eCommerce

e-Commerce

1.An Overview

1.1 What is e-Commerce: e-Commerce refers to the process of buying or selling products or service over an electronic network. The most popular medium in which e-Commerce is conducted is the internet. It combines a range of process such as :

• Electronic Data Interchange (EDI)
• Electronic mail (E-mail)
• World Wide Web (WWW)
• Internet Applications
• Network Applications.

[XXXX Basically e-Commerce involves the sale or purchase of goods or services over computer mediated networks. These goods or services may be ordered though these networks, but payment for them and the ultimate delivery of the goods and services may be conducted on or off line. Some analyst define e-commerce as simple buying and selling over electronic networks; and use e-business (buzzword) to refer to these wider range of supporting business activities that can be conducted over such networks.]

**There are three basic components to every e-commerce solution:

• Communications
• Standards
• Software

1.2 Existing Barriers:

• Security
• Tariffs
• Legal issues

1.3 History of E-Commerce:

• In 1950’s companies began to use computers to store and process internal transaction records
• By 1960’s businesses that engaged large volume of transaction had began exchanging transaction information on punched card
• In 1968 Transportation Data Co-ordination Committee (TDCC ) was formed by some companies
• In 1979 ANSI (American National Standards Institute) chattered a new committee to develop uniform EDI (Electron Data Interchange)
• In 1987 UN publish its first standards under the title EDI

2.Traditional and Electronics Business Transaction:

The business process are broadly divided into five main categories namely:

• Market product and services
• Sell and deliver products and services
• Process payments
• Manage relationship
• Manage the enterprize

2.1 Traditional Commerce vs e-Commerce

Items	e-Commerce	Traditional Commerce
Sales Channel	Enterprize ® Internet ® Consumer	Manufacturer ® Wholesaler ® Retailer ® Consumer
Sales Hour /Region	Entire world 24x7	Restricted area Restricted sales hour
Sales place/method	Market space (Network) Sale based on information	Market space (store) Sale based on display
Customer information acquisition	Any time acquisition through internet Digital Data without no re-entry	Market survey and salesman Require information re-entry
Marketing activity	1:1 Marketing via bi-directional communication	One way marketing to consumer
Customer support	Real time support for customer Dissatisfaction Real time acquisition of customer needs	Delayed support for customer Dissatisfaction Time different for catching customer needs
capital	small	large

3. Types of E-Commerce:

E-commerce can be divided into primarily three catagories

(1) Business to consumer(B2C): Where enterprizes sell directly to the customer, often cutting out (‘disinter mediating’ ) wholesalers or ‘bricks and mortars’ retail outlets. B2C is the most commonly understood form of internet business (www.amazon.com). The most successful trading has been with standard products such as CDs, Books, Software, downloadable music etc.

(2) Business to Business (B2B): it is larger, growing faster. This includes procurements of raw materials and supplies, liaison with contractors, sales channels, servicing customers, collaborating with partners, integrated management with data and knowledge.

(3) Business to Government(B2G): Here business trade directly with government offices and agencies for public procurement (e.g. supplies for hospitals, school and other government contracts.

(4) Consumer to consumer (C2C): Online transaction between private individuals.

(5) Consumer to business(C2B):

4. Benefits of E-Commerce

The benefits of e-Commerce are many and many. Some of them include:

(1) 24X7 operation: Round the clock operation is an expensive proposition in the brick and mortar world while it is natural in the click and conquer world

(2) :Global reach: The net being inherently global, reaching global customers is relatively easy on the net compared to the world of bricks

(3) Cost of acquiring serving and retaining customers: It is relatively cheaper to acquire new customers over the net. Thanks to 24 X 7 operation and its goal reach. Through innovative tools of push technology to retain customers, loyalty with minimal investments.

(4) An extended enterprise is easy to build: In today’s world every enterprise is a part of the ‘connected economy’; as such you need to extend your enterprise all the way to your suppliers and business partners like distributers, retailers and ultimately you end customers. Internet provides an effective (often less expensive) way to extend your enterprise beyond the narrow confines of your own organization. Tools like enterprize resource planning (ERP) ,supply chain management (SCM) and customer relationship management (CRM), can easily be deployed over the net permitting amazing efficiency in time needed to market, customer loyalty, on time delivery and eventually profitability.

(5) Dis-intermediation: Using the net one can directly approach the customers and suppliers, cutting down the number of level sand in the process, cutting down the costs.

(6) Improved customer service to your clients: It results in higher satisfaction and more sales

(7) Power to provide the ‘best of both the worlds’: It enhances traditional along with internet tools.

[XXX*** The impact of e-Commerce to business can be huge. E-commerce can transform the way products and services are created, sold and delivered to the customers. It can also change the way in which the company works with its partners. The followings are well established benefits of e-commerce:

· Improved productivity :Using e-commerce, the time required to create, transfer and process a business transaction between trading partners is significantly reduced. Furthermore human errors like duplication of records are largely eliminated with the reduction of data entry and re-entry in the process. This improvement in speed and accuracy plus the acess to document and information, will result in increase in productivity.

· Cost savings: The cost savings stem from efficient communication, quicker turnaround and closer access to market.

· Streamlined business process: Use of internet and with automation of business process can make business more efficient

· Better Customer service: Customer can enjoy the convenience of shopping at any our and anywhere in the world.

· Opportunities for new business: Business over the internet have global customer reach. There are endless possibilities for business to exploit and expand their customer base.]

4.1 Benefits of e-Commerce to Organization

· Expands the Marketplace to national and international market

· Decrease the cost of creating, processing, distributing, storing and retrieving paper based information

· Allows reduced inventories and overhead by facilitating pull-type supply chain management

· The pull-type processing allows for customization of products and services which provides competitive advantage to its implementers

· Reduces the time between the outlay of capital and the receipt of product and services

· Supports Business process re-engineering (BPR) efforts

· Lowers telecommunication cost- the internet is much cheaper than value added networks (VANs)

4.2 Benefits of e-Commerce to Consumers

• Enables consumers to shop or do other transaction 24 hours a day, all year round from almost any location
• Provides consumers with more choices
• Provides consumers with less expensive products and services by allowing them to shop in many places and conduct quick comparisons
• Allows consumers to interact with other consumers n electronic communities and exchange ideas as well as experiences
• Facilitates competition which results in substantial discounts
• Allows quick delivery of products and services (in some cases) especially with digitized products
• Consumers can receive relevant and detail information in seconds rather than in days or weeks
• Makes it possible to participate in virtual auction

4.3 Benefits of e-Commerce to Society

• Enables more individuals to work at home, and to do less traveling for shopping, resulting in less traffic on the roads and lower air pollution
• Allows some merchandise to be sold at lower prices benefiting less affluent people
• Enable people in third world countries and rural areas to enjoy product and services which otherwise are not available to them
• Facilitates delivery of public services at reduced cost, increases effectiveness and or improve quality

4.4 Disadvantages: Some disadvantages because of newness of e-Commerce. If e-commerce matured they will perhaps remove.

· Inadequate inspection facility

· Security

· legal issues

4.5 Technical Limitations to e-commerce

· Lack of sufficient system security, reliability, standards and communication protocols

· Insufficient telecommunication bandwidth

· The software development tools are still evolving and changing rapidly

· Difficulties in integrating the internet and e-commerce software with some existing application and data base

· The need for special web servers and other infrastructures, in addition to the network servers (additional cost)

· Possible problems of inter operability, meaning that some EC softwares does not fit with some hardware, or is incompatible with some operating systems or other components

4.6 Non- Technical Limitations to e-commerce

• Cost and Justification

- The cost of developing an EC in a house can be very high …….

• Security and privacy
• Lack of trust and user resistance
• Channel conflict
• Other limitations factors are:

-Lack of touch and feel online etc

(8) What are the reasons to put a company on a website?

1. To establish a presence: To be a part of the internet community and show that you are interested in serving them.

2. To network

3. To make business information available

4. To serve your customers

5. To heighten public interest

6. To release time sensitive materials

7. To sell things

8. To make pictures sound and film files available

9. To reach a high desirable demographic market

10.To answer frequently asked questions

11. To stay in contact with Sale people

12. To open international markets

13. To create a 24 hour service

14. To make changing information available quickly

15. To allow feedback from customers

16. To test market new services and product

17. To reach the media

18. To reach the education and youth market

19. To reach the specialized market

20. To serve your local market.

(9) Describe the difference between e-commerce and e-business

e-Business vs e-Commerce

e-Commerce

e-Commerce describes the process of buying, selling, transferring, or exchanging products, services, and or information via computer networks including the internet.

e-Commerce can take several forms depending on the degree of digitization(the transformation from physical to digital). The degree of digitization relates to:

• The product (service) sold
• The process
• The delivery agent (or intermediary)

e-Business:

· Compared with e-Commerce, e-Business is a more generic term; it refers not only to information exchanges related to buying and selling but also to servicing customers and collaborating with business partners, distributors and suppliers.

· E-Business encompasses sophisticated B2B interactions and collaboration activities at a level of enterprise applications and business process.

Characteristics of e-Business

e-Business is about integrating external company with an organization’s internal business process:

· Collaborative product development

· Collaborative planning, forecasting and replenishment

· Procurement and order management

· Operations and logistics

(10) Describe the main ingredients of e-business solution

1. Web: Website act as the pioneer role in e-commerce

2. Customer relationship management system (CRM): “front office” that help enterprise deal directly with their customers. CRM integrates and automates customer serving process within a company.

3. Enterprize Resource Planning System (ERP): Management Information system that integrate and automate many of the business practices associated with the operations or production aspects of a company. An ERP system includes:

· Production: Manufacturing resource planning and execution process

· Buying a product: Procurement process

· Sales of products and services: Customer order management process

· Costing, paying bills and colleting: financial/management accounting and reporting process

4. Supply Chain Management (SCM): A supply chain is a network of facilities and distribution option that performs the function of procurement of materials; transformation of these materials into intermediate and finished product & distribution of these finished products to customer. A supply chain has three essentially main parts: the supply, manufacturing and distribution.

5. Knowledge Management (KM): Knowledge regarding markets, products, processes, technologies and organization that a business owns that enable its business process to generate profits. Also include the subsequent planning and control of actions.

Budgetary control

Budgetary control

There are two types of control, namely budgetary and financial. This chapter concentrates on budgetary control only. This is because financial control was covered in detail in chapters one and two. Budgetary control is defined by the Institute of Cost and Management Accountants (CIMA) as:
"The establishment of budgets relating the responsibilities of executives to the requirements of a policy, and the continuous comparison of actual with budgeted results, either to secure by individual action the objective of that policy, or to provide a basis for its revision".
Chapter objectives
This chapter is intended to provide:
• An indication and explanation of the importance of budgetary control in marketing as a key marketing control technique
• An overview of the advantages and disadvantages of budgeting
• An introduction to the methods for preparing budgets
• An appreciation of the uses of budgets.
Structure of the chapter
Of all business activities, budgeting is one of the most important and, therefore, requires detailed attention. The chapter looks at the concept of responsibility centres, and the advantages and disadvantages of budgetary control. It then goes on to look at the detail of budget construction and the use to which budgets can be put. Like all management tools, the chapter highlights the need for detailed information, if the technique is to be used to its fullest advantage.
Budgetary control methods
a) Budget:
• A formal statement of the financial resources set aside for carrying out specific activities in a given period of time.
• It helps to co-ordinate the activities of the organisation.
An example would be an advertising budget or sales force budget.
b) Budgetary control:
• A control technique whereby actual results are compared with budgets.
• Any differences (variances) are made the responsibility of key individuals who can either exercise control action or revise the original budgets.
Budgetary control and responsibility centres;
These enable managers to monitor organisational functions.
A responsibility centre can be defined as any functional unit headed by a manager who is responsible for the activities of that unit.
There are four types of responsibility centres:
a) Revenue centres
Organisational units in which outputs are measured in monetary terms but are not directly compared to input costs.
b) Expense centres
Units where inputs are measured in monetary terms but outputs are not.
c) Profit centres
Where performance is measured by the difference between revenues (outputs) and expenditure (inputs). Inter-departmental sales are often made using "transfer prices".
d) Investment centres
Where outputs are compared with the assets employed in producing them, i.e. ROI.
Advantages of budgeting and budgetary control
There are a number of advantages to budgeting and budgetary control:
• Compels management to think about the future, which is probably the most important feature of a budgetary planning and control system. Forces management to look ahead, to set out detailed plans for achieving the targets for each department, operation and (ideally) each manager, to anticipate and give the organisation purpose and direction.
• Promotes coordination and communication.
• Clearly defines areas of responsibility. Requires managers of budget centres to be made responsible for the achievement of budget targets for the operations under their personal control.
• Provides a basis for performance appraisal (variance analysis). A budget is basically a yardstick against which actual performance is measured and assessed. Control is provided by comparisons of actual results against budget plan. Departures from budget can then be investigated and the reasons for the differences can be divided into controllable and non-controllable factors.
• Enables remedial action to be taken as variances emerge.
• Motivates employees by participating in the setting of budgets.
• Improves the allocation of scarce resources.
• Economises management time by using the management by exception principle.
Problems in budgeting
Whilst budgets may be an essential part of any marketing activity they do have a number of disadvantages, particularly in perception terms.
• Budgets can be seen as pressure devices imposed by management, thus resulting in:
a) bad labour relations
b) inaccurate record-keeping.
• Departmental conflict arises due to:
a) disputes over resource allocation
b) departments blaming each other if targets are not attained.
• It is difficult to reconcile personal/individual and corporate goals.
• Waste may arise as managers adopt the view, "we had better spend it or we will lose it". This is often coupled with "empire building" in order to enhance the prestige of a department.
Responsibility versus controlling, i.e. some costs are under the influence of more than one person, e.g. power costs.
• Managers may overestimate costs so that they will not be blamed in the future should they overspend.
Characteristics of a budget
A good budget is characterised by the following:
• Participation: involve as many people as possible in drawing up a budget.
• Comprehensiveness: embrace the whole organisation.
• Standards: base it on established standards of performance.
• Flexibility: allow for changing circumstances.
• Feedback: constantly monitor performance.
• Analysis of costs and revenues: this can be done on the basis of product lines, departments or cost centres.
Budget organisation and administration:
In organising and administering a budget system the following characteristics may apply:
a) Budget centres: Units responsible for the preparation of budgets. A budget centre may encompass several cost centres.
b) Budget committee: This may consist of senior members of the organisation, e.g. departmental heads and executives (with the managing director as chairman). Every part of the organisation should be represented on the committee, so there should be a representative from sales, production, marketing and so on. Functions of the budget committee include:
• Coordination of the preparation of budgets, including the issue of a manual
• Issuing of timetables for preparation of budgets
• Provision of information to assist budget preparations
• Comparison of actual results with budget and investigation of variances.
c) Budget Officer: Controls the budget administration The job involves:
• liaising between the budget committee and managers responsible for budget preparation
• dealing with budgetary control problems
• ensuring that deadlines are met
• educating people about budgetary control.
d) Budget manual:
This document:
• charts the organization
• details the budget procedures
• contains account codes for items of expenditure and revenue
• timetables the process
• clearly defines the responsibility of persons involved in the budgeting system.
Budget preparation
Firstly, determine the principal budget factor. This is also known as the key budget factor or limiting budget factor and is the factor which will limit the activities of an undertaking. This limits output, e.g. sales, material or labour.
a) Sales budget: this involves a realistic sales forecast. This is prepared in units of each product and also in sales value. Methods of sales forecasting include:
• sales force opinions
• market research
• statistical methods (correlation analysis and examination of trends)
• mathematical models.
In using these techniques consider:
• company's pricing policy
• general economic and political conditions
• changes in the population
• competition
• consumers' income and tastes
• advertising and other sales promotion techniques
• after sales service
• credit terms offered.
b) Production budget: expressed in quantitative terms only and is geared to the sales budget. The production manager's duties include:
• analysis of plant utilization
• work-in-progress budgets.
If requirements exceed capacity he may:
• subcontract
• plan for overtime
• introduce shift work
• hire or buy additional machinery
• The materials purchases budget's both quantitative and financial.
c) Raw materials and purchasing budget:
• The materials usage budget is in quantities.
• The materials purchases budget is both quantitative and financial.
Factors influencing a) and b) include:
• production requirements
• planning stock levels
• storage space
• trends of material prices.
d) Labour budget: is both quantitative and financial. This is influenced by:
• production requirements
• man-hours available
• grades of labour required
• wage rates (union agreements)
• the need for incentives.
e) Cash budget: a cash plan for a defined period of time. It summarises monthly receipts and payments. Hence, it highlights monthly surpluses and deficits of actual cash. Its main uses are:
• to maintain control over a firm's cash requirements, e.g. stock and debtors
• to enable a firm to take precautionary measures and arrange in advance for investment and loan facilities whenever cash surpluses or deficits arises
• to show the feasibility of management's plans in cash terms
• to illustrate the financial impact of changes in management policy, e.g. change of credit terms offered to customers.
Receipts of cash may come from one of the following:
• cash sales
• payments by debtors
• the sale of fixed assets
• the issue of new shares
• the receipt of interest and dividends from investments.
Payments of cash may be for one or more of the following:
• purchase of stocks
• payments of wages or other expenses
• purchase of capital items
• payment of interest, dividends or taxation.
Steps in preparing a cash budget
i) Step 1: set out a pro forma cash budget month by month. Below is a suggested layout.
Month 1 Month 2 Month 3
$ $ $
Cash receipts
Receipts from debtors
Sales of capital items
Loans received
Proceeds from share issues
Any other cash receipts
Cash payments
Payments to creditors
Wages and salaries
Loan repayments
Capital expenditure
Taxation
Dividends
Any other cash expenditure
Receipts less payments
Opening cash balance b/f W X Y
Closing cash balance c/f X Y Z
ii) Step 2: sort out cash receipts from debtors
iii) Step 3: other income
iv) Step 4: sort out cash payments to suppliers
v) Step 5: establish other cash payments in the month
Figure 4.1 shows the composition of a master budget analysis.
Figure 4.1 Composition of a master budget
OPERATING BUDGET FINANCIAL BUDGET
consists of:- consists of
Budget P/L acc: get: Cash budget
Production budget Balance sheet
Materials budget Funds statement
Labour budget
Admin. budget
Stocks budget
f) Other budgets:
These include budgets for:
• administration
• research and development
• selling and distribution expenses
• capital expenditures
• working capital (debtors and creditors).
The master budget (figure 4.1) illustrates this. Now attempt exercise 4.1.
Exercise 4.1 Budgeting I
Draw up a cash budget for D. Sithole showing the balance at the end of each month, from the following information provided by her for the six months ended 31 December 19X2.
a) Opening Cash $ 1,200.
19X2 19X3
Sales at $20 per unit MAR APR MAY JUN JUL AUG SEP OCT NOV DEC JAN FEB
260 200 320 290 400 300 350 400 390 400 260 250
Cash is received for sales after 3 months following the sales.
c) Production in units: 240 270 300 320 350 370 380 340 310 260 250
d) Raw materials cost $5/unit. Of this 80% is paid in the month of production and 20% after production.
e) Direct labour costs of $8/unit are payable in the month of production.
f) Variable expenses are $2/unit. Of this 50% is paid in the same month as production and 50% in the month following production.
g) Fixed expenses are $400/month payable each month.
h) Machinery costing $2,000 to be paid for in October 19X2.
i) Will receive a legacy of $ 2,500 in December 19X2.
j) Drawings to be $300/month.
An example
A sugar cane farm in the Lowveld district may devise an operating budget as follows:
• Cultivation
• Irrigation
• Field maintenance
• Harvesting
• Transportation.
With each operation, there will be costs for labour, materials and machinery usage. Therefore, for e.g. harvesting, these may include four resources, namely:
• Labour:
-cutting
-sundry
• Tractors
• Cane trailers
• Implements and sundries.
Having identified cost centres, the next step will be to make a quantitative calculation of the resources to be used, and to further break this down to shorter periods, say, one month or three months. The length of period chosen is important in that the shorter it is, the greater the control that can be exercised by the budget but the greater the expense in preparation of the budget and reporting of any variances.
The quantitative budget for harvesting may be calculated as shown in figure 4.2.
Figure 4.2 Quantitative harvesting budget
Harvesting 1st quarter 2nd quarter 3rd quarter 4th quarter
Labour
Cutting nil 9,000 tonnes 16,000 tonnes 10,000 tonnes
Sundry nil 300 man days 450 man days 450 man days
Tractors nil 630 hours 1,100 hours 700 hours
Cane trailers nil 9,000 tonnes 16,000 tonnes 10,000 tonnes
Imp, & sundries nil 9,000 tonnes 16,000 tonnes 10,000 tonnes
Each item is measured in different quantitative units - tonnes of cane, man days etc.-and depends on individual judgement of which is the best unit to use.
Once the budget in quantitative terms has been prepared, unit costs can then be allocated to the individual items to arrive at a budget for harvesting in financial terms as shown in table 4.2.
Charge out costs
In table 4.2 tractors have a unit cost of $7.50 per hour - machines like tractors have a whole range of costs like fuel and oil, repairs and maintenance, driver, licence, road tax and insurance and depreciation. Some of the costs are fixed, e.g. depreciation and insurance, whereas some vary directly with use of the tractor, e.g. fuel and oil. Other costs such as repairs are unpredictable and may be very high or low - an estimated figure based on past experience.
Figure 4.3 Harvesting cost budget
Item harvesting Unit cost 1st quarter 2nd quarter 3rd quarter 4th quarter Total
Labour
Cutting $0.75 per tonne - 6,750 12,000 7,500 26,250
Sundry $2.50 per day - 750 1,125 1,125 3,000
Tractors $7.50 per hour - 4,725 8,250 5,250 18,225
Cane Trailers $0.15 per tonne - 1,350 2,400 1,500 5,250
Imp. & sundries $0.25 per tonne - 2,250 4,000 2,500 8,750
- $15,825 $27,775 $17,875 $61,475
So, overall operating cost of the tractor for the year may be budgeted as shown in figure 4.4.
If the tractor is used for more than 1,000 hours then there will be an over-recovery on its operational costs and if used for less than 1,000 hours there will be under-recovery, i.e. in the first instance making an internal 'profit' and in the second a 'loss'.
Figure 4.4 Tractor costs
Unit rate Cost per annum (1,000 hours)
($) ($)
Fixed costs Depreciation 2,000.00 2,000.00
Licence and insurance 200.00 200.00
Driver 100.00 per month 1,200.00
Repairs 600.00 per annum 600.00
Variable costs Fuel and oil 2.00 per hour 2,000.00
Maintenance 3.00 per 200 hours 1,500.00
7,500.00
No. of hours used 1,000.00
Cost per hour 7.50
Master budget
The master budget for the sugar cane farm may be as shown in figure 4.5. The budget represents an overall objective for the farm for the whole year ahead, expressed in financial terms.
Table 4.5 Operating budget for sugar cane farm 19X4
1st quarter 2nd quarter 3rd quarter 4th quarter Total $
Revenue from cane 130,000 250,000 120,000 500,000
Less: Costs
Cultivation 37,261 48,268 42,368 55,416 183,313
Irrigation 7,278 15,297 18,473 11,329 52,377
Field maintenance 4,826 12,923 15,991 7,262 41,002
Harvesting - 15,825 27,775 17,875 61,475
Transportation - 14,100 24,750 15,750 54,600
49,365 106,413 129,357 107,632 392,767
Add: Opening valuation 85,800 135,165 112,240 94,260 85,800
135,165 241,578 241,597 201,892 478,567
Less: Closing valuation 135,165 112,240 94,260 90,290 90,290
Net crop cost - 129,338 147,337 111,602 388,277
Gross surplus - 66,200 102,663 8,398 111,723
Less: Overheads 5,876 7,361 7,486 5,321 26,044
Net profitless) (5,876) (6,699) 95,177 3,077 85,679
Once the operating budget has been prepared, two further budgets can be done, namely:
i. Balance sheet at the end of the year.
ii. Cash flow budget which shows the amount of cash necessary to support the operating budget. It is of great importance that the business has sufficient funds to support the planned operational budget.
Reporting back
During the year the management accountant will prepare statements, as quickly as possible after each operating period, in our example, each quarter, setting out the actual operating costs against the budgeted costs. This statement will calculate the difference between the 'budgeted' and the 'actual' cost, which is called the 'variance'.
There are many ways in which management accounts can be prepared. To continue with our example of harvesting on the sugar cane farm, management accounts at the end of the third quarter can be presented as shown in figure 4.6.
Figure 4.6 Management accounts - actual costs against budget costs Management accounts for sugar cane farm 3rd quarter 19X4

Item Harvesting 3rd quarter Year to date
Actual Budget Variance Actual Budget Variance
Labour
- Cutting 12,200 12,000 (200) 19,060 18,750 (310)
- Sundry 742 1,125 383 1,584 1,875 291
Tractors 9,375 8,250 (1,125) 13,500 12,975 (525)
Cane trailers 1,678 2,400 722 2,505 3,750 1,245
Imp & sundries 4,270 4,000 (270) 6,513 6,250 (263)
28,265 27,775 (490) 43,162 43,600 438
Here, actual harvesting costs for the 3rd quarter are $28,265 against a budget of $27,775 indicating an increase of $490 whilst the cumulative figure for the year to date shows an overall saving of $438. It appears that actual costs are less than budgeted costs, so the harvesting operations are proceeding within the budget set and satisfactory. However, a further look may reveal that this may not be the case. The budget was based on a cane tonnage cut of 16,000 tonnes in the 3rd quarter and a cumulative tonnage of 25,000. If these tonnages have been achieved then the statement will be satisfactory. If the actual production was much higher than budgeted then these costs represent a very considerable saving, even though only a marginal saving is shown by the variance. Similarly, if the actual tonnage was significantly less than budgeted, then what is indicated as a marginal saving in the variance may, in fact, be a considerable overspending.
Price and quantity variances
Just to state that there is a variance on a particular item of expenditure does not really mean a lot. Most costs are composed of two elements - the quantity used and the price per unit. A variance between the actual cost of an item and its budgeted cost may be due to one or both of these factors. Apparent similarity between budgeted and actual costs may hide significant compensating variances between price and usage.
For example, say it is budgeted to take 300 man days at $3.00 per man day - giving a total budgeted cost of $900.00. The actual cost on completion was $875.00, showing a saving of $25.00. Further investigations may reveal that the job took 250 man days at a daily rate of $3.50 - a favourable usage variance but a very unfavourable price variance. Management may therefore need to investigate some significant variances revealed by further analysis, which a comparison of the total costs would not have revealed. Price and usage variances for major items of expense are discussed below.
Labour
The difference between actual labour costs and budgeted or standard labour costs is known as direct wages variance. This variance may arise due to a difference in the amount of labour used or the price per unit of labour, i.e. the wage rate. The direct wages variance can be split into:
i) Wage rate variance: the wage rate was higher or lower than budgeted, e.g. using more unskilled labour, or working overtime at a higher rate.
ii) Labour efficiency variance: arises when the actual time spent on a particular job is higher or lower than the standard labour hours specified, e.g. breakdown of a machine.
Materials
The variance for materials cost could also be split into price and usage elements:
i) Material price variance: arises when the actual unit price is greater or lower than budgeted. Could be due to inflation, discounts, alternative suppliers etc.
ii) Material quantity variance: arises when the actual amount of material used is greater or lower than the amount specified in the budget, e.g. a budgeted fertiliser at 350 kg per hectare may be increased or decreased when the actual fertiliser is applied, giving rise to a usage variance.
Overheads
Again, overhead variance can be split into:
i) Overhead volume variance: where overheads are taken into the cost centres, a production higher or lower than budgeted will cause an over-or under-absorption of overheads.
ii) Overhead expenditure variance: where the actual overhead expenditure is higher or lower than that budgeted for the level of output actually produced.
Calculation of price and usage variances
The price and usage variance are calculated as follows:
Price variance = (budgeted price - actual price) X actual quantity
Usage variance = (budgeted quantity - actual quantity) X budgeted price
Now attempt exercise 4.2.
Exercise 4.2 Computation of labour variances
It was budgeted that it would take 200 man days at $10.00 per day to complete the task costing $2,000.00 when the actual cost was $1,875.00, being 150 man days at $12.50 per day. Calculate:
i) Price variance
ii) Usage variance
Comment briefly on the results of your calculation.
Management action and cost control
Producing information in management accounting form is expensive in terms of the time and effort involved. It will be very wasteful if the information once produced is not put into effective use.
There are five parts to an effective cost control system. These are:
a) preparation of budgets
b) communicating and agreeing budgets with all concerned
c) having an accounting system that will record all actual costs
d) preparing statements that will compare actual costs with budgets, showing any variances and disclosing the reasons for them, and
e) taking any appropriate action based on the analysis of the variances in d) above.
Action(s) that can be taken when a significant variance has been revealed will depend on the nature of the variance itself. Some variances can be identified to a specific department and it is within that department's control to take corrective action. Other variances might prove to be much more difficult, and sometimes impossible, to control.
Variances revealed are historic. They show what happened last month or last quarter and no amount of analysis and discussion can alter that. However, they can be used to influence managerial action in future periods.
Zero base budgeting (ZBB)
After a budgeting system has been in operation for some time, there is a tendency for next year's budget to be justified by reference to the actual levels being achieved at present. In fact this is part of the financial analysis discussed so far, but the proper analysis process takes into account all the changes which should affect the future activities of the company. Even using such an analytical base, some businesses find that historical comparisons, and particularly the current level of constraints on resources, can inhibit really innovative changes in budgets. This can cause a severe handicap for the business because the budget should be the first year of the long range plan. Thus, if changes are not started in the budget period, it will be difficult for the business to make the progress necessary to achieve longer term objectives.
One way of breaking out of this cyclical budgeting problem is to go back to basics and develop the budget from an assumption of no existing resources (that is, a zero base). This means all resources will have to be justified and the chosen way of achieving any specified objectives will have to be compared with the alternatives. For example, in the sales area, the current existing field sales force will be ignored, and the optimum way of achieving the sales objectives in that particular market for the particular goods or services should be developed. This might not include any field sales force, or a different-sized team, and the company then has to plan how to implement this new strategy.
The obvious problem of this zero-base budgeting process is the massive amount of managerial time needed to carry out the exercise. Hence, some companies carry out the full process every five years, but in that year the business can almost grind to a halt. Thus, an alternative way is to look in depth at one area of the business each year on a rolling basis, so that each sector does a zero base budget every five years or so.
Key terms
Budgeting
Budgetary control
Budget preparation
Management action and cost control
Master budget
Price and quantity variance
Responsibility centres
Zero based budgeting