Budgeting To Balance Scorecard

BUDGETING and PERFORMANCE ANALYSIS
Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento MM 2013-A
Budgeting 101
A budget is a quantitative expression of a plan for a defined period of time. It may include planned sales volumes and revenues, resource quantities, costs and expenses, assets, liabilities and cash flows. (CIMA Official
Terminology, 2005)
Budgeting helps all types of organization to plan and control their operations, and to support their managerial strategies. A budget sets out the benchmark against which performance will be measured. Managers should be held responsible for those items that they can actually control to a significant extent.
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Budgeting 101
Define goals and objectives Communicate plans Think about and plan for the future
Advantages
Coordinate activities Uncover potential bottlenecks Means of allocating resources
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Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento
Budgeting 101: Budget Period

Operating Budget
2013
2014
2015
2016
Operating budgets ordinarily cover a one-year period corresponding to a companys fiscal year.
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A continuous (or rolling) budget is a 12-month budget that rolls forward one month (or quarter) as the current month (or quarter) is completed.
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Budgeting 101: Budget Process

Stakeholders Input / Target Setting
Monitoring / Evaluation
Budget Preparation / Formulation
Execution
Approval Process
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TOP-DOWN / Imposed
Unrealistic high targets = motivation is at risk Too much slack = waste may occur
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BOTTOM-UP / Participative
Most employees are members of the budget team More accurate estimate Motivation is higher; unrealistic is not an excuse Potential increase in slack is higher; needs counter check

PARALLEL / Negotiated
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Budgeting 101: Master Budget

Sales budget
Ending inventory budget Production budget Selling and administrative budget
Direct materials budget
Direct labor budget
Manufacturing overhead budget
Cash Budget Budgeted income statement

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Budgeted balance sheet

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Budgeting 101: Alternatives

Budgeting Types / Alternatives Rolling forecast Incremental / Last year plus percentage Bottom up Activity based budgeting Zero based budgeting Demand pull % 48 45 41 30 26 16
Activity based - is based on an activity framework. It uses cost driver data in the budget setting and variance feedback processes. Zero based - requires all costs to be specifically justified by the benefits expected Incremental - where the budget is based on the previous period's budget or on actual results, and contains an uplift for inflation or other known changes
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Budgeting 101:
How would you drive your budget in case of the following scenarios: STARTING-UP SOLD-OUT Market, Capacity = Demand UNDERUTILIZED, Capacity < Demand SHORTAGE, Capacity > Demand
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Budgeting 101: Planning Budget

Planning Budget
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Actual Results . . .
Actual Results
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Flexible Budget
Actual Results Compared with the Planning Budget
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Flexible Budget
Planning budgets are prepared for a single, planned level of activity. Performance evaluation is difficult when actual activity differs from the planned level of activity.
Hmm! Comparing static planning budgets with actual costs is like comparing apples and oranges.
Flexible Budget
The relevant question is . . .
How much of the cost variances is due to higher activity, and how much is due to cost control?
To answer the question, we must the budget to the actual level of activity.
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Flexible Budget
May be prepared for any activity level in the relevant range. Show costs that should have been incurred at the actual level of activity, enabling apples to apples cost comparisons. Help managers control costs. Improve performance evaluation.
Flexible Budget
Flexible Budget
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Performance Analysis: Activity Variance

Flexible Budget Compared with the Planning Budget
Activity and revenue increase by 10 percent, but net operating income increases by more than 10 percent due to the presence of fixed costs.
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Performance Analysis : Revenue Variance

Flexible Budget Compared with the Actual Results
$1,750 favorable revenue variance
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Performance Analysis : Spending Variance

Flexible Budget Compared with the Actual Results
Spending variances
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Performance Analysis:
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STANDARD COSTS
Value of a Good/ Service
Price
Quan tity
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STANDARDS are benchmarks or norms for measuring performance. Types of Standards

Quantity Standards
specify how much of an input should be used to make a product or provide a service.
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Price Standards
specify how much should be paid for each unit of the input.
ASSUMPTIONS:
Manufacturing Practical
Company
Standards
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Deviations from standards deemed significant are brought to the attention of management, a practice known as Management by Exception.
Amount
Standard Direct Material
Direct Labor
Manufacturing Overhead
Type of Product Cost

Price Standards
Quantity Standards
Final, delivered cost of materials, net of discounts.
Summarized in a Bill of Materials.
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Standard Price/ Unit
Purchase Price Freight Purchase Discount Standard Price/ml
P 135.00 9.45 2.70 P 147.15
Standard Quantity/ Unit
Material Requirements Allowance for Waste & Spoilage Allowance for Rejects Standard Quantity, in ml
5.00 0.35 0.10 5.45

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Rate Standards
Time Standards
Often a single rate is used that reflects the mix of wages earned.
Use time and motion studies for each labor operation.
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Standard Rate/Hour
Basic Wage Rate/Hour Tax at 10% Fringe Benefits at 8% Standard Rate/ DL Hour
P 53.63 5.36 4.29 P 63.28
Basic Labor Time/Unit, in hours Allowance for Breaks/Personal Needs Allowance for Machine Downtime Allowance for Rejects _____ Standard DL Hour/ Vial
0.10 0.01 0.03 0.02 0.16

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Rate Standards
Quantity Standards
The rate is the variable portion of the predetermined overhead rate.
The quantity is the activity in the allocation base for predetermined overhead.
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Standard Rate/Hour
Predetermined Overhead Rate: P 12.66
Direct Labor-Hours/Vial: 0.016
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(1)
Inputs Standard Price or Rate P 147.15/ ml P 63.28/hour P 12.66/hour
(2)
Standard Quantity or Hours 5.450 ml 0.16 hour/vial 0.16 hour/vial
(1) X (2)
Standard Cost P 801.97 10.12 2.03 P 814.12
Direct Materials Direct Labor Variable Mfg Overhead
Total Standard Cost/Unit
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Identify questions
Receive explanations
Take corrective actions
Analyze variances
Conduct next periods operations

Prepare standard cost performance report
Begin
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(1)
(2)
(3)
Actual Quantity Actual Price
Actual Quantity Standard Price
Standard Quantity Standard Price
Price Variance
(1) (2)
Quantity Variance
(2) (3)
Materials Price Variance Materials Quantity Variance Labor Rate Variance Labor Efficiency Variance Variable OH Rate Variance Variable OH Efficiency Variance
TOTAL VARIANCE
Actual Quantity Actual Price
Actual Quantity Standard Price
Standard Quantity Standard Price
Price Variance
AQ (AP SP)
Quantity Variance
SP (AQ SQ)
AQ = Actual Quantity AP = Actual Price

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SP = Standard Price SQ = Standard Quantity

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Variabl e Mfg OH
Direct Materi als Direct Labor
Product Cost
GlaxoSmithKline Philippines, Inc. Variance Report Purchasing Department

(1) Item Purchased Keppra IV Quantity Purchased 250,000ml (2) Actual Price P 145.00 (3) (4) Total Price Variance (1) x (4)
Difference in Standard Price Price (2) - (3) P 147.15
P 2.15 P 537,500.00 F
Type of Materials
Keppra IV
Standard Price
Actual Quantity
P 147.15 250,000ml
Standard Difference in Total Quantity Quantity Quantity Variance Allowed (2) - (3) (1) x (4) 45,000*5.45 = 4,750ml P 698,962.50 U 245,250ml
MATERIALS VARIANCE= 537,500 F + 698,962.50 U =

P 161,462.50U
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(1) Item Purchased Keppra IV Actual Hours of Input 8,200 (2) (3) (4) Labor Rate Variance (1) x (4) P 4,346 F
Actual Rate Standard Rate Difference in of Input of Input Rate (2) - (3) P 62.75 P 63.28 P 0.53
Type of Materials
Keppra IV
Standard Rate of Output
Actual Standard Hours Difference in Labor Efficiency Hours of for Output Hours Variance Input (2) - (3) (1) x (4) 45,000*0.16 = P 63.28 8,200 1,000 P 63,280 U 7,200
MATERIALS VARIANCE= 19,350.00 F + 66,217.50 U =

P 58,934 U
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(1) Item Purchased Keppra IV Actual Hours of Input 8,200 (2) (3) (4) Labor Rate Variance (1) x (4) P 4,346 F
Actual Rate Standard Rate Difference in of Input of Input Rate (2) - (3) P 11.00 P 12.66 P 1.66
Type of Materials
Keppra IV
Standard Rate of Output
Actual Standard Hours Difference in Labor Efficiency Hours of for Output Hours Variance Input (2) - (3) (1) x (4) 45,000*0.16 = P 12.66 8,200 1,000 P 12,660 U 7,200
MATERIALS VARIANCE= 19,350.00 F + 66,217.50 U =

P 8,314 U
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Rule of Thumb : Variance Analysis should NOT be used to assign blame but to support line managers and assist them in meeting the goals they set for the company.
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GOAL SETTING: Budgets + Standards

If Not Met
VARIANCE
How do I know which variances to investigate?
Larger variances, in dollar amount or as a percentage of the standard, are investigated first.
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Warning signals for investigation Favorable Limit Desired Value
Unfavorable Limit
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Variance Measurements
Management by exception
Promotes economy and efficiency
Advantages
Simplified bookkeeping
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Enhances responsibility accounting

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Emphasizing standards may exclude other important objectives. Potential Problems Standard cost reports may not be timely. Invalid assumptions about the relationship between labor cost and output.
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Favorable variances may be misinterpreted.
Emphasis on negative may impact morale. Continuous improvement may be more important than meeting standards.
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OPERATING PERFORMANCE MEASURES

Alcaraz, De la Pea, Luciano, Santiago, Sarmiento MM 2013-A
Delivery Performance Measure

Order Received Production Started Goods Shipped
Wait time
Process Time
Inspection Time
Move Time
Queue Time
Throughput Time Delivery Cycle Time

Throughput or Manufacturing Cycle time is the sum of process time, inspection time, move time, and queue time Delivery cycle time is the elapsed time from when a customer order is received to when the completed order is shipped
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Delivery Performance Measure

Order Received Production Started Goods Shipped
Wait time
Process Time
Inspection Time
Move Time
Queue Time
Throughput Time Delivery Cycle Time Manufacturing Cycle Efficiency

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Value-added time
___________________________________________________
Manufacturing Cycle Time

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An MCE less than one indicates that nonvalue-added time is present in the production process Process time is the only value-added time
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Application:
Vermex Company keeps careful track of the time relating to orders and their production. During the most recent quarter, the following average times were recorded for each unit or order: Times in Production Wait Time Inspection Time Process Time Move Time Queue Time Days in Production 17.0 0.4 2.0 0.6 5.0
Goods are shipped as soon as production is complete.

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Required: Calculate manufacturing cycle efficiency. MCE = Value-added time / Throughput time MCE = 2.0 days* / 8.0 days** MCE = 0.25
*Only process time (2.0 days) represents value-added time **Throughput time = Process time + Inspection time + Move time + Queue time = 2.0 days + 0.4 days + 0.6 days + 5.0 days = 8.0 days
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Summary:
Measures Formula
Throughput or Manufacturing Cycle Time
Move + Process + Inspection + Queue
Delivery Cycle Time
Wait Time + Throughput Time
Manufacturing Cycle Efficiency

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Process Time / Throughput Time

What does the figure says?
If the MCE is less than 1, then non-value added time is present in the production process. If the firm wants to reduce throughput and delivery cycle and increase MCE it should begin by finding ways at reducing non-value adding times.
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Segment Reporting, Decentralization and the Balanced Scorecard

DECENTRALIZATION
the delegation of decisionmaking function or power from a central authority to lower levels of management.
+ Top Management can focus on Strategy. + Lower Management, with detailed & up-todate information, can make decisions quickly. + Empowerment increases motivation and fosters growth. - Without strong central direction, spreading innovative ideas may be difficult. - Lower Management may lack coordination when making own decisions. - Decisions may not be in line with entire organizations objectives.
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RESPONSIBILITY ACCOUNTING
Cost Centers
have control over costs.
Profit Centers
have control over costs and revenues.
Investment Centers
have control over costs, revenues and investments in operating assets.
RESPONSIBILITY CENTERS
Payak Manufacturing
President and CEO
Operations
Vice President
Finance
CFO
General Services
Vice President
Personnel
Vice President
Undergarments
Product Manager
Shirts
Product Manager
Trousers
Product Manager
Production
Manager
Packaging
Manager
Distribution
Manager
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Payak Manufacturing
President and CEO
Operations
Vice President
Finance
CFO
General Services
Vice President
Personnel
Vice President
Undergarments
Product Manager
Shirts
Product Manager
Trousers
Product Manager
Production
Manager
Packaging
Manager
Distribution
Manager
COST CENTERS
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Payak Manufacturing
President and CEO
Operations
Vice President
Finance
CFO
General Services
Vice President
Personnel
Vice President
Undergarments
Product Manager
Shirts
Product Manager
Trousers
Product Manager
PROFIT CENTERS
Production
Manager
Packaging
Manager
Distribution
Manager
COST CENTERS
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INVESTMENT CENTERS
Operations
Vice President
Payak Manufacturing
President and CEO
Finance
CFO
General Services
Vice President
Personnel
Vice President
Undergarments
Product Manager
Shirts
Product Manager
Trousers
Product Manager
PROFIT CENTERS
Production
Manager
Packaging
Manager
Distribution
Manager
COST CENTERS
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SEGMENT REPORTING
A segment is any part or activity of an organization about which managers seek cost, revenue or profit data.
Image from www.brightermindspublishing.com
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Keys to Segmented Income Statements

A contribution format should be used because it separates fixed from variable costs and it enables the calculation of a contribution margin. Traceable fixed costs should be separated from common fixed costs to enable the calculation of a segment margin.
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Traceable and Common Fixed Costs

Operations
Common Fixed Costs support more than one business segment, but is not traceable in whole or in part to anyone of the business segments.
Personnel
Finance
General Services (Admin, Facilities)
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Operations
Common Fixed Costs - eg. Salary of President and CEO
Finance
Personnel
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Operations
Common Fixed Costs - eg. Salary of President and CEO
Finance
Personnel
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Operations
Finance
Common Fixed Costs
General Services (Admin, Facilities) Personnel
Traceable Fixed Costs are incurred because of the existence of a particular business segment that would be eliminated over time if the segment were eliminated.
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Operations
Finance
Common Fixed Costs
General Services (Admin, Facilities) Personnel
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Common Fixed Costs
Finance
-Cost of accounting software
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Segmented Income Statement in Contribution Format

Segments Defined as Divisions Divisions Payak Manufacturing Sales Variable Expenses: Variable Cost of Goods Sold Other Variable Expenses Contribution Margin Traceable Fixed Expenses Division Segment Margin Common Fixed Expenses NET OPERATING INCOME $ 580,000 208,800 58,000 313,200 197,200 116,000 92,600 23,400 $ Shirts 394,400 171,216 47,560 175,624 98,600 77,024 $ Trousers 150,800 31,320 8,700 110,780 88,740 22,040 Undergarments $ 34,800 6,264 1,740 26,796 9,860 16,936
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SEGMENT MARGIN
A segment margin is obtained by deducting traceable fixed costs from the segments contribution margin. It represents the margin available after a segment has covered all of its own traceable costs.
Segment Margin vs. Contribution Margin SM is the best gauge of the long-run profitability of a segment. It is most useful in major decisions that affect capacity such as dropping a segment. CM is useful in decisions involving short-run changes in volume, such as pricing special orders that involve temporary use of capacity.
Image from www.smartpassiveincome.com
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Segmented Income Statement in Contribution Format

Common costs should not be allocated to the divisions. These costs would remain even if one of the divisions were eliminated.
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Levels of Segmented Statements

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Segments Defined as Product Lines Shirts Division Sales Variable Expenses: Variable Cost of Goods Sold Other Variable Expenses Contribution Margin Traceable Fixed Expenses Product Line Segment Margin Common Fixed Expenses NET OPERATING INCOME $ 394,400 171,216 47,560 175,624 88,600 87,024 10,000 77,024 $ Cotton Knit Shirts 145,928 55,453 17,511 72,964 32,104 40,860 Product Lines Woven Cotton Shirts $ 130,152 49,458 15,618 65,076 31,236 33,840 $ Man-made Fiber Shirts 118,320 66,306 14,430 37,584 25,259 12,325
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Segments Defined as Product Lines Shirts Division Sales Variable Expenses: Variable Cost of Goods Sold Other Variable Expenses Contribution Margin Traceable Fixed Expenses Product Line Segment Margin Common Fixed Expenses NET OPERATING INCOME $ 394,400 171,216 47,560 175,624 88,600 87,024 10,000 77,024 $ Cotton Knit Shirts 145,928 55,453 17,511 72,964 32,104 40,860 Product Lines Woven Cotton Shirts $ 130,152 49,458 15,618 65,076 31,236 33,840 $ Man-made Fiber Shirts 118,320 66,306 14,430 37,584 25,259 12,325
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Hindrances to Proper Cost Assignment

Omission
of Costs: Costs assigned to a segment should include all costs attributable to that segment from the companys entire value chain. Inappropriate methods for assigning traceable costs among segments: Failure to trace costs directly Inappropriate allocation base Arbitrarily Dividing Common Costs among Segments
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Evaluating Investment Center Performance
RETURN ON INVESTMENT
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RETURN ON INVESTMENT (ROI) Formula

Earnings Before Interest and Taxes ( (EBIT) )
Net operating income ROI = Average operating assets

Cash, accounts receivable, inventory, plant and equipment, and all other assets held for operating purposes; computed as average of beginning and ending assets
RETURN ON INVESTMENT (ROI) Formula Net operating income Margin = Sales Sales Turnover = Average Operating Assets
ROI = Margin x Turnover
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ELEMENTS OF ROI
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Sample Exercise Montvale Burger Grill

Sales Operating expenses Net operating income Average operating assets $ $ $ $ 100,000 90,000 10,000 50,000
ROI = Margin x Turnover

Net operating income ROI = Sales x Sales Ave. Operating Assets
=
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$10,000 $100,000
$100,000 $50,000
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= 10% x 2 = 20%
Sample Exercise Montvale Burger Grill

Investing in Operating Assets to increase Sales Assume that the manager is considering to invest $2,000 in an ice cream machine that is assumed to boost sales by $4,000, while increasing operating expenses by $1,000. Net operating income ROI = Sales x Sales Ave. Operating Assets
$13,000 $104,000
$104,000 $52,000
= 12.5% x 2 = 25%
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ROI increased from 20% to 25%.

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Criticisms of ROI
In
the absence of the Balanced Scorecard, management may not know how to increase ROI. Managers often inherit many committed costs over which they have no control making it difficult to fairly assess the performance of this manager. Managers evaluated on ROI may reject profitable investment opportunities.
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Evaluating Investment Center Performance
RESIDUAL INCOME
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RESIDUAL INCOME
Residual Income is the net operating income that an investment center earns above the minimum required return on its operating assets.
ROI vs Residual Income ROI measures net operating income earned relative to the investment in average operating assets. Residual income measures net operating income earned less the minimum required return on average operating assets.
RESIDUAL INCOME
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RESIDUAL INCOME
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RESIDUAL INCOME
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RESIDUAL INCOME vs ROI New Project
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RESIDUAL INCOME vs ROI New Project
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RESIDUAL INCOME
Performance Evaluation using ROI vs Residual Income/EVA To maximize ROI, the manager will not pursue investments with lower rate of return than its divisions current ROI even if it is above the companys minimum requirement. To maximize Residual Income, the manager will pursue investments that are higher that the set minimum ROI. Economic Value Added (EVA) is a concept in which value is created when the return on the firm's economic capital employed is greater than the cost of that capital. This is computed by making adjustments on GAAP financial statements.
Evaluating Performance
BALANCED SCORECARD
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Balanced Scorecard is an integrated set of performance measures that are derived from and support the organizations strategy.
Financial Performance Measures Internal Business Processes Learning and Growth Customers
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BALANCED SCORECARD
Need for non-financial measures Financial measures are lag indicators that report on the results of past actions; while, non financial measures of key success drivers are leading indicators for future financial performance. Top managers are ordinarily responsible for financial performance measures not lower level managers. Non financial measures are more likely to be understood and controlled by lower level managers.
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BALANCED SCORECARD
A personal scorecard should contain measures that can be influenced by the individual being evaluated and that support the measures in the overall balanced scorecard.
If we improve this performance measure, then,
This other performance measure should also improve.

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BALANCED SCORECARD
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KEY PERFORMANCE INDICATORS

Features of well-designed KPIs: Easily understood Has clear and direct line of sight to a strategic goal or objective Simple Has an owner Has at least one strong link to at least one other measure Provides regular feedback over time Is cost effective to measure Is fully documented
BALANCED SCORECARD
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Budgeting To Balance Scorecard

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BUDGETING and PERFORMANCE ANALYSIS

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento MM 2013-A

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Budgeting 101: Budget Period

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Budgeting 101: Budget Process

Budget Preparation / Formulation

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Budgeting 101: Budget Process

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Budgeting 101: Budget Process

Budgeting 101: Budget Process

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Budgeting 101: Master Budget

Direct materials budget

Direct labor budget

Manufacturing overhead budget

Cash Budget Budgeted income statement

Budgeted balance sheet

Budgeting 101: Alternatives

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Budgeting 101: Planning Budget

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Performance Analysis: Activity Variance

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Performance Analysis : Revenue Variance

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Performance Analysis : Spending Variance

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Value of a Good/ Service

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

STANDARDS are benchmarks or norms for measuring performance. Types of Standards

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Standard Direct Material

Type of Product Cost

Final, delivered cost of materials, net of discounts.

Summarized in a Bill of Materials.

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Standard Price/ Unit

Purchase Price Freight Purchase Discount Standard Price/ml

P 135.00 9.45 2.70 P 147.15

Standard Quantity/ Unit

5.00 0.35 0.10 5.45

Use time and motion studies for each labor operation.

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

P 53.63 5.36 4.29 P 63.28

Standard Quantity/ Unit

0.10 0.01 0.03 0.02 0.16

The rate is the variable portion of the predetermined overhead rate.

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Predetermined Overhead Rate: P 12.66

Standard Quantity/ Unit

Direct Labor-Hours/Vial: 0.016

Alcaraz, Dela Pena, Luciano, Santiago, Sarmiento

Direct Materials Direct Labor Variable Mfg Overhead

Total Standard Cost/Unit