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- 20 Marks
Question
a) Explain the following:
i) Incremental Budgeting (2 marks)
ii) Zero-Based Budgeting (2 marks)
iii) Activity-Based Budgeting (2 marks)
b) Cox Ltd is a manufacturing company that produces a body shaping drink for the African market. The company employs a marginal costing system as an integral part of its reporting systems. During the reporting period, there was no opening or closing inventory. The company produces its budgeted and actual results for December 31, 2022, as follows:
| Budget | Actual | |
|---|---|---|
| Production/sales (units) | 2,000 | 1,400 |
| Sales (GH¢) | 60,000 | 42,400 |
| Variable Costs: | ||
| Direct material (GH¢) | (20,000) | (13,200) |
| Direct labour (GH¢) | (10,000) | (7,600) |
| Variable overhead (GH¢) | (6,000) | (4,400) |
| Contribution (GH¢) | 24,000 | 17,200 |
| Fixed cost (GH¢) | (20,000) | (20,800) |
| Net profit/loss (GH¢) | 4,000 | (3,600) |
Required:
Prepare a budget that will be useful for management cost control purposes and briefly comment on the company’s performance in December 2022. (14 marks)
Answer
a)
i) Incremental Budgeting:
This is the system of budgeting where the previous period’s or year’s budget is used as a basis for preparing the current period’s budget by making incremental adjustments influenced by factors such as inflation, expansion needs, and growth. It is simple to apply in practice because you need not develop a decision package or justify the inclusion of the cost of an item into the budget. However, this method perpetuates past inefficiencies and does not lead to optimal and efficient allocation of budgetary resources. (2 marks)
ii) Zero-Based Budgeting:
This is a process of budgeting whereby all activities contained in the budget are re-evaluated each time the budget is prepared. Every item of expenditure must be justified in its entirety to be included in the next year’s budget. This approach adds a psychological impetus to employees to avoid wasteful expenditure, but it creates extra paperwork as the process of preparing the decision packages under Zero-Based Budgeting can be repetitive and cumbersome. (2 marks)
iii) Activity-Based Budgeting:
This is a method of budgeting based on an activity framework and the utilization of cost driver data in the budget-setting and variance feedback process. It involves defining activities that drive costs and using the level of activity to decide how much resource should be allocated and to determine how well an activity is being managed and to explain variances from the budget. While it helps managers to identify the cost of an activity and facilitate cost reduction, it can sometimes be difficult to trace objectively the cost of an activity to a product. (2 marks)
b)
Cox Limited – Cost Card
| Cost Element | Calculation | GH¢ |
|---|---|---|
| Selling price | (GH¢60,000 / 2,000 units) | 30 |
| Direct material | (GH¢20,000 / 2,000 units) | 10 |
| Direct labour | (GH¢10,000 / 2,000 units) | 5 |
| Variable overhead | (GH¢6,000 / 2,000 units) | 3 |
| Budgeted production cost | 18 | |
| (2 marks) |
Flexible Budget for the Month, 31 December 2022
| Performance Area | Fixed Budget | Flexible Budget | Actual Result | Variance |
|---|---|---|---|---|
| Production/Sales | 2,000 units | 1,400 units | 1,400 units | |
| Sales (GH¢) | 60,000 | 42,000 | 42,400 | 400F |
| Variable Costs: | ||||
| Direct material (GH¢) | 20,000 | 14,000 | 13,200 | 800F |
| Direct labour (GH¢) | 10,000 | 7,000 | 7,600 | 600A |
| Variable overhead (GH¢) | 6,000 | 4,200 | 4,400 | 200A |
| Total variable cost (GH¢) | (36,000) | (25,200) | (25,200) | 0.00 |
| Contribution (GH¢) | 24,000 | 16,800 | 17,200 | 400F |
| Fixed cost (GH¢) | (20,000) | (20,000) | (20,800) | 800A |
| Net profit/loss (GH¢) | 4,000 | (3,200) | (3,600) | 400A |
| (Marks are evenly spread for flexible budget and variance = 10 marks) |
Commentary:
Sales variance was GH¢400F. This means that budgeted selling price is
(GH¢60,000/2,000units) GH¢30 and actual selling price is (GH¢42,400/1,400 units)
GH¢30.285. The overall performance is GH¢400 worse than budgeted. That is, the
flexible budget is GH¢3,200 compared with actual loss of GH¢3,600. Control of
direct material cost has been very good as this has been GH¢800 better than
expected. Direct labor cost is overspent as does fixed overhead by GH¢600 and
GH¢200 respectively.
(2 marks)
- Topic: Budgeting, Marginal Costing and Absorption Costing
- Series: JULY 2023
- Uploader: Joseph