David is the Managing Director of MJ Ltd, a UK company that manufactures components for the healthcare industry. The company accountant has historically used a ‘traditional’ incremental approach to creating their budgets. However, the company accountant has suddenly resigned at a time of significant political and economic uncertainty. As a result, David has approached you to prepare the functional budgets for the forthcoming financial quarter.
Each of the departmental managers has provided David with the following information in respect to the forthcoming 3-month period
Sales information
Sales in units are forecast as follows:
- Average selling price per unit: £105
- August 5,030
- September 6,525
- October 6,000
- November 5,830
- December 5,540
Production information
Opening stock of finished goods at 1stAugust are 5,300 units. In order to always meet customer demand, the sales manager demands that the closing stocks at the end of each month should equal 1.5 times the following month’s expected sales level.
Raw materials information
Each unit produced requires 5 kgs of material which they estimate will be £6 per kg, they have been purchasing all their raw materials from the same German supplier for the past 6 years. Opening stocks of raw materials at 1stAugust are 4,200kgs.The company also has a long-standing policy of increasing closing stock levels by 5% each month in order to ensure they have enough raw materials.
Labor information:
Each unit produced requires 4 labor hours which costs £10 per hour.
Production overheads information:
Absorbed on the basis of £2 per direct labour hour.
Administration overheads information:
Administration overheads are forecast at £10,000 for August, but expected to rise by 3% each month.
Selling overheads information:
Selling overheads have historically run at 10% of sales revenue for each month. The sales manager believes that the current average selling price per unit of £105 per unit is as high as the firm’s customers can bear at this time.
Required:
Prepare a report for David in which you:
Part 1:
- Prepare the functional budgets for the financial quarter August to October from the information provided above.
- Comment on your findings.
Part 2:
As previously mentioned, the company has always used a ‘traditional’ incremental approach towards building its budgets to plan for the future. David is now concerned that this may not be appropriate in the current turbulent political and economic environment which he believes may last for a number of years. As a result, he has also asked you for advice about how he might adopt a more flexible planning approach without losing financial control.
- Critically review the current budget preparation process
- Critically analyse the potential advantages and disadvantages of adopting a ‘beyond budgeting’ approach instead
- Provide David with a recommendation(s) for the future based on your findings
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