Accounting Business Reporting for Decision Making

CHAPTER 9 Budgeting 399

Cash inflow may be increased by:

• improving the collections of cash from accounts receivable — perhaps the entity needs to review its invoicing

and follow-up procedures, offer incentives for prompt payment or charge interest on overdue accounts

• seeking ways to improve sales or fees — increasing advertising campaigns, or changing features of

the product/service to increase fees

• reducing unnecessary inventory levels — discounting obsolete inventory will generate cash


• arranging external finance — bank overdraft, accounts receivable factoring, invoice discounting


• receiving an extra capital contribution from the owners, or considering a change in ownership structure


• selling excess non-current assets — a sale and leaseback arrangement may be more suitable.

Cash outflow may be reduced by:

• cutting expenses by identifying areas of waste, duplication or inefficiency


• making use of terms of credit — where purchases are made on credit, there is some benefit in using

the full extent of the credit terms

• keeping inventory levels to only what is required, as excess inventory ties up cash and often adds to

storage and handling costs

• deferring capital expenditures — it may be necessary to delay the acquisition of any non-current assets


• reducing the carbon footprint, which may reduce resource use and cash outflows.

The reality check, ‘Iron ore price tumbles’, highlights the need for entities to review budget estimates

during the budget period, particularly in light of changing circumstances beyond their control.

REALITY CHECK

Iron ore price tumbles

Iron ore is a major input into the iron smelting and steel manufacturing industries. Prior to 2012/2013

increased steel production in developing countries, such as China and India, led to strong demand for

iron ore and as a consequence high iron ore prices. During this time the price of iron ore peaked at

over US$200 per tonne. In 2014/2015 the situation changed with the price dropping to below US$50

per tonne. Many factors have led to this dramatic price decrease including increased production from

Australia and Brazil that has flooded the market and decreased demand from China.

Accountants working in the iron smelting and steel manufacturing industries probably did not antici-

pate the size of the price decrease when they developed their company’s budget. If you work in an

industry using/selling a commodity such as iron ore, what can you do when prices are in such decline

and also tend to fluctuate? The original master budget would not be an appropriate tool for monitoring

performance in such a volatile market, and from the sellers’ perspective the accountants would need

to revise cost and revenue budgets, and search for ways to use resources more efficiently or increase

sales volume, as there would be no opportunity to change the selling price.

Like all decision-making processes, budgeting is affected by human attitudes and assumptions.

To further examine budget variances let’s return to our Mountain Blue Bikes example and compare the actual

operating activity against the budget expectations. The variance report is shown in illustrative example 9.13.

ILLUSTRATIVE EXAMPLE 9.13

Variance analysis for Mountain Blue Bikes

Extract from financial statements for the year ended 31 December 2016

Budget estimate Actual Variance

Sales

Materials usage

Labour usage

Production overhead

Selling and administrative expenses

$ 80 000 000

14 140 000

4 040 000

10 300 000

33 000 000

$ 75 000 000

14 400 000

5 000 000

11 000 000

30 000 000

$5 000 000 (u)

260 000 (u)

960 000 (u)

700 000 (u)

3 000 000 (f)