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Choose the most correct answer and mark the answer sheet (a), (b), (c), (d) with an ‘X’. DO NOT MARK THE QUIZ.

1. The key objective of budgeting is to:

(a) control costs(b) maximise profit(c) motivate managers to plan and achieve targets(d) allocate overhead correctly

2. In preparing budget reports:

(a) absolute accuracy is not necessary(b) accepted auditing standards must be followed(c) the needs of stockholders are important(d) the only important figure is profit

3. In budgeting, break-even analysis mainly helps management to:

(a) achieve break-even(b) determine the need to raise prices(c) reduce variable costs(d) understand profit/volume relationships

4. In budgeting the key job of the controller is to:

(a) develop a creative environment(b) train staff(c) cut costs continuously(d) make profits

5. Costs which relate directly to a product are normally:

(a) managed costs(b) engineered costs(c) uncontrollable costs(d) true costs

6. If the budget indicates that one of several products is not profitable then:

(a) the product should be dropped(b) the product price must be raised(c) none of these(d) the allocation of fixed costs to the product must be reduced

7. Top management sponsorship of the budget system involves:

(a) providing funds for its operation(b) active use of results(c) participation in formulating goals(d) all of the above

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QUIZ BOOKBasic Planning and

Budgetary Control

To be used and returned to the Organiser

AGLAUTONOMOUS GROUP LEARNING

Copyright: LTM 2002 No copies of this material may be made without written permission

FINANCE FUNDAMENTALS 2

8. All costs are controllable:

(a) in the short run(b) at some level of responsibility(c) when they are truly sunk(d) if they are variable

9. If the manager must spend 500,000 for a vital project but his annual budget is exhausted, he should:

(a) spend it and argue afterwards(b) spend it and charge it to some other account(c) not spend it(d) spend it and charge next year

10. Transfer prices for goods and services rendered by one profit centre to another are best:

(a) negotiated by the managers concerned(b) treated as transportation costs(c) negotiated by managers and then set by controller(d) set by top management

11. Variation between actual and standard cost is:

(a) never justified(b) always justified(c) a miscalculation of standard cost(d) sometimes justified

12. Flexible budgets are:

(a) are always better than fixed budgets(b) add flexibility to the budget system(c) are superfluous if break-even analysis is used(d) are too complicated to be practical

13. Managers generally beat the budget system to:

(a) survive in a defensive and oppressive environment(b) avoid reasonable responsibilities(c) achieve the best results for the business(d) do well

14. Budget reports encourage management by exception and thus:

(a) improve management efficiency(b) direct attention at major variances from budget(c) ignore minor variances from budget(d) all the above

15. A creative environment for budgetary control motivates managers to:

(a) set high levels of achievement

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(b) study budget reports(c) prepare budgets quickly(d) defensive budget targets

16. When a manager feels that he achieves his personal objectives by achieving the company’s budget target, then the budget system is really:

(a) too involved in company politics(b) effective(c) defensive(d) too personal and not rigorous

17. To measure the performance of managers in a budget period, we compare actual departmental costs in the period against:

(a) previous year and budget(b) different departments(c) budget(d) budget, previous year and other departments

18. In selling or marketing routine budget reports to managers within the company, the key needs to be satisfied are those of the:

(a) accountants(b) operating managers(c) sales managers(d) chief executive

19. Graphical presentations of budget data:

(a) are meaningful only to engineers(b) over-simplify key financial problems(c) communicate key signals effectively(d) are not generally accurate enough for budgetary control

20. The most difficult problem in changing and planning any budgetary control system are:

(a) technical(b) human and technical(c) accounting(d) strategic and human

21. Budgets are usually:

(a) a summary of the business plan(b) only a part of the business plan(c) the most important part of the business plan(d) nothing to do with the business plan

22. Forecasting a future activity to set targets in financial terms is:

(a) budgeting(b) control estimating

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(c) planning(d) budgetary control

23. Which of the following is wrong about budgetary control:

(a) budgetary control sets targets and measures performance against those targets

(b) budgetary control is part of accounting work(c) budgetary control includes forecasting and controlling(d) budgetary control is only part of the total business plan

24. The overall effectiveness of a budgetary control system may best be measured by the:

(a) way managers achieve budget targets(b) budget reports(c) creativeness of the planning(d) profit of the company

25. Budgets are in financial language because:

(a) in practice they are prepared by accountants(b) they are the only way to plan business operations(c) top management only understands financial plans(d) they put business activity into a common language

26. Managers generally use routine budget reports to:

(a) allocate resources day by day(b) make difficult decisions(c) force people to work harder(d) control performance

27. Defensive budgeting results where the dominant motivating force is:

(a) fear(b) money(c) participation(d) avoidance of responsibility

28. For creative budgeting, managers usually should:

(a) set their own targets(b) accept the targets(c) participate in setting their own targets(d) not have targets

29. A budgetary control system must be mainly designed to relate to the:

(a) organisation and critical factors of the industry(b) personalities of the managers(c) accounting system(d) organisation and shareholders

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30. An operating budget is:

(a) an income statement(b) a future income statement(c) an estimate of production and sales(d) a forecast of sales and costs

31. The key assumption in an operating budget is:

(a) profit(b) sales(c) overhead(d) production

32. An operating budget which indicates contribution, clearly shows:

(a) sales less fixed costs(b) sales less variable overheads(c) sales less variable costs(d) gross profit less overhead costs

33. In an operating budget, the best forecast of overhead expense is by:

(a) scientific analysis(b) percentage of labour cost(c) last year(d) estimate from the managers responsible

34. The degree of detail in an operating budget depends upon the:

(a) time allowed to prepare the budget(b) usefulness of the budget to operating managers(c) value of the budget to top management(d) trouble involved for accountants

35. If our operating budget has assumptions which may not be valid we should:

(a) not complete the budget until the assumptions have been completely validated

(b) complete the budget and hope for the best(c) make alternative budgets on different assumptions(d) ignore the doubtful assumptions

36. The sales target in an operating budget depends main upon:

(a) all of these(b) management guidelines(c) productive capacity(d) market

37. Operating budgets may be prepared for the business as a whole, by department, by division, by product group, by area, depending on the:

(a) usefulness of separate budgets

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(b) experience and skills of the budget staff(c) volume of departmental sales(d) other considerations

38. In a manufacturing company the operating budget should normally be prepared:

(a) for six months in detail(b) for six months in detail and six months in total(c) for twelve months in detail(d) for four quarters in detail

39. An annual operating budget should normally be revised:

(a) regularly each quarter(b) every month(c) when the underlying assumptions become completely inappropriate(d) when actual results differ substantially from the budget

40. An operating budget indicates:

(a) cash required by the business(b) profit targets for the current year(c) cash and profit targets(d) sales and profit targets

41. A budget report which forecasts fixed assets, working capital and owner’s equity is a:

(a) cash budget(b) budgeted balance sheet(c) operating budget(d) capital budget

42. A budgeted balance sheet always shows:

(a) assets and profits(b) assets and how they are financed(c) assets, liabilities and costs(d) assets and forecasted equity only

43. The level of working capital on the budgeted balance sheet may be estimated as:

(a) a percentage of sales(b) a percentage of cash receipts(c) a percentage of cost of sales(d) a percentage of profit

44. Which items in a budgeted balance sheet may best be estimated from cost of sales:

(a) debtors and creditors(b) creditors and stock

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(c) creditors and fixed assets(d) stock and debtors

45. A business has sales of 1,200 for the half-year and estimates receivables at two months sales, then the budgeted balance sheet at the end of the half-year will show receivables as:

(a) 800(b) 600(c) 400(d) some other figure

46. A business balance sheet shows an opening equity of 25, budgeted profit of 10, and budgeted dividends of 5, then the closing equity in a budgeted balance sheet will be:

(a) dependent upon the volume of activity(b) 40(c) 20(d) 30

47. When the validity of assumptions used to prepare a budgeted balance sheet is very doubtful, we should:

(a) ignore the assumptions(b) prepare several new budgeted balance sheets with different assumptions(c) prepare a new budgeted balance sheet with different assumptions (d) change all the assumptions

48. In the budgeted balance sheet the excess of assets required over available finance from liabilities and owner’s equity represents:

(a) arithmetical errors(b) additional equity(c) shortage of cash(d) excess of funds

49. The figure of fixed assets in a budgeted balance sheet usually consists of the opening balance:

(a) plus the capital budget(b) less depreciation(c) plus a percentage of production cost(d) plus additions less depreciation

50. In a budgeted balance sheet increase of investment in assets without provision of additional finance from owner’s equity will probably result in:

(a) excess funds(b) excess payables(c) shortage of assets(d) excess cash

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51. A budgeted balance sheet enables management to:

(a) forecast cash shortage(b) set targets for assets and available finance(c) all of these things(d) see the effect of all budgets on the overall financial position

52. The following are all sources of long term funds in a funds flow budget, except:

(a) profits(b) sale of an investment(c) new capital(d) dividends

53. A funds flow budget is the same as:

(a) source and use of funds budget(b) operating budget(c) budgeted balance sheet(d) cash flow budget

54. All the critical long term management decisions of a business are best revealed by a:

(a) budgeted balance sheet(b) operating budget(c) funds flow budget and capital budget(d) operating budget and capital budget

55. The following are all sources of long term funds, except:

(a) new capital(b) sale of fixed assets(c) depreciation(d) losses

56. The following are all uses of long term funds, except:

(a) fixed assets(b) dividends(c) depreciation(d) repayment of loans

57. The difference in a funds flow statement is generally reflected in:

(a) working capital changes(b) dividend changes(c) cash surplus(d) profit changes

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58. A funds flow statement shows: new fixed assets 20, new capital 10, net profit after depreciation 50, dividends 10. The change in working capital is therefore:

(a) decrease 25(b) decrease 30(c) increase 30(d) increase 35

59. In a funds flow budget, a deficiency could be provided for by:

(a) increasing dividends(b) decreasing loans(c) increasing working capital(d) sale of fixed assets

60. If a manager overspends his budget every year for four years, the controller should:

(a) fire the manager as “…. unreliable and inefficient”(b) investigate(c) investigate and then increase the budget(d) convince the manager that he must try harder

61. Sales of 543 467-16 are best shown in budget reports as:

(a) 543 467-16(b) 543 500(c) 543 000(d) 543.0

62. A sale of 50-00 on the 15th January on terms of “60 days net from invoice date” will normally become a cash receipt in:

(a) March(b) February(c) January(d) some other time

63. A forecast of cash receipts and payments for an accounting period is a:

(a) funds flow(b) cash budget(c) operating budget(d) funds flow budget

64. “It is usually more important in business to plan cash than to plan profit.” This statement is:

(a) true(b) false(c) not relevant to practical business(d) irrelevant to budgeting

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65. A cash forecast shows receipts and payments month by month in order to:

(a) compute the timing and peak cash requirements(b) compute the peak balance or overdraft(c) compute the balance at the end of the period(d) check the cash book accuracy

66. Failure to control investment in stock and debtors normally results in:

(a) cash shortage(b) extended credit from creditors(c) profit shortage(d) restricted dividend

67. We normally revise a cash forecast:

(a) monthly for six months ahead(b) each quarter(c) monthly for twelve months ahead(d) once per year

68. A business plan for one year:

(a) is useless unless there is also a five year plan(b) is more meaningful if there is also a five year plan(c) forces us to revise the five year plan(d) is more meaningful if there is also a twenty-five year plan

69. The business plan for the year relates:

(a) business objectives to environment(b) objectives to resources and environment(c) resources to environment(d) business objectives to resources

70. Guide lines from top management:

(a) are a small part of the business plan(b) enable management to revise the business plan(c) are necessary before the business plan can be prepared(d) are not really necessary for a good practical business plan

71. Planning of business resources to achieve objectives (in words and figures) is known as:

(a) estimating(b) budgetary control(c) business planning(d) management control

72. The budgets prepared as part of the business plan include:

(a) more than those budgets mentioned below(b) operating, cash and capital budgets(c) capital and operating budgets

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(d) operating budgets and financial statements

73. A long-term business plan is normally revised:

(a) yearly for twenty years ahead(b) yearly for five years ahead(c) half-yearly for five years ahead(d) at five-yearly intervals

74. Debt capacity exists when we have:

(a) ability to lend cash(b) high payables, low receivables(c) ability to borrow cash(d) high payables and low owner’s equity

75. In preparing a business plan, interaction between top and other management is:

(a) irrelevant(b) useful but not really necessary(c) not practical(d) necessary

76. Co-ordination of resources for marketing, production, finance and research is best achieved in:

(a) budgetary control(b) business planning(c) management guidelines(d) management accounting reports

77. Budgets for operating departments:

(a) simply frustrate departmental managers(b) provide controls for accountants(c) are vital for day-to-day decision making(d) providing financial framework within which the manager may operate

78. Budgetary control is the responsibility of:

(a) accountants(b) accountants and top managers(c) someone else(d) every manager in the business

79. Where top management uses the budgeting system to control and punish managers then the system becomes:

(a) defensive(b) effective(c) useless(d) creative

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80. For effective budgetary control top management should always set targets in the budget which are higher than the employees may achieve. This statement is:

(a) practical(b) false(c) immoral(d) irrelevant to budgetary control

81. When managers feel that the budget system is a tool to help them plan and achieve higher targets more effectively, the system is usually described as:

(a) exciting(b) defensive(c) creative(d) theoretical

82. The following are all evidence of “defensive” budgeting, except:

(a) tough cost targets(b) deferring sales and costs(c) frequent budget revision requests(d) high sales targets

83. A budget target really motivates a manager when he:

(a) accepts it verbally(b) is consulted by the top manager(c) puts it in writing(d) believes that it is consistent with his own personal objectives

84. Participation in setting budget targets:

(a) always leads to acceptance(b) always makes budgeting creative and acceptable(c) may make budgeting more creative and acceptable(d) is seldom really effective

85. A creative budgeting system may generally be effective:

(a) only after years of operation(b) only if fully supported by top management(c) in the beginning but not later(d) quickly if accountants are competent

86. Communication is:

(a) irrelevant to budgetary control(b) irrelevant to motivation(c) necessary for motivation(d) the controller’s only concern

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87. “Budget reports should always be prepared very carefully to the highest possible degree of accuracy.”. This statement is:

(a) always true(b) seldom true(c) generally true(d) false

88. To help managers achieve targets, budget reports should be:

(a) regularly prepared and distributed to every manager of the organisation(b) prepared rapidly and systematically for responsible managers(c) prepared only on demand(d) as accurate as humanly possible

89. In budget reports management concentrates attention on:

(a) excess of actual over budget(b) any difference between actual and budget(c) excess of actual over previous year(d) significant differences between actual and budget

90. Monthly budget reports should be expected after the month end:

(a) five working days(b) one working day(c) 25 working days(d) 50 working days

91. The following are all good qualities of budget reports, except:

(a) detail avoided(b) important and trivial data segregated(c) one performance standard(d) precisely accurate

92. When dealing with non-routine matters, management needs:

(a) comprehensive routine reports(b) special reports(c) a catalogue of miscellaneous data(d) engineering rather than cost data

93. Effective budget reports generally show:

(a) actual and budget for this month(b) actual and budget for this month and last month(c) budget for this month and last month(d) actual and budget for month and year to date

94. Budget accountants should spend considerable time outside their offices talking to managers who use budget reports because:

(a) they need a break(b) budgetary control would be more effective

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(c) they can check up on the managers’ work(d) they could take over if required

95. To determine the effectiveness of budget reports we should:

(a) research carefully into the use of reports(b) ask managers personally if they need each report(c) not send reports for three months(d) send out a questionnaire to managers

96. Based on sales of 4,000, gross profit percentage of 40% and overhead expenses of 1,000, budgeted operating profit is:

(a) 1,400(b) 300(c) 400(d) 600

97. Given bank receipts of 400, payments of 200, and an opening negative bank balance (overdraft) of 100, the forecast cash balance is:

(a) 200(b) 100(c) 300(d) 400

98. “Budgetary control systems rest on concepts that have more to do with human relationships than the rules of accounting.” This statement is:

(a) not very practical(b) theoretical rubbish(c) true(d) false

99. Which of the following is not part of a good business plan:

(a) setting management objectives(b) analysis of business resources(c) study of the business environment(d) setting penalties applicable if the plan is not achieved

100. In practical business the most difficult problem for management in budgetary control is:

(a) how to construct budgets(b) how to use budgets(c) the human effects of budgeting(d) the language of budgetary control

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NAME: __________________________________________________

Mark each correct answer with a clear X – e.g. (a), (b), (c), (d)

1. (a) (b) (c) (d) 26. (a) (b) (c) (d) 51. (a) (b) (c) (d) 76. (a) (b) (c) (d)

























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QUIZ ANSWER SHEET


























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QUIZ ANSWER SHEET

ASSIGNMENT 10.0

Giltim is a quoted limited public company organised into “decentralised” divisions. The Glass Division has separate marketing and manufacturing arrangements. Plant managers have profit responsibility. The budget system involves a long interaction in setting sales and profit targets to achieve company objectives. Does it motivate the managers to behave appropriately?

Top Management requires increased earnings per share every year. Probably concerned with stock market reaction of EPS on the market price of the company. Willing to sacrifice even better long term development and profit for … a continuous but steady improvement in earnings regardless of the poor economic climate. Managers encouraged to economise in costs even below budget levels unless sales targets achieved. Increased profit this year and every year … “a reliable growth company”. Fixed not flexible budget system.

Product quality, delivery, customer service, cost control. Plant manager best able to meet and control achievement in these critical areas.

Company “decentralised” into divisional profit and investment centres. Divisions function as independent companies except for: labour relations, capital expenditure, finance and the many informal controls that Head Office imposes without realising it.

Sales districts and plants are not consistently organised for special reasons not explained in detail in the case.

Plant manager not merely cost but profit conscious.

Extreme pressure on the plant manager if sales fall off.

Budgets consolidated at divisional level but considerable Head Office pressure on plants. Are divisions really managing the plants?

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LECTURE ON GILTIM COMPANY (A) (30 minutes)

10.1 STORY OF THE

10.2 TOP MANAGEMENT OBJECTIVES

10.3 INDUSTRY PROFIT-MAKING FEATURES

10.4 ORGANISATIONAL STRUCTURE

May - Division heads submit estimates of sales, profits and capital requirements.

June - Market research forecasts of overall political, economic and business environment. Head Office sets the guidelines for each division.

July - Divisional marketing managers and district sales managers set and adjust targets.

August - Sales targets allocated to plants to develop operating budgets.

September - Head Office controller visits plants.

October - Plant and divisional budgets consolidated for Head Office review and approval.

November - Changes negotiated and final targets agreed on to achieve overall objectives.

December - Top management final approval. Targets communicated to responsible managers as fixed commitments for the budget year.

NOTE: Top Management retains complete control of long term planning. Managers involved in short term budgets for many months. This continuous “interaction” probably leads to budget “acceptance”. Management by exhaustion? Budgets appear to be imposed but probably agreed by managers during the long period of “conditioning”.

Worthwhile for many reasons.

Investigates budget “padding” and obtains information to justify the budgets to Head Office

Demonstrates Head Office interest and involvement.

Allows lower managers to express aggressions.

Creates relationships with head office and lower levels.

Tends to bypass the Divisional Managers and emphasises the close centralised control … not at all decentralised!

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10.5 BUDGET PREPARATION

10.6 CONTROLLER’S VISIT

10.7 BEHAVIOUR OF PLANT MANGERS

(a) Plant manager best able to control quality, delivery and cost competitive features of the Industry.

(b) Feels responsible for profit because of extensive interaction in setting targets.

(c) System seeks behaviour that achieves profit targets. Environment probably highly defensive and managers may try to “pad” cost budgets and keep targets of sales activity low to provide the necessary freedom to “live” under the system. May result in poor quality of production at year end.

(d) Probable tendency to economise on anything but absolutely necessary maintenance, training, research and development, etc. in early months of the year when sales and profits are uncertain.

(e) Such behaviour is probably economic and effective for cost economy and profit achievement SINCE NO COSTS ARE ABSOLUTELY VITAL EXCEPT IN RELATION TO OTHER PRIORITIES.

(f) “The manager who gets promoted in GILTIM is probably the one who meets budget targets.”

Company needs improved EPS every year for stock market purposes. Needs to achieve a fixed profit target every year.

Fixed budget targets are clear and definite.

Revisions may excuse poor performance and may encourage manager to devote more energy to justifying budget revision than to achieving the budget.

Revised budget could relieve the plant manager of undue pressure due to poor sales performance.

10.8a Budget Problem as Plant A

(a) Decision:-

Plant Manager should fight hard for:

(i) Capital equipment budget (600,000) required to put the plant into efficient condition and then accept the required profit target, OR

(ii) Lower profit target for the technical reasons outlined in the case.

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10.8 BUDGET REVISION

NOTE: If unsuccessful, accept the required target then, if sales fall off, press for budget revision; lower sales target and profit target could be achieved by cutting costs for this one further year despite manufacturing efficiency. Possible request an “action team” to help the plant; get Divisional Manager’s support for this critical period and it will help the budget revision required.

(b) Justification

Company’s policy to hold Plant Managers responsible for meeting Head Office targets motivates “beating the system” through padding and sabotage, etc.

However, overall company need for earnings per share takes precedence over immediate technical efficiency in the plant although long term problems must be dealt with by the system.

NOTE: Key problem in budget setting is the strategic power of the parties concerned. Does the Plant Manager have the power and support to overcome the Controller’s sales and profit objectives? If not, he may as well accept the targets, do his best and then press for revision early in the year.

However, if he gets his capital budget substantially, then he must meet the targets!

A sophisticated budget preparation designed for a specific industry and organisation to achieve specific objectives.

Interaction over long periods “conditions” managers to believe that budget targets have been participatively “agreed” … they probably feel responsible and act accordingly, even though in purely rational economic terms this is ridiculous … but then managers never behave rationally in purely economic terms….

System probably very effective in achieving short term goals. May well perform adequately (if not optimally) in long term. However, does not “develop” creative managers…!!

(a) Budget preparation systems depend not only on technical problems but also the organisational environment.

(b) Before setting the budget system determine the industry’s critical profit making factors.

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10.9 MOTIVATION AND BEHAVIOUR

10.10 LEARNING POINTS

(c) Top management sets short term and long term objectives…. It may well prefer reasonable rather than “optimum” long term goals.

(d) Top management and the controller create the organisational environment for the budget system.

(e) Controller and Head Office visits provide both technical and human benefits.

(f) Defensive or creative environments motivate managers accordingly.

(g) Budget preparation may involve several months of technical and human interaction… interaction is not necessarily “wasted” time since manager motivation is complex!!

(h) Top management can agree the key common assumptions about the political, economic and business environment and then sets sales and profit guidelines.

(i) Market research at corporate level ensures consistent overall assumptions at the lower levels.

(j) Managers may be “conditioned” by interaction in the budget process to accept “irrational responsibilities” and yet be motivated to achieve required targets.

(k) Budget revision may excuse poor performance and reduce motivation to achieve targets.

(l) Organisational structure and responsibility must be clearly defined for effective budget structure.

(m) The lower in the organisation we locate profit centres, the more profit oriented the managers behave. Get “profit orientation in the FRONT LINE”!

(n) Managers should be profit rather than merely cost conscious.

(o) In multi plant operations it may be possible to use divisional standard costs and to budget local deviation from standards.

(p) Cost reduction programmes can be features in annual budget targets.

(q) OTRA approach.

(r) Motivation of managers is a complex problem: money, status, fear, jealousy and KITA may be less effective than challenge, responsibility and achievement.

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10.11 LEARNING PATTERNS - REVIEW

10.11a BUDGET PREPARATION AND SYSTEM

10.11b INTERACTION

10.11c MOTIVATION

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10.11d BUDGET REVISION

10.11e CONTROLLER

10.11f OTRA

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(a) Reassemble in Small Groups (CSG) now.

(b) Study the note and learning patterns very carefully and record key points in your notebook. (10 minutes)

(c) Discuss each key point in SG. (10 minutes)

John Marais finances business expansion with a bank loan. He budgets a need of 75m. His results show increased sales over forecast and slightly increased profits. However, dividends use up necessary cash; inventory is high; creditors are stretched. The equity/debt relationship is weaker. Was the expansion really worthwhile? What budget should be set.

Suggested solution:

ActualLast yr

BudgetThis Yr

000* 000*Selling Expense: Sales salaries 25 45 Office salaries 15 20 Office expenses 16 20 Sales commission 70 100 Travel expense 25 45 Advertising 60 70 General promotion 35 50 Discounts allowed 80 120

326 470

Administrative Expense: Salaries 25 25 Office expense 29 35 Legal expense 6 10 Audit expense 4 10 General expense, interest and depreciation (offfice equipment) 26 30

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10.12 INSTRUCTIONS (20 MINUTES)

ASSIGNMENT 6.0LECTURE: JOHN MARAIS COMPANY (30 minutes)

6.1 STORY OF THE CASE

6.2 BUDGET THIS YEAR-SELLING AND ADMINISTRATION

90 110Total (see below) 416 580

NOTE: (a) Moderate increase in sales expense except for sales commission, travel, advertising, promotion. Discounts allowed increased substantially.

(b) Administrative expense well controlled.

(c) Total (416 – 580) due to sale increase from 1,583 – 2,500.

(d) ALL BUDGET TARGETS ARE ONLY REASONABLE ESTIMATES. (YOU MAY HAVE ALTERNATIVE SOLUTIONS THAT ARE EQUALLY ACCEPTABLE.)

ActualLast yr

BudgetThis Yr

000* 000*

Net sales 1,583 2,500Cost of sales 1,053 1,667

Gross profit 530 833 (33%)Selling & administrative expense(see above) 416 580

Operating profit 114 253Income tax (40%) 45 101 Net profit 69 162

Dividend paid 43 43

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6.3 BUDGET THI S YEAR - OPERATIONS

Suggested solution:

ActualLast yr

BudgetThis Yr

000* 000*

Current assets: Cash - (19) (e)

Accounts receivable (debtors) 127 208 (a) Inventory 314 559 (b)

441 748Fixed assets: Cost 92 92

Less: Accumulated depreciation 12 30

80 62 Total assets 521 810

Current liabilities: Accounts payable (creditors) 139 288 (c) Current tax liability 45 101 Bank (loan 75 50

259 439

Owner’s Equity:? Capital 100 100

Accumulated profit 162 271 (d)

262 371 Total liabilities and owner’s equity 521 810

NOTE: (a) Sales 2,500 @ 8.2% = 208

(b) Cost of sales 1,667 @ 33.3% = 559

(c) Cost of sales @ 10.6% = 288

(d) Accumulated profit 162 plus net profit 152 less dividend 43 = 271

(e) Difference – cash deficiency (19).

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6.4 BUDGET THIS YEAR – BALANCE SHEETS

(a) Operations – Expansion of sales and profits despite reduced gross profit % and loss of purchase discounts. Good cash flow (152m + dep. 18m).

(b) Capital – No substantial expansion. Will this be possible with increased sales?

(c) Cash – Liquidity difficult even with stock, debtors and creditors controlled.

(d) Overall Financial Position – Poor! Required assets increased by 289 (521 – 810) yet profit retained only 109 (152 – 43). This forces a stretching of creditors to finance the assets.

(e) Overall – Expansion at reduced margins is dangerous unless “required assets” are controlled. Need higher equity base.

(a) Continue expansion to achieve budget targets, which provide: profit, cash flow to improve liquidity and equity base.

(b) Control carefully the following:

(1) Sales – not to expand above budget because it would involve increase in required assets.

(2) Gross Profit – hold sales prices, avoid inventory losses, improve purchasing, take cash discounts, etc. and thus hold the 33% margin (gross profit percentage).

(3) Sales Expense – control carefully salesmen commission, sales discount and advertising the major costs.

(4) Administrative Expense – watch general expense and hold other costs.

(5) Debtors and Inventory – hold to budget levels with careful controls.

(6) Fixed Assets – avoid substantial new expenditure.

(7) Creditors – take cash discounts if available but stretch other payables if possible.

(8) Dividends – control to budget level or cut to nil if possible. Get more equity!

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6.5 EVALUATION OF THIS YEAR’S BUDGET

6.6 ITEMS TO BE CAREFULLY WATCHED

(c) Overall – Sales and profit expansion only leads to financial strength if finance is available for the increased assets. This company needs to get more equity base – and control operations very carefully – cash availability is vital!!

(a) Operations

(1) Sales increased substantially (1,163m – 1,583m).

(2) Gross profit increased (430m – 530m).

(3) Gross profit percentage fell substantially (37.6% - 33.5%).

(4) Selling expense exceeded budget (232m – 326m) due to sales commission and excessive sales discount allowed.

(5) Administrative expense controlled but general expense requires investigation (15m – 26m).

(6) Dividends used up most of the cash flow (43m – 69m).

(7) Excess sales (1,583m – 1,163m = 420m) produced only small additional net profit (69m – 65m = 4m) due to falling margins and high sales discount.

(b) Activity

(1) Inventory higher than budget (183m – 314m) and inventory turnover fell (4,0 – 3,3 times).

(2) Receivables higher but consistent with increased sales (30 – 29 days).

(3) Payables stretched (9 – 48 days)!

(c) Liquidity

Poor. Company will find it difficult to repay 25m to bank within two weeks.

(d) Overall

Excessive activity at lower margins led to increased need for assets. Liquidity crisis and deterioration in equity/debt ratio (2,8/1 – 1,0/1).

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6.7 PERFORMANCE LAST YEAR – ACTUAL AGAINST BUDGET

NOTE: Need to either restrain sales or increase equity base with new cash or retained earnings.

May be due to: poor inventory valuation, selling price cuts, excessive returns and allowances, inventory losses, poor purchases, loss of purchase discount, embezzlement of cash, sales not recorded to avoid tax, etc. (Did you get them all?)

(a) Increased sales target must increase stock (inventory) and debtors.

(b) Operating budget based upon assumptions of sales, margins and overhead expenses. Margin means gross profit percentage.

(c) Capital budget provides fixed assets to support operating sales targets.

(d) Overall financial position – budgeted balance sheet based on assumptions for: stock, fixed assets, debtors, creditors and capital.

(e) Distinguish fixed costs which remain stable from variable costs which increase with sales volume.

(f) With sales expansion the increase in required assets must be carefully controlled by management.

(g) Equity/debt position may be improved by high retained profits and low dividends or new equity.

(h) Budgets not merely for operations, but also the effect of operations on cash, capital and overall financial position.

(i) Budgets based upon assumptions.

(j) Several alternative budgets could be prepared from the same basic data.

(k) Use the past performance, ratios, estimates and common sense to forecast budget for the future.

(l) Evaluate a budget in terms of: sales, costs, profit, assets required and finance available.

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6.8 FALL IN GROSS PROFIT PERCENTAGE

6.9 LEARNING POINTS

6.10a EXPANSION

6.10b SALES

6.10c COSTS

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6.10 LEARNING PATTERNS - REVIEW

6.10d BUDGETS

6.10e ASSUMPTIONS

(a) Reassemble in Small Groups now.

(b) Study this note and learning patterns very carefully and record key points in your notebook. (10 minutes)

(c) Discuss each key point in SG. (5 minutes)

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REMEMBER!Always write in your Course Diary. Your manual is for information

ASSIGNMENT 5.0LECTURE ON GILTIM COMPANY (B) (30 minutes)

Giltim (A) described budget objectives and preparation.Giltim (B) deals with reporting and action.

Problems arise in evaluating the reporting system and its effect on the behaviour of managers in the company.

(a) Design – reports include actual and target data. H.O. requires re-forecasting of activity that deviates from budget. Highlight on excess spending over budget but no importance attached to under-spending. Concentrates on problem areas with special reports. Report sample badly designed.

(b) Speed – flash reporting in three days and full reporting to H.O. in 8 days provides timely data for management. Probably achieved by cut-off of activities before the month end and efficient data processing. Computers, possibly used to print reports

(c) Frequency – monthly data on regular operations, weekly or daily data for critical problems – excellent.

(d) Clarity – poor layout and lack of graphical presentation.

(e) Effectiveness – highly effective for H.O. control of activity against budget. Provides control data to focus manager on target achievement and critical problems. Probably over-emphasises short term ‘meeting the budget’ at the expense of long term performance.

(a) Difficult to evaluate the performance of Plant X from this report since the ‘year to date’ figures not provided.

(b) However, evaluation of March performance raises many questions to be investigated:

1. Sales seriously below target with very high discounts and allowances – why sales department failure?

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5.1 STORY OF THE CASE

5.2 EVALUATION OF REPORTING SYSTEM

5.3 PERFORMANCE AT PLANT X AND DESIGN OF REPORT NO.1

2. Variable cost of sales controlled – due to manufacturing efficiency?

3. Fixed manufacturing cost seriously above target – why?

4. Operating income well below target both in the amount and percentage – due to failure of sales?

5. Special costs and profits generally consistent with targets but why did Plant Manager fail to cut back costs to make up for lack of activity?

6. Plant income well below target and return on assets employed unacceptable.

NOTE: Plant Manager’s action depends on results for ‘year to date’. If below target he could apply for budget revision on the grounds that the sales are failing to meet targets; alternatively, he could cut other special costs extensively and press the Sales Manager hard to achieve both sales volume and prices!

Controller also should press Sales manager and then ‘follow’ Plant Manager in cutting costs where possible. Situation requires immediate investigation and possibly an ‘Action Team’ to visit the plant and Sales Department to help them achieve results.

(c) Improvement of Report No.1

1. Eliminate previous month and last year figures since the budget is the real target.

2. Show only actual data for the month and the year to date with variances from budget (not budget itself).

3. Eliminate all data below 000 to reduce the digits to significant items only. Reports should not be “too black with figures”.

4. Design each report page as a complete entity supported by detail on subsequent sheets. Every report can be so designed for easy and effective communication.

5. Design report with graphical sections to highlight signals.

NOTE: Revised draft reports given in Exhibits 1 and 2.

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EXHIBIT 1Assignment 5.3

Giltim Company (B)

19

Revised

20

Plant

21

Operati

22

ng Su

23

mmary

24

–

25

March

Report No.1Month

(Under)Year to Date

(Under)

ActualOver

Budget ActualOver

Budget

Gross Sales 264 (62) 847 (122)

Discounts & allowances 47 31 84 56Net sales 217 (93) 763 (66)

26

% Gain (Loss) - (30.0%) - (7.9%) See Report 2

Gain (Loss) due to:

Sales price - (150) - (10)

Sales volume - 50 - (34)

Sales mix - 7 - (22)(93) (66)

Variable cost of sales 142 (45) 384 (64) See Report 3

Gross margin 75 (48) 379 (2)% Sales 34.5% (4.0%) 49.6% 3.6%

Fixed manufacturing expense 41 5 211 10 See Report 4

Operating income 34 53 168 (12)

% Sales 15.6% 22.0%

Special costs (profits) 23 (30) 12 11 See Report 5

10.5% 1.5%Plant Income 11 (83) 156 (1)% Sales 5.1% 20.4%

Assets employed 1,816 (58) 1,816 (58) See Report 6

% Return .6% 5.1% 8.6% 8.4%

NOTE: See Graphical Reporting (Exhibit 2).

See Copy in Course Diary

27


Giltim Company (B)

Revised Plant Operating Summary

Example of Graphical Reporting

No. 1 CUMULATIVE SALES Actual and Budget

B A4000

B A

240 309 J J 240 309

279 237 F F 519 546

550 217 M 3000 M 829 763

670 A A 1129

720 M M 1399

250 J2000

J 1649

240 J J 1889

280 A A 2169

300 S 1000 S 2469

320 O O 2789

360 N N 3149

480 D D 3729

J F M A M J J A S O N D

NOTE: Similar charts for other key items!

See Copy in Course Diary

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Actual

Budget

(a) System provides highly centralised control by HO and is probably defensive.

(b) Extensive ‘interaction’ in setting the targets probably ‘conditions’ managers to accept them. Personal contact with HO staff and visit by Controller most helpful.

(c) Unreasonable to expect plant managers to meet profit targets if sales fall off, but quite possible for them to feel bound to do so and to ‘accept’ and believe that they can …. and to achieve target!

(d) Plant managers probably underspend on maintenance, research, training, etc. in the early months of the year until sales levels indicate that they can ‘afford’ to spend up to the budgeted cost levels.

(e) Plant managers motivated to achieve targets by:

1. Budget preparation process.2. Top management interest and follow-up of reporting.3. Salaries and bonuses.4. Competition among plants.5. Staff assistance and daily reports on critical problems.6. Requirement to continually re-forecast any expected

performance below target.7. Budget effect on personal promotion in the company.

(f) Tendency to achieve short-term targets with some loss of long-term potential. However, this loss may not be significant.

(g) Long-term planning retained by HO and Divisional Management (latter fairly impotent). Little motivation to think beyond current year at plant level. Poor development of plant manager’s potential.

(h) Fairly dynamic environment created by the constructive friction between plant, HO and Division.

(i) May achieve lower level of long-term performance but all staff not merely cost but PROFIT orientated.

(j) System meets Top Management objectives of profit now. Puts profit responsibilities close to operations which achieve profit. Relates to the specific industry features of: delivery, quality and efficient cost.

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5.4 MOTIVATION OF MANAGERS

(a) Consider the technical, human and organisational problems that any change would have to overcome. Managers may prefer “the devil they know to the devil they don’t!” and therefore be reluctant to accept and to work with any new system!

(b) Consider all alternatives and their implications:

1. Make Division a profit centre (plants become only cost oriented)?

2. Make plant responsible for the sales department as well (new types of plant managers)?

3. Make sales districts and plant profit centres with a ‘Transfer Price’ system and guaranteed volumes (arguments over the transfer price)?

4. Allow budget revision when sales fall off (managers more motivated to justify revisions than to achieve profit targets)?

(c) Proposals:

1. Tray to assign sales and profit responsibility to one manager in one centre.

2. If not possible, introduce some flexibility in budget revision when sales fall off substantially.

3. Expand budget system to ‘Total Business Planning’ in words and figures for a five year horizon period. Replan every year for five years ahead. Let the annual budget targets be developed from the first year of the plan.

4. Include all managers in short and long-term planning processes .

5. Introduce a training and development programme for managers to provide an understanding of long-term and short-term planning.

6. Discourage the idea that meeting the budget is the same as doing the management job!!!

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5.5 CHANGES RECOMMENDED

(a) Budget reports should be available three to eight days after the month end.

(b) Achieve fast reporting day early ‘cut off’ and efficient data processing (possibly use critical path techniques to determine delay factors).

(c) Design reports for use by managers not accountants. Simple, graphic, exciting. Exclude non-target history.

(d) Report signals of key factors, not complete detail.

(e) Design reports for local as well as top management.

(f) Recognise that manager motivation is not automatically achieved by participation but is a complex factor resulting from the total system.

(g) Managers may sometimes not be rationally ‘responsible’ but may be convinced that they are responsible and may act accordingly. Behaviour is not completely rational in logical or economic terms …. emotional needs.

(h) To modify the budget system and motivate managers is a complex problem. They may not work as effectively under a new ‘better’ system.

(i) Sales and manufacturing together make a more logical basis for a profit centre, but transfer price systems are available if this combination is not practicable.

(j) Set profit centres as close to operations (‘the front line’) as practicable, to make managers not merely cost oriented by profit oriented!

(k) HO ‘advice’ may really be ‘orders’.

(l) Plant ‘agreement’ may really be imposed by HO.

(m) Budget technical problems are fairly easy to solve but human problems are complex and difficult.

(n) Top management involvement in the budget process is vital if it is to motivate managers.

(o) Total business planning in five year horizons involving all managers is more useful than mere budgetary control each year. The TBP provides the underlying data for the annual and monthly budget targets.

(p) Design the budget system in relation to top management objectives, industry profit-making factors and the organisational structure of the

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5.6 LEARNING POINTS

firm.

(q) Measure the effectiveness of the budget system by the action and behaviour of the managers and not by what managers say ….

(r) Review and redesign budget reports periodically to meet current needs.

(s) Recognise that reports for HO may not necessarily meet local management key needs – thus leading to two (or more) reporting systems – formal and informal.

5.7a REPORTING

5.7b DESIGN

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5.7 LEARNING PATTERNS

5.7c DIGITS MUST COUNT

5.7d MOTIVATIONS

5.7e PROFIT CENTRES

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(a) Reassemble in Small Group.

(b) Read this note and learning patterns very carefully and record key points in your notebook. (10 minutes)

(c) Discuss each key point in CSG. (5 minutes)

(a) Assemble in SG now.

(b) SG work. (Exhibits 1-4) (45 minutes)

(c) CSG work. (30 minutes)

A with DB with E ‘Dealers’ A, B and CC with F

34


ASSIGNMENT 4.0CASE ANALYSIS OF GILTIM COMPANY (B) (45 + 30 minutes)

4.1 INSTRUCTIONS


Giltim Company (B)

In Giltim (A) you made a simple analysis of a budget system with emphasis on setting budget targets. Now Giltim (B) challenges you to make a more sophisticated analysis of the reporting and overall effectiveness of the budget system. (See previous lecture points 2.2, 2.4, 2.8 and 2.9.)

Role Assignments:

Dealers - (Plant Manager)Receivers - (Controller)

1. Evaluate the Giltim budget reporting system in terms of: design, speed, frequency, clarity, and overall effectiveness for plant, division and Head Office.

2. Evaluate the performance of Plant X as indicated in Exhibit 3. What action would you take if you were (a) Plant Manager, and (b) Controller? Criticise the design of the report.

3. How well does the budget system motivate plant managers to achieve company objectives? Consider the long term effects of the system on the behaviour of managers.

4. How could Top Management make the system more effective? Consider all the alternatives. Set out a plan and justify your decision in both technical and human terms.

35

QUESTIONS (45 MINUTES)


Giltim Company (B)

36

Top Ma

37

nagem

38

ent Ap

39

proach

40

to Rep

41

ortingThe Chief Executive and Controller of Giltim insisted upon a rapid and efficient reporting system of monthly operations. They believe in timely reports to allow timely action by Head Office, Division and plant managers.

However, they believed that plant managers should not wait until the month end to deal with critical problems but should be on top of them daily.

42

Plant reports were reviewed on an “exception” basis comparing actual against budget performance. This was felt to be good for morale and plant managers were expected to explain over-spending but not under-spending.

Top management concentrated on: sales, gross profit, manufacturing efficiency, etc. – but also checked up on cost and progress of projects under control of the plant managers.

A schedule of plant monthly reports is given in Exhibit 4.

43

Monthl

44

y Fla

45

sh

46

ReportsOn the third business day after the month end each plant wired to Division and Head Office the key figures for: sales, gross profit, manufacturing efficiency and net profit, together with the variances from budget. A summary of these figures was studied the next day by Top Management, which was concerned with critical variances.

47

Monthl

48

y Det

49

ailed

50

ReportsOn the eighth business day the plant operating summary (Exhibit 3) and supporting reports (see Exhibit 4) were due at Division and Head Office. These were consolidated to show the results by plant and division and distributed the next day to Top Management.

In addition, at the beginning of each month, plant managers were expected to submit current re-forecasts of anticipated performance for the month and year end. Such re-

51

forecasts enabled Head Office to shape financial plans and to get plant managers to look at their programmes on a yearly as well as day-to-day basis.

52

Dealing

53

with

54

Plant

55

Pro

56

blemsWhen a potential trouble spot became apparent, daily reports were required on this item for Division and Head Office. A staff specialist team was sometimes sent to the plant concerned to make recommendations. It was up to the plant manager to accept or reject such recommendations. However, it was expected that they would generally accept such “advice” gracefully.

57

Sales

58

DeclineIf a sales decline became evident early in the year and the plant manager could convince Top Management that the change was permanent, then plant budgets could be revised to reflect these new circumstances. However, if towards the year end the sales fell below predicted volume no revision was allowed.

59

Plant managers were expected to go back over the budgets with their staff and see where cost reductions could be effected to do the least harm. Specifically they were expected to consider what could be either eliminated or postponed until next year.

60

Sales

61

and Pla

62

nt Co-

63

ordi

64

nationWhenever problems arose between plants and sales districts, local managers were expected to solve the problems themselves. If customers insisted upon immediate delivery, plants were expected to comply somehow. Customers’ needs always came first.

However, if the sales programme involved a major plant expense out of line with the budget then this was decided upon by Division or Head Office.

65

Sales districts had sole responsibility for product, volume, pricing, sales mix and delivery. Direct responsibility for plant operations and profit was the concern of the plant manager. However, it was understood that Sales should co-operate with Plant wherever possible.

66

Motiva

67

tion of

68

Plant

69

Ma

70

nagerPlant managers and indeed all their staff were motivated to meet profit targets through promotion, bonuses and pressures from Division Head Office. In addition, each month plants were ranked competitively for manufacturing efficiency and results published widely throughout the group.

71

Plant managers were entirely responsible for manufacturing variances against divisional standards. Efficiency ratings were computed as actual variable manufacturing cost as a percentage of standard cost.

Inter-plant competitions with prizes were also conducted for special cost reduction programmes, improvements in methods, etc.

Plants were encouraged to stress quality and delivery to meet competitive pressures. All plant workers knew that to survive in the competitive market, Giltim had to produce high quality products on time and at reasonable cost.

72

Ov

73

erallPlant managers and other staff were not “happy” under the system but they worked hard to achieve targets and were generally successful despite changes in the market conditions.

NOTE: This case has been developed from other cases and practical experience.

74


Giltim Company (B)

No. 1 Plant Operating Summary – March

This Month This Month

Actual Budget Last Month Last Year

Gross Sales 264,432.27 326,425.00 237,111.26 316,201.27 Discounts & allowances 47,132.16 16,100.00 37,420.16 13,111.11

Net Sales 217,300.11 310,325.00 199,691.10 303,090.16Variable cost of sales 142,216.99 187,500.00 137,821.26 192,174.72Gross margin 75,083.12 122,825.00 61,869.84 110,915.44Fixed manufacturing cost 41,211.11 36,400.00 38,174.14 41,117.76

Operating income 33,872.01 86,425.00 23,695.70 69,797.68

% sales 15.587% 27.849% 11.865% 23.028%

Special profits or (costs): Method improvements 17,426.22) 21,300.00 28,321.89 12,174.16

Standard revisions (24,174.14) (9,400.00) (7,416.27) (6,811.20) Mater. price variance 12,111.11 6,000.00 (3,567.47) (4,666.54)

Misce. (profits) 8,126.46 6,000.00 30,100.26 22,178.88

Total (profits) 13,489.65 23,900.00 47,438.41 22,875.30Plant Income 47,361.66 110,325.00 71,134.11 92,672.98

Assets employed 1,816,411.22 1,874,426.001,742,111.8

91,052,111.9

1

% Return 3.58654% 5.88714% 4.08345% 8.80912%

NOTE: Year to date figures on next page (not provided here)

75


Giltim Company (B)

76

Schedu

77

le of

78

Monthl

79

y Pla

80

nt

81

Reports1. Plant Operating Summary Sales, costs, other income and expense. Actual

against budget for the month and year to date. Percentage analysis on sales and assets employed.

82

2. Sales Analysis Sales and margins by product groups. Actual, budget and variance analysis for the month and year to date.

3. Plant Variable Cost of Sales Raw material, labour and variable expense. Actual, budget and variance analysis.

4. Plant Fixed Manufacturing Plant expense other than variable and specialExpense expense. Actual, budget and variance analysis.

5. Special Costs and Profits Special items under the control of the plant manager including: sale of scrap, methods improvements, standard revisions, material price variances, cost reduction programmes, etc. Actual, budget and variance analysis.

6. Plant Investment Stock, capital projects, debtors included in computation of assets employed by the plant. Actual, budget, variance and ageing analysis.

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