Human Problems with Budgeting - Assignment Example

Finance and Accounting   and Finance and Accounting   Question a) Outcomes Strategies Probability Small facility large facility Low demand 0.6 700,000 420,000 High Demand 0.4 520,000 2,100,000 Using expected value decision rule, the most profitable mode of action will be the one that yield the highest returns given the following combination of outcomes. Build small facility = (0.6*700,000) + (0.4*520,000) = 420,000 +208,000 = 628,000 Build large facility = (0.6* 420,000) + (0.4*2,100,000) = 252,000 + 840,000 = 1,092,000 Decision rule: Alan should build a large facility because it yields the highest expected value of £1,092,000 (b) Payback period Initial investment= 1,360,000 Therefore, payback period will be the duration the investment will take to recover the amount that was initially invested. Payback schedule Year cash flow Cumulative 1 470,000 470,000 2 580,000 1,050,000 3 580,000 1,108,000 4 500,000 1,608,000 Payback period= 3 years + (1,360,000-1,108,000) * 12 months = 580,000 = 3 years 5 months Accounting rate of return Depreciation = cost- scrap value Number of years = 1,360,000-0 4 = 340,000 Profit schedule Year 1 year 2 year 3 year 4 Profit before depreciation and tax 470,000 580,000 580,000 500,000 Less: Depreciation (340,000) (340,000) (340,000) (340,000) Profit before tax 130,000 240,000 240,000 160,000 Less: Tax @ 26% 33,000 62,400 62,400 41,600 Profit after tax 96,200 177,600 177,600 118,400 Accounting rate of return (AAR) = Average Income*100% Average Investment Average income = (96,200+177,600+ 177,600+118,400)/4 = 142,450 Average investment = 1,360,000 Accounting rate of return= 142,450/ 1,360,000 = 0.1047 or 10.17 % Net present value (NPV) Investment by Health and fitness centre Year cash flow Discount rate Net present value (NPV) 0 (1,360,000) 1 (1,360,000) 1 470,000 0.909 427,230 2 580,000 0.826 479,080 3 580,000 0.751 435,580 4 500,000 0.683 341,500 323,390 Advise: Since the net present value is positive, the business should invest in the new equipment as it will be profitable. The main functions of budgets A budget can be referred to as a tool that helps in projecting future income and expenses (Hopwood 1974). Budgeting refers to the act of quantifying objectives in financial basis. In broad terms, the budget performs the following key functions in an organization. Forecasting Forecasting is the attempt to establish what the future holds. It is a complex exercise that requires consideration of variables based on the actions of the competitors, economic outlook, government actions and forces of demand and supply. Planning Planning, to a large extent, depends on forecast that has been made to make the decision about the future (Markowitz 1952). Basically, the estimated data generated by forecasting is used in making plans. For instance, businesses use forecast figures to estimate use of materials and make plans that ensure they are availed when due. Communication In an organization, budget acts as a communication tool through gathering of information- information about the company and its competitors, which is brought together during the process of making budgets (Campbell & Viceira 2004). The other way through which budgets can act as a communication tool is information dissemination. Motivation Budgets act as a driving force that motivates workers towards achievement of the set goals. However, for a budget to motivate workers, it should neither have goals that are too difficult nor too easy to achieve. Evaluation Budgets represent target performance, which will be compared with the actual performance. Therefore, corrective actions are usually taken whenever a deviation is noted. Authorization Budgets help minimize misappropriation that would be characterized if the system of approval is absent. Through approval, managers are made more answerable for their expenditure. (d) Andy Bevan Original performance report Budget Actual Variance Production in units 10,000 8,800 Variable costs Direct Materials 400,000 364,000 36,000 F Direct labor 80,000 78,000 2,000 F Selling and distribution 120,000 110,000 10,000 F Andy Bevan Revised performance report Budget Actual Variance Production in units 8,800 8,800 Variable costs Direct Materials 352,000 364,000 12,000 A Direct labor 70,400 78,000 7,600 A Selling and distribution 105,600 110,000 4,400 A The original budget shows that Andy bevan is below the budget as indicated by the favorable variances. However, based on the revised budget, he is operating above the budgeted amounts as shown by the adverse variances and should, therefore, not be amused by the reported figures, but instead cut on costs to operate within the budget. (e) John Castle Ltd Variance analysis Material usage variance= standard price (standard quantity- Actual quantity) = 3 (5- 5.5) = 1.5 Adverse (A) Material price variance= Actual quantity (standard price- Actual price) = 5.5 (3-3.08) = 0.44 (A) Labor Efficiency Variance = Standard rate (standard hours- Actual hours) = 10(0.5-0.52) = 0.2 A Labor rate variance= Actual hours paid (standard rate- Actual rate) `= 1000(10-11) =1000A (f) Human behavior and motivation as an effective system of budgetary planning and control. It is necessary for managers to develop strategies and attitudes that maintain and cultivate cooperative and supportive relationships with the rest of the workers. However, budgets should not only be used as a computational tool for control, but behavioral aspects should also be considered to motivate the staff in order to achieve the budget goals (Hilton 1994). The budget acts as a tool of control when used to measure managerial performance. As such, the resulting outcome may either result to a reward or punishment. When the management adopts participative approach to budgeting, it allows individuals to play a role in the budgeting process. Workers gain access to information regarding operations in their areas of responsibility, which enhances employee commitment and motivation to achieve set targets and goals. Question Two (a) (1) Economic Order Quantity (EOQ) = √2DCo Ch Where; D- Annual demand Co- Order cost Ch- Holding cost EOQ=√ 2*14,000*20 15%*10 = √ 373,333 = 611 (2) Number of orders= Annual demand/ EOQ = 14,000/611 = 23 Orders (3) Total cost= Holding cost + Ordering cost = EOQ/2 Ch + (Demand*Ordering cost/ EOQ) = (611/2*1.5) + (14,000*20/611) = 458.25+458.27 = £ 916.50 (b) Importance of inventory in a manufacturing concern Inventories are the items held in stock. In a manufacturing concern, it is always prudent to hold some stock items to make certain smooth production according the needs of the marketing department. In addition, manufacturing concerns maintain inventory to ensure prompt deliveries to the retailers when requisitions are made (Argyris 1953). At times, a firm may wish to take advantage of quantity discounts and, therefore, would prefer to purchase in bulk and keep the materials for future use. Holding inventories will help a company to hedge against uncertain lead times. When the supplier takes more than normal to supply stock items required, this will affect production schedule and supply of customer orders. To avoid such problems, the firm maintains high quantities of stock items. References Argyris, G 1953, ‘Human Problems with Budgeting’, Harvard Business Review, vol.31 no.1, pp. 97-110. Campbell, JY & Viceira, LM 2004, The Term Structure of the Risk-Return Tradeoff, Harvard University, Washington. Hilton, R 1994, Managerial Accounting, 2nd ed, McGraw-Hill Book, New York. Hopwood, A 1974, Accounting and Human Behavior, Haymarket Publishing Ltd, London. Markowitz, H 1952, ‘Portfolio selection’, Journal of Finance, vol. 7 no.5, 77-91. Read More