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In any organisation,
planning and control are the major activities and budgets are
at the centre of these activities. Budgets are used as a management
tool which supports planning, aids control of costs and decision
making, motivation and communications. It is also used to evaluate
the performance of the company. Budgetary control is the method
of establishing budgets for different departments giving responsibilities
to individual managers and comparing actual results against
expected results. Plans are made for the future, they are implemented
and monitored to see whether they conform to the plan. For this
to happen requires support, cooperation and motivation from
the management and staff.
A budgeting system should ideally, allow for the goals of individuals
and groups of people to correspond with the goals of the company
overall. Objectives of the organsisation should not be imposed
without consulting with employees. Authority which is accepted
from the lower hierachial levels is more effective than imposed
authority and this is more effective when achieving goals. Senior
management is able to impose different budgets on different
departments however if the preparation of the budgets involves
the employees at a lower level then acceptance of the budgets
is more likely. Involving people makes them feel more part of
the team resulting in increased motivation.
People will be more
motivated with increased participation and this in turn will
encourage responsibility and initiatives. It is more beneficial
to have a reward system (i.e promotions, salary increases, bonuses)
consistent with the organisational control system. If they are
not consistent, then employees may ignore the system and it
will be seen as having little importance and this could effect
the objectives of the company. Generally, people will work more
efficiently and effectively is they have been given clear targets
and objectives. Communicating effectively between employees
is also a factor to ensuring a successful budget. Thus, budgeting
is a crucial part of control and planning. They allow there
to be plans made for the future and the implementation of these
plans. For this, it is required that all members of the company
give full cooperation and support to the budgets.
For absorption costing, incorrect assessment of the labour hours
used, the amount of material wastage not correctly accounted
for will result in inaccuracies and errors for the calculation
of OAR. Human errors such as incomplete paperwork, delays in
completing paperwork, deliberate falsification of data to give
a false impression would result in incorrect information for
the management.
The Roles of Absorption Costing and Variable Costing in product
costing and decision making
In a manufacturing business, one needs to calculate how much
a product costs to make. This is required to set a selling price
in order to recover the costs incurred and to make profit in
order that the business keeps running. Departments that provide
services to the production department, but not involved directly
in the production must have some means of recovering their costs.
The cost of the service departments must be apportioned to the
product department. These indirect costs are called overheads
and they are absorbed or included into the total cost of the
product. All costs are absorbed into production and there is
no separation of fixed and variable costs. Proper records of
expenses by other departments must be kept. After the overheads
have been apportioned to the appropriate cost centres, the amount
of overhead to be included into the cost of each unit needs
to be calculated. This is done by means of overhead absorption
rate (OAR) and there are a number of different methods of calculating
it. Absorption Costing does however have some problems such
as that the OAR must be updated on a regular basis. They are
calculated from budgeted information and therefore can change
as the actual results will be different from the budgeted, thus
leading to inaccuracies. Accurate information is required if
management has to make the right decisions.
Choosing an incorrect unit of absorption base can also introduce
errors. Also calculations are based on predicted levels of output
and variations in levels of output can lead to over or under
absorption of overheads. Under and over absorption of overheads
occurs when actual overhead costs are different from budgeted
overheads. Over absorption means that the overheads charged
to the cost of production are greater than the overheads actually
incurred. Under absorption means that insufficient overheads
have been included in the cost of production. Management must
use an absorption rate that provides a reasonably accurate estimate
of overhead costs. The absorption base must reflect the activities
in a given cost centre. In a labour intensive cost centre, direct
labour hour basis is most appropriate. But nowadays, production
is achieved by using large number of machines and using this
method will introduce errors.
Machine hour basis is appropriate for a cost centre employing
large number of machines. Direct Wages basis is widely used.
Because of the different rates paid to different employees,
this can cause some errors. Absorption costing is often used
for profit reporting and must be used for financial accounting
purposes.
When considering Marginal Costing there are two types of costs
--- variable and fixed. Variable costs are direct labour and
materials etc, i.e. costs that vary with the level of activity.
It increases proportionately with the level of production. Fixed
costs are those which do not vary with the level of activity,
e.g. heating, lighting, rent etc. Now if same value of fixed
costs are taken along with different values of variable costs
(which represents different production levels) to calculate
the unit cost, then we get different answers. To avoid this
Marginal Costing is used to removes the fixed costs and uses
the total variable costs to calculate unit cost. Marginal cost
is the variable cost of one unit of product. The contribution
can be worked out which is sales revenue less variable costs.
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