Basic accounting & budgets Lecture 5

On completion of this topic you should
be able to:
• Define the difference between financial &
management accounting
• Recognise the behaviour of costs
• Define budgets and cost centres
• Identify different budgetary control systems
7032maa Lecture 5
What is accounting?
7032maa Lecture 5 2
It’s the story of a business told in
numbers
It tells us how
much the business
is worth in total,
what it owns &
what it has
borrowed
Different types of
accounting
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Financial accounting
Discuss the following in your groups:
•What is financial accounting?
•Who needs it and in what format?
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Provides financial data and information
generally to external parties such as
government and shareholders for taxation
and financial performance purposes. These
may be documents such as profit & loss
accounts and balance sheet
Management accounting
• What is management accounting?
• Who needs it? What is it used for?
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Provides financial data and information generally
to interested parties within a company such as
middle and senior management (sometimes
senior management may need financial accounts
too). It is used for decision making and planning
Banks, other credit and government agencies may
have an interest too
The main differences
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Source: Dyson, J.R (2010) Accounting for non-accounting students, FT Prentice
Hall p272, fig12.1
Management accounting
functions
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Source: Dyson, J.R (2010) Accounting for non-accounting students, FT Prentice
Hall p275, fig12.3
Management accounting
functions
• Cost accounting: involves calculation and
recording of on going costs, revenues and actual
product or services costs for stock evaluation
• Decision making: involves anticipated future
costs and revenue data that is not normally
recorded
• Auditing: internal and external audits, check
and verify the accounting information and
reports. It can involve external and internal
parties working closely
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Types of costs
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An economist
would say this
is a cost
Types of costs
• Direct costs: Costs that relate directly
to an activity and are easily identified for
example, labour and material costs or any
other direct costs
• Absorption costs: All costs are
charged to products
• Marginal costs: Cost of producing and
extra unit of output
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Behaviour of types of costs
• Indirect costs: Costs that cannot be relate
directly to an activity for example, rent or cost of
heating office. Sometimes called overheads
• Fixed costs: Cost is constant regardless of
activity for example rent
• Variable costs: Cost changes with activity
• Fixed and variable costs can also be direct or
indirect costs
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What is a budget?
• It’s a story that predicts what your business will
sell and how much it will cost
• Or to put it another way: It’s a financial plan
about future expenditure or revenues usually for
the next 12 months
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Main features of a budget
• It has policies that will help to achieve objectives
• It has monetary data which is documented & in writing
• It is about a future time period
• In most cases there are sub-budgets that are put
together to form a master budget
• A master budget is checked for compliance with the
business plan or strategy
• All he budgets need to be relevant and reflect each other
requirements (if a sales budget shows an increase in
deliveries, the fuel budget needs to reflect an increase
too)
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Types of budgets
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Sales budget example
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January February
Product A Volume
Unit Price (£)
Value (£)
100
£2
£200
150
£2
£300
Product B Volume
Unit Price (£)
Value (£)
200
£3
£600
250
£3
£750
Total £ £800 £1050
Production budget example
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January February
Opening stock
Less Sales of
Plus Production
= Closing stock
1000
500
1000
1500
1500
600
100
1000
Material Unit Cost (£)
Total Production Material Cost (£)
Labour Unit Cost (£)
Total Production Labour Cost (£)
Overheads (£)
2
2000
8
8000
1200
2
200
8
800
120
Total (£) 11200 1120
Operating a budget control
system
• Budgets are used to control activity & cost
• Actual result are compared with budgets
and actions are taken to correct significant
variances
• This is known as Variance Analysis
Variance = Budget – Actual
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Features of budgetary
control
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Adapted from: Dyson, J.R (2010) Accounting for non-accounting students, FT Prentice Hall p326
Dyson, J.R (2010) Accounting for non-accounting students, FT Prentice Hall
Budget procedures
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Source: Dyson, J.R (2010) Accounting for non-accounting students, FT Prentice
Hall p330, fig15.3
Cost centres
Fixed, flexible & zerobased
budgets
• Fixed budget: A budget designed for a
predetermined volume of output
• What happens when future output is not
met?
• Fixed budget is not so useful, as other
components of budget are now incorrect
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Fixed & flexible budgets
• Flexible budget: A budget designed to allow for
adjusting the permitted cost levels to match with the
level of activity actually attained
• Recognises the difference in behaviour % variable
costs in relation to fluctuations in output
• What happens when future output is not met?
• The budget is “flexed” appropriately with such
fluctuation
• If sales rises 10%, then associated costs must also rise
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Source: Dyson, J.R (2010) Accounting for non-accounting students, FT Prentice
Hall p337, example15.2
Flexible budget procedure
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Source: Dyson, J.R (2010) Accounting for non-accounting students, FT Prentice
Hall p338, example15.2
20% increase (60%-50%/50% x 100)
Fixed costs are same
Flexible budget procedure
Why is
there a
variance?
Controlling budgets
• Consult managers about any budgetary system
• Train mangers about budgeting and control
systems
• Direct involvement of managers (particularly their
department)
• Allow managers to prepare their budgets
• Do not impose budgets on managers
• Budgets are not for disciplinary procedures, only
discipline for variances if negligence , not when
the budget is imposed
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Summary
• Defined the difference between financial &
management accounting
• Recognised the behaviour of costs
• Defined budgets and cost centres
• Identifed different budgetary control
systems
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