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Not For Profit Organizations Prepare Financial Statement Accounting Essay

Contributions are the primary revenue to a Not-for-profit organization. Because of the fundamental accounting of NFPO is different with profit-oriented companies, NFPO has its own accounting method for recognizing contributions. There are two methods of recording contributions are restricted fund method and deferral method. The objective of paper is to identify which method should be used. The restricted fund method recognizes restricted contributions as revenue when they are received. The deferral method recognizes restricted contributions until related expenses are incurred in future period. The paper will illustrate an example to compare the difference between the two methods, analyze the effects on financial statements and advantages and disadvantages of each method. The timing treatment restricted donation is primary difference among two methods. The advantages of deferral method is reduces noise from timing mismatch between when expenses are incurred and when revenues are recognized. The matching helps avoid misstating cost for a period. It better evaluate the actual performance of organization. And deferral method can help the organization to develop an accounting plan extends beyond the current period which more rational use the contributions. But under the deferral method, it is not clearly presents information regarding how the organization manages the restricted contributions. And deferral of external restricted contributions to a liability may be confusing to the basic users. The restricted fund method will give a different result than deferral method. Restricted fund method is more clearly to present the information regarding restricted contributions how to use. Another advantage is the restricted funds method increasing comparability between current year and previous years in one organization. This is seen as both advantage and disadvantage in the same time. Because of an organization chooses which restricted funds to report, it lack comparability between with two organizations. Choosing an appropriate accounting method is important for nonprofit. It can attract more donations to support organization activities. Organizations should seek the help of professionals to assist it in implementing its accounts.
2.0 Introduction Contributions are the primary revenue to a Not-for-Profit Organization (NFPO). Because the NFPO has characteristics which difference with the for-Profit Organization, its accounting method of recording contributions has own standards in Part III of CICA Handbook-Accounting section. NFPO is required to use the restricted fund method or the deferral method of recording contributions. The purpose of this report is to identify which accounting method should be used to record contributions when Not-for-Profit organization prepares the financial statements. The report will illustrate an example to compare the different between the two methods, analyze the effects on financial statements and advantages and disadvantages of each method. This report is significance because adoption of different accounting method will affect result of financial statement presented. Financial statements are important communication information about NFPO to members, contributors and creditors. Financial statements satisfy their and others interested needs, like the financial condition of organizations and how the management has discharged its stewardship responsibility to those that have provided resources to the organizations, especially important as resources are contributed for specific purposes and management is accountable for the appropriate utilization of such resources. The study is limited to Not-for-Profit Organization.
The potentially benefit from this report is for all Not-for-Profit organizations. CICA states that many not-for-profits are subject to reporting requirements such as the production of audited statements or mandatory reporting to funders. (Improved Annual Reporting by Not-for-Profit Organizations.p4) Thus, effective financial report help build an organization’s reputation. They can make a support, and can be a key means of reaching new partners and volunteers.
3.0 Background Although the not-for-profit organization applies a separate set of accounting standards in Part III of the CICA Handbook, the Accounting Standards Board (AcSB) emphasizes that the accounting standards for not-for-profit are not a stand-alone set of standard, there should be no differences in accounting between profit-oriented enterprises and non-for-profit organizations when the circumstances and transaction are the some. (CICA. Handbook) In 2008, the AcSB invited not-for-profit organizations to comment on a proposal that would see them use the same system of financial reporting that publicly traded corporations would soon be using. Some respondents opposed change the rules governing the way they report their financial information. “When you try to put charitable organizations in the same realm as publicly traded organizations it becomes a challenge because the users of the financial statements have very different needs than a shareholder would have.” said Michael Herrea, interim treasurer for the Anglican Church of Canada. If the church was required to use IFRS, Mr. Herrera said it would greatly increase the amount of financial reporting required; the additional information generated would be of no benefit to end users. According to comments received, the AcSB adopted a free choice of the accounting standards for not-for-profit organizations in Part III or IFRSs in Part I of the Handbook. Let us assume that non-for-profit organizations apply Part III of Handbook, which requires recording contributions should adopt restricted fund method or deferral method.
4.0 Definition Not-for-profit organizations have three types of contributions to report: unrestricted contributions, restricted contributions and endowment contributions. Following I will discuss that how three types of contributions are accounted for under the restricted fund method and the deferral method.
4.1 Deferral Method Under the deferred method, unrestricted contributions are automatically recorded as revenue when they are received. Restricted contributions are recorded as revenue until the related expense as been incurred in the future. Endowment contributions are recognized as direct increases in net assets, which are shown in the statement of changes in net assets. Especially, restricted contributions for the purchase of depreciable capital assets are deferred; the revenue is realized as the asset is being amortized. Non-depreciable capital assets, like land, are recognized as increase in net assets.
4.2 Restricted Fund Method The restricted fund method requires the entity must have a general fund and at least one restricted fund. The Unrestricted contributions and investment income are recorded as revenue in general fund. Restricted contributions are recognized as revenue if a restricted fund has been established for that purpose. If no related fund has been established, restricted contributions are treated the same way under the deferred method in general fund.
5.0 Comparison on Deferral Method and Restricted fund Method The primary difference among two methods is timing treatment restricted contributions. This affects the amount of liabilities and revenues reported. There is an example details a NFPO using deferral method and restricted fund method of recording contributions separately blow.
The ABC Company is a not-for-profit training organization, funded through an agreement with the Province of AB. ABC’s purpose is to provide accounting training program to all accountants in Alberta. ABC received $100,000 from the Province to establish the Princess Royal Scholarship endowment. This amount was invested in debt securities, which generated the $50,000 of investment income. The investment income is restricted for use to provide annual scholarships. $900,000 received from a wealthy and grateful benefactor on Jan 1, 2012 the beginning of its fiscal year. He requested that the money was to be used for purchasing and maintaining a property to house the administrative offices and operating facility. At the July 1, the following item were purchased in cash: Land $400,000; operating facility $300,000, it estimated life of 20 years. At the November 21, a donor contributes $10,000, without restriction for the operation of ABC. $ 25,000 of investment income paid out for Scholarship. In addition, ABC spent $16,000 for the year on maintenance costs for the operating facility.
Deferral Method
Restricted Fund Method
One fund
one general fund; one capital fund; one endowment fund
As net asset
Recognized as revenue in endowment fund
Included in deferred contribution; Recognized as revenue until facility expense incurred
Recognized as revenue in capital fund
Start to amortize deferred contribution
Included in capital fund
Interest earned on endowment
Included in deferred contribution;
Recognized as revenue until scholarships paid out
Recognized as revenue in endowment fund
As net asset
As asset in capital fund
6.0 What are the effects on Financial Statements? Primarily the nonprofit organization must produce three important annual financial statements: the statement of financial position, the statement of operation, and the statement of cash flow. Kelly Bourgeois conclude that each component of a nonprofit organization’s existence, like organization’s programs or projects, is dependent on the organization’s financial feasibility. Financial feasibly is accounted for through primarily those three financial statements. One of the principle differences in nonprofit financial statements compared to for-profit entities is the objective of a nonprofit is to realize its socially desirable goals and objectives for the community it serves, rather than to realize a net profit (2003. P16). According to analysis above, financial statements are showed blow.
6.1 Deferral Method ABC
The Statement of Operation
For the year ended December 31, 2012
Contributions 58,500
Maintenance expense 16,000
Amortization 7,500
Scholarship 25,000
Excess revenues over expenses 10,000
Statement of Changes in Net Assets
For the year ended December 31, 2012
Unrestricted Investment in Restricted for Total
Funds Capital Assets Endowment
Net assets at the
Beginning of the year — — — —-
Add: Excess revenues
Over expenses 10,000 10,000
Investment in
Land 400,000 400,000
Endowment 100,000 100,000
Net assets at end of year 10,000 400,000 100,000 510,000
Statement of Financial Position
For the year ended December 31, 2012
Cash and investment 319,000
Capital assets
Land 400,000
Operating facility 300,000
Accumulated amortization (7,500) 692,500
Deferred contributions 501,500
Net assets
Invested in capital assets 400,000
Restricted for endowment 100,000
Unrestricted net assets 10,000 510,000
6.2 Restricted Fund Method If the ABC adopts the restricted fund method of recording contributions, the different format and results of financial statements will be presented than the deferral method.
Statement of Operation
For the year ended of December 31, 2012
General Capital Endowment Total
Fund Fund Fund
Contributions 10,000 900,000 100,000 1010,000
Interest income 50,000 50,000
Maintenance 16,000 16,000
Amortization 7,500 7,500
Scholarship 25,000 25,000
Excess of revenues
Over expenses 10,000 876,500 125,000 1011,500
Statement of Position
For the year ended of December 31, 2012
General Capital Endowment Total
Fund Fund Fund
Cash and investment 10,000 184,000 125,000 319,000
Capital assets
Land 400,000 400,000
Operating facility 300,000 300,000
Accumulated amortization (7,500) (7,500)
10,000 876,500 125,000 1,011,500
Deferred contributions — — —
Fund balances
Invested in capital assets 692,500 692,500
Externally restricted 184,000 184,000
Endowment 125,000 125,000
Unrestricted 10,000 10,000
10,000 876,500 125,000 1,011,500
(Fund balance=Asset-Liability)
Under the deferral method, interest is recognized as an increase in the contribution revenue on the statement of operation as scholarship paid out. The operating facility is capitalized and amortization is recorded as expense. The amount of the restricted contribution recognized as revenue for the year is equal to the corresponding expenses incurred. The revenue over expense $10,000 which is unrestricted contribution received. The amount of the contribution not used at the end of the year is recorded as an increase in the liabilities “deferred contributions” on the statement of position. The deferred contributions decrease when the related revenues are recognized. Land and endowment are recorded as increase in net asset. Under the restricted fund method, the contributions are classified to general fund, capital fund and endowment fund. Each fund has a self-balancing separately. The Contributions and interest earned are immediately recognized as revenues in the corresponding fund. Any expenditure related to that fund is deducted from the balance. In this case, using the restricted fund method of recording contributions is better than using the deferral method. Because the restricted fund method is more clearly shows the ABC how to spend the restricted contributions. The restricted fund method makes ABC easy to report activity to its members, donators, and also to any government entity that is charged with the responsibility of overseeing its operation.
7.0 Advantages and Disadvantages Before identify which accounting method should be used of recording contributions for nonprofit, it is necessary to know the advantages and disadvantages of the restricted fund method and the deferral method. In terms of the ABC example this means that two methods would give different results of financial statements.
7.1 Deferral Method Under the deferral method, the recorded deferred contributions are transferred to the income statement as revenue when corresponding expenses been incurred. The contribution revenue is matched to the related expenses in the same accounting period.
7.1.1 Advantages For an accounting perspective, using the deferral method means the contribution revenues expected during a specific accounting period are directly matched to the anticipated expenses during this period. This helps the organization to develop an accounting plan extends beyond the current period which more rational use the contributions. Secondly, the deferral method reduces noise from timing mismatch between when expenses are incurred and when revenues are recognized. The matching helps avoid misstating cost for a period. The mention above, the objective of nonprofit financial statements is assessing whether the organization is achieving its objectives at the lowest possible cost. The deferral method can avoid misstating, for instance, avoid result in understated cost. Thus, it better evaluate the actual performance of organization.
7.1.2 Disadvantages Along with the benefits of the deferral method, there are several disadvantages need to be aware of. Using the deferral method the results of the unrestricted and restricted contributions are combined, and organization-wide totals are presented in the each of the financial statement. The restricted contributions remain unfulfilled are accumulated as deferred contribution. The organization’s excess of revenue over expenses for the period represents the increase in resources that are not restricted to cover specific expenses of a future period (Cynthia L. Orr. 1996. P4). Thus, it is not clearly presents information regarding how the organization manages the restricted contributions. Another disadvantage is the restrictions are deferred and not reported until used. Deferral of external restricted contributions to a liability may be confusing to the basic users.
7.2 Restricted Fund Method As mentioned above that the fund accounting must be set up if a nonprofit adopts the restricted fund method. The organization would choose which restricted funds to report, and all similar contributions would be treated in the same manner.
7.2.1Advantages Using fund accounting system to record contributions can help to ensure that organizations use their resources in accordance with the stipulations donors; granting agencies and governing boards impose. Fund accounting segregates the account balances related to its purpose and keeps these funds from mingling with the other accounts of the organization. This ensures that the assets assigned to each fund remain available for the purpose of that fund. And the restricted fund method keeps the organization accountable to the donors who support the organization. Each donor wants to see the nonprofit serve the individuals who need its assistance. When the nonprofit organization issues its financial statements at the end of the year, the contributors can review the performance of each fund. The financial statements identify the money received for each fund and how the organization distributes those funds (Kathy Adams Mclntosh). Thus, the restricted fund method is more clearly to present the information of restrictions. Secondly, choosing the restricted funds to report and treating similar contributions in same manner consistently that is increase comparability between current year and previous years in one organization. This is seen as both advantage and disadvantage in the same time.
7.2.2Disadvantages Because of an organization chooses which restricted funds to report, it lack comparability between with two organizations. Because of this choice, two organizations following the restricted fund method may each report similar kinds of restricted contributions differently. For example, one organization may present contributions restricted for purchasing equipment in a separate restricted capital fund. Another organization may not report a separate capital fund. It results in lacking comparability on similar contributions of two organizations.
8.0 Recommendation Which accounting method is best? This is a matter of what the entity wants to communicate in the financial statements. “The best system is a system that gives the members of an organization control over its financial health and portrays this health through their records.”(Kelly Bourgeo. June, 2003. p16). So the executive director and board of nonprofit should assess the financial health thought that, the financial statements should be easily comprehensible so that any person taking the time to read them will understand the financial picture; they should be concise and they should clearly show the relationship among the each transaction without confusing detail involving transfers (Kelly Bourgeo. P17).
First, I recommend that using fund accounting. Because the fund accounting approach is more clearly presents information regarding how the restrictions are distribution and spent. And it can be effective, especially when accounting reports must be sent to more than one government agency. For example, if a charity receives an endowment for the childcare program, a contribution restricted to support homeless shelter and a grant for providing meals to stray pets, each of these programs is to fall into the jurisdiction of a different government agency. So by creating funds for each program, it is provide each monitoring agency with an accounting of what has been done with the donations received to support each program (Malcolm Tatum. 2012).
The organizations determine an appropriate accounting method should determine who the uses of the financial statements will be and what their needs. For a nonprofit, it receives recurring restricted contributions, so donors will be one of the major users. In my opinion, the restricted fund method is better than deferral method. Because the restricted fund method provides donors with simply but robust information on how their contributions are be used. It let users clearly to understand the financial pictures. And it reflects a more accurate accrual basis of revenue recognition for the funds presented than the deferral method. The deferral method may be confusing to users because of recording restricted contributions as a liability. Each method has advantages and disadvantages separately for its use. So organizations should seek the help of professionals to assist it in implementing its accounts.
9.0 Conclusion The not-for-profit organization is required to choose either the restricted fund method or the deferral method of recording contributions when it prepares financial statements. According to analysis above, the timing restriction treatment is the primary cause for some of the more significant reporting and recognition differences. Using the restricted fund method, the restricted contributions are recognized as revenue when they are received. It more clearly presents the information of restrictions for the funds presented. The deferral method recognizes contributions until they are spent. The matching principle helps avoid misstating cost for a period. It better evaluate the actual performance of organization. But it may be confusing to basic users because of deferred restricted contributions as a liability. Each method has its advantages and disadvantages. The choice depends on the financial reporting objective and on the motivations of organization’s manager. The accounting method, once selected, all received contributions must been applied that method consistently. The accounting policy seems be changed if the organization changes its method. There is not required to, I recommend that nonprofit uses fund-based structure. If no such fund has been established, restricted contributions are treated the same way as under the deferred contribution method. Choosing an appropriate revenue recognition policy is important. The organizations should seek the help of professionals to assist it in implementing its accounts.

A Budgetary Control Systems Accounting Essay

I have re-read my last years HNC paperwork and used my current years HND paperwork to help with the various aspects of the report. I used my HNC costing booklets and lecture notes, HND Investment Appraisal literature, HND Business Tax literature, HND Capital Allowances literature and HNC Standard Costing literature.
I went to the library and used college resources such as ebray for information of more in-depth budgeting control systems. I used Cost and Management Accounting books which covered cost assignment of direct and indirect costs. They covered issues about fixed, variable and semi variable costs. I used Accounting Theory and Practice for in-depth budgetary planning and variance analysis. I used an up to date Taxation book to allow me the most up to date tax percentages to be used, the correct Asset Investment Allowances applicable and the written down values for Capital Allowance calculations.
CASE STUDY ANALYSIS This formal report has been requested by the Managing Director by Ergo design
He requires a full business report which will appraise the launch of a new quality ergonomic chair. As well as the appraisal, the managing director would like advice on how to set up and implement an efficient budgetary control system. Ergo Design already make a different range of products and are wanting to find out if it would feasible to undertake the making of another new product. The company currently has spare capacity and as they don’t want spare capacity are looking into making a new chair. This however involves the purchase or hire of a new asset namely a new machine which will be capable of making the new product. This asset is not inexpensive and cost £125,000. Ergo Design are guaranteed an order for 1 year amounting to 1800 chairs to be distributed evenly over the month. The factory is only open 48 weeks of the year to allow for maintenance, repairs etc and therefore leaves 12 periods of 4 weeks to evenly distribute 160 chairs per 4 weeks. The company have had a trial period and all seems to be well. The MD awaits reports before committing final sanctions.
APPENDICES 1-9 Attached as appendices is the Activity Based Costing comparison followed by the functional budgets then Capital Investment Appraisal and lastly a Break Even Analysis based on my figures.
Appendix 1. Activity Based Costing comparison. I have used Activity Based Costing (ABC) to work out the costs of producing the new product. Ergo Design in previous years have recovered costs using a blanket wide rate based on the number of machine hours. The last two years however they have changed to ABC. I have made a comparison using traditional overhead recovery and ABC. ABC was developed in order to more accurately reflect the factors which cause overhead costs to arise. Overhead costs are attributed to products on the basis that it is activities that cause costs to arise. Each activity can be identified with a cost driver and the cost drivers I have used are machine hours, Labour hours, number of orders, production runs, set up hours and inspections. After the cost drivers have been identified then each cost driver’s overheads are collected together. These collections of costs are called cost pools. Each pool is then divided by its driver, for example all overheads in the cost pool for the materials ordering process would be divided by the number of orders placed to give a value for the cost of placing an order. The costs of all activities relating to a product would be added together to give the overhead element of the cost of production. Because activity based costing shares out overheads using cost drivers compared with the traditional costing systems which use departments, then a greater number of drivers can be used, reflecting all the different activities taking place in the manufacturing process. This leads to a fairer and more accurate way of charging overheads to the products. The traditional methods ignore the detail of many of the activities that actually take place. In my findings the cost of producing the new product using ABC is £167.95 per unit whereas the blanket method only £150.18 is allocated for cost, This would give a higher contribution and a higher profit.
I have assumed that we are going to be charging £195 per unit and at this price we are still making a profit of £63,975 for the first year. We can look at raising prices at the end of the initial 3 year period if the turnover is still constant.
My creditors are to allow me credit purchases payable for :
Aluminium Sheets………. 1 month Memory Foam…………….2 months
Fabric…………………………1 month Hardware……………………3 months
My debtors are to be allowed 1 month’s credit sales.
A new asset is to be purchased at a cost of £125,000, which will gather depreciation over 10 years straight line method. The new machine will need to be replaced after this time and will have a residual value of £15,000. Maintenance will need to be carried out regularly to allow for optimum usage and guarantee residual value. The maintenance cost will be estimated at 5% of the capital cost per annum. The asset is purchased with a long term loan for the full £125,000. The loan will have a 3% fixed rate interest per annum. The interest is added to the original amount and not compounded yearly. This is to be repaid over 10 years with repayments and interest payments split. The total cost of the loan is £162,500 with repayments being £62500 every 6 months and Interest being £1,875.
There is currently spare capacity within Ergo Design’s production facilities and can therefore produce 2 batches of 20 chairs per week for the full 48 weeks that the factory is open. This allows for surplus stock of (1920-1800)=120 chairs surplus at the end of the year. We will supply 150 chairs per month to the customer and make 160 chairs to allow for full capacity, this will leave us a surplus of 10 chairs which will be opening stock for the month of Feb and the units will 10 more units every month compounded.
The following budgets are prepared for the first six months of the new multi-level chair and include:
Appendix 2. Opening Balance at beginning of the month of Jan. This is the beginning of the month and lists the purchases made to enable the company to begin production and sell them at the end of the month.
Appendix 3. Key Variables input. As the figures were given for batches I had to break them down into single units costs so that a uniform approach was taken across the board. The direct material costs have accounted for the biggest costs followed by the labour then the variable overheads.
Appendix 4. Sales budgets- This is also the main budget which has to be prepared first. It shows that we are to sell 150 units per month at a cost of £195 creating a sales value of £29,250.
Production budget- This budget is prepared after the sales budget and states the amount of units to be produced within the period. I have carried over excess units in case of any unforeseen circumstances which will reduce production in later months e.g. machinery breaking down and staff absences etc. The machinery is also working at full capacity if I make the amount required as well as the excess.
Direct Material usage budget is prepared next and the figures are for 1 single unit which is obtained from the key variables sheet shown in Appendix 2.
Direct material purchases budget is next with figures for the required production for each month and the cost of goods to be purchased. The cost figure is taken from the key variable appendix 2.
Direct labour budget figures come from the production budget for the amount to be produced multiplied by the cost of the direct labour unit from key variables appendix 2.
Overhead budget gives us monthly fixed overheads and depreciation figures taken from key variables in appendix 2.
Variable cost budget…….This budget takes the amount of units to be produced multiplied by the variable cost per unit. Both these figures are from the key variables sheet.
Production cost budget……This budget gives us a breakdown of how much each unit will cost to produce. It takes into consideration the material and variable costs and add the figure to the raw material costs.
Debtors budget…..We have been giving our debtors 1 month to pay after receiving their finished goods.
Creditors budget……We have 4 of these for each of the different raw materials we need. Each shows opening balances, purchases, payments and closing balances.
Appendix 5. The Cash budget shows the inflows and outflows and gives a final figure for the bank balance to go into the Balance sheet.
Appendix 6. The Operating statement lists the cost of sales when taken from sales will give us a profit. Expenses are then deducted leaving us with healthy net profit of £25,744.25
Appendix 7. The Balance sheet is the 6 month balance sheet ending on 30th June 2013. Our current assets are a higher amount than our current liabilities and therefore give us net current assets to be added to the fixed assets. Once the long term liabilities come off then this leaves us with a balance of £25,844.25
Appendix 8. Capital Investment appraisal. I have started this by working out the inflows for the first 3 years as we know the selling price and we know the change in production. After year 3, I have assumed that turnover will remain stable and have therefore carried out my Capital Allowance calculations over 10 years. I have deducted the Asset Investment allowance of £25,000 and written down value for each year at 18%. I have assumed a residual value of the machine to be £15,000 and added the balancing allowance figure to the capital allowances. Using the inflow figures and deducting capital allowances for each year, I was able to work out the taxable amount and tax it at this year’s appropriate amount. I carried out 2 Discounted Cash Flow (DCF) methods , 1 being Net Present Value (NPV) and the other is the Internal Rate of Return (IRR). The DCF includes all cash flows and the time value of money telling you what you £1 will be worth in X years ahead. The IRR also includes the time value of money and includes all cash flows but the IRR if far more easily understood. If the net present value is zero or positive, the project is accepted, I have used 15% and 45% discount factors and they are both returning a positive number so the project should be accepted. You can think of IRR as the rate of growth a project is expected to generate and a higher IRR value would provide a much better chance of strong growth. The rate for this project is 59.93 so again promoting the acceptance of this project..
Appendix 9. I have put in an extra break even analysis chart for your perusal as break even charts work well with a single product. The break-even analysis is a calculation of the approximate sales volume required to just cover costs, above which production would be profitable or unprofitable break-even analysis focuses on the relationship between fixed costs, variable cost, and profit. The summary shows that the BEP in units 1058 and the margin of safety in units is 742. Costs taken into account are distinguished by variable costs which change in according to the production level.
BUDGETARY CONTROL SYSTEMS A budget is a financial plan for an organisation prepared in advance for a given period.
Budgets can be prepared as a whole or broken down into component departments e.g. sales and production or purchases or cash or capital etc.
There can be many different types of budgets and for a variety of departments such as sales or production or financial items such as capital, expenditure, manpower, purchase etc.
The budgeting process is a vital part of a business’s planning and control.
The overall objective of the company is prepared in advance and agreed with cooperation and detailed into a feasible plan of action.
It is about planning, monitoring, reviewing and amending budgets to suit management objectives.
When the long term strategies are written down everyone is starting from the same place and it will not matter if new people come and go, the long term plans will still be there.
Long term objectives after being decided need to be broken down into manageable chunks of short term objectives. A limiting factor needs to be distinguished and a budget is prepared solely for this. The most common limiting factor is sales and this needs to be as accurate as possible as all other budgets will be based on the limiting factor’s budget.
Once all the budgets are prepared a master budget is drafted and given to all of the budget holders for agreement. Once any tweaks or changes are made and an agreement reached then the master budget is presented to senior management.
When the budgets need to be prepared again for the next period then actual figures are measured against budgeted figures and there are favourable and adverse variances produced showing management what areas need attention and where money is being lost, it may be efficiency problems that are highlighted for attention etc.
There is actually an 8 step plan involved in advanced preparation budgeting.
Step 1 is agreeing long term goals
Step 2 Changing long term goals to short term goals
Step 3 Identify limiting factor
Step 4 Prepare limiting factor budget
Step 5 Prepare all other budgets
Step 6 Bring all budgets together to prepare the master budget
Step 7 Agree with all budget holders
Step 8 Present to the management
There are many benefits to having financial planning and good budgetary control to name a few, by doing extensive planning there is a much clearer picture on where the business is going. It will reduce stress in the work place with all staff knowing where, when and how things are to done. Management can keep on top of things and have peace of mind. With budgeting control there is a more detailed structure of how the business is organised. With all the planning, organising and controlling it is easier for management to keep on top of changes and variances and make it easier to quickly adapt to the said changes. There is co-ordination with everyone working in the same direction. Budgets can be used to make communication and motivation more effective using them to exchange information concerning ideas, goals, achievements etc. thus giving staff a sense of togetherness and teamwork with everyone working towards the same goal.
There is however barriers with a lack of knowledge, resources or motivation making the planning extremely difficult to start. Maybe not knowing where to start or even how to start. Maybe needing to sacrifice some things for others. Budgets are a time consuming job and to draw up each individual budget is a laborious task but it is still worthwhile as the benefits usually outweigh the efforts. If there is no co-ordination then the planning will fall apart. Preparing budgets is extremely subjective and they are based on predicted assumptions.
ADDITIONAL AND ALTERNATIVE APPROACHES The company has taken out a loan for the CNC machine perhaps they could have hired it for a year or so, see how the product is doing then maybe buy it later on. Leasing equipment means there is not maintenance or repair costs to consider.
Instead of keeping the CNC machine for 10 years with a value of £15,000, Ergo designs can sell it sooner when it is worth more money.
The company have adequate production facilities at this time and are therefore not considering contracting out however with proper budgetary controls in place it will be easier to spot any variance changes with efficiency or cost and it may be that in the future it may well be cheaper to contract certain parts of the process out to someone else. They do not run at full capacity in the other products they make and look at contracting out some of that work instead.
The company should put in place an advertising campaign for when they believe sales will stabilize to generate renewed interest in the product which can be researched by potential buyers now as it has been on the market for 3 years.
As Direct material has accounted for the biggest cost maybe Ergo Design can look around for cheaper suppliers or substitute certain ingredients for others.
A price increase could be implemented in later years.
CONCLUSIONS The launch of this new product is feasible. It is returning a good profit and there is lots of potential for increasing profitability in the coming next few years and there is room for selling price increases. The new asset can be used for its economical life, sold off earlier or can be hired out to other companies so more room for increased profitability.
RECOMMENDATIONS A proper budgetary control system should most definitely be put in place.
Future advertising is also a must. They need to do this sooner rather than later as they have only projected increases in turnover for the next 2 years.
As the cost of materials are so high, I would recommend that the buyers look around for alternative materials or try to negotiate more with the current suppliers for larger discounts.
Let’s be aware of the future, this can be done easier with the budgetary control in place. We need to be aware of what our competitors are up to and trends in markets. We need to be aware of what the government is changing and how it will affect the business e.g. Higher corporation taxes, inflation rates etc.