Engineering Management Accounting Lecture 6

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Engineering ManagementAccounting Lecture 6
ELE 22EMT
George Alexander G.Alexander_at_latrobe.edu.au http/
/www.latrobe.edu.au/eemanage/
10 September, 2004
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Resources Human Materials Equipment Financial Inf
ormation
managerial Planning Organisation Leading Controll
ing Technology
Outcomes Products services Profit
loss employees growth satisfaction
Inputs
Transformation Process
Outputs
Bartol Management A Pacific Rim Focus,
McGraw-Hill, 2001
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Last week

• Management Accounting
• The budget process
• Inputs to the budget process
• Internal organisation structure
• Functions within a typical organisation
• Typical types of expenditure

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Summary of this week

• The budget process in more detail
• Budget for a manufacturing organisation
• The different types of budget involved
• Applying the budget data to product cost
  calculation

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Significance of the manufacturing budget

• It is a major factor in determining the cost of
  the goods sold (refer PL).
• It needs to be accurate or
• Overstated cost could result in uncompetitive
  pricing.
• Understated cost could result in low pricing and
  reduced profit

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Example Profit Loss Statement
Net Sales 69,160,000 Less cost of goods
sold 33,250,000 Gross Margin (gross profit)
35,910000 Less operating expenses
31,813,600 Net Profit 4,096,400
Note Tax is calculated on the Net Profit
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Manufacturing budgets required

• Budget Type
• Capital
• Personnel
• Expenses
• Inventory
• Purchases

• Impacts
• Cash flow, depreciation expenses
• People-related expenses
• Hourly rate calculations
• Borrowings, warehouse planning
• Cash flow

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Manufacturing Resource PlanningMRP II

• Computer based information system integrating
  production planning and control activities of
  basic MRP systems with related financial,
  accounting, personnel, engineering and marketing
  information.
• MRP Materials Requirements Planning
• Bartol, K.M., Martin, D.C., Tein, M.,
  Matthews, G., Management A Pacific Rim Focus,
  McGraw-Hill, 2002 (Supplement 2 to Chapter16)

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MRP II features- in the budget context

• Feature
• Bill of material
• Operation times/labour type
• Equipment used

• Budget Application
• Inventory, purchases, forecasts to suppliers
• Direct personnel
• Equipment capacity planning, needs analysis

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Possible Organisation Structure
Board of Directors
CEO
Operations
Human Resources
Finance Treasury
RD
Sales Marketing
Budget Control
IT Services
Production
Engineering Support
Service
Logistics
Quality Assurance
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Possible Organisation Structure
Board of Directors
CEO
Operations
Production
Engineering Support
Logistics
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Possible Organisation Structure
Board of Directors
CEO
Operations
Production Dept. 1 Dept. 2 Dept. 3
Engineering Support Prod. Eng. Test
Eng. Maintenance
Logistics Planning Purchasing Stores
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Budget Inputs Required

• Forecast of specific product volumes
• The latest comparison of budget and actuals
• Forecasts of inflation rates and salary
  increases.
• Specific cost reduction/efficiency initiatives.
• Charges from other departments (facilities,
  support etc.)

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Capital budget

• Inputs
• Capacity planning data from MRP II
• Any new efficiency proposals
• Any new products being introduced
• Considerations
• Alternatives such as shift work, subcontracting
• Outputs
• New capital equipment requirements, including
  total costs, timing, and economic justification.

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Personnel budget

• Inputs
• Direct labour requirements from MRP II
• Current data on direct/indirect ratios,
  non-direct labour requirements, attendance data.
• Any new products being introduced
• Considerations
• Planned changes in current ratios.
• Any special initiatives e.g. specialised training
• Overtime and shift policy
• Outputs
• Personnel numbers including timing,
  classification, planned overtime and shift work.
  Includes direct and non-direct personnel.

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Expense budget

• Inputs
• Personnel budget for labour-related costs
• Capital budget and existing asset data for
  depreciation costs.
• Charges from other areas support, rental
  charges etc.
• Current data on actual vs budget
• Inflation forecasts
• Considerations
• Any special initiatives, programs
• Overtime and shift policy, bonuses payable
• Outputs
• Monthly budgeted expenses for the budget period

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Major expense items - manufacturing

• Personnel-related costs including overtime,
  bonuses, shift allowance, payroll tax, WorkCover,
  superannuation.
• Equipment depreciation charges
• IT charges
• Rent (internal), power, general facilities
  charges
• Support charges e.g. maintenance, engineering, IT
• Process-related materials
• Inventory costs (depending on accounting
  treatment of these)

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Inventory/Purchases budget

• Inputs
• Total materials required including time and cost
  from MRP system.
• Current inventory turnover performance and
  planned changes
• Considerations
• Any special initiatives to reduce inventories
  e.g. Just In Time system
• Any threats to the supply line that warrant
  deliberate inventory increases.
• Outputs
• Monthly budgeted purchases for the budget period
• Monthly budgeted inventory levels (including any
  manufactured components and assemblies)
• Forecasts to suppliers

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Calculating product costs

• Aim To reflect in the product cost all of the
  costs associated with producing the product over
  the budget period.
• The resulting cost calculation is an estimate
  usually termed a standard cost for each item.
• If everything happens according to forecast
  volumes and budget, the actual cost will be the
  same as the standard cost.
• If not, there will be variances favourable or
  unfavourable.

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Composition of the standard cost

• Material derived directly from the MRP II
  system
• Direct Labour also derived from the MRP II
  system by applying a labour rate /hour
• Overhead includes fixed costs and any other
  costs which cannot be directly attributed to
  specific products often also applied on the
  basis of an hourly rate.
• It is vital that the total manufacturing costs
  are included in the cost calculation to provide
  an accurate cost of sales.

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Variances in standard costing

• When the actual cost differs from the standard
  cost, it is referred to as a variance.
• Variances can be favourable or unfavourable
  and impact profitability accordingly through cost
  of goods sold.
• Some types of variance
• Overall manufacturing cost
• Purchase price
• Exchange rate

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One method of calculating direct labour and
overhead costs

• Determine the total number of direct hours i.e.
  those budgeted hours directly spent on production
  - H.
• Determine total budgeted costs associated with
  the budgeted direct hours C.
• Determine all other budgeted expenses E.
• Direct labour rate C/H per hour
• Overhead rate E/H per hour
• The labour and overhead costs of each unit are
  then determined by applying the rates to the unit
  direct hours.

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For example

• 1 Total number of direct hours
• H 100,000
• 2 Total budgeted costs associated with the
  budgeted direct hours
• C 5,000,000
• All other budgeted expenses
• E 8,333,000
• 4 Direct labour rate C/H 50.00 per hour
• 5 Overhead rate E/H 83.33 per hour
• For a unit with direct labour content of 0.3
  hours,
• direct labour cost 0.3 x 50 15
• overhead cost 0.3 x 83.33 25
• Assume material cost 60.
• Total standard cost 100

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Example Profit Loss Statement
Net Sales 69,160,000 Less cost of goods
sold 33,250,000 Gross Margin (gross profit)
35,910000 Less operating expenses
31,813,600 Net Profit 4,096,400
Note Tax is calculated on the Net Profit
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Overall Purpose of the Budget

• Budgetary Control actual performance can be
  compared with the budget to identify any
  deviations so that management can take corrective
  actions. (Bazley et al).
• Budgetary control provides a useful mechanism for
  predicting likely financial outcomes to the
  stakeholders.

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Some Specific Purposes of Budgets(Bazley et al)

• Compels planning.
• Co-ordinates the functions within the
  organisation.
• Form of communication
• Provides a basis for responsibility accounting.
• Provides a basis for a control mechanism.
• Authorise expenditure.
• Motivate employees.

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Thanks for your attention