Budgets Data

A budget is not part of GAAP, but is management data prepared outside of an accounting system.

Let us now discuss the important question referring to the structure of our company’s Budget Data.

It is just a very basic rule, that will tell us:

If we like to compare something we have done, we need some data structure that will make this comparison possible. We know very well, that this rule corresponds also to our need of comparing information within our company.

For the Internal Accounting, this is a very essential requirement. Without a Budget Data structure, Internal Accounting will not be able to show management important reports and information.

We need prepare these Budgets from Class 2, the Cost Elements.

Here we prepare the budgeted information of the total values of the different Cost Elements. We will have to identify these values of the Salaries of our personnel and naturally values of the Wages that we calculate to have to pay. Under some conditions, the total Wages will have to be divided into Main accounts, so we have a better control of wages paid to different groups of workers.

Our Budget must also refer to all other important Cost Elements and as a very important part, we have to prepare the budget for the values of raw material that we expect to use in our production. This is naturally not an easy project – but we need very reliable information such as obtained from a Direct Material budget.

As you will understand, such Direct Material budget will have to be prepared with Standard cost elements. In same way we will have to work with Standard elements when preparing our Budget for Wages.

In the next chapter of our presentation, we will discuss the important details of Standard Costs.

After finishing the Budget structure for Class 2 – we turn our attention to Class 3 – and all budgets referring to our Responsibility Accounting System.

The work of developing the different budgets for every department, must be realized with the responsible employed person of each department. These persons are responsible for preparing the budget for their department. This is not an easy task – but must the realized the first year for all 12 month ahead – a years budget.

The Departmental Operating Budget should not be put on a shelf and be forgotten for the rest of the calendar year. In no way.

Expenditure Budget.

Class 1 provides actual accrued monthly expenditures. It should be compared to budgeted amounts to find Variances. Few management tools provide the insight offered by Internal Cost Accounting. Internal Accounting treats indirect, fixed cost allocation traditionally: salaries and wages, rent, supplies, depreciation and so on are automatically charged to departments using pre-determined methods. General costs, like telephone bills, can be allocated to a variety of departments using a variety of algorithms. Internal Accounting records budget data to compare actual allocated departmental costs with budgeted costs.

By identifying accrued monthly expenditures, and by comparing these figures with an Expenditures budget, Internal Accounting provides detailed Expenditure analysis. Internal Accounting also provides a facility to compare Variances between budgeted Cost Elements and actual Cost Elements.

Departmental Operating Cost Budget.

Actual costs charged to Direct Departments will be compared with budgeted amounts at month end, to report Variances for managers.

Actual costs allocated to specific departments in this way can be compared with budgeted amounts very simply. A budget is not part of GAAP’s, but is management data prepared outside of an accounting system. The Internal Accounting structure, however, harmonizes perfectly with, and may be direct compared to, budgeted departmental operating costs.

This clarity gained in comparing actual to budgeted amounts, along with the Variance reports resulting from the comparison, is a major step forward in gaining relevance in Cost Accounting.

Departmental variances: Shows differences between actual departmental operating costs and budgeted departmental absorbed amounts charged to production. Now we have a handle on over-absorbed and under-absorbed variances for direct production, administration, sales, indirect production and service departments.

Group 5 shows the difference between actual departmental operating costs and departmental absorbed amounts charged to production.

Here is a wealth of detail about over-absorbed and under-absorbed variances. Not only from Direct Production Departments, but also from Administrative and Sales Departments, from Indirect Production, and from Service Departments, actual operating costs are compared with budgeted values.

Maintenance Department Budget.

What is the difference between maintenance and repair work? There seems to be some overlap. Let us define our terms right away:

Repair consists of tasks to salvage equipment value for continued use, thus saving purchase expenditures. Such tasks may require direct material.
Maintenance consists of smaller tasks to keep equipment in good shape so that major problems do not occur spontaneously. As such, they require supplies, but no direct material. Management can control these activities best by budgeting both separately. Some companies can combine maintenance and repair departments into one department. Other companies may have multiple maintenance departments along with multiple repair departments. The Internal Cost Accounting System will accommodate any size company. In the examples below we have two departments only, one for maintenance and one for repair.

Preventive Maintenance.

Indirect Production Departments costs absorption can be complex. Maintenance and Repair departments, in some companies, are critical and costly. In these cases, perhaps a preventive maintenance budget will help establish absorption rates. At the same time, it is not worthwhile to prepare a very complicated absorption system. A simple structure can often give adequate information. After a year or two of use, it may be appropriate to fine tune the absorption system.

Maintenance and Repair activities are tracked within Functional Activity accounts. An ordinary preventive maintenance budget provides special accounts for these activities, (for example, special building maintenance, vehicle maintenance, machine maintenance, etc.).

Repairs.

Internal Accounting helps managers avoid charging an unpredicted repair cost to a single month’s production by supporting preventative repair budgets and estimating operating costs. An annual absorption rate for each Repair department is also recommended. Internal Accounting can treat finished repairs as Assets, and provides the option to re-allocate it to a Department or depreciate it over time. Internal Accounting can treat a large repair as an equipment purchase.

At month end, the Product Inventory accounts (Class 7) transfer its balance to Asset accounts, since these accounts in class 7 are Contra accounts to Assets. Compare these amounts with budgets for true cost insights.

At Month-End, variances are reported by comparing Budgeted activity values with Actual activity values.

Repair departments receive allocated operating costs just as with any other department: costs for salaries, wages, rent, depreciation, phones, office supplies, and work supplies are allocated to Repair Departments (Class 3).

But accurate budgets for repair are not easy, since predicting equipment break down is nearly impossible. A ‘preventative repair budget’ can help by sizing the department personnel, operating costs can be estimated. Historical of different repairs during previous years could be used to project budget amounts.

Repairs that must be tightly controlled should have repair Job-Orders. When a repair is finished, the amount for this repair could be handled in two ways:

Now, we can predict an equipment purchase, but we cannot predict a repair ‘purchase.’ If we estimate a repair budget, and nothing breaks down this month, can we charge future repair costs to today’s production? There are many different solutions to this problem, but the Internal Cost Accounting System recommends the “internal lease” agreement, described in IAE Articles ; Machine Lease Agreement Procedure.

Service Departments: Reallocation Budget.

This is the procedure of Re-allocation: After we have prepared the budget of the Service Departments, we identify the Re-allocation base. While it is complicated, again, too much detail on this step is not worthwhile. Our matching of Re-allocations must be simple and clear. We may simply decide on a set monthly base to be Re-allocated to the other (Admin, Sales, Direct and Indirect) departments served. Such bases are subject to annual revision.

Direct Labor Budget.

Each Direct Production department has an established number of Direct Labor employees working and recorded in it’s Direct Labor budget. We charge that department with actual Direct Labor wages paid, then compare this amount with the budgeted amount. Do not allocate Direct Labor costs (Class 2) directly to a Production Cost account (Class 5). Take the time to analyze Direct Labor costs in more detail. Computing the Labor Payment and Efficiency Variance is a powerful new tool for managers.

Class 4 transfers Direct Labor transactions to Class 5 at a STANDARD RATE. Because of this we can report the Variance between the Actual and Budgeted (Standard) amounts.

Direct Labor is usually tracked as a Variable Cost, that is, one which varies along with the rises and falls in Product output. However Internal Accounting tracks Direct Labor as Fixed Cost, and notes Direct Labor for its LACK of rising and falling with Product output, because wages are typically paid by the hour, regardless of output, and not by piece-work, which alone is tied to output.

If we wish to track the Efficiency of Labor, or compare workers with their past performance or performance of their peers, we use a Labor Efficiency Variance methodology (comparing actual labor time against budgeted time) by Product and Job Order. It is done this way:

Make a Direct labor Budget. This involves setting the Standard Rate for Labor time expended on a given product.
Charge a Direct Labor department with Actual Direct Labor wages paid, then compare this amount with the budgeted amount.
To compute Labor Variances, Charge a holding Department account with a Standard Labor cost.
Compare the Actual Cost with the Standard Cost

Though traditionally accounted as a variable cost (that is, varies with the rise and fall of production), Direct Labor should be monitored closely precisely because it does not rise and fall with production. The fact that hourly wages represent a fixed cost more so than a variable cost, allows us to design a new account to measure labor efficiency. It would be named the Labor Efficiency Variance account, because it would compare actual labor time against budgeted labor time. This account would track rise and falls in output at the lowest Job-Order level.