Question

1- Incremental Analysis:

Explain two (2) examples of unavoidable costs for a sample business decision for a company.

2- Master Budget Terms:

List and explain three (3) benefits of budgeting for a company.

3- Additional Budget Terms:

Explain how to compute a flexible budget performance report.

Answer 1

Incremental Analysis

Incremental analysis is a decision-making technique used in business to determine the true cost difference between alternatives.

Also called the relevant cost approach, marginal analysis, or differential analysis, incremental analysis disregards any sunk cost or past cost.

Incremental analysis is useful for business strategy including the decision to self-produce or outsource a function.

Examples of unavoidable costs

Examples of unavoidable costs refer cases where quality depends on a single provider of an input with a unique quality of product impact over costs of firm.

This kind of cost cannot be controlled by firm and avoided unless firm get new providers and switch it as an avoidable cost.

Additional examples of unavoidable costs happen when systematic risk of taking a position of financial assets impact negatively over return of firm,

and cannot be covered with diversification of investment.

Benefits of Budgeting of a Company

Planning orientation. The process of creating a budget takes management away from its short-term, day-to-day management of the business and forces it to think longer-term.

This is the chief goal of budgeting, even if management does not succeed in meeting its goals as outlined in the budget - at least it is thinking about the company's competitive and financial position and how to improve it.

Profitability review. It is easy to lose sight of where a company is making most of its money, during the scramble of day-to-day management.

A properly structured budget points out what aspects of the business produce money and which ones use it, which forces management to consider whether it should drop some parts of the business or expand in others.

Assumptions review. The budgeting process forces management to think about why the company is in business, as well as its key assumptions about its business environment.

A periodic re-evaluation of these issues may result in altered assumptions, which may in turn alter the way in which management decides to operate the business.

Performance evaluations. You can work with employees to set up their goals for a budgeting period, and possibly also tie bonuses or other incentives to how they perform.

You can then create budget versus actual reports to give employees feedback regarding how they are progressing toward their goals

. This approach is most common with financial goals, though operational goals (such as reducing the product rework rate) can also be added to the budget for performance appraisal purposes.

This system of evaluation is called responsibility accounting.

Funding planning. A properly structured budget should derive the amount of cash that will be spun off or which will be needed to support operations.

This information is used by the treasurer to plan for the company's funding needs.

Flexible Budget Performance Report:

A flexible budget performance report is used to compare actual results for a period to the budgeted results generated by a flexible budget.

This report varies from a traditional budget versus actual report, in that the actual sales figure is plugged into the budget model, which then uses formulas to alter the budgeted expense amounts.

This approach results in budgeted expenses that are significantly more relevant to the actual performance that an organization experiences.

If the flexible budget model is designed to adjust to actual sales inputs in a reasonable manner, then the resulting performance report should closely align with actual expenses.

This makes it easier to spot anomalies in the report, which should be rare. Management can then focus on the significant variances to see

if any actions should be taken to ensure that actual results remain close to expectations.

For example, ABC International has adopted a flexible budget model, in which the cost of goods sold should be 25% of sales.

In the most recent period, actual sales were $1,000,000. When this figure is input into the model, it generates a budgeted cost of goods sold of $250,000.

The actual cost of goods sold was $260,000. This information is inserted into the accounting department's flexible budget performance report,

where the cost of goods sold line item shows a $10,000 unfavorable variance.

The flexible budget model and its related reports are a significant improvement over the more common static model, where there is only one version of a budget, and that budget does not change.

When a static model is the basis of comparison, the likely outcome is large favorable and/or unfavorable variances for many line items, since the static model may have been based on a sales level that is no longer relevant to actual conditions.