-time deliveries	90%	76%
Profitability
Gross Profit Margin	55.0%	52.2%
Operating Profit Margin	6.8%	0.1%
Return on Capital Employed	2.7%	0.0%
Efficiency
Net Asset Turnover (times)	0.39	0.37
Solvency
Current ratio X:1	2.0	4.2

Required:

Task 2a)

• Write an informal note which indicates the degree of success or otherwise of The Marketing and Production directors in achieving their goals;

• Write an informal note which indicates the degree of success or otherwise of the Finance and Distribution directors in achieving the goals set;

Task 2b)

Explain how the concept of „Value Added? is important to Folkestone

Task 2c)

Define „Total Quality Management? and discuss how it might assist the business in improving its performance.

Task 2 d)

As indicated above, Folkestone plc has been in operation for 3 months since October 2013. The following is a summary of the performance of the first 3 months, budget and actual:

Folkestone plc	October	October
Income Statement	December	December
	2013	2013
	Budget	Actual
	£	£
Sales	6,250,000	5,940,000
Cost of goods sold	(2,812,500)	(2,840,625)
Gross profit	3,437,500	3,099,375
Operating costs
Salaries	1,000,000	900,000
Rent and rates	500,000	600,000
Heating and Lighting	600,000	606,000
Office consumables	300,000	294,000
Vehicle running expenses	200,000	202,000
Depreciation of equipment	10,000	10,000
Repairs and maintenance	400,000	480,000
Total operating expenses	(3,010,000)	(3,092,000)
Operating Profit / Loss (-)	427,500	7,375

You are required to prepare a detailed (line by line) numerical variance report for the management of the organisation which:

• Shows the variances, budget against actual, for each item in the table above, and

• An informal note which briefly highlights and discusses each of the variations from budget where actual performance is in excess of £10,000 above or below the budget.   

Task 2e)

• Re-state the Income statement shown in 2d), above on the basis that the October to December 2013 actual sales had been £6,100,000 and the gross profit margin 51% (all other operating costs remain unchanged.)

• Write a short explanation as to whether you think that the revised operating results are better or worse than the initial scenario and indicate why this position might have occurred.   

Task 3a)

Your organisation uses a range of budgeting and budgetary control techniques in the course of its business activities.

You are required to prepare some short briefing notes, suitable for the new recruits to the business, which explain briefly:

• the overall purpose of the planning and budgeting process (including co- ordination and motivation);

• how the budgeting process is linked to the organisation?s overall objectives and strategy;

• the nature of incremental and zero based budgets,

• which briefly discusses  „creative? aspects of budgeting which can impact on the behaviour of budget managers.

Task 3b)

Your organisation has recently formed a new manufacturing unit, Fabrication Ltd

The following information has been produced to illustrate the manufacturing and other budgets required to support the initial months of trading during 2014:

Fabrication Ltd	March	April	May	June
	2014	2014	2014	2014
Production Budget (Units)
Sales Quantities	-	2,000	2,500	3,000
Add closing stock of finished goods required	2,000	2,500	3,000	3,500
	2,000	4,500	5,500	6,500
Deduct Opening stock of finished goods	0	(2,000)	(2,500)	(3,000)
Production Required	2,000	2,500	3,000	3,500

Labour production costs are £160 for each item manufactured. Each item of production requires 1 item of raw material costing £30 per item:

Fabrication Ltd	March	April	May	June
	2014	2014	2014	2014
Raw Materials Budget (Units)
Required for Production	2,000	2,500	3,000	3,500
Stock of raw materials (units) required at end of month (1 months)	2,500	3,000	3,500	4,000
	4,500	5,500	6,500	7,500
Deduct Opening stock of raw materials	(2,000)	(2,500)	(3,000)	(3,500)
Purchase (units)	2,500	3,000	3,500	4,000
Raw material purchases required £	75,000	90,000	105,000	120,000

 

Fabrication Ltd	March	April	May	June
	2014	2014	2014	2014
Labour budget (£)
Production Required (Units)	2,000	2,500	3,000	3,500
Labour cost per unit £	160	160	160	160
Production Labour cost £	320,000	400,000	480,000	560,000

The following additional information is also relevant:

• All raw materials (other than the initial 2,000 units of opening stock in March 2014) will be purchased on credit with suppliers being paid one month after the month of purchase. The purchase of 2,500 units of raw materials in March 2014, therefore, which would cost £75,000, would be paid for in April 2014.

• Labour costs are paid for as incurred. The labour cost of producing 2,000 units in March 2014, therefore, £320,000, would be paid for in that month.

• There is £350,000 of cash available in March 2014, which, after paying the labour costs of £320,000 in that month, would leave a balance of £30,000 at the bank to start the month of April 2014.

• The selling price of the product is £250 and sales are all on credit. Customers are given 1 month in which to pay, so the 2,000 items planned for sale in April 2014, value £500,000, will be paid for in May 2014.

You are required to prepare your own version of the following debtors, creditors and cash budgets (or provide the budgeting information in a format of your own choosing). Selective figures have been provided for guidance.

Fabrication Ltd	March	April	May	June
Debtors Budget	2014	2014	2014	2014
Opening Balances		0	500,000	?
Sales in Month		500,000	?	?
		500,000	?	?
Receipts from Debtors in Month		0	?	?
Closing Balances		500,000	?	750,000

Fabrication Ltd	March	April	May	June
Creditors Budget	2014	2014	2014	2014
Opening Balances	0	75,000	?	?
Raw Material Purchases in Month	75,000	?	?	?
	75,000	?	?	?
Payments to Creditors in Month	0	?	?	?
Closing Balances	75,000	?	?	120,000

Fabrication Ltd	March	April	May	June
Cash Budget	2014	2014	2014	2014
Opening Balances	350,000	30,000	?	?
Receipts from Debtors	-	?	?	?
	350,000	?	?	?
Payments to Creditors	-	?	?	?
Payments for Labour	(320,000)	?	?	?
Total Payments	(320,000)	?	?	?
Closing Balances	30,000	?	?	(555,000)

Task 3c)

Commencing with the scenario in 3b), above, reproduce the debtors and cash budgets on the assumption that the selling price per item was £275 (not £250) and that the customers are given 2 months in which to pay (rather than 1 month.
All other aspects of the case remain unchanged.

Comment on your answer assuming that Industrial Ltd have an agreement with the bank to overdraw the bank account by up to £500,000.  

Task 4

In recent months, the Directors of your organisation had been considering launching a new product range in April 2014 and running that part of the business as a separate entity. The new business would be called Reaction Ltd.

During March 2014, in preparation for the launch of the new business Reaction Ltd, labour was recruited on a temporary basis and a trial batch of the proposed new product was manufactured. This was to be representative of a typical month?s production. At the same time a variance reporting mechanism was created as part of the management accounting control system for the proposed new product.

During March 2014, the trial batch of 10,000 items of the new product range was produced. The following information was gathered as part of the control system:

Operating budget for the March 2014 trial batch of the proposed new product. (Direct labour and materials only)

Reaction Ltd	Production volume (number of items)					10,000
			No	Rate	Per Item	Total Cost
				£	£	£
Labour hours per item			5	18	90	900,000
Kilograms of Material per item			3	20	60	600,000
						1,500,000

Actual results for March 2014 trial batch. (Direct labour and materials only)

Reaction Ltd	Production volume (number of items)					10,000
			No	Rate	Per Item	Total Cost
				£	£	£
Labour hours per item			4	19	76	760,000
Kilograms of Material per item			2	22	44	440,000
						1,200,000

As can be verified below, the actual cost represents a favourable (F) total cost variance of £300,000, made up of a favourable (F) labour cost variance of £140,000 and a favourable (F) materials cost variance of £160,000.

Reaction Ltd				Budgeted	Actual	Difference
Volumes				10,000	10,000	-
Labour				900,000	760,000	140,000
Materials				600,000	440,000	160,000
Total Cost Variance				1,500,000	1,200,000	300,000

You are required to:

Task 4a)

• analyse the labour cost variance, £140,000 (F) into the following components:

Labour rate variance, and Labour efficiency variance;

Your two calculations should total £140,000 (F)

Task 4b)

• analyse the materials cost variance, £160,000 (F) into the following components:

Material price variance, and Material quantity variance.

Your two calculations should total £160,000 (F)
 
Task 4c)

• Comment on why you think these variances could have occurred.

• Outline the main purpose of undertaking variance analysis such as that demonstrated in this task.