S6: Management Accounting

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• UNIT 1:FORECAST INCOME AND EXPENDITURE

  Key unit competence: To be able to forecast an income and expenditure for an accounting period.

  

  

  Accounting Management | Student Book | Senior Six

  
  

  1.1.2.Definition of concepts
  • Forecasting 
  It refers to the practice of predicting what will happen in the future by taking into 
  consideration events in the past and present. Basically, it is a decision-making 
  tool that helps businesses cope with the impact of the future’s uncertainty by 
  examining historical data and trends. It is a planning tool that enables businesses 
  to chart their next moves and create budgets that will hopefully cover whatever 
  uncertainties may occur.
  • Financial forecasting
  It is predicting a company’s financial future by examining historical performance 
  data, such as revenue, cash flow, expenses, or sales. This involves guesswork and 
  assumptions, as many unforeseen factors can influence business performance. 
  Common types of forecasts include cash flow forecast, projected profit and 
  loss and balance sheet forecast.
  • Difference between Budgeting and Forecasting
  Budgeting and forecasting are both tools that help businesses plan for their 
  

  future. However, the two are distinctly different in many ways:

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  • Budgeting

  It involves creating financial statements for a specific period, such as projected 
  revenue, expenses, cash flow and investments. It is usually conducted with input 
  from many different departments in order to come up with a holistic and detailed 
  report. Therefore, the budgeting process takes time to complete. The company 
  uses the budget to guide it in its financial activities. In other words, a budget is 
  a plan for a company’s future.
  While budget are usually made for an entire year, forecasts are usually updated 
  monthly or quarterly. Through forecasting, a company can project where it’s 
  going, and it may adjust its budget and allocate more or less funds to an activity, 
  depending on the forecast. In summary, budgets depend on the forecast.
  Forecasting is a common statistical task in business, where it helps to inform 
  decisions about the scheduling of production, transportation and personnel, 
  and provides a guide to long-term strategic planning. However, business 
  forecasting is often done poorly, and is frequently confused with planning and 
  goals. They are three different things.
  • Forecasting
  It is about predicting the future as accurately as possible, given all of available 
  the information , including historical data and knowledge of any future events 
  that might impact the forecasts.
  Goals are what business would like to have happen. Goals should be linked to 
  forecasts and plans, but this does not always occur. Too often, goals are set 
  without any plan for how to achieve them, and no forecasts for whether they are 
  realistic.
  Planning is a response to forecasts and goals. Planning involves determining 
  the appropriate actions that are required to make your forecasts match your 
  goals.
  Forecasting should be an integral part of the decision-making activities of 
  management, as it can play an important role in many areas of a company. 
  Modern organizations require short-term, medium-term and long-term forecasts, 
  depending on the specific application.
  1.1.2. Source of information in forecasting
  The data used for forecasting methods can either come from primary sources 
  or secondary sources. Primary sources provide first-hand information, collected 
  directly by the person or organization that is doing the forecasting, Secondary 
  sources provide information that has already been gathered and processed by 
  

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  a third-party organization.
  Collection of data is a first step in any statistical investigation. It is the basis 
  for any analysis and interpretations. Before collection of data, planner needs 
  to know the source in which you can get information. Below is key source of 
  information in forecasting 
  
  a) Market or industry data: Market or industry is Secondary source 
  supplying information that has been collected and published by other 
  entities. Examples of this type of information might be industry reports, 
  growth rate of economy, inflation, interest rate, tax incentives, etc. These 
  data are useful for predicting future. As this information has already been 
  compiled and analyzed, it makes the process quicker.
  
  b) Competitors: A competitor is a person, business, team, or organization 
  that competes against you or your company. If somebody is trying to 
  beat you in a race, that person is your competitor. Information like sales 
  quantity, competitor’s price, market share, financial performance and 
  position will help business to predict future
  
  c) Key customers: A customer is a person or business that buys goods 
  or services from another business. Customers are crucial because they 
  generate revenue. Without them, businesses would cease to operate. 
  Any decision and forecast that business need to make it is necessary to 
  first look at customer’s capacity to pay, quality needed, volume needed. 
  For example, in forecasting sales volume you need to know how much 
  customer is willing and able to buy.
  
  d) Suppliers: A supplier is a person, company, or organization that sells or 
  supplies something such as goods or equipment to you. In forecasting 
  any company needs to gather information from suppliers to know how 
  many resources you are going to receive, the willingness of suppliers to 
  continue to serve you and financial capabilities of supplier to continue to 
  serve in future.
  e) Procurement department: Also called the purchasing or sourcing 
  department, the procurement department is where the procurement 
  process starts and finishes. This is the place where the procurement 
  manager discusses the time for procurement process, list of goods, list of 
  suppliers, products price levels and tender awarded should go with the 
  other team members. This is also where each member of the procurement 
  team does its respective assignments. That is why it is very important for 
  the company to do forecast after consulting procurement department. 
  
  f) Humana resource department: Human resources (HR) department is 
  the division of a business that is charged with finding, screening, recruiting, 
  and training job applicants. It also administers employee-benefit programs. 
  

  Human resource department is key source of information for forecasting 

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  the labor cost and the availability of human contribution. Leaves, needed 
  skills labor, capacity building cost, tasks and responsibilities, salaries and 
  wages, fringe benefits, labor turnover, labor contracts.... )
  g) Financial goal and objectives: Financial objectives are the goals or 
  targets related to the financial performance of a business. There are six 
  types of financial objectives: revenue objectives, cost objectives, profit 
  objectives, cash flow objectives, investment objectives and capital 
  structure objectives. Those objectives offer information to budgeting 
  

  department to be based on in forecasting future.

  Application activity 1.1
  

  1. Define the following concepts:
  A. Forecasting. 
  B. Budgeting
  C. Financial Forecasting
  2. Manager of XYZ Ltd has planned to forecast future sales but he 
  is unsure on where he can get reliable information to be based on 
  while making prediction. Advise him five key sources of information 
  

  for forecasting.

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  1.1.Forecasting Methods for income and expenditure 
  

  Learning Activity 1.2
  

  
  

  i) What are two variables shown on above image?
  

  ii) What come to your mind once you see image above?

  There are two primary categories of forecasting: quantitative and qualitative.
  

  N = Total number of periods

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  A.Quantitative Methods
  When producing accurate forecasts, business leaders typically turn to 
  quantitative forecasts, or assumptions about the future based on historical data.
  1.1.1.Straight Line
  The straight-line method assumes a company’s historical growth rate will 
  remain constant. Forecasting future revenue involves multiplying a company’s 
  previous year’s revenue by its growth rate. Although straight-line forecasting is 
  an excellent starting point, it doesn’t account for market fluctuations or supply 
  chain issues.
  For arriving to the forecasted future revenue or cost the following step will be 
  followed: 
  1. The first step in straight-line forecasting is to determine the sales/cost 
  growth rate that will be used to calculate future revenues.
  2. To forecast future revenues, take the previous year’s figure and multiply 
  it by the growth rate.
  For example, Total income of Akeza Ltd for year ended 31 December 2021 and 
  2022 is Frw 24,000,000 and Frw 30,000,000 respectively. Compute growth 
  rate and forecast revenue for the year ended 2023if the calculated will continue 
  

  to grow by same growth.

                                          Solution: 

  

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  future. This method involves more closely examining a business’s high or low 
  demands, so it’s often beneficial for short-term forecasting. For example, you 
  can use it to forecast next month’s sales by averaging the previous quarter. 
  Moving average forecasting can help estimate several metrics. While it’s most 
  commonly applied to future stock prices, it’s also used to estimate future 
  revenue.
  To calculate a moving average, use the following formula:
  A1 + A2 + A3 … / N
  Formula breakdown:
  A = Average for a period
  N = Total number of periods
  1.1.3.Time series
  This is a sequence of variable values like sales or production that change over a 
  uniform set of time. The variable values represent statistical data while time can 
  be in seconds, hours, days, weeks, etc. 
  Time series analysis is a specific way of analyzing a sequence of data points 
  collected over an interval of time. In time series analysis, analysts record data 
  points at consistent intervals over a set period of time rather than just recording 
  the data points intermittently or randomly.
  All-time series contain at least one of the following four components: 
  1. Secular trend: The general underlying tendency of the time series data 
  to increase, decrease or remain constant for a long period of time.
  2. Seasonal variations: Are periodic movements of the data where the 
  duration is less than a year. The factors that mainly cause these variations 
  are: 
  a) Climatic changes 
  b) The customs and habits that people follow at different times
  3. Cyclical variations: Are periodic movements within the time series 
  data where the duration is more than a year. They are not as regular as 
  the seasonal variations but their sequence of change is the same. The 
  causes of the cyclical variations are the four phases of an economic cycle 
  which include: the boom/peak, decline/downturn, depression/trough and 
  recovery/upswing.
  

  4. Random/ irregular erratic variations: These are completely 

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  unpredictable variations within the data caused by unpredictable events 
  like sickness, machine breakdown, weather conditions, strikes etc. They 
  are non-recurring influences which cannot be mathematically captured 
  yet they have profound consequences on a time series.
  

  The equation for trend is:

  Y = a+ bx
  Formula breakdown:
  Y= Dependent variable (the forecasted number)
  b = line’s slope
  

  x = Independent variable (time numbered from 0 upwards)

   

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  1.1.4.Simple Linear Regression/least squares method

  Linear regression analysis (the least squares method) is one technique for 
  estimating a line of best fit. Once an equation for a line of best fit has been 
  determined, forecasts can be made. Simple linear regression forecasts metrics 
  based on a relationship between two variables: dependent and independent. The 
  dependent variable represents the forecasted amount, while the independent 
  variable is the factor that influences the dependent variable.
  

  The equation for simple linear regression is:

  Y = a+ bx
  Formula breakdown:
  Y = Dependent variable (the forecasted number)
  b = Regression line’s slope
  x = Independent variable
  a= Y-intercept
  
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  Qualitative forecasting relies on experts’ knowledge and experience to predict 
  performance rather than historical numerical data.
  These forecasting methods are often called into question, as they’re more 
  subjective than quantitative methods. Yet, they can provide valuable insight into 
  forecasts and account for factors that can’t be predicted using historical data.
  1.1.5.Market Research
  Market research is essential for organizational planning. It helps business leaders 
  obtain a holistic market view based on competition, fluctuating conditions, 
  and consumer patterns. It’s also critical for start-ups when historical data isn’t 
  available. New businesses can benefit from financial forecasting because it’s 
  essential for recruiting investors and budgeting during the first few months of 
  operation.
  When conducting market research, begin with a hypothesis and determine 
  what methods are needed. Sending out consumer surveys is an excellent way 
  to better understand consumer behavior when you don’t have numerical data to 
  inform decisions.
  1.1.6. Delphi Method
  This method incorporates both judgmental and subjective factors. It is an 
  iterative process that allows experts to make an objective forecast. There are 3 
  groups of participants involved namely: 
  1. Decision makers: group usually consists of 5 - 10 experts who will be 
  making the actual forecast. 
  2. Staff personnel: assist the decision makers by preparing, distributing, 
  collecting and summarizing a series of questionnaires and survey results.
  3. Respondents: The respondents are a group of people whose views 
  and judgments are valued and are being sought. This group provides 
  input to the decision makers before the forecast is made. In this method, 
  it is crucial to select participants from different functional fields due to the 
  following reasons: 
  – To get diverse opinions 
  – To have diversity of ideas and experience 
  – To reduce prediction error 
  

  – To improve on quality of final results

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  1.2. Forecasting Models for income and expenditure

  Application activity 1.2

  Alex Mugabo is Budget manager of MG factory a company based in Kigali to 
  produce and sales furniture to household. The following table shows the actual 
  

  units sold from 2010 to 2016 by MG factory

  

  Required 
  d) Take a moving average of the annual sales over a period of three 
  years 
  

  e) Based on calculated moving value in a) Advice Alex on future sales 

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  vi. Based on knowledge acquired from previous methods of forecasting 
  what is method identified in the image above?
  

  vii.What the participants in this image trying to do?

  Forecasting models are one of the many tools’ businesses use to predict 
  outcomes regarding sales, supply and demand, consumer behavior and more. 
  These models are especially beneficial in the field of sales and marketing. There 
  are several forecasting methods businesses use that provide varying degrees 
  of information. From the simple to the complex, the appeal of using forecasting 
  models comes from having a visual reference of expected outcomes.
  There are numerous ways to forecast business outcomes; there are four main 
  types of models that companies use to predict revenue and expenditure in the 
  future.
  1.2.1. Time Series Model
  This type of model uses historical data as the key to reliable forecasting. You’ll 
  be able to visualize patterns of data better when you know how the variables 
  interact in terms of hours, weeks, months or years. Time series has four main 
  components which are trend, seasonal variations, cyclical variations and random 
  variations.
  1.2.2. Econometric Forecasting Model 
  

  Econometric forecasting models are systems of relationships between variables

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  such as GNP, inflation, exchange rates etc. Their equations are then estimated 
  from available data, mainly aggregate time series. Econometric models attempt to 
  quantify the relationship between the parameter of interest (dependent variable) 
  and a number of factors (explanatory variables) that affect the dependent 
  variable. A simple example of an econometric model is one that assumes that 
  monthly spending by consumers is linearly dependent on consumers’ income in 
  the previous month.
  1.2.3. Judgmental forecasting Model
  Various forecasting models of the judgmental kind utilize subjective and intuitive 
  information to make predictions. For instance, there are times when there is no 
  data available for reference. Launching a new product or facing unpredictable 
  market conditions also creates situations in which judgmental forecasting 
  models prove beneficial.
  Product life cycle and market knowledge: Management should know that, 
  most products have a limited product life cycle which will show different sales 
  and profitability patterns at different stages of the life cycle. 
  In time series method, analysis makes the assumption that the sales figures 
  will continue to change in line with the trend. Such statistical projections are 
  helpful in forecasts but a manager should not ignore knowledge of the market 
  or product itself.
  The trend will not continue unchanged in practice as most products have a 
  limited product life cycle which will show different sales and profitability patterns 
  at different stages of the life cycle.
  The product life cycle is generally thought to split naturally into five separate 
  stages: Development, Launch, Growth, Maturity and Decline.
  So, a business has to consider not only its products’ sales trends but also 
  the stage of the life cycle of each product and the state of the market for that 
  product.
  However, the analysis could go even further, into the general state of the 
  environment in which the business operates. This can often be efficiently done 
  by carrying out a PEST analysis. This examines the following factors: Political, 
  

  Economic, Social, And Technological.

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  1.2.4. Delphi Model

  This method is commonly used to forecast trends based on the information 
  given by a panel of experts. It assumes that a group’s answers are more useful 
  and unbiased than answers provided by one individual. The total number of 
  rounds involved may differ depending on the goal of the company or group’s 
  researchers. 
  These experts answer a series of questions in continuous rounds that ultimately 
  lead to the “correct answer” a company is looking for. The quality of information 
  improves with each round as the experts revise their previous assumptions
   following additional insight from other members in the panel.
  Application activity 1.3
  Most products have a limited product life cycle which will show different 
  sales and profitability patterns at different stages of the life cycle.
  Required :
  

  List and explain four cycles of products

  
  

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  1.3. The Process /Step of Forecasting

  Management of institutions/ company needs to follow carefully the process in 
  order to get accurate results. Below is the process for forecasting 
  1.3.1. Determine what the forecast is for
  The first step in the process is to determine what kind of forecast you need to 
  make. Remember that forecasts are made in order to plan for the future. To do 
  so, we have to decide what forecasts are actually needed. This is not as simple 
  as it sounds. For example, do we need to forecast sales or demand? These 
  are two different things, and sales do not necessarily equal the total amount of 
  demand for the product. Both pieces of information are usually valuable.
  1.3.2. Select the items for the forecast. 
  This step involves identifying what data are needed and what data are available. 
  This will have a big impact on the selection of a forecasting model. For example, 
  if you are predicting sales for a new product, you may not have historical sales 
  information, which would limit your use of forecasting models that require 
  quantitative data.
  1.3.3. Select the time horizon. 
  A time horizon is a fixed point of time in the future at which point certain 
  processes will be evaluated or assumed to end. Forecasts in Business are 
  classified according to period, time and use. There are long term forecasts and 
  short-term forecasts. Operation managers need long range forecast for making 
  strategic decisions related to products, processes and facilities. They also need 
  short term forecasts to assist them in making decisions about production issues 
  that span, only few weeks. Forecasting forms an integral part of planning that 
  

  why production managers must be aware about the horizon of forecasts.

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  1.3.4. Select the forecast model, type and method. 

  Based on what you want to forecast for, you should select appropriate model 
  and type that will give you reliable results, there are number of factors that 
  will influence you in choosing right forecasting model, amount and types of 
  available data, degree of accuracy required, forecast time horizon and kind 
  of data. Appropriate method of sales forecasting is selected by the company 
  taking into account all the relevant information, purpose of forecasting and the 
  degree of accuracy required.
  1.3.5. Gather data to be input into the model
  There are generally two kinds of information available for forecasting: statistical 
  data which is generally historic numerical data and the accumulated judgment and 
  expertise of key personnel. Also, other relevant data such as the time and length 
  of any significant production downtime due to equipment failure or industrial 
  disputes may prove useful and therefore may also be collected in gathering 
  data they will consider primary source of information (information collected 
  from internals) and secondary source of information (information collected from 
  externals) all that information will give required data in forecasting.
  1.3.6. Make the forecast.
  Perform initial analysis of the data to see if it is usable. Check trends and patterns 
  shown in the data to see if they are helpful. Cut out any unwanted data. Using 
  your chosen model, run the data, analyze it, and make the forecast.
  1.3.7. Verify and Implement the results
  Every step is checked, refinements and modifications are made at the end you 
  will get outcomes from the forecasting model and plan accordingly. Forecasting 
  isn’t a measure just to get the business up and running. Successful companies 
  use their market forecast to calculate their progress and use it as a management 
  

  tool to run the business better. 

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  Application activity 1.4

  The General Manager of AOB Limited is planning to launch a new product 
  Urwiwacu which is new product to Rwanda market and the rest of east Africa 
  but is unsure on profitability of Urwiwacu. CEO convening meeting with 
  chief operation Manager, Sales Manager and budget manager to discuss 
  the feasibility of the proposal to launch Urwiwacu. The following concerns 
  were raised by the participants: the budget manager has concern of timing 
  the launch of Urwiwacu due to the lack of sufficient information related to 
  the cost, revenue and profitability. He has concern over the method that 
  AOB can use to estimate the profit expected from Urwiwacu. The Chief 
  Operation Manager tells the meeting that the raw materials needed for 
  production will be available at a high cost and this is due to the lack of local 
  supplier. The sales manager says that the department has been trying to 
  collect data related to Urwiwacu and tells the participants that the product 
  is needed on market and customer will be happy to buy product but he was 
  not sure of price to be charged in order to cover cost and remain with profit. 
  General manager requests all participants to take one month and come up 
  with forecasted revenue and cost from Urwiwacu product.
  Required: You have completed senior six and you are hired by AOB ltd in 
  department of budgeting. Referring to the case above Apply first 4 steps of 
  

  forecasting

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  1.4. Challenges to forecasting
  

  Learning Activity 1.5
  

  
  

  a) What do you think about the problems this man would have after 
  

  looking above photo?

  Every large businesses or medium perform financial forecasting for various 
  reasons such as projecting future sales, understanding working capital needs, 
  launching new product and more. With accurate financial forecasting, businesses 
  can easily achieve both their short-term and long-term goal but forecasting has 
  its challenge:
  a) Forecasting Time Period
  Shorter the period more is the accurate financial forecasting. Longer the period 
  less is the accurate and difficult financial forecasting. Mostly, less difficulty 
  comes for a short span and more difficulty comes for a long span. In simple 
  words, we say the shorter forecasting period will always be more accurate as 
  compared to the larger prediction time.
  b) Data Collections
   Collecting and gathering all the business finance data to proceed further can 
  never be easy. This task can take a week to weeks to gather all the information 
  to build the cash flow projection and revenue forecast. Collecting these data for 
  forecasting is one of the huge financial forecasting problems.
  c) Problems with the Input data
  Forecasts using linear analysis can be common, but this type of forecasting 
  fails to account for the uncertainty in the future. In statistics, the assumption 
  

  of linearity is necessary when certain assumptions are made about the future. 

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  However, there is no assurance that a relationship between two variables 
  will continue in the future. Many factors come into play when you’re making 
  a forecast, especially when it’s on an important matter. Human error which is 
  common can mean the difference in wrong predictions.
  d) Unforeseeable Events
  Another financial forecasting problem is unforeseeable. In spite of the businesses 
  achieve the quantitative and qualitative forecasting techniques to make their 
  prediction accurate, unforeseeable can never be achieved. These components 
  can vary inherently, and reach the risks of forecasting. For example, let us take 
  an example of supermarket that opens the store with the pillar financial growth. 
  It leads to affecting the other supermarket in the particular area. It can never be 
  forecasted.
  e) Accuracy of past data
  Financial forecasting is performed based on past business data to predict the 
  future. Take an instant that your business average growth as 10% as a stable 
  one for the past 4 years, you could predict your business finance for the next 4 
  years as 10%. While you use this kind of system wider, then you are on the way 
  to financial forecasting problems. 
   If a company has variable results year over year, using the previous period data 
  is worthless. Additionally, the financial data will not be available for the startups, 
  as they should go by approximate estimation without any accurate idea.
  Note, Apart from the above-mentioned challenges there are many other 
  challenges such as Social changes, Technological advances, Environmental 
  changes, Political and economic changes, No easy way to capture forecast 
  assumptions of all managers, Lack of tools to analyze historical trends, etc.
  Application activity 1.5
  You are employed by ABZ company as sales officer. Budget department 
  sent to you target sales value for first quarter but you are not sure if you will 
  achieve target.
  You know that forecasts are subject to error, but the likely errors vary from 
  case to case due to:
  a) The further into the future the forecast is for; the more unreliable it is 
  likely to be. 
  

  b) The less data available on which to base the forecast, the less reliable 
  the forecast.
  c) The pattern of trend and seasonal variations cannot be guaranteed to 
  continue in the future. 
  d) There is always the danger of random variations upsetting the patterns.
  

  Required: Explain 3 main challenges of forecasting.

  Skills Lab 1

  The students visit one of the nearest manufacturing industries. Let us take 
  MUTEXRWA Industry as our case study.
  Let us approach production departmental manager and share us the 
  methods used in forecasting their production volume and the challenges 
  they face with. We have selected one kind of products they produce 
  which is Uniforms clothes for secondary schools. The Sales departmental 
  manager is about sharing how forecasting is most useful in their prediction 
  of production sales level. “We collect forecasting information from Ministry 
  of education to know school calendar year and new schools are about 
  opening.
  We mostly use time series method based on the calendar year set by 
  Ministry of Education as it is the key determinant of our uniform clothes 
  demand, this where the method of time series comes as the time series has 
  a component called seasonal variation, 
  For previous academic terms we have much data recorded in our financial 
  statements and their trend analysis report is there, we base on the above 
  historical trends data and we use time series mathematical calculations to 
  predict the production demand for the future.
  Let Sales production manager also tells us about the challenges 
  MUTEXRWA faces in forecasting, 
  “There are less data available to be based on, this lead less reliability on 
  forecast because in our sector the demand of uniform clothes is limited, 
  the many customers demand diversity design of clothes, We also meet 
  with challenges of Technology changes, here I want to mean that the past 
  is not a reliable indication of likely future events. For example, the availability 
  of faster machinery may make it difficult to use current output levels as the 
  basis for forecasting future production output, there many other factors out 
  of our control such Economical and political factors
  
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  Also as in forecasting uncertainty future events there are many assumptions 
  used, this become challenge to our company because each manager has 
  his/ her own assumption. Apart from the above challenges, I would like to 
  conclude by saying that forecasting is the useful tool in company as it is 
  used to predict company future operations” Said by MUTEXRWA Sales 
  departmental manager.
  Before leaving this industry, let us also have a short interview with 
  MUTEXRWA Production departmental Manager. Let us ask him whether 
  forecasting is the recommendable basing on its result to their industry. 
  “Yes, forecasting is highly recommendable to all companies as it helps of 
  predicting what will happen in the future by taking into consideration events 
  in the past and present and this enables businesses to predict their next 
  moves and create budgets that will hopefully cover whatever uncertainties 
  

  may occur” said by Production departmental manager.

  End of unit assessment 1

  Question 1
  Time series is method for forecasting where independent variable is time. 
  What do you understand by time series? Give examples of time series.
  Question2
  If manager wants to forecast; he will need to collect information to be based 
  on, those collected information are either primary source or Secondary 
  source.
  Advise him 5 sources of forecasting information and specify whether that 
  source is primary or secondary.
  Question 3
  The data below shows the monthly sales (Frw million) made by Mukungwa 
  ltd. for the year 2020. 
  

  Month

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  Required 
  c) Calculate the moving average of order 3
  Question 4
  Methods for forecasting are classified into Quantitative and Qualitative. 
  Explain 2 qualitative methods. 
  Question5
  Most of time forecast and actual results differ significantly. Elaborate clearly 
  3challenges of forecasting.
  Question 6
  In forecasting steps there is time horizon, Explain three forecasting time 
  

  horizons in forecasting

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  
  

  
  

• unit 2:BUDGET AND BUDGETARY CONTROL

  Key unit competence: To be able to maintain budget and budgetary control within organization.

  Introductory activity:

  

  Questions:
  1. Identify the different books brought by every participant in meeting 
  as seen on the above picture.
  2. Suggest the main motif of the above meeting.
  3. Enumerate the two responsibilities of chief Budget Committee in 
  budgeting process. 
  4. Suggest the above meeting is held in manufacturing business; 
  enumerate the list of participants according to their function in 
  budgeting process.
  5. One of the purposes of the above meeting is to increase the 
  production of business. What is approach the participants should 
  

  adopt to achieve the organizational objective?

  Accounting Management | Student Book | Senior Six

  2.1. Budget
  

  Learning Activity 2.1
  

  
  

  Questions 

  6. Outline the main stages of budgeting
  Learning Activity 2.1
  2.1.1. Definition of concepts
  Budget: is a financial and quantitative statement, prepared and approved prior 
  to a defined period of time, of the policy to be pursued during that period for the 
  purpose of attaining a given objective.
  Budget is also defined as a quantified plan in monetary terms, prepared and 
  approved prior to a defined period of time, usually showing planned income to 
  be generated and expenditure to be incurred during that period. It shows the 
  

  projections or future estimates of output, costs and revenues.

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  This implies that the budget is a plan of management intentions to attain the 
  specified objectives. 
  a) Budgets: is an estimate of income and expenditure for a set period of 
  time for portion or part of business/ organization.
  b) Budgeting: Is the process of preparing and using budgets to achieve 
  management objectives. 
  c) Budget manual: Is a book containing charts of organization, details of 
  budget procedures, account codes for items of expenditure and revenue, 
  timetables of process, clearly defines the responsibility of persons involved 
  in the budgeting system. Is a rule book which lays down the budgeting 
  procedures, organization structure, designations of responsibility and 
  budget time table. 
  d) Budget period: Is a specific period on which the budget is supposed 
  to be prepared for. The budget period may be one month, six months, 
  one year or five year. If the budgets are prepared for a longer period then 
  these budgets may be divided into short periods. These short periods are 
  known as control periods for the purpose of budgetary control.
  e) Master budget: Is a budget contains various subsidiary or functional 
  budgets. It is the kind of summary of all budgets including even budgeted 
  profit, loss account and balance sheet.
  f) Key factors: those are limiting factors or principal budget factors. Those 
  factors limit the activities of an organization. The key factors may include 
  limited demand, limited production capacity and shortage of labor, 
  shortage of material, less space or lack of finance… As the challenges, 
  the key factors affect the preparation of budgets. For example, if the 
  limiting factor is shortage of material or labor then the production cannot 
  be increased beyond some limits. Similarly, the limited demand will affect 
  the sales. 
  g) Budget committee: those are persons responsible for the coordination 
  and administration of the budget process. The chief executive of 
  this committee is the chairman who is usually a senior member of the 
  management. The other member of the budget committee may be 
  department heads. 
  h) Budget officer: is a person who is responsible for formulating the general 
  procedure of the budget preparation and submits to budget committee 
  the budgets for a specific period from departments.
  i) Budget control: is a process of comparing actual results on regular 
  basis with budgeted results. The aim of budget control is not only to 
  check at which rate the budget was unrealistic in implementation pathway 
  

  but also inefficiency use of available resources.

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  2.1.2.Advantages / importance and disadvantages of budget 

  • Advantages of budget
  
  Within an organization, each activity carried out presents certain benefits not 
  only to the business owner but also to the stakeholders. Certain advantages 
  include efficiency and improvement in the working of organization, easy way 
  of communicating the plans to the various units of organization. Assigning the 
  responsibilities through establishing the divisional, departmental or sectional 
  budgets, minimizing the possibilities of buck passing if the budget figures are 
  not met, a way of motivating managers to achieve the goals set for their units. 
  Serving as a benchmark for controlling on-going operations, developing a team 
  spirit, reducing wastage and losses by revealing them in time for collective 
  action, serving as a basis for evaluating the performance of managers and entire 
  business production process.
  • Disadvantages of budget
  Although high number of advantages of budget, some authors present its 
  disadvantages namely conflict arises because of competition for resource 
  allocation, budgets are perceived by the work force as pressure devices 
  imposed by to management, the pressure in the budgeting system may result 
  in inaccurate record keeping, manager may overestimate cost in order that 
  they will not be held responsible in future for over spending accompanied with 
  uncertainties in the system.
  2.1.3. Skills needed for budget preparation
  Skills budget preparation is a comprehensive program that focuses on the 
  essential skills required to understand the processes of costing and budgeting 
  within organizations. The structure designed to address all the relevant issues 
  concerning cost analysis, budget preparation and performance measurement. 
  The effective budget preparation requires not only knowledge but also skills. The 
  necessary skills to every participant (head of center) in budget preparation are 
  from field relating to accounting and finance, inventory planning, budgeting and 
  forecasting, cash flow management, accounting standards, capital structure, 
  sales and marketing, economic factors analysis. 
  2.1.4. Stages in budgeting process
  Budgeting process is a set of stages along with every center manager has to 
  fulfill a certain number of responsibilities. The procedures involved in preparing 
  a budget will differ from organization to organization, but the step by step 
  

  approach described is indicative of the steps followed by many organizations. 

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  The preparation of budget may take several periods where budget committee 
  may meet several times before an organization’s budget is finally agreed. 
  The main stages are:
  – Budget formulation 
  • Communicating details of budget policy
  The need to prepare budget and needed guidelines is communicated to those 
  people responsible for preparation of budgets. Management must ensure that 
  all policy effects should be made aware to staff who are participating in budget 
  making. Managers responsible for preparing the budget must be aware of the 
  way it is affected by the plan so that it becomes part of the process of meeting 
  the organization’s objectives.
  • Determining the factors that restrict performance
  This period represents the resource that constrains the productivity or capacity 
  of the firm. Management should strive and identify the factor that restricts 
  performance, since this factor determines the point at which the annual budgeting 
  process should begin. However, the proper identification of the budget factor 
  enables management to allocate resources in the most efficient manner.
  Example of limiting factors may include machine, labor, and raw material.
  – Budget approval 
  • Preparation of revenue /Sales budget
  This provides a forecast of future sales or revenue to be made. This stage is a bit 
  burdensome because it involves the forecast and analysis of economic factors 
  or market forces. Since all other operational (functional) budgets are based 
  on the sales or revenue budget, it is important that the sales budget must be 
  prepared first. 
  • Preparation of budgets
  The managers who are responsible for meeting the budgeted performance 
  should prepare the budget for those areas for which they are responsible. The 
  preparations of budgets should be a “bottom-up” process. All these budgets 
  are integrated and coordinate into a master budget
  • Negotiation of budgets
  The step at which the lower cadres who originate sectional budget usually 
  negotiates the budgets with their subordinates or with their supervisors in their 
  lines of command. At each stage of the process, the budget would be negotiated 
  between the manager who had prepared the budget and their superior until 
  

  agreed by both parties.

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  • Coordination and review of budgets

  The independent budgets prepared by different sections or department 
  managers should be reviewed and reconciled to ensure that they address 
  the same objectives. Such review may indicate that some budgets are out of 
  balance with others and need modification. The budget officer must identify 
  such inconsistencies and bring them to the attention of the manager concerned. 
  However, the revision of one budget may lead to the revision of all budgets. 
  During this process, the budgeted statement of profit or loss and budgeted 
  statement of financial position and cash budget should be prepared to ensure 
  that all the individual parts of the budgets combine into an acceptable master 
  budget.
  • Final acceptance of the budgets
  After the prepared budgets have been harmonized and accepted, they are 
  integrated into a master budget. A master budget is compressive plan which 
  include sales budget, production budget, material usage, labor cost and factory 
  overhead cost budgets.
  – Budget execution 
  Once a budget is approved by the budget committee, business departments/ 
  centers are authorized to spend money, consistent with the legal appropriations 
  for each line item. The budget execution includes different stages namely the 
  authorization stage , the commitment stage, the verification stage (this signifies 
  that goods have been delivered fully or partially according to the contract, or the 
  service has been rendered and the bill has been received), Payment authorization 
  or payment order stage, Payment stage (at this stage, the bill is paid by cash, 
  check, or electronic transfer), Accounting stage (the cash transactions are 
  recorded as complete in the books, which allows a reconciliation from the cash 
  based).
  – Budget review
  This covers a control stage which must be carried out in order to establish 
  whether the set of objectives or target are being achieved. The review exercise 
  will also involve the taking of action to address any anomaly. The important 
  point to note is that the budgeting process does not end for the current period 
  once the budget period begun; budgeting should be seen as a continuous and 
  dynamic process.
   2.1.5. Techniques in budgetary process
  Budgeting is a process with stages across the time. Due to the time for which the 
  

  budget is prepared, the budgeting process uses different techniques including 

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  economic techniques consisting to planning for future markets, technological 
  evolutions and environment parameters, statistical techniques focusing on linear 
  adjustment, correlation analysis, regression analysis; discounting techniques 
  basing on profitability analysis, investments choice (NPV, IRR) and accounting 
  techniques that point on cost accounting, financial accounting and variances 
  analysis.
  2.2.6. Classification of budget
  Budget can be classified basing on different attributes which includes the 
  function they serve, the time they are covering and the ability to change them 
  when need arises. Hence the following are classification.
  a) Types of budget according to time
  The period budgets cover a fixed period of time but continuous budgets are 
  updated and this procedure provides a base to review the budgets of longer 
  periods after shorter intervals. The type of budget according to time can be 
  prepared for one year (annual budgets); for six months (semi-annual budgets); 
  for three months (quarterly budgets) and one month (monthly budgets).
  b) According to the ability to change
  The rate of change of budget improves two main types of budget namely fixed 
  budget which is designed to remain unchanged irrespective of the volume of 
  output or turnover attained for specific period of time and flexible budget which 
  is designed to adjust the costs according to actual level of activity attained. For 
  the preparation of flexible budgets, the costs are divided into fixed and variable 
  elements. 
  The main objective of a flexible budget is to provide an instrument of control. 
  The actual results should be compared with flexible budget of the activity level 
  achieved. This comparison helps the management to evaluate the performance 
  of the organization.
  c) According to the function 
  A functional budget is one which relates to any of the functions of an enterprise. 
  The following describes the various functional budgets as used in different 
  organizations. 
  – Sales budget
  Shows the number of units of different products which a firm wants to sell in 
  next incoming determined period. The sales budget indicates the amount of 
  sales in units and value the company intends to sale in the next coming period. 
  

  This is an important budget which must be prepared before any other budget 

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  is prepared because all other budgets are relaying on it. The preparation of this 
  budget involves the need to make sales forecasts and prediction of economic 
  factors and market forces that will influence the sales budget to be prepared.
  – Production budget
  The production budget provides production units to satisfy the sales forecasts 
  and to achieve the desired level of closing finished goods inventory. It gives the 
  details of goods to be produced in a specific period.
  Throughout the production budget preparation, Unit to produce = budgeted 
  sales (units) desired closing inventory of finished goods – opening stock of 
  finished goods.
  – Production cost budget
  This represent the quantity of products to be manufactured expressed in terms 
  of cost. This budget summaries the materials utilization budget, labor budget 
  and the factory overhead budgets. The cost of units to be produced in a period 
  is given by units needed multiplied by the units cost.
  – The direct materials utilization budget
  The direct materials are simply the function of the production budget, with an 
  allowance made for any waste. This budget indicates the amount of materials in 
  units that will be needed to meet the production requirements. The preparation 
  of this budget is based on the information drawn from the production budget 
  and the materials utilization budget must provide material units to satisfy the 
  units to be produced. 
  – The direct purchase budget
  This kind of budget express the direct materials utilization budget and closing 
  level inventory in monetary terms. This means that the units of materials to be 
  purchased are expressed in terms of costs by multiplying materials purchase 
  price by units involved.
  Unit needed= raw material units needed for production desired closing 
  inventory of raw materials- opening stock of raw materials
  The main advantage of materials purchases budget is to enable the purchase 
  department to plan its programs well in advance and make its purchases under 
  the best conditions.
  – The direct labor cost budget
  This budget estimates the adequate labor in number and grades to enable the 
  production budget to be realized. The labor budget prepared must disclose the 
  

  number of each type or grade of workers required in a period to achieve the

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  budget output, period of training necessary for different types of worker. 
  However, the labor cost to be incurred in a period is computed by multiplying 
  number of labor needed for production by the rate per direct labor hour.
  Budgeted labor hour = budgeted production units number of hours per units
  Budgeted labor cost = budgeted labor hours rate per hour
  – The factory overhead cost budget
  This budget is prepared to accommodate all manufacturing factory costs that 
  cannot be traced to specific products or services. These are usually referred 
  to as common cost or overhead costs. The factory overhead budget covers 
  indirect labor costs, indirect material costs and indirect expenses.
  – Cash budget
  It comprises the details of expected cash receipts and cash payments in 
  specific next period. In other words, cash budget involves a projection of future 
  cash receipts and cash disbursements over various time intervals. It consists 
  of the projected cash receipts (inflows) and the planned cash disbursement 
  (outflows). 
  Moreover, Cash receipts include collection from debtors, cash sales, dividend 
  received, sale of assets, loans received and issue of shares and debentures 
  whereby payment include wages and salaries, payment to creditors and 
  suppliers, rent and rates, capital expenditure, dividend payable.
  – The capital expenditure budget
  Capital expenditure budget refers to the plan of purchase of durable, fixed 
  assets. Always it is a long term budget set for three to five or more years. It 
  requires frequent revision because of the changes in cost of land, buildings, 
  machinery and equipment.
  – Budgeted profit and loss account and balance sheet.
  At the end of budgeting process, the budget officer in accordance with budget 
  committee prepares the forecasted results through the final accounts namely 
  profit and loss account and balance sheet. This budgeted profit and loss 
  account should be real and perfect if the planned operations and activities are 
  exhaustively implemented. 
  2.1.7. Approaches to budgeting
  Application of budgeting process using different methods and techniques as 
  early explained requires certain approaches for achieving the same framework 
  

  institutional objectives. The following are certain different approaches used in 

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  organizational budgeting process.
  – Incremental Budgeting /Rolling / Revolving / Continuous
  In this approach, the previous budget is used as a reference point in preparing 
  of budgets. This approach involves making adjustment to the previous budget 
  figures. The budgets formulated using this approach tends to reinforce 
  the status quo and they are often extrapolations of the past. This approach 
  prepares budgets by updating periodically the previous budgets by adding a 
  new incremental time period such as quarter, a month.
  This approach presents some weaknesses like to justify previous budgets as 
  correct. Inefficiencies in the previous budgets are carried forward to the next 
  budget, it discourages innovation and creativity to the budget preparation, it 
  promotes complacency on part of management or managers.
  – Zero-Based Budgeting (ZZB) or Priority budgeting
  It involves a budget for each cost centre from zero-base. It sets budget for 
  every activity in an organization from zero bases. It assumes that the budget is 
  being made at the first time. However, it presents both advantages (leads to 
  efficient allocation of resources, encourages the identification and removal of 
  inefficient or obsolete operations from the budget, encourages innovation and 
  creativity in budgeting, forces managers to look for alternatives activities and 
  challenge the status quo) and disadvantages (time consuming or wasting and 
  can generate a lot of paper work, skilled manpower /managers are required to 
  draw the decisions packages and rank them, it requires the skilled managers 
  who are expensive therein).
  – Activity Based Budgeting (ABB)
  This seeks to challenge traditional budgets especially those budgets that are 
  based on departments or functions (cost centers). This is the modern approach 
  to budgeting and it is based on the principle that there are activities that drive 
  costs and these activities should be identified with cost pools. The budget is 
  prepared based on the activities to be carried out by each cost centre. 
  – Self-Imposed Budgeting (SIB)
  It is also called participative budgeting; Participative budgeting involves 
  employees throughout an organization in the budgetary process, most people 
  will perform better and make greater attempts to achieve a goal if they have 
  been consulted in setting that goal. Such participation can give employees the 
  feeling that “this is our budget” rather than the all-too-common feeling that “this 
  is their budget you imposed on us”. 
  To the business and other partners, self-imposed budget present advantages 
  

  on one hand where individuals at all levels of the organization are recognized 

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  as members of the team whose views and judgments are valued by the top 
  management, budget estimates prepared by employees themselves tend to be 
  more accurate and reliable, if people are not able to meet budget specifications, 
  they have only themselves to blame. But when a budget is imposed to them, 
  they can always say that the budget was unreasonable or unrealistic to start 
  with and therefore was impossible to meet.
  On other hands there some challenges; too much participation and discussion 
  the self-imposed budgeting will be time-consuming (delay), difficult to agree 
  mutually on the same estimates, the problem of budget padding can be severe 
  and too much budgetary slack, before a budget is accepted, the budgets 
  prepared by lower-level managers should be carefully reviewed by immediate 
  supervisors that necessitate more time. 
  2.8.1.Characteristics of good budget
  Practically and typically, the business is different one from another. This implies 
  that the content of budget is different from another as business is different one 
  from another. But whatever the difference, the structure remains the same with 
  same following characteristics if processed perfectly. The good budget must 
  be participative (every party in business has own duties and responsibilities 
  to fulfill for achieving the business target), Comprehensiveness (the contents 
  must be comprehensive to the whole organization), Standards (it should have 
  measures of performance), Flexibility (allow for changing due to reasonable 
  circumstances), Feedback (constantly monitor performance) and analysis of 
  costs and Revenues.
  2.1.9. Hierarchy of budget in an enterprise
  The hierarchical budget differs from one business to another due to respective 
  business operational sector. As discussed from 2.1.6, the end of each budget 
  process is finalized with pointing out the results throughout the budgeted profit 
  and loss account and balance sheet.
  With the same budget process end, the hierarchical budgeting is different 
  to different businesses. However, the following hierarchical can be observed 
  meanwhile. It presents Sales budget, Production budget and budgeted stock 
  levels, Direct materials usage budget, Direct materials purchase budget, Direct 
  labor budget, Factory overheads budget, Administration overheads budget, 
  Selling and distribution overheads budget, Departmental budgets, Muster 
  

  budget, Cash budgets and Profit and loss accounts and balance sheets 

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  2.1.10. Preparation of budget 

  AKABUYE PLC manufactures two types of product for the printing industry. 
  

  Budgeted sales of the products, known as P and Q for 2020 are:

  
  

   For different businesses, the pictures of budget are not exhaustive but the cash 
  

  budget has the common manner of being presented. It looks like.

  Management Accounting | Experimental Version | Student Book | Senior Six

  
  

  2.1.11. Impact of external and internal factors on budget

  – Impact of external factors on budget

  External factors on budget means the variables beyond the business that can 
  change or influence (positively or negatively) the specific budget for given 
  period of time. 
  • General trade prospects
  The general trade prospects (diagnosis, predictions) gathered in this connection 
  from trade papers and magazines affect the sales considerably. 
  • Technology factor 
  Technology is used extensively in modern business, from production to product 
  selling and customer support. Technology allows a company to save time and 
  labor costs while achieving more efficiency which in the long run can result in 
  a competitive advantage. Technology factor includes automation (is the use of 
  robots to perform repetitive tasks formerly done by humans), e-commerce (is 
  the buying and selling of goods and services on the internet) and digital media 
  (are online channels that get businesses in contact with their customers). 
  • Orders on hand
  In case of industries where production is quite a lengthy process, orders on 
  hand also have a considerable influence in the amount of sales. 
  • Seasonal fluctuations
  Past experience will be the best guide in this respect. However, efforts should 
  be made to minimize the effects of seasonal fluctuations by giving special 
  

  concessions or off-season discounts thus increasing the volume of sales.

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  • Potential markets

  Market research should be carried out for ascertaining the potential markets for 
  the company’s products. Such an estimates like expected population growth, 
  purchasing power of consumers and buying habits of the people should always 
  be brought to play. 
  • Availability of material and supply
  Adequate supply of raw materials and other supplies must be ensured before 
  drafting the sales program. The rate at which the raw materials are available 
  would like to influence the quantity to produce.
  • Competition level 
  Competitive influence refers to the impact of competition in the business 
  environment. The impact can come from changes in price, product, or business 
  strategy. For example, if a company selling similar products at a similar price 
  to your business suddenly drops its price to attract more customers, you may 
  have to reduce the price as well or risk losing customers. The volume of budget 
  in terms of units, money to receive or to pay will change depending on the 
  structure of market in fraction of competitiveness. 
  To avoid the negative impact of competitive influence, a company can develop 
  competitive advantages. These are attributes that allow the company to 
  outperform its rivals. A business can gain a competitive advantage by investing 
  in a high-quality labor force, exceptional customer support, stellar products, 
  extra services, or a reputable brand image.
  • Political situation 
  This refers to new legislation that affects consumers, employees, and businesses 
  rights. Political factors are grouped into consumer laws (these are laws that 
  ensure businesses will provide consumers with quality goods and services), 
  employment laws (these are laws that protect employee rights and regulate 
  the relationship between employees and consumers) and intellectual property 
  laws (these are laws that protect creative work within the business world, e.g. 
  copyrights of music, books, films, and software). 
  • Economic factors
  Businesses and the economy have a mutual relationship. The success of 
  businesses results in a healthier economy, whereas a strong economy allows 
  businesses to grow faster. Thus, any changes in the economy will have a 
  significant impact on taxes rate, unemployment, interest rate and inflation that 
  consequently affect the organizational budget.
  

  Changes in tax, interest rates, and inflation can result in a rise or fall in

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  aggregate demand, which affects economic activity. For example, with lower 
  taxes, individuals and households have more income at their disposal to spend 
  on goods and services. This contributes to higher demand, resulting in more 
  production and jobs created. As a result, business activities grow and the 
  economy flourishes. 
  • Availability of capital 
  The budget provides guidance to the amount of funds that may be needed 
  for procurement of capital assets during the budget period. The budget is 
  prepared after taking into account the available productive capacities, probable 
  reallocation of existing assets and possible improvement in production 
  techniques. If necessary separate budgets may be prepared for each item of 
  assets, such buildings budget, a plant and equipment budget.
  • Social factors 
  Social influence on business refers to changes in consumer tastes, behavior, or 
  attitude that might affect business sales and revenues. For example, nowadays, 
  consumers are paying more attention to environmental issues such as climate 
  change and pollution. This puts pressure on firms to adopt eco-friendly solutions 
  to their production and waste disposal that affect the budget therein. 
  – Impact of internal factors on budget
  Internal factors on budget means the variables under the control of the business 
  that can change or influence (positively or negatively) the specific budget for 
  given period of time. Internal factors include values, organizational structure, 
  culture and management style, human resources, labor unions, and physical 
  and technological resources.
  • Plant capacity
  How much can be budgeted and produced depends upon the available plant 
  capacity. There must be sufficient capacity to process the annual requirements 
  and also to meet seasonal high demands.
  • Receipts and payments method
  In case of this method the cash receipts from various sources and the cash 
  payments to various agencies are estimated. In the opening balance of cash, 
  estimated cash receipts are added from the total, the total of estimated cash 
  payments is deducted to find out the closing balance. The length (delaying or 
  

  not method) can lead to inefficiency of budget. 

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  Application activity 2.1
  

  Questions: 

  4. Present the hierarchy of budget in given enterprise.
  5. Referring to environment in which is located your school; explain the 
  factors that can lead to non execution of budget.
  6. AKABUYE PLC manufactures two types of product for the printing 
  industry. Budgeted sales of the products, known as P and Q for 
  

  2020 are: 

  
  

  Required: Prepare production budget 

  7. AGAHOZO PLC is producing the bricks at new village. For three 
  months ago, it budgeted to produce 100,000 bricks at Frw 50. 
  The expected labor cost was Frw 180,000, raw materials were Frw 
  100,000 and overhead expenses were Frw 80,000. At the end of 
  three months all heads of departments hold a meeting to present how 
  budgeted plans were implemented. The sales manager presents the 
  total sales of 120,000 bricks at Frw 60; the production manager 
  shows the use of raw materials values to Frw 120,000, labor cost 
  value to Frw 150,000 and overheads expenses Frw 160,000. You 
  are one of decision maker of the above manufacturing business; you 
  are required to compare the planned and actual results and advise 
  

  the top management.

  Management Accounting | Experimental Version | Student Book | Senior Six

  2.2. Budgetary control

  Learning Activity 2.2
  

  AGAHOZO PLC is producing the bricks at new village. For three months 
  ago, it budgeted to produce 125,000 bricks at FRW 50. The expected 
  labor cost was Frw 200000, raw materials were Frw 80,000 and overhead 
  expenses were FRW 8000. At the end of each three months all heads 
  of departments hold a meeting to present how budgeted plans were 
  implemented and give recommendation. The sales manager presents the 
  total sales of 150,000 bricks at Frw 60, the production manager shows the 
  use of raw materials values to Frw 120,000, and overheads expenses Frw 
  25,000.
  Question 
  

  1. What was the objective of meeting hold at each every three months 
  

  at AGAHOZO PLC?
  

  2. What do expect as the results from the actual results of activities and 
  the planned
  2.2.1. Definition of concepts 
  – Budgetary control 
  It is the process of preparing budgets for the future period, comparing the 
  standards set by the budget with the actual performance, finding out the reasons 
  for the differences in performance, and taking corrective actions.
  Budgetary control is also method of controlling the total expenditure on 
  material, wages and overhead by comparing actual performance with planned 
  performance.
  – Variance 
  Variance in management is the difference between the planed variables and 
  actual variables (amount, units, value). 
  2.2.2. Budgetary control objectives, purpose and tools. 
  Budgetary control has different objectives including formulation of the policy of 
  the business, coordinating the business activities, controlling each function set 
  through the budget. The budgetary control finally shows the variance that is the 
  difference between planned, budgeted or standard cost (S6, Unit 4) and actual 
  

  costs and similarly in respect of revenues. 

  Management Accounting | Experimental Version | Student Book | Senior Six

  The purpose of budgetary control system is to assist management in planning and 
  controlling the resources of their organization by providing appropriate control 
  information. The information will only be valuable, however, if it is interpreted 
  correctly and used purposively by managers and employees. However, the 
  managers who set the budget or standards are often not the managers who 
  are then made responsible for achieving budget targets. A supervisor might get 
  weekly control reports, and act on them; their supervision might get monthly 
  report, and decide to take different control actions. Different managers can get 
  in each other’s way and resent the interference from others.
  Whatever the types of budget to be controlled; only three factors to take into 
  consideration in budgetary control are standard variables (cost and revenues), 
  actual variables (cost and revenues) form both which results in variance.
  2.2.3. Advantages of budgetary control 
  Compels management to think about the future, which is probably the 
  most important feature of a budgetary planning and control system. Force 
  management to look ahead, to set out detailed plans for achieving the targets 
  for each department, operation and (ideally) every manager, to anticipate and 
  give the organization purpose and direction.
  Budgetary control clearly defines areas of responsibility and promotes 
  coordination and communication and 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. 
  Budgetary management enables remedial action to be taken as variances 
  emerge and motivates employees by participating in the setting of budgets by 
  improving the allocation of scarce resources. 
  2.2.4. Budgetary control process 
  There are five steps to an effective budgetary control system that including 
  preparation of budgets, communicating and agreeing budgets with all 
  concerned, having an accounting system that will record all actual costs, 
  preparing statements that will compare actual costs with budgets, showing 
  any variances and disclosing the reasons for them, and taking any appropriate 
  action based on the analysis of the variances. 
  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 
  
  Management Accounting | Experimental Version | Student Book | Senior Six
  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. 

  Application activity 2.2

  AMARA PLC is a manufacturing company producing the cement from 
  western province of Rwanda. The number of customers is increasing day 
  to day due to the development of construction sector across the country. 
  For each six months, the heads of department from AMARA PLC hold a 
  meeting for evaluating the six past months and preparing the upcoming six 
  months production’. From this meeting, different alternatives are discussed 
  with the purpose of getting high effective and efficiency production to 
  meet the consumers’ testes and preferences. Chief budget committee has 
  to present all necessary documents related to production budget, sales 
  budget, labor cost budget and overheads budget to ensure the proper 
  use of available resources. Given the data from the previous periods, the 
  budget committee adopts new technology in production, new system in 
  labor management, requesting fund from neighbor financial institutions. The 
  new management planning results not only in high increase in production, 
  increase of salaries and remarkable construction development sector but 
  also exclusion of some unnecessary employees, changing the raw materials 
  previously used and imposing the overtime to the less number of remaining 
  

  staff.

  Questions 
  1. What do you suggest as the main advantages of budget
  

  2. Enumerate the main disadvantages of budget

  Management Accounting | Experimental Version | Student Book | Senior Six

  Skills Lab 2
  

  Students guided by their teacher, visit the bursary officer of their respective 
  schools.
  The bursary officer provides the documents showing the different budget 
  lines of schools.
  The students read carefully and interpret the given information from the 
  received documents.
  The teacher asks the students in manageable team to prepare the budget 
  

  for nine months from the information provided by bursary officer.

  End of unit assessment 2
  

  3. Respond by true or false

  a) Budget is defined as a document outlining the revenue of one year 
  and expenses of six months for the same business
  b) Budget is a financial and quantitative statement, prepared and 
  approved prior to a defined period of time, of the policy to be pursued 
  during that period for the purpose of attaining a given objective
  c) Budget is the same as budgeting in matter of budgetary control 
  d) Master budget is different from budget manual
  e) The sales budget cannot be semi-annually 
  1. List the characteristics of good budget
  2. Classify the budget according to their function 
  3. Enumerate the disadvantages of budget.
  

  4. Explain Approaches to budgeting

  
  

  
  

  
  

  
  

• UNIT3:ANALYSIS OF TYPES OF BUDGET ACCORDING TO FUNCTION

  Key unit competence: To be able to analyze the rationale behind 
  

  different types of budget 

  Introductory activity:
  From the following’ information you are required to prepare a sales budget 
  

  for the half year ending 30th April 2019

  

  Questions:
  Required: Prepare the following functional budgets
  

  i) Sales budget

  3.1. Sales budget analysis

  Learning Activity 3.1

  The Morning Businesses PLC develops and manufactures two agri-products 
  (A and B). To achieve the high performance and satisfying the customers’ 
  needs and wants; the Morning Businesses prepares the budgets to 
  identify, plan, track and allocate personnel and financial resources across 
  their operations. Company prepares a sales budget to determine how much 
  revenue expected to generate from their products and services and how 
  

  much to spend for specific period of time. 

  Accounting Management | Student Book | Senior Six
  

  Questions:

  1. Explain the two main contents of sales budget
  

  2. Enumerate the reasons of cash budget preparation.

  3.1.1. Factors of sales budget
  The preparation and implementation of sales budget is subject of certain number 
  of variables that lead to the fluctuations of this budget. Those factors include 
  production costs, taste and preferences of customers, Expansion or contraction 
  of the investment, Increase or decrease in stocks and debtors, Rate of inflation 
  anticipated, Policy decisions like credit control, dividends and taxation. 
  3.1.2. Calculation/ presentation of sales budget
  Illustration
  ABARCO Plc sales two types of products for the printing industry. For better 
  of maximizing the profit Budgeted sales of the products, known as P and Q for 
  2024 are: 
  Question:
  

  Prepare sales budget

  

  3.1.3. Interpreting results and advising the management
  
  There is no format for a cash budget and no regulations regarding how it 
  should be set out but whatever the format, cash budget includes necessary the 
  

  sources of cash receipts and the total cash receipts for the period, source of 

  Management Accounting | Experimental Version | Student Book | Senior Six

  cash payments and the total cash payments for the period, net cash flow for the 
  period, bank balance brought forward and bank balance carried forward. 
  Illustration: 
  RWANDEKO PLC is a business located in Muhanga District and producing 
  different goods. The business plan for first four months 2023 is presented in the 
  

  following table and opening balance for the specified period is Frw 25,000 .

  
  

   With the above data, the sales Manager of RWANDEKO PLC is in responsible 
  to prepare sales budget for not only meeting the business objective but also 
  

  satisfying the consumers and maximizing the profit.

  

  Management Accounting | Experimental Version | Student Book | Senior Six

  
  

  
  

  

  Management Accounting | Experimental Version | Student Book | Senior Six

  
  

  Application activity 3.1
  

  3. Umulisa plc has started a business 10 years ago investing Frw 
  15,000,000 allocated in building society. She maintains a bank 
  account showing a small credit balance and she plans to approach 
  her bank for the necessary additional finance. She asks the planning 
  officer for advice and provides the following additional information.
  • Arrangements have been made to purchase non-current 
  assets costing Frw 8million These will be paid for at the end 
  of September and are expected to have a five-year life, at the 
  end of which they will possess a nil residual value.
  • Inventories costing Frw 5 million will be acquired on 28 
  September and subsequent monthly purchases will be at a 
  level sufficient to replace forecast sales for the month.
  • Forecast monthly sales are Frw 3million for October, Frw 
  6million for November and December, and Frw 10.5 million 
  from January 2024 onwards.
  • Selling price is fixed at the cost of inventory plus 50%.
  • Two months’ credit will be allowed to customers but only one 
  month’s credit will be received from suppliers of inventory.
  • Running expenses, including rent but excluding depreciation 
  of non-current assets, are estimated at 1.6 million FRW per 
  month.
  • Umulisa PLC intends to make monthly cash drawings of Frw 
  1million. 
  

  Prepare sales budget for six months for Umulisa Plc

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  3.2. Purchase budget analysis
  

  Learning Activity 3.2
  

  ABARCO Plc manufactures two types of product for the printing industry. 
  For better of maximizing the profit Budgeted sales of the products, known 
  

  as P and Q for 2024 are: 

  Learning Activity 3.2
  

  
  

  Questions:

  a) Prepare purchase budget

  3.2.1. Factors of purchase budget 
  However, there are a number of additional considerations that can make the 
  purchases budget considerably more complex including inventory beginning 
  balance, desired service level, process of product / services of production, 
  availability of cash (cash liquidity), labor turnover, season variables, availability 
  of raw materials, number of employees, investment in plant and equipment, 
  materials and supplies, utilities, cost of transportation to market, costs associated 
  with administration and manufacturing. 
  3.2.2. Calculation/ presentation of purchase budget
  The units of materials to be purchased are expressed in terms of costs by 
  multiplying materials purchase price by units involved.
  • Units needed = raw material units needed for production
  desired closing inventory of raw materials- opening stock of raw 
  materials
  • Labor cost = Labor cost per person * rate per worker per period.
  However, 
  

  The purchase is cost of sales + ending inventory –opening inventory.

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  
  

  3.2.3.Interpreting results and advising the management 

  For any business, the purchase budget is purely linked to production and 
  production cost budget. Referring to example 3.2.2, the purchase manager 
  would present the cash outflow of Frw 200,000, Frw 539,000 and Frw 444,000 
  respectively to products W, J and S for achieving the business objective.
  As shown @3.2.2, during the period purchases of 1,183,000 are required in 
  order to be able to sell goods costing Frw 240,000, Frw 490,000 and Frw 
  300,000 respectively to W, J and S. (cost of sales) and to increase inventory 
  levels by 160,000, 126,000 and 96,000 (beginning inventory) to Frw 120,000, 
  

  Frw 175,000 and Frw 120,000 (ending inventory). 

  Management Accounting | Experimental Version | Student Book | Senior Six
  1. CALISONITH Plc is a business producing the cassava bread located 
  in Ruhango District. The following accounting  record of payment 
  information has been made available from the purchase department 
  for the last six months of 2019 (and of only sales for January 2020). 
  i) The units to be sold in different months are:
  • July: 2,200
  • August: 2,200
  • September: 3,400
  • October: 3,800
  • November: 5,000
  • December: 4,600
  • January 2020: 4,000
  ii) There will be no work-in- progress at the end of any month.
  iii) Finished units equal to half the sales for the next month will be in 
  stock at the end of every month (including June 2019)
  iv) Budgeted production and production costs for the year ending 
  December 2019 are as following:
  • Production units: 44,000
  • Direct materials per unit: FRW 10.00
  • Direct Wages per unit: FRW 4.00
  • Total factory overheads apportioned to the product: FRW 88,000
  Prepare:
  a) Production budget for the last six months of 2019 
  b) Production cost budget for the same period of 2019
  
  

  3.3. Cash budget analysis

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  Learning Activity 3.3
  

  
  

  The following information is available:

  Cash in hand at the end of May 2010 will be Frw 180,000
  1. 60% of the sales proceeds are received in the current month, 30% 
  in the following month and the balance is received in two months 
  after sales
  2. Suppliers are paid one month after delivery of goods.
  3. Corporation tax for 2009 amounting to FRW 20,000 will be paid on 
  30th September 2010
  4. Contractor’s retention monies amounting to FRW 50,000 will be 
  paid on 30thJune 2010
  5. The shareholders at their last extraordinary general meeting increased 
  the share capital by FRW 70,000 and the first call of FRW 40,000 
  will be received in October 2010
  6. In October 2010, the company is due to receive FRW 20,000 as 
  compensation for civil suit
  7. The monthly administration expenses amounting to Frw 33,000 
  include factory depreciation charge of FRW 4,000 and preliminary 
  expenses of FRW 3,000
  8. Office equipment worth FRW 13,000 will be paid for in November 
  2010
  Required: 
  

  Prepare a cash budget for the period 1st June to 31st December 2011

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  3.3.1. Factors of cash budget

  Cash budget is an estimate of cash receipts and their payment during a 
  future period of time. It deals with other budgets especially materials, labor, 
  overheads and research and development budget. It estimates cash inflows 
  and use of cash during a specific period of time. It provides on one hand the 
  sources of cash including receipts from debtors, interest on loan, dividends 
  on shares, and other incomes from the sales of fixed assets, bill receipts and 
  on other hand cash utilization including payment to creditors, payment of fixed 
  assets purchased and daily routine payments such as wages, rent, postages, 
  telephone and entertainment expenses. The cash budget is also changed due 
  to expansion or contraction of the investment, increase or decrease in stocks 
  and debtors, rate of inflation anticipated, policy decisions like credit control, 
  dividends and taxation.
  3.3.2. Calculation/ presentation of cash budget
  Whatever the type of business is, the important objective is more liquidity 
  obtained from more sales, it is from this assumption that cash budget must 
  be prepared at the first rank from other business budget. The following is how 
  

  business cash budget looks like

  
  

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  3.3.3. Interpreting results and advising the management

  The cash budget allow managers to ensure that cash is available for revenue 
  expansion, to indicate when, where and how much cash will be needed (activity), 
  to preserve the cash throughout the year (saving), to guide management 
  on financing capital expenditure (efficiency) and revealing surplus cash for 
  

  investment (effectiveness).

  Application activity 3.3
  

  A firm expects to have Frw 30,000 as opening balance on 1st May, 2018 
  and requires you to prepare an estimate of the cash position for three 
  

  months May to July 2018. The following information is supplied to you.

  

    

  Management Accounting | Experimental Version | Student Book | Senior Six

  Skills Lab 3
  

  The students accompanied with their trainers, visit the business operating in area 
  of school. They focus their journey to selling and purchase departments where 
  are shown data of purchase, stocking and selling purchased or manufactured 
  products. They ask different questions regarding the planning and budgeting 
  

  the cash, purchase and sales budgets.

  End of unit assessment 3
  1. Describe the budget according to the functional factor
  2. Explain what is meant by incremental budgeting and discuss its 
  suitability for a government department budgeting for office rental 
  costs and for advertising expenditure on a new health initiative.
  3. The government’s Education department has a budget of Frw 1,704m 
  for utilities for the year ending June 20x2. Two contracts are in place for 
  water and energy, with fixed amount for the year if usage remains within 
  agreed limits. The water contract, comprising one quarter of the total 
  utilities budget, is paid in equal amount each month. Energy is paid in 
  four equal instalments in July, September, December, and March.The 
  budget holder has received the following budget monitoring report for 
  the six months July to December 20x1 which shows the water budget 
  to be under spent by Frw 213m and the energy budget to be over 
  

  spent by Frw 532,5m.

  Management Accounting | Experimental Version | Student Book | Senior Six

  
  

  The budget holder says the payments are fixed and the expenditure for the year 
  to date has been in accordance with expectations of the contracts. Water and 
  energy usage remained within the agreed limits of the contracts for the period.
  Prepare a revised budget monitoring report, using a profiled budget based on 
  

  the information provided for the utility contracts.

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  
  

  
  

  
  

• UNIT4:STANDARD COST

  Key unit competence: To be able to control account using standard 

  costing

  Introductory activity:

  Read the following case study and answer the given questions
  The management must continually search for ways to obtain maximum 
  operating effectiveness from the available resources. One of the most 
  important functions of management accounting is facilitating managerial 
  control. A manufacturing firm is usually concerned with producing its product 
  at the lowest possible costs consistent with the quality it wishes to maintain. 
  Actual costs become a factor in determination of the net income for the 
  period. Such actual cost information can also be useful in establishing basis 
  for product costing and pricing, as it reflects a desirable level of performance. 
  Management, in assigning responsibility for the actual results of operations, 
  wants to know that those results were measured accurately. For that reason 
  a measure of acceptable performance i.e, a standard must be applied to 
  actual results. So the standard cost is an effective management tool for 
  planning, decision-making, coordinating and control.
  1.Complete the following sentence:
  a. Predetermine cost are……………….used for cost control and performance 
  evaluation
  

  2. What is the importance of Standard costing in budgetary control?

  Management Accounting | Experimental Version | Student Book | Senior Six

  4.1. Introduction to standard costing
  

  Learning Activity 4.1
  

  Standard cost accounting can be a highly beneficial tool for managers who 
  are attempting to plan a more accurate budget. Accurate budgets could 
  lead to a more profitable and efficient business at the end of the day. This 
  is because a standard costing system provides managers with a projected 
  idea of the spending costs.
  Standard costing is the practice of estimating the expense of a production 
  process. It’s a branch of cost accounting that’s used by a manufacturer, for 
  example, to plan their costs for the coming year on various expenses such 
  as direct material, direct labour or overhead. These manufacturers will also 
  be able to compare the standard cost to actual costs.
  1. What does it mean “standard costing”.
  

  2. Outline the benefits of standard costing in the company

  4.1.1. Definition of standard costing 

  According to the Chartered Institute of Management Accountants (C.I.M.A) 
  standard costing is defined as “the preparation and the use of standard costs, 
  their comparison with actual costs and analysis of variance their causes and 
  point of incidence”
  Brown and Howard have defined it as “a technique of cost accounting which 
  compares the standard cost of each product or service with actual cost to 
  determine the efficiency of the operation so that any remedial action may be 
  taken immediately”.
  Standard costing is planned, generally established well before production 
  begins, and provide management with goals to attain (planning) and a basis 
  for comparison with actual results (control). Standard costs are costs per unit 
  while a budget is total costs. Standard costs are also known as planned costs, 
  predicted costs and scheduled costs.
  Standard cost: is defined in the CIMA official Technology as” the planned unit 
  cost of the product, components or service produced on a period.
  Historical costs: means actual or past costs and historical costing is a system 
  in which actual costs incurred in the past are ascertained.
  
  Management Accounting | Experimental Version | Student Book | Senior Six
  4.1.2. Standard costing steps
  The following are the steps which are to be taken while doing standard costing:
  a) Setting the standard or establishing standards: The first step is 
  to set standards on the basis of management’s estimation. Basically 
  standards are set considering the past data, future trends, and production 
  plan.
  b) Ascertaining actual results or Determination of actual costs: 
  When standards are set the second step is to determine the costs for 
  each element like material, labor and overhead.
  c) Comparison of Actual value costs and standard costs: The next 
  step is to compare the standard cost with the actual cost to determine 
  the variance.
  d) Determination of causes: once the comparison is done, the next step 
  is to find out the reason for the variance so that corrective measures can 
  be taken
  e) Investigation of the variance or Disposition of variance: The last 
  step involves the disposition of variance by transferring it to the profit and 
  loss account
  4.1.3. Purpose of standard costing
  In accounting, a standard costing is a tool for planning budget, managing and 
  controlling costs and evaluating cost management performance. A standard 
  costing system involves estimating the required costs of a production process. 
  But before the start of the accounting period, determine the standards and 
  set regarding the amount and cost of direct materials required for production 
  process and the amount and pay rate of direct labour required for the production 
  process. In addition, these standards are used to plan a budget for the production 
  process. At the end of the accounting period, use the actual amounts and 
  costs of direct material. Then utilize the actual amounts and pay rates of direct 
  labour to compare it to the previously set standards. When you compare the 
  actual costs to the standard costs and examine the variance between them, it 
  allows manager to look for ways to improve cost control, cost management, and 
  operational efficiency
  4.1.4. Advantages and Disadvantages of standard costing
  – Advantages of standard costing
  The advantages to be derived from a system of standard costing will vary from 
  

  one business to another, possible advantages are as follows:

  Management Accounting | Experimental Version | Student Book | Senior Six

  a) It serves as a basic for measuring operating performance and cost control
  b) It aids price fixing
  c) c) Standard costing facilitates evaluation of jobs and introduction of 
  incentives
  d) It serves as basis for inventory valuation
  e) It facilitates delegation of authority
  f) Standard costing facilitates coordination
  g) It reduces wastes
  h) Standard costing is also used for the measurement of profit
  i) iStandard costing is used in planning, budgeting and decision making
  – Disadvantages.
  Standard costing system suffers from certain disadvantages.
  a) The system may not be appropriate to the business
  b) The staff may not be capable for operating the system
  c) A business may not be able to keep standards up-to-date
  d) Inaccurate and unreliable standards cause misleading results and thus 
  may not enjoy the confidence of the users of the system
  e) Operations of the standard costing 
  f) Standard costing is expensive and unsuitable in job order industries 
  which are manufacturing non-standardised products.
  4.1.5. Types of standard costing
  There are four types of standard costing. These are explained as under:
  a) Ideal Standards
  These standards costs represent perfect performance. They assume 100% 
  efficiency that there are no losses or idle time. They represent the minimum 
  costs that are possible under the most efficient operating conditions. Ideal 
  standard costs are not generally used in practice as they are in practice as they 
  are likely to have demotivation effect on staff.
  b) Basic Standards
   These are standard costs that do not change over many years. The advantage 
  of this type of standard cost is that it provides a base for comparison with actual 
  costs over a period of years. However, change may occur in prices; method of 
  production; or other factors so that basic standard costs are no longer useful as 
  

  they do not represent current costs; they do not accurately represent what the

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  organisation expects to achieve now.
  c) Expected Standards or Attainable standards
  These are also known as attainable standards. They are based on normal 
  operating conditions and an allowance is made for average wastages and 
  inefficiencies. In this case, it is assumed that there will be some loss of production 
  due to power failure, machinery breakdown or labour turnover etc. An expected 
  or attainable standard can be defined as” standard which can be attained if a 
  standard unit of work is carried out efficiently, a machine properly operated or 
  material properly used”. These can be used for product costing, for cost control, 
  for stock valuation and as a basis for budgeting.
  d) Current Standards
   Current standard costs should be tough but realistic. They should be tough 
  so that staff will have to work hard to achieve the standards but they also must 
  be realistic because if not, staff will not be motivated to work hard. Currently 
  standard costs are the most suitable for companies to use. They provide 
  information for planning and control purposes.
  e) Normal standard
  These are such standards which are expected if normal circumstances prevail. 
  Term normal represents the normal conditions of the business in the absence of 
  any unexpected fluctuations (either favourable or unfavourable). Even through 
  normal standards are more of theoretical in nature as reality cannot be sufficiently 
  predicted with all its fluctuations in advance. Also, circumstances may change 
  in such a way that factors which were expected to be controllable are not so 
  

  controllable by the managers

  Application activity 4.1
  

  1. Which of the following is true about standard costing?
   a. It is a technique of implementing cost control within the organisation
   b. It helps in planning out business activities within the organisation
   c. Both a and b are incorrect
  

   d. Both a and b are correct

  Management Accounting | Experimental Version | Student Book | Senior Six

  2. Which of the following industries is standard costing most suited for?
   a. It is suitable for industries that produce standard product
  b. It is suitable for enterprises that are engaged in service activities
  c. It is suitable for industries that produce non-standard products
  d. None of the above
  3. Which of the following is an advantage of the standard costing system?
  a. It helps in promoting and measuring efficiencies within an organisation
   b. It helps to control and reduce the overall costing within an organisation
  c. It helps to fix the selling price for the products manufactured within an 
  organisation
  d. All of the above
  4. Which of the following activities is true about the cost variance under the 
  standard costing system?
  a. Cost variance is the difference between the standard cost and actual cost
  b. Cost variance is the difference between the standard cost and the budgeted 
  cost
  c. Cost variance is the difference between the standard cost and the marginal 
  cost
  d. Cost variance is the difference between the actual cost and marginal cost
  5. Which of the following activities is the standard costing system used for?
  a. It is a basis for implementing cost control and fixing the price of products 
  through variance analysis
  b. It helps to ascertain the cost -volume relationship between product 
  manufactured by the business
  c.It helps to establish the breakeven point for the products manufactured by 
  the company
  

  d. None of the above

  Management Accounting | Experimental Version | Student Book | Senior Six

  6. A………standard is a standard for certain period, for certain conditions 
  and for certain circumstances
  a. basic
  b. current
  c. normal
  d. ideal
  7. This is a standard which is established for, unaltered over a long period of 
  time
  a. Basic standard
  b. Current standard
  c. Normal standard
  d. Ideal standard
  8. Basic standards are more
  a. Idealistic
  b. Realistic
  c. Both (a) and (b)
  d. None of the above
  9. Define” standard costing”
  10. What are the steps of standard costing?
  11. What is the main purpose of standard costing?
  12. Explain the 5 advantages and 5 disadvantages of standard costing
  13. List the various types of standards
  6. A………standard is a standard for certain period, for certain conditions and for 
  certain circumstances
  a. basic
  b. current
  Management Accounting | Experimental Version | Student Book | Senior Six
  
  

  4.2. Comparison between budget control and standard 

  costing

  
  

  Learning Activity 4.2

  Read the following information and answer the question below:
  Both Standard Costing and Budgetary Control are the methods that provide 
  a reference point for assessing performance and analysing discrepancy 
  between actual and estimated figures.
  But as Budgetary Control makes side-by side comparisons, the regular 
  changes are made in the budgets, and so it eliminates the need to mention 
  the variance. And this is what the majorly missing from the standard costing.
  From the information above, compare budget control to standard costing.
  Learning Activity 4.2
  
  4.2.1. Similarities between budget control and standard 
  costing
  Budget control and standard costing are comparable systems of cost accounting 
  in that they are both predetermined and forward-looking. Both standard costing 
  and budgetary control achieve the same objective of maximum efficiency and 
  cost reduction by establishing a predetermined standard, comparing actual 
  performance with the standard, and taking corrective measures where necessary. 
  Thus, both are useful tools for management in controlling costs.
  4.2.2. Difference between budget control and standard costing
  The following are the major differences between standard costing and budgetary 
  control:
  – Standard costing is a cost accounting system, in which performance is 
  measured by comparing the actual and standard costs. Budgetary control 
  is a control system which actual and budgeted results are compared 
  continuously in order to achieve the desired results.
  – Standard costing is limited to, cost data, but budgetary control is related to 
  cost as well as economic data of the enterprise.
  – Standard costing is a unit concept, but budgetary control is a total concept.
  – Standard costing has a restricted scope, limited to production costs only, 
  whereas budgetary control has a comparatively wider scope as it covers all 
  the operations of the whole organization. 
  Management Accounting | Experimental Version | Student Book | Senior Six
  – In standard costing the comparison is made between actual cost and 
  standard cost of actual output. On the other hand, in budgetary control the 
  comparison is made between the actual and budgeted performance.
  – Standard costs do not change due to short-term changes in the conditions, 
  but budgeted costs may change.
  – Standard costing applies to manufacturing concerns. In contrast to budget 
  

  control, which applies to all organisations.

  Application activity 4.2

  I. Multiple choice questions
   1. Budgetary control helps in implementation of:
   a. Standard Costing
   b. Marginal Costing
   c. Ration Analysis
   d. Technical Analysis
   2. Standard costing is a tool, which replaces the bottleneck of the…………
  costing
   a. present
   b. future
   c. historical
   d. none of the above
  3. Both standard costing and budgetary control have the following common 
  feature(s)
   a. Both techniques are based on the presumption that cost is controllable
   b. In both techniques, results of comparison are analysed and reported 
  to management
   c. Both have a common objective of improving managerial control
   d. All of the above
  4. What are the similarities between budget control and standard costing?
  

  5. Differentiate between budget control from standard costing

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  4.3. Using standard costing in budgetary control
  

  Learning Activity 4.3
  

  Read the following information and answer the question below
  A standard costing system involves estimating the required costs of a 
  production process. Standard costs are estimates of actual costs in a 
  company’s production process because actual costs cannot be known in 
  advance. 
  

  How is standard costing used in budgetary control?

  4.3.1. Use of variance in the budgetary management

  Variance analysis is used in budgeting and in management accounting. 
  Management of business use variances in decision making. Variance analysis 
  helps project managers in outlining sudden and systematic changes between 
  the amounts budgeted for a project and the actual amount spent. This term is 
  also applicable in sales, for instance, if an individual budgets of Frw 80,000 for 
  sales in a particular month and the actual sales is Frw 42,000, the variance is 
  Frw 38,000. For further the use of variance will be discussed in detail in the 
  

  following unit 5.2.

  Application activity 4.3

  1. How variance is used in budgetary management?
  

  2. Explain the useful of standard costing in budgetary control?

  Skills Lab 4
  

  Students visit the purchase department from their respective schools 
  and the purchase officer gives the different articles and their respective 
  prices on the markets. Referring to those prices the students present the 
  

  standards costs of each product to be bought by schools for next week.

  Management Accounting | Experimental Version | Student Book | Senior Six

  End of unit assessment 4
  

  END UNIT ASSESSMENT

  1. Complete the following statement 
   A Standard cost is…………………………
  2. What are two main uses of standard costing?
  3. A control technique which compares standard costs and revenues with 
  actual results to obtain variances which are used to stimulate improved 
  performance is known as:
   A. Standard costing
   B. Variance analysis
   C. Budgetary control
   D. Budgeting
  4, What are the types of standard costing? 
  5.. Which statement is true?
  A. Standard which includes no allowance for losses, wastes and 
  inefficiencies. It represents the level of performance which is attainable 
  under perfect operating conditions.
  B. A standard which includes some allowance for losses, wastes and 
  inefficiencies. It represents the level of performance which is attainable 
  under efficient operating conditions.
  C. A standard which is based on currently attainable operating conditions.
  

  D. standard which is kept unchanged, to show the trend in cost.

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  6. Choose the best definition from the following of a standing hour?
  An operating hour in which there no exceptional events, e.g machine 
  breakdowns
  An hour during which only standard unit are made
  The amount of work achievable in an hour, working at standard efficiency 
  levels
  An hour during which only standard hourly rates are paid to labour
  
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• UNIT5:VARIANCE ANALYSIS

  Management Accounting | Experimental Version | Student Book | Senior SixKey unit competence: To be able to interpret the variance and advice the top management

   Introductory activity:

  Read the following case study of Specialty Food ltd profit Report for the 
  month of June. 
  MUHIRE, the new management accountant, has just completed his first 
  month’s work. He has entered a huge amount of data into the finance and 
  accounting system and is now faced with a pile of report. One such report 
  is shown below.
  

  Specialty Foods ltd profit Report: June (unit-FRW)

  
  

  a) Explain the meaning of the above report
  

  b) What is the budget variance analysis?

  Management Accounting | Experimental Version | Student Book | Senior Six

  5.1. Identify any significant deviation
  

  Activity 5.1
  

  Read the following case study and answer the question below:
  The chocolate Cow Ice Cream Company has grown substantially recently, 
  and management now feels the need to develop standard and compute 
  variances. A consulting firm was hired to develop the standards and the 
  format for the variance computation. One standard in particular that the 
  consulting firm developed seemed too excessive to plant management. The 
  consulting firm’s standard was production of 100 gallons of ice cream every 
  45 minutes. The plant’s middle level of management thought the standard 
  should be 100 gallons every 55 minutes, while the top management of the 
  company thought that the consulting firm’s standard would provide more 
  motivation to the employees.
  1.Why is the company establishing a standard costs for production
  2.What are some factors the company may need to consider before 
  

  selecting one of the proposed standard costs

  5.1.1. Meaning of Variance
  Variance: is the difference between a forecasted variable and the actual 
  variable. Variances are common in budgeting, but you can have a variance 
  in anything that you forecast. In many accounting applications, a variance is 
  considered to be ”the difference between an actual cost and standard coast”. 
  The act of computing and interpreting variances is called Variance Analysis.
  -Variance analysis: refers to identifying and examining the difference between 
  the standard numbers expected by the business and the actual numbers 
  achieved.
  Frank wood and Allan Sangster defined variance analysis as” a mean of 
  assessing the difference between a predetermined cost and actual cost.
  Analysing variance helps businesses understand current outgoings and them
  budgeting for future expenses. Businesses often carry out variance analysis a 
  quantitative investigation into differences between planned and actual costs 
  

  and revenues.

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  Variance analysis can be applied to both revenues and expenses. When actual 
  results are better than planned, variance is referred to as “favourable”. If results 
  

  are worse than expected, variance is referred to as” adverse” or” unfavourable”

  5.1.2. Purpose of variance analysis
  Variance analysis helps to reveal where your business exceeded expectations 
  and where it came up short.
  A company must use variance analysis to determine how managers have 
  performed to achieve their objectives. In this case, variance analysis enhances 
  the benefits of budgeting. Variance analysis promotes responsibility in various 
  areas. Variance analysis can also identify any errors in a budget.
  Variance analysis can provide information to prepare budgets in the future. 
  Variance analysis fixed that by establishing actual performance.
  5.1.3. Structure of variance
  The total difference between the budgeted profit and actual profit for a specific 
  period is divided into various parts. These parts relate to material, labour, 
  overhead and sales variances. The particular variances which are computed in 
  any given organization are those which are relevant to its operations.
  The operating profit variance is the difference between budgeted and actual 
  operating profit for a specific period. This variance is the sum of all other 
  variances. i.e. cost variances and sales variances.
  5.1.4. Causes of budget variance
  There are three primary causes of budget variance: errors, changing business 
  condition, and unmet expectations.
  1. Errors by the creators of the budget can occur when the budget is being 
  compiled. There are a number of reasons for this, including faulty math, 
  using the wrong assumptions, or relying on stale or bad data.
  2. Changing business conditions, including changes in the overall economy 
  or global trade, can cause budget variances. There could be an increase 
  in the cost of raw materials or new competitors may have entered the 
  market to create pricing pressure. Political and regulatory changes that 
  were not accurately forecast are also included in this category
  3. Budget variance will also occur when the management team exceeds or 
  underperforms expectations. Expectations are always based on estimates 
  and projects, which also rely on the values of inputs and assumptions built 
  

  into the budget. As a result, variances are more common than company 

  Management Accounting | Experimental Version | Student Book | Senior Six

  managers would like them to be.
  5.1.5. Types of budget variance
  There is a need of knowing types of variance before measuring the variance. 
  Generally ,the variances are classified on the following basis.
  a) On the basis of element of cost
  1. Material variance
  2. Labour variance
  3. Overhead variance
  b) On the basis of controllability
  1. Controllable variance
  2. Uncontrollable variance
  c) On the basis of impact
  1. Favourable variance
  2. Unfavourable variance
  d) On the basis of nature
  1. Basic variance
  2. Sub-variance
  5.1.6. Calculation of budget Variance 
  A brief explanation of the above mentioned variance is presented below
  1. Material variance
  It is the difference between actual cost of material used and the standard cost for 
  the actual output. The difference between the standard cost of direct materials 
  and the actual cost of direct materials that an organisation uses for production 
  is known as Material variance
  Types/Methods of Material cost variances are:
  a) Material cost variance (MCV): It is the difference between the 
  standard cost of materials and actual cost. If actual cost is less than the 
  standard cost, it is a favorable variance and vice versa.
  

   Material cost variance formula:

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  c) Material usage (or Quantity) Variance (MQV): It measures the difference 
  in material cost arising, from higher of less consumption of material than the 
  standard consumption. It is calculated by multiplying the standard Price with the 
  difference between the standard Quantity and actual Quantity
  MUV= (Standard Quantity-Actual Quantity) × Standard Price
  

  Example: The Standard and Actual figures of product ‘Z’ are as under

  
  

  
  

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  c) Material Cost Variance
  

  
  

  d) Material Mix variance (MMV): This variance arises when more than one 
  type of materials is used in manufacturing the product and the quantities of 
  materials issued are not in predetermined proportion. It is that part of direct 
  material usage variance, which is due to difference between the standard and 
  actual composition of a mixture. It is obtained by multiplying the standard price 
  of materials with the difference between revised standard Quantity and the 
  

  Actual Quantity.

  
  

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  hours. But actual wage rate is Frw 22.5 per hour and actual hours used are 12 
  hours
  

  Calculate Labor cost Variance 
  

  
  

  
  

  Management Accounting | Experimental Version | Student Book | Senior Six
  Required: Calculate the following Variances
  a) Labor Rate Variance
  b) Efficiency Variance
  

  c) Total Labor Cost Variance

  
  

  LMV arises due to change in composition of labor force (like mix in material).
  It tells the management how much labor efficiency variance occurs due to 
  change in its composition and thus it a part of labor efficiency variance.
  Its computation is:
  i) If standard composition/mix of time and actual composition of time (time spent 
  by them) is same.
  LMV =Standard cost of standard composition – Standard cost of actual 
  composition
  Or
  Total actual time spent by labour (standard rate per hour of standard mix – 
  

  standard rate per hour of actual mix)

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  Or
  ii) If standard composition/mix of time and actual composition of time is not the 
  

  same

  
  

  
  

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  Fixed Overhead Variance: This is a cost that is not directly related to output; 
  itVolume variance can further be divided into three variances, which are:

  a) Capacity Variance

  b) Calendar Variance

  c) Efficiency Variance

  a) Capacity Variance This is the portion of volume variance that arises due to 

  high or low working capacity. It is influenced by idle time, machine breakdown, 

  strikes or lockouts, or shortages of materials and labor. Thus, Standard rate 

  (Revised units – budgeted hours)

  b) Calendar Variance This variance arises due to the difference in the number 

  of working days when the actual number of working days is greater than the 

  Standard working days. It is regarded as a favorable type of variance. It is 

  expressed in the following way:

  Calendar variance = No. of working days more or less × Standard (st.) 

  rate per unit

  c) Efficiency Variance This is the portion of volume variance that is due to 

  the difference between the budgeted output efficiency achieved. This is due to 

  Labor working efficiency. Thus, it can be expressed as:

  Efficiency Variance = Std. rate (Actual production – Std. production) 

  
  in unit is a general time-related cost. Specially, fixed overhead variance is defined as 
  the difference between standard cost and fixed overhead allowed for the actual 
  output achieved and the actual fixed overhead cost incurred.
  Formula to calculate Fixed Overhead Variance:
  FOV=Actual output ×Standard fixed overhead rate-Actual fixed overheads
  The following are the other variances:
  i. Expenditure Variance
  This shows the over/under absorption of fixed overheads during 
  a particular period. When the actual output exceeds the standard 
  output, it is known as over-recovery of fixed overheads. Expenditure 
  variance (EV) is expressed as follows:
  EV = (Standard overhead – Actual overhead)
  ii. Volume Variance
  It is favorable if the actual output is less than the standard output, and 
  vice -versa.
  This is due to the nature of fixed overheads, which are not expected 
  to change with the change in output. This variance can be expressed 
  
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  as:

  Volume Variance = (Actual output ×Standard rate)-Budgeted 
  fixed overheads
  Volume variance can further be divided into three variances, which are:
  a) Capacity Variance
  b) Calendar Variance
  c) Efficiency Variance
  a) Capacity Variance This is the portion of volume variance that arises due to 
  high or low working capacity. It is influenced by idle time, machine breakdown, 
  strikes or lockouts, or shortages of materials and labor. Thus, Standard rate 
  (Revised units – budgeted hours)
  b) Calendar Variance This variance arises due to the difference in the number 
  of working days when the actual number of working days is greater than the 
  Standard working days. It is regarded as a favorable type of variance. It is 
  expressed in the following way:
  Calendar variance = No. of working days more or less × Standard (st.) 
  rate per unit
  c) Efficiency Variance This is the portion of volume variance that is due to 
  the difference between the budgeted output efficiency achieved. This is due to 
  Labor working efficiency. Thus, it can be expressed as:
  Efficiency Variance = Std. rate (Actual production – Std. production) 
  

  in unit

  Example: Using the information given below compute the fixed overhead cost, 
  

  Expenditure, and Volume variance

  

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  2. Variable overhead Variance

  Variable overheads consist of expenses other than direct material and direct 
  labor which vary with the level of production. If variable overhead consists of 
  indirect materials, then in this case it varies with the direct material used. On the 
  other hand, if variable overhead is depending on number of hours worked then 
  in this case it will vary with labor hours or machine hours. If nothing is mentioned 
  specially then we take labor hours as basis. Variable overhead cost variance 
  calculation is similar to labor cost variance.
  Variable overhead cost variance = (standard variable overhead for 
  production -Actual variable overheads)
  The variable overhead cost variance is divided into two parts 
  Variable overhead expenditure variance
  Variable overhead Efficiency variance
  Variable overhead Expenditure variance= (Standard variable Overheads 
  for actual hours) –(Actual variable overhead)
  Variable overhead Efficiency Variance= (Standard Variable Overheads for 
  production) – (Standard Variable Overheads for Actual Hours)
  Example: From the following information of G ltd,
  

  Calculate i) variable Overhead Cost Variance

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  Total sales margin variance is the difference between the budgeted margin from 
  sales and the actual margin when the cost of sales is valued at the standard 
  cost of production. This is the sum of sales margin price variance and sales 
  margin quantity variance.
  a) Sales Margin Price Variance
  This is that portion of the total sales margin variance which is the difference 
  between the standard margin per unit and the actual margin per unit for the 
  number of units sold in the period.It is calculated as under:
  Sales Margin Price Variance=Actual sales-(Standard selling price-Actual sales 
  quantity)
  Sales Margin Quantity Variance
  This is that portion of the total sales margin variance which is the difference 
  between the budgeted number of units sold and the actual number sold valued 
  at the standard margin per unit. It is calculated as under:
  Sales Margin Quantity Variance=Standard sales Margin or profit (Actual Sales 
  Quantity – Budgeted Sales Quantity)
  

  Example: From the following information, calculate the sales variances

                                         Sales selling price per unit FRW 30 

  
  

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  
  

  Controllable cost variance is a cost variance which can be identified as a primary 
  responsibility of a specified person.
  6. Uncontrollable Variances
  External factors are responsible for uncontrollable variances. The management 
  has no power or is unable to control the external factors. Variance for which a 
  particular person or a specific department or section or division can’t be held 
  responsible are known as uncontrollable variances.
  7. Favourable variances
  

  Whenever the actual costs are lower than the standard costs at per-determined 
  

  level of activity, such variance termed as favourable variances. The management 
  is concentrating to get actual results at cost lower than the standard costs. It 
  
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  shows the efficiency of business operation.
  8. Unfavourable variances
  Whenever the actual costs are more than the standard costs at predetermined 
  level of activity, such variances termed as unfavourable variances. These 
  variances indicate the inefficiency of business operation and need deeper 
  analysis of these variances.
  9. Basic Variances
  Basic variances are those variances which arise on account of monetary rates 
  (i.e.price of raw materials or labour rate) and also on account of non- monetary 
  factors (such as physical units in quantity or time)
  10. Sub Variance
  Basic variance arising due to non-monetary factors are further analysed and 
  classified into sub-variances taking into account the factor responsible for them. 
  Such sub variances are material usage variance and material quantity variance
  5.1.7. Reconciliation Statement budgeted profit with actual 
  profit
  We have discussed above various cost variances and sales margin variances. 
  Sometimes the budgeted profit and actual profit are given and the students 
  are required to reconcile the budgeted profit with actual profit after calculating 
  various variances. The layout of a reconciliation statement is given as under:
  

  Statement showing the reconciliation of Budgeted Profit with Actual Profit

  

  Management Accounting | Experimental Version | Student Book | Senior Six

  
  

  
  

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  
  

  
  

  5.1.8. Accounting entries of Variance

  The difference between Standard and Actual figures are called variances. 
  These variances may be favourable or unfavourable. These are recorded into 
  cost accounts. For this purpose, the following procedures are adopted:
  a) Variance is calculated at the time of occurrence or when the respective 
  elements of cost are charged to production.
  b) Variance accounts are maintained for each type of variance.
  c) Transfers between the work – in- progress, finished goods and cost of 
  sales are made at the standard figures.
  d) Stocks of raw materials, work-in- progress and finished goods are valued 
  at standard cost.
  

  e) Unfavorable price or expenditure variances are credited to the respective 

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  control account and debited to the respective variance account. For 
  example, adverse labor rate variance is debited to the labor rate variance 
  account and credited to wages control account. Similarly, adverse material 
  price variance is debited to material price variance account and credited 
  to stores control account. Favorable price or expenditure variances are 
  debited to respective control account and credited to respective variance 
  account.
  f) Unfavorable usage or efficiency variances are debited to respective 
  variance account and credited to work-in-progress account. For example, 
  adverse material usage variance of adverse labor efficiency variance is 
  debited to material usage variance account or labor efficiency account 
  and credited to W.I.P. account. If the usage or efficiency variances 
  are favorable then debit W.I.P. account and credit respective variance 
  account.
  g) At the end of the year, the balances in the variance accounts are transferred 
  to the profit and loss account. It means adverse variances are debited to 
  the profit and loss account and favorable variances are credited to the 
  profit and loss account.
  Example; ABC Ltd. makes and sells a single product, Z. The company 
  operates a standard cost system and during a period, the following 
  

  details were recorded:

  
  

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  Application activity 5.1
  

  
  

  
  

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  5.2. The use of budgetary control to ensure organization achievement of target
  

  Learning Activity 5.2
  

  Read the following information and answer the question below
  Budgetary control is a system of controlling costs which includes the 
  preparation of budgets, coordination the departments and establishing 
  responsibilities, comparing actual performance with the budgeted, and 
  acting upon results to achieve maximum profitability.
  

  What are the functions of budgets in achieving the goal of an organization?

  5.2.1 Management efficiency with budgetary control
  Budgetary control is known as setting up particular budget by management to 
  know the variation between the company’s actual performance and budgetary 
  performance.
  It is also helps managers utilize these budgets to monitor and control various 
  costs within a particular accounting period.
  Importance of budgetary control is reflected from the fact that it helps the 
  management to efficiently track the company’s performance. Such monitoring 
  ensures that the deviation of the company’s actual performance from the 
  budgeted one is always under the scanner and can be rectified before it too 
  

  late.

  Application activity 5.2

  What are the benefits of having budgetary control mechanism to a 
  

  business?

  5.3. Report and Recommendation to Management
  Read the following information and answer the questions below.
  The reporting to management is a process of providing to various levels of 
  management, so as to enable them judging the effectiveness of their responsibility 
  centres and become a base for taking corrective measures.
  
  Management Accounting | Experimental Version | Student Book | Senior Six
  

  Question: 

  What are the benefits of report and recommendation to management? 
  5.3.1. Report to Management
  Reporting to management can be defined as an organized method of providing 
  each manager with all the data and which he needs for his decision, when 
  he needs them and in a form which aids his understanding and stimulates his 
  action.
  Finally, compile all of the results into a singular report for management. The 
  report should contain the identified variances and the root causes of each 
  variance. It should also contain corrective actions and recommendations for 
  management on what to do.
  5.3.2. Recommendation to Management
  Management recommendations means determinations of, amount of, level of 
  intensity, timing of, any restrictions , conditions , mitigation , or allowances for 
  activities proposed for a project area pursuant to this rule.
  Before approaching management with any recommendation, first point out the 
  following: 
  • Clarify your thoughts through the act writing.
  • Serve as notes you can refer to during your discussion
  

  • Provide your manager with written record to refer to late

  Management Accounting | Experimental Version | Student Book | Senior Six

  Application activity 5.3
  

  
  

  Skills Lab 5

  Students visit the manufacturing company located in their school 
  environment with their teacher. The later requests in favour of students the 
  budget prepared for last 10 months. The planning officer or budget officer 
  provide again the document showing the actual cost incurred. Referring 
  to those two different documents, the students in manageable groups are 
  

  requested to calculate the variance if any and advice the current managers.

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  End of unit assessment 5
  

  
  

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• UNIT6:UNDERSTANDING LOAN / CREDIT POLICY

  Key unit competence: To be able to explain the loan/credit procedures 

  Introductory activity:

  Mr. Nkundurwanda is a business man operating his business in Rwanda in 
  small scale business. Apart of his main activity Mr. Nkundurwanda has family 
  responsibilities which require him more finances. The capital amount of his 
  business amounted to Frw 10,000,000, Due to the progress of his business 
  he is in need of Frw 10,000,000 more which will help his business to grow 
  and continue to expand and operate in different countries. In this process 
  there are many alternatives to deal with this issue and Mr. Nkundurwanda 
  

  needs to find the best one which will meet his needs. 

  Questions;
  What is the activity of Mr. Nkundurwanda?
  What are the challenges do you think that Mr. Nkundurwanda is facing?
  What are the potential alternatives Mr. Nkundurwanda needs to think about 
  to overcome those challenges?
  Among alternatives which one you can you advise Mr. Nkundurwanda to 
  take?
  

  What will be the importance of alternative chosen by Mr. Nkundurwanda?

  Accounting Management | Student Book | Senior Six

  Learning Activity 6.1
  

  
  

  Answer the following questions 

  1) What do you understand about this picture?
  2) What is the role of the bank in this picture?
  

  3) What is the relationship between bank and borrower

  6.1.1. Definition of concepts related to the credit

  a. Credit

  “By credit, we mean the power which one person has to induce another to put 
  economic goods at his deposal for a time on promise or future payment. Credit 
  is thus an attribute of power of the borrower.” Prof. Kinley.
   “Credit is purchasing power not derived from income but created by financial 
  institutions either as on offset to idle income held by depositors in the bank or 
  

  as an addition to the total amount or purchasing power.” Prof. Cole.

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  “The term credit is now applied to that belief in a man’s probability and solvency 
  which will permit of his being entrusted with something of value belonging to 
  another whether that something consists, of money, goods, services or even 
  credit itself as and when one may entrust the use of his good name and 
  reputation.” Prof. Thomas.
  On the basis of those definitions it can be said that credit is the exchange 
  function in which, creditor gives some goods or money to the debtor with a 
  belief that after sometime he will return it. In other words Trust ‟is the Credit‟.
  b. Credit policy
  A credit policy includes detailed guidelines for the size of the loan portfolio, 
  the maturity period of the loan, security against loan, the credit worthiness of 
  the borrower, the liquidation of loans, the limits of lending authority, the loan 
  territory, etc.
  Credit policy provides some directions for the use of funds, to control the size 
  of loans and influences the credit decision of the bank. So, the loan policy is a 
  necessity for a bank.
  In formulating the loan policies, the policy formulators must be very cautious 
  because the lending activity of the bank affects both the bank and the public 
  at large. All the influencing factors should be considered such as Size of loan 
  account; Credit for infrastructure; Types of loan portfolio; Acceptable security; 
  Maturity of the loan; Compensating balance; Lending criteria; Loan territory; 
  Limitations of lending authority.
  c. Credit monitoring
  A good lending is that the amount lent, should be repaid along with interest 
  within the stipulated time. To ensure that safety and repayment of the funds, 
  banker is necessary to follow-up the credit, supervise and monitor it. Credit 
  monitoring is an important integral part of a sound credit management. The 
  bank should always be careful for that fund properly utilized for what it has 
  been granted. Banker keeps in touch with the borrower during the life of the 
  loan. There are some steps from the banker’s point of view, to ensure the safety 
  of advance which are documentation, disbursement of advance, inspection, 
  submission of various statements, annual review and market information.
  d. Credit services 
  It is the business of providing loans, other forms of credits and information about 
  

  credits to people and companies.

  Management Accounting | Experimental Version | Student Book | Senior Six

  e. Credit delivery

  In credit delivery, the borrowers are allowed to draw funds from the account 
  to the extent of the value of inventories and receivables less stipulated margin 
  within the maximum permissible credit limit granted by the bank.
  6.1.2 Types of credit
  The credit assistance provided by a banker is mainly of two types, one is fund 
  based credit support and the other is non-fund based. The difference between 
  fund based and non-fund based credit assistance provided by a banker lies 
  mainly in the cash out flow. Banks generally allow fund based facilities to 
  customers in any of the following manners.
   TRADITIONAL CREDIT PRODUCTS
  • Cash credit
  Cash credit is a credit that given in cash to business firms. It is an arrangement by 
  which, a bank allows its customers to borrow money up to a certain limit against 
  tangible securities or share of approved concern. Cash credits are generally 
  allowed against the hypothecation of goods/ book debts or personal security. 
  Depending upon the nature of requirements of a borrower, bank specifies a 
  limit for the customer, up to which the customer is permitted to borrow against 
  the security of assets after submission of prescribed terms and conditions and 
  keeping prescribed margin against the security.
  • Overdraft:
  A customer having current account, is allowed by the banks to draw more 
  than his deposits in the account is called an overdraft facility. In this system, 
  customers are permitted to withdraw the amount over and above their balances 
  up to extent of the limit stipulated when the customer needs it and to repay it 
  by the means of deposits in account as and when it is convenient. Customer 
  of good standing is allowed this facility but customer has to pay interest on the 
  extra withdrawal amount.
  • Demand loans
  A demand loan has no stated maturity period and may be asked to be paid on 
  demand. Its silent feature is, the entire amount of the sanctioned loan is paid to 
  the debtor at one time. Interest is charged on the debit balance.
  • Term loans
  Term loan is an advance for a fixed period to a person engaged in industry, 
  business or trade for meeting his requirements like acquisition of fixed assets 
  

  etc. The maturity period depends upon the borrower’s future earnings. Next to

  Management Accounting | Experimental Version | Student Book | Senior Six
  

    cash credit, term loans are assumed of great importance in an advance portfolio 
  of the banking system of country.
  • Bill purchased
  Bankers may sometimes purchase bills instead of discounting them. But this 
  is generally done in the case of documentary bills and that from approved 
  customers only. Documentary bills are accompanied by documents of title to 
  goods such as bills of lading or lorry and railway receipts. In some cases, banker 
  advances money in the form of overdraft or cash credit against the security of 
  such bills.
  • Bill discounted
  Banker lends the funds by receiving a promissory note or bill payable at a future 
  date and deducting that from the interest on the amount of the instrument. The 
  main feature of this lending is that the interest is received by the banker in 
  advance. This form of lending is more or less a clean advance and banks rely 
  mainly on the creditworthiness of the parties.
   INNOVATIVE CREDIT PRODUCTS
  Since the liberalization period there have been drastic changes in the way loans 
  have been granted to individual customers and businessmen. The changing 
  pattern of banks from universal to branch banking after the liberalization period 
  also forced banks to adopt easy lending. Technology has supported the 
  development of financial service industry and reduced the cycle of money to the 
  shortest possible duration.
  • Credit cards
  Credit cards are alternative to cash. Banks allow the customers to buy goods 
  and services on credit. The card comprises different facilities and features 
  depending on the annual income of the card holder. Plastic money has played 
  an important role in promoting retail banking.
  • Debit cards
  Debit card can be used as the credit card for purchasing products and also for 
  drawing money from the ATMs. As soon as the debit card is swiped, money is 
  debited from the individual’s account.
  • Housing loans
  Various types of home loans are offered by the banks these days for purchasing 
  or renovating house. The amount of loan given to the customer depends on 
  the lending policies and repayment capacity of the customer. These loans are 
  

  usually granted for a long period.

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  • Auto loans
  Auto loans are granted for the purchase of car, scooter and others. It may be 
  granted for purchasing vehicle.
  • Personal loans
  This is an excellent service provided by the banks. This loan is granted to the 
  individuals to satisfy their personal requirements without any substantial security. 
  Many banks follow simple procedure and grant the loan in a very short period 
  with minimum documents.
  • Educational loans
  This loan is granted to the student to pursue higher education. It is available for 
  the education within the country or outside the country.
  • Loans against securities
  These loans are provided against fixed deposits, shares in the market, bonds, 
  mutual funds and life insurance policy.
  • Consumption loans for purchase of durables
  Banks fulfill the dreams and aspirations by providing consumer durable loans. 
  These loans can be borrowed for purchasing television, refrigerator, laptop, 
  

  mobile, etc.

  6.1.3. Importance of loan
  Credit plays an important role in the gross earnings and net profit of commercial 
  banks and promotes the economic development of the country. The basic 
  function of credit provided by banks is to enable an individual and business 
  enterprise to purchase goods or services ahead of their ability. Today, people 
  use a bank loan for personal reasons of every kind and business venture too. 
  The following are other importance of loan;
  • Exchange of ownership
  Credit system enables a debtor to use something which does not own completely.
  • Employment encouragement
  With the help of bank credit, people can be encouraged to do some creative 
  business work which helps increasing the volume of employment.
  • Increase consumption
  Credit increases the consumption of all types of goods. By that, large scale 
  

  production may be stimulated which leads to decrease cost of production. In 

  Management Accounting | Experimental Version | Student Book | Senior Six

  turn also it lowers the price of product which in result rising standard of living.
  • Saving encouragement
  Credit gives encouragement to the saving habit of the people because of the 
  attraction of interest and dividend.
  • Capital formation
  Credit helps in capital formation by the way that it makes available huge 
  funds to unable people to do something. Credit makes possible the balanced 
  development of different regions.
  • Development of entrepreneurs
  Credit helps in developing large scale enterprises and corporate business. It 
  has also helped the different entrepreneurs to fight against difficult periods of 
  financial crisis. Credit also helps the ordinary consumers to meet requirements 
  even in the inability of payment. 
  • Priority sector development
  Credit helps in developing many priority sectors including agriculture. This 
  has greatly helped in rising agriculture productivity and income of the farmers. 
  Banks in developing countries are providing credit for development of SSI in 
  

  rural areas and other priority sectors too.

  6.1.4. Importance of liquidity management 

  Liquidity refers to the ability of an organization to pay its suppliers on time, 
  meet its obligation costs, such as wages and salaries and to pay longer-term 
  outstanding amounts such as loan repayment. Adequate liquidity is often a key 
  factor in contributing to the success of failure of a business. For example liquid 
  assets include cash, short term deposits, trade receivables and inventories. 
  Those are called Working capital of a business.
  Cash is the most liquid of assets and it is part of working capital of the business. 
  However, the time taken to convert trade receivables into cash and the time 
  taken to pay creditors affect the liquidity position of the business.
  Liquid assets are current asset items that will, or could soon, be converted into 
  cash, and cash itself. Two common definitions of liquid assets are all current 
  assets or all current assets with the exception of inventories.
  The main source of liquid assets for a trading company is Sales. A company can 
  obtain cash from sources other than sales, such as the issue of shares for cash, 
  

  a new loan or the sale of non current assets but company cannot rely on these 

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  and in general, obtaining the liquid funds depends on making sales and profits.
  The management needs to carefully consider the level of investment in working 
  capital and to consider the impact that this is having on a company’s liquidity 
  position; an overview of this is given by the cash operating cycle/working capital 
  cycle.
  Cash operating cycle/working capital cycle is the period of time between 
  the outflow of cash to pay the raw materials and the inflow of cash from 
  customers. The number of days credit taken by accounts receivable has a direct 
  effect on the amount of time money is tied up for in working capital. Therefore, 
  managing the period of credit customers take is vital to the management of the 
  organization’s liquidity.
  6.1.5. Granting loan 
  Granting credit to customers is essential for many organizations and brings 
  many benefits to both organizations and the customers. However, the risks 
  associated with granting credit should be monitored and managed carefully.
  a. Applicant profile
  To make prudent credit decision, bank essentially should know well the borrower 
  well. Without these information bank cannot judge the loan application. 
  Creditworthiness of the applicants is evaluated to ensure that the borrower 
  conforms to the standards prescribed by the bank. It can be said that a loan 
  properly made is half-collected. So, a bank should make proper analysis before 
  making any credit decision. With increasing credit risks, banks have to ensure 
  that loans are sanctioned to „safe‟ and „profitable‟ projects. For this, they need 
  to fine tune their appraisal criteria.
  b. Application form
  It is a document on which the lender bases the decision to lend. A loan 
  application is neither a pledge by the applicant nor a commitment by the lender. 
  It contains essential financial and other borrower information. Detailed business 
  plan, projected income statements showing profit and loss, balance sheet, and 
  cash flow statement are required for a business loan. Loan amount and purpose, 
  period and means of repayment, and guaranties and/or collateral offered are 
  required of a company applying for a loan. Banks generally use standard forms 
  for the applicant to fill-in. It is also known as credit application.
  c. Information required for granting credit
  When assessing the credit status of either on established or a new customer 
  there are a range of sources of information that the credit controller can use.
  
  Management Accounting | Experimental Version | Student Book | Senior Six
  Some are external to the business and others are internal to the business.
  The credit controller needs to consider the customer’s ability and willingness 
  to pay within the stated credit terms and also that the customer will remain 
  solvent. No single source of information can guarantee either of these but there 
  are varieties of sources which can be pooled for a final decision on credit status 
  to be made
  External sources: Bank Reference, Trade reference, Credit reference agencies, 
  Office of Register General, Management accounts from the customer, Media 
  publication, Internet searches.
  Internal sources: Staff knowledge communicated by conversations, emails, 
  meetings, customer visit, financial analysis of either external published financial 
  statements or internal management and previous trading history.
  
  6.1.6. Evaluating credit worthiness 
  
  The purpose of analyzing the financial statements for credit control assessment 
  is to find the indicators of the customer’s performance and position in four main 
  areas as follow:
  Profitability Indicators; Liquidity indicators; Debt indicators; Cash flow indicators
   Profitability Ratios
  When credit has been granted one major concern will be the profitability of the 
  customer. If the customer is not profitable in the long term then it will eventually 
  go out of the business and this may mean a loss, in the form of an irrecoverable 
  debt, if it has been granted credit.
  Gross profit margin: Gross profit/Revenue*100% It shows how profitable the 
  trading activities of business are.
  Net profit margin: PAT/Revenue*100%. It indicates the overall profitability of 
  the business
  Return on capital employed (ROCE): Net profit/Capital employed*100%
   Net asset turnover: Capital employed/Revenue. It measures the number of 
  times that revenue represents capital employed (or net assets).
  Liquidity Ratios
  The purpose of calculating liquidity ratio is to provide indicators of the shortterm and
   medium-term stability and solvency of the business. It is also to assess 
  

  if the business can pay its debts when they fall due. There are two overall ratios:

  Management Accounting | Experimental Version | Student Book | Senior Six

  Current ratio: Current assets /Current Liabilities. Ideal ratio is 2:1
  Quick ratio or acid ratio: (Current assets-Inventory)/Current liabilities. Ideal ratio 
  is 1:1
  Gearing Ratios
  When assessing a customer’s credit status, the credit controller will also be 
  concerned with the longer-term stability of the business. One area of anxiety 
  here is the amount of debt in the business ‘ capital structure and its ability to 
  service this debt by paying periodic interest charges.
  Main measures are: 
  Gearing ratio= Long term debt/ (Long term debt + Equity)*100%. Is a measure 
  of the proportion of interest-bearing debt to the total capital of the business.
  Interest cover = Profit before interest and tax / Interest. It is calculated as the 
  number of times that the interest could have been paid, it represents the margin 
  of safety between the profits earned and the interest that must be paid to service 
  the debt capital.
  Credit scoring
  Credit scoring is a method of assessing the credit worthiness of an individual 
  or organization using statistical analysis and is used by the organizations such 
  as banks, utility companies, insurance companies and landlords to assess the 
  ability of an individual or organization to repay any loans or pay for services or 
  goods.
  A credit score is a number ranging from 300-850 that depicts a consumer’s 
  creditworthiness. The higher the credit score, the more attractive is the borrower. 
  A credit score is based on credit history such as number of open accounts, total 
  levels of debt, and repayment history. 
  Lenders use credit scores to evaluate the probability that an individual will repay 
  loans in a timely manner.
  Your credit score, a statistical analysis of your creditworthiness, directly affects 
  how much or how little you might pay for any lines of credit you take out.
  Illustration
  A company has share capital of Frw 200million, resources totaling Frw 188million 
  and a loan of Frw 100 million . The net profit for the year is Frw 45million, after 
  

  deducting depreciation of Frw 12 million and interest of Frw 6million.

  Management Accounting | Experimental Version | Student Book | Senior Six

  Solution:

  Opening a new customer account
  Once a decision has been made to grant credit to a customer then a file and 
  account in the trade receivable ledger must be set up. 
  The following information will be required: Business name of the customer; the 
  contract name and title within the customer’s business; business address and 
  telephone number; the credit limit agreed upon; the payment terms agreed.
  
  Refusal of credit
  
  The credit controller may decide that it is not possible to trade with a new 
  potential customer on credit terms.
  It is a big decision for the credit controller as the business will not wish to lose 
  this potential customer’s business but the credit controller will have taken a 
  view that the risk of non- payment is too high for credit terms to be granted.
  It simply means that on the evidence available to the credit controller, the chance 
  of non-payment is too high for the company to take the risk.
  The reasons are the following:
  A non-committal or poor bank reference
  Poor trade references
  Concerns about the validity of any trade references submitted
  Adverse press comment about the potential customer
  Poor credit agency report
  Indications of business weakness from analysis of financial statements
  Lack of historical financial statements available
  Information from a member of the business’s credit circle
  The credit controller will consider all the evidence available about a potential 
  customer and the reason for the refusal of credit may be due to a single factor 
  noted above or a combination of factors.
  
  Communication of changes or refusal
  
  If a credit facility is to be changed or not granted to a potential customer then 
  

  this must be communicated in a tactful and diplomatic manner. The reason for

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  the change or refusal of credit must be politely explained and any future actions 
  required from potential customer should also be made quite clear.
  Communication method
  It is common to communicate the reasons for the refusal of credit in a letter 
  initially. In the letter the credit controller may suggest that a telephone call may 
  be appropriate in order to discuss the matter and any future actions.
  6.1.7. Terms and conditions associated with Overdraft and 
  loan 
  Most of us are familiar with the concept of an overdraft, which is a form of 
  short-term borrowing from the bank, available to both business and personal 
  customers. The overdraft allows the account holder to continue withdrawing 
  money even when the account has no funds in it or has insufficient funds to cover 
  the amount of withdrawal. If a bank is approached for an overdraft, then it will 
  normally agree an overdraft facility. This is the amount by which the business’s 
  account is allowed to be overdrawn. It is then up to the customer to determine 
  how much of this overdraft facility is to be used by having an actual overdraft. 
  And loan is credit facility under which a bank allows funds withdrawn to exceed 
  fund deposited in accordance with specified terms and conditions
  Among the terms and conditions associated with overdraft and loan application, 
  it should be disposed within a reasonable period of time and state specific time 
  period from the date of acknowledgement, within which the decision on loan 
  request will be conveyed to the borrower.
  In case of rejection, specific reasons should be conveyed in writing. Credit limits 
  which may be sanctioned may be mutually settled.
  Terms and conditions governing credit facilities such as margin security should 
  be based on due diligence and creditworthiness of borrower.
  Lender should ensure timely disbursement of loans sanctioned.
  Lender should give notice of any change in the terms and conditions including 
  interest rates and service charges.
  6.1.8. Types of investments, risks and their terms and conditions
  There are five major factors to be considered when any investor chooses 
  

  investments

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  
  

  a. certificate of deposit (CD)

  A certificate of deposit is a document issued by a bank or building society 
  which certifies that a certain sum, has been deposited with it, to be repaid on a 
  specific date. The term can range from seven days to five years but is usually for 
  six months. CDs are negotiable instruments which means, they can be bought 
  and sold. Therefore, if the holder does not want to wait until the maturity date, 
  the CD can be sold in the money market. CDs offer a good rate of interest, are 
  highly marketable and can be liquidated at any time at the current market rate. 
  The market in CDs is large and active; therefore they are an ideal method for 
  investing large cash surpluses.
  b. Government securities 
  • Bills of exchange
  A bill of exchange can be defined as an unconditional order in writing from 
  one person to another, requiring the person to whom it is addressed to pay a 
  specified sum of money, either on demand (a sight bill) or at some future date (a 
  term bill). A cheque is a special example of a type of bill of exchange. 
  • Trading in bills of exchange 
  Most bills of exchange are term bills with a duration or maturity of between two 
  weeks and six months and can be in any currency. If one company draws a bill 
  on another company, this is known as a trade bill. However, the market in these 
  is small. Most bills are bank bills, which are bills of exchange drawn and payable 
  by a bank, the most common of these is known as a banker’s acceptance. There 
  is an active market in such bills and a company with surplus cash could buy a 
  bill of exchange at a discount and either hold it to maturity or sell it in the market 
  before maturity again at a discount. The difference between the price at which 
  the bill is purchased and the price at which it is sold or it matures is the return
  

  to the investor. Commodities (Gold) are physical products such as gold. They 

  arQuestions:

  What do you observe on the above picture?

  Explain the function of each image found in this picture

  After watching careful this picture is there any relationship between the 

  images in the picture?e traded on commodity exchanges where standard contracts are bought and 

  sold.

  c. Shares Equity

  An Equity investment is generally the purchase of shares in another company. 
  Often this takes place through a stock market. Income is from dividend payments 
  and capital gains on the increase in the share value.
  Investments in companies that are traded on a stock exchange are very easily 
  sold, so these are a relatively liquid form of investment. However, unless 
  the investment is a speculative one, in anticipation of a rapid increase in the 
  company’svalue, investments in equity are normally held for longer periods.
  Property and land
  Investing in property and land is generally a very safe investment. However, 
  the costs of maintaining and generating an income from property and land are 
  higher than for other forms of investment.
  These are generally long-term investments due to the costs and time associated 
  with purchasing and selling land and property.
  
  Diversification and types of investment
  
  A business should aim to create a diversified portfolio of investments, with 
  a spread of risk and return. Marketable securities can be ranked in order of 
  increasing risk and increasing expected return.
  Government securities Low risk
  Other ‘public’ corporation stocks
  Company loan stocks
  Other secured loans
  Unsecured loans
  Convertible loan stocks
  

  Preference shares

  Equities   High risk

  Management Accounting | Experimental Version | Student Book | Senior Six

  Government stock

  The risk of default is negligible and hence, this tends to form the base level for 
  returns in the market. The only uncertainty concerns the movement of interest 
  rates overtime, and hence, longer dated stocks will tend to carry a higher rate 
  of interest.
  Company loan stock
  Although there is some risk of default on company loan stock (also called 
  corporate bonds), the stock is usually secured against corporate assets.
  CDs and Bills of Exchange
  The riskiness of CDs and bills of exchange varies with the creditworthiness 
  of the issuers. They are riskier than government securities, but less risky than 
  

  shares.

  Application activity 6.1.
  

  Questions 

  8. Give and explain the types of loans
  9. What is the purpose of analyzing financial statements in evaluating 
  the credit worthiness? 
  10. Discuss the importance of liquidity management 
  11. List external sources of available external information which help to 
  understand creditworthiness? 
  

  12. What do you understand by A certificate of deposit (CD)?

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  6.2. Effect of legislation to credit control
  

  Learning Activity 6.2
  

  
  

  
  

  
  

  Questions:

  What do you observe on the above picture?
  Explain the function of each image found in this picture
  After watching careful this picture is there any relationship between the 
  

  images in the picture?

  6.2.1. Law legislating the credit and remedies for breaches

  a. Relevant contract law and remedies for breaches
  • What is a contract?
  A contract is a legally enforceable agreement between two or more parties.
  Main elements of contract: Agreement; Consideration and Intention to create 
  legal relations
  

  • The importance of contract

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  The importance of contract law is that if a contract is made between two parties 
  and if one party does not satisfactory carry out its side of the agreement, the 
  other party can take the defaulting party to court for breach of contract.
  The following are the main legal contract elements
  a) Offer: An offer is the beginning of a contract.
  b) Acceptance. An offer can be accepted in writing, in person or over 
  the phone. Volunteer of each group to operate or Free Consent of each 
  group. 
  c) Consideration. Consideration is something of value that the parties are 
  contracting to exchange.
  d) Mutuality of obligation; each contracted party has reciprocal duties 
  and responsibilities, one to another. 
  e) Competence/Capacity: Competent parties who have the legal capacity 
  to contract. By this each party legally assign what is able to do to another 
  and to the business concerned. 
  

  f) Legality: all job contracts must be legal tender.

  An invitation to treat

  Care must be taken to distinguish between an offer and the invitation to treat. 
  An invitation to treat is an invitation by the seller of goods for the buyer to make 
  an offer to buy them at that price. Examples are advertisements, catalogues, and 
  the price tickets displayed on goods.
  Duration of an offer
  
  If an offer is made then it does not have to remain in place indefinitely. There are 
  a number of ways in which an offer can be brought to an end:
  If there is a set time period for an offer, then the offer will lapse at the of time 
  period. If there is no express time period set then the offer will lapse after a 
  reasonable period of time.
  
  An offer can be revoked by the offeror at any point in time before it has been 
  accepted. Revocation of an offer means that the offer is at cancelled.
  An offer comes to an end if it is rejected. An offer can be rejected by a counter 
  offer. Eg. If an offer is made to sell an item for Frw 1M and the offeree replies 
  to say that he will buy at Frw 0.9M this is a rejection of the original offer to seller.
  The offer comes to an end when a valid acceptance is made.
  

  Acceptance of an offer

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  The acceptance of an offer must be absolute and unqualified
  Acceptance can be made verbally or in writing
  If an offer requires a particular form of acceptance (such as verbal, in writing or 
  by fax) then this is the form in which the acceptance must be made.
  It must be unqualified- if any additional conditions or terms are included in an 
  acceptance then takes the form of counter-offer, which rejects the original offer.
  Value
  The second required element of a contract is that of there being some value. 
  The basis of contract law is that we are dealing with a basis of contract law is 
  that we are dealing with a bargain of some sort, not just a promise by one of the 
  parties to a contract to do something.
  What is required for there to be a valid contract is known in legal terms as 
  consideration. Consideration can be thought of as something given, promised 
  or done in exchange for the action of the other party.
  In terms of business transactions, the consideration given for a sale of goods is 
  either the money paid now or the promise by a receivable to pay at a later date.
  Both parties must bring something of value to the contract for it to be legally 
  binding i.e. valid. It can be item or service.
  Unilateral Contracts
  Most contracts are known bilateral Contracts meaning that two persons or 
  parties have taken action to form a contract. Unilateral Contracts involve an 
  action undertaken by one person or a group alone. In contract law, Unilateral 
  Contracts allow one person to make a promise, so only they are under an 
  enforcement obligation
  A common example is with the insurance contracts, the insurance company 
  promises it will pay the insured person a specific amount of money if certain 
  event happens. If the event doesn’t happen, the company won’t have to pay. The 
  insured party doesn’t make any promise and to his part of the deal, only needs 
  to pay the insurance premium.
  Defective contracts
  There are situation in which an apparent contract will only have limited legal 
  effect or even no legal effect at all.
  A void contract is not a contract at all. The parties are not bound by it and if they 
  transfer property under it, they can sometimes recover their goods even from a
  
  Management Accounting | Experimental Version | Student Book | Senior Six
  

  third party. This normally comes about due to some form of common mistakes 
  on a fundamental issue of the contract.
  A voidable contract is contract which one party may set aside. Property 
  transferred before avoidance is usually irrecoverable from a third party. Such 
  contracts may be with minors, or contracts induced by misrepresentation, duress 
  or undue influence. In these cases, it can be deemed that a party did not have 
  legal capacity to consent to a contract. For instance here can be intoxication, 
  mental health impairment or being too young to enter into contract. A contract 
  may be voidable due to coercion; this is where one party to the contract may be 
  using behaviors towards the other party.
  An unenforceable contract is a valid contract, property transferred under it cannot 
  be recovered, even from the other party to the contract. However, it either party 
  refuses to perform or to complete their part of the performance of the contract, 
  the party cannot compel them to do so. A contract is usually enforceable when 
  the required evidence of its terms, for example written evidence of a contract 
  relating to land, is not available. 
  Terms in a contract
  Legally, different terms of a contract have different effects.
  Express terms are terms that are specifically stated in the contract and are 
  binding on both parties.
  Conditions are terms that are fundamental to the contract and if they are broken 
  then the party breaking them will be in breach of contract and can be sued for 
  damages. The injured party can regard the contract as is ended.
  Warranties are less important terms in a contract. If any of these are not fulfilled 
  then there is a breach of contract but the contract remains in force. The injured 
  party can still claim damages from the court for any loss suffered but he cannot 
  treat the contract as is terminated.
  Implied terms are terms of a contract which are not specifically stated but are 
  implied in such a contract, either by trade custom or by law.
  Remedies for breach of contract
  A breach of contract arises where one party to the contract out of its side of the 
  bargain, such as a credit customer who does not pay. The following are some 
  of the remedies: 
  Action for the price- a court action to recover the agreed price of the goods/
  

  services

  Management Accounting | Experimental Version | Student Book | Senior Six

  Monetary damages- compensation for loss
  Termination-one party refusing to carry on with the contract
  Specific performance-a court order that one of the parties must fulfill its 
  obligations
  Quantum merit -payment ordered for the part of the contract performed
  Injunction- one party to the contract being ordered by the court not to do 
  something
  In terms of credit customer not having paid for goods or services provided, the 
  most appropriate remedy would normally be an action for the price.
  
  6.2.2. Terms and conditions associated with granting credit
  
  The credit terms offered to a customer are part of the agreement between the 
  business and the customer and as such should normally be in writing. The terms 
  of credit are the precise agreements with the customer as to how and when 
  payment for the goods should be made. The most basic element of the terms 
  of credit is the time period in which the customer should pay the invoice for the 
  goods. There are a variety of ways of expressing these terms as follow:
  Net 10/14/30 days- Payment is due 10 or 14 or 30 days after delivery of the 
  goods.
  Weekly credit-all goods must be paid for by a specific date in the following 
  week.
  Half-monthly credit-all the goods delivered in one-half of the month must be 
  paid for by a specified date in the following half-month.
  Monthly credit-all goods delivered in one month must be paid for by a specified 
  date in the following month.
  Settlement and cash discounts
  In some cases customers may be offered a settlement discount or cash discount 
  for payment within a certain period which is shorter than the stated credit period.
  The terms of such a settlement discount may be expressed as:
  Net 30 days, 2% discount for payment within 14 days. This means that the 
  basic payment terms are that the invoice should be paid within 30 days of its 
  date but that if the payment is made within 14 days of the invoice date a 2% 
  discount can be deducted. It is up to the customer to decide whether or not to 
  

  take advantage of the settlement discount offered.

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  6.2.3. Data Protection law

  Data Protection law is becoming increasingly onerous in the modern, digital 
  world. For instance, in Europe, the new General Data Protection Regulation 
  legislation(GDPR) places significant responsibilities on companies to safeguard 
  the data they use, and only to keep personal data that is authorized to be kept 
  ,and is current, complete and accurate.
  
  Due to mounting international regulation, pressure is being exerted on Rwandan 
  economy to improve regulations, to in turn protect its key export markets.
  Recently adopted legal frameworks in Rwanda exclusively focus on security 
  and confidentiality of electronic communication data, leaving aside all other 
  categories of personal data. In Rwanda, there is information and communication 
  Technology law that provides that ‘Every subscriber or user’s voice or data 
  communications carried by means of an electronic communication network or 
  service must remain confidential to the subscriber and or user for whom the 
  voice or data is intended (ICT, 2016:art 124), but development of the law and 
  regulation is ongoing.
  
  General Data Protection Regulation (GDPR) is the latest European regulation 
  relating to data protection, which more strictly enforces data subject rights and 
  significantly increases the potential fines for breaches.
  What follows may be considered best practice based on the General Data 
  Protection Regulation requirements:
  What is personal data?
  The GDPR applies to the processing data that is:
  Wholly or partly by automated means or 
  The processing other than by the automated means of personal data which 
  forms part of, or is intended to form part of, a filing system.
  
  What are identifiers and related factors??
  
  An individual is ‘identifiable’ if you can distinguish him from other individuals.
  A name is the most common means of identifying someone. However, whether 
  any potential identifier actually identifies an individual depends on the context.
   GDPR provides non-exhaustive list of identifiers, including:
  Name
  

  Identification number, location, data and 

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  An online identifier 
  An online identifier includes IP address and cookie identifiers which may be 
  personal data. Other factors can identify an individual.
  There will be circumstances where it may be difficult to determine whether data 
  is personal data. If this is the case as a matter of good practice, you should treat 
  the information with care, ensure that you have a clear reason for processing the 
  data and, in particular, ensure you hold and dispose of it securely.
  Inaccurate information may still be personal data if it relates to an identifiable 
  individual
  
  Eight principles of good practice
  
  Information should be:
  Fair and lawfully processed 
  Processed for limited purposes
  Adequate, relevant and not excessive
  Accurate and up to date
  Not kept for longer than necessary
  Processed in line with the data subject’s rights
  No transferred to countries elsewhere unless such data is adequately protected 
  in those countries
  
  6.2.4. Legal and administrative procedures for debt collection 
  Restitutionary and compensatory damages
  Restitutionary damages aim to strip from a wrongdoer, any gains made by 
  committing a wrong or breaching a contract. They are concerned with the 
  reversal of benefits that we have been earned unjustly by the defendant at the 
  expense of the claimant.
  If the monetary remedy or damages is to be the loss made by the claimant, these 
  are known compensatory damages and are intended to provide the claimant 
  with the monetary amount necessary to replace what was lost and nothing 
  

  more. Common examples are loss of wages or income.

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  Bringing a dispute to court

  If it is decided that the only course of action to recover money owed by a credit 
  customer is that of legal action, then the first step is to instruct a solicitor. The 
  solicitor will require details of the goods or services provided, the date the liability 
  arose, the exact name and trading status of the customer, any background 
  information( Such as disputes in the past) and a copy of any invoices that are 
  unpaid.
  Which court?
  Outstanding amounts owed to an entity are civil claims. Uncomplicated claims 
  with a similar value will be dealt with in the local district court. Larger and more 
  complex claims will be heard provincial courts.
  
  Methods of receiving payment under a court order
  Once there has been a court order that the money due must be paid, there are 
  

  a number of methods of achieving this.

  
  

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  
  

  6.2.5. Bankruptcy and insolvency

  Bankruptcy arises when an individual cannot pay his or her debts and is declared 
  bankrupt. Insolvency is where a company cannot pay its debts as they fall due.
  
  Petition for bankruptcy
  
  A statutory demand can be issued for a payment of the amount due within a 
  certain period of time. This may result in the customer offering a settlement. 
  If, however, there is no settlement offer from the customer a petition for a 
  bankruptcy will be received from the court.
  Once the individual has received the statutory demand they have 21 days, either 
  to pay the debt or reach an agreement to settle the outstanding amount.
  There are time limits in making a statutory demand and these are:
  The demand should be made within four months of the debts. If the debt is older 
  than four months a court has to be contracted to explain the reasons behind 
  the delay.
  Normally a statutory demand cannot be made after six years have elapsed.
  Consequences of a petition for Bankruptcy
  The consequences of a petition for bankruptcy against receivables
  If the customer pays money to any other suppliers or disposes of any property 
  then these transactions are void.
  Any other legal proceedings relating to the customer’s property or debts are 
  suspended. 
  An interim receiver is appointed to protect the estate.
  Consequences of a bankruptcy order
  The following are among others:
  

  The official receiver takes control of assets

  Accounting Management | Student Book | Senior Six
  

  A statement of the assets and liabilities is drawn up-this is known as statement 
  of affairs.
  The receiver summons a meeting of creditors of the individual within 12 weeks 
  of the bankruptcy order.
  The creditors of the individual appoint a trustee in bankruptcy.
  The assets are realized and a distribution is made to the various creditors.
  The creditor who presented the petition does not gain any priority for payment 
  

  over other creditors.

  Order of distribution of assets

  The assets of the bankrupt will be distributed in the following order:
  Secured creditors
  Bankruptcy costs
  Preferential creditors such as employees, pension schemes, government taxes 
  payable
  Unsecured creditors, such as trade payables
  The bankrupt’s spouse
   The bankrupt
   Insolvency
  The process of insolvency for a company that cannot pay its debts as they 
  fall due is similar to that of a bankrupt individual; there are 2 main options for 
  companies
  Liquidation
  Administration
   Liquidation
  In liquidation the company is dissolved and the assets are realized, within 
  debts being paid from the proceeds and any excess being returned to their 
  shareholders. This process is carried out by a liquidator on behalf of shareholders 
  and/or creditors. The liquidator’s job is simply to ensure that the creditors are 
  paid and once this is done the company can be wound up. Again, unsecured 
  creditors are a long way down the list of who is paid first, therefore there may 
  

  be little left in the pot.

  Management Accounting | Experimental Version | Student Book | Senior Six

  Administrative receivership

  An alternative to liquidation is that the shareholders, directors or creditors can 
  present a petition to the court for an administration order. The effect of this is that 
  the company continues to operate but an insolvency practitioner (administrator) 
  is put in control of it, with the purpose of trying to save the company from 
  insolvency, as going concern - or at least achieve a better result than liquidation.
  Administrative receivership is a process whereby a creditor can enforce security 
  against a company’s assets in an effort to obtain repayment of the secured 
  debt. It used to be the most popular method of obtaining payment by secured 
  creditors, but legislative reforms have reduced its significance.
  Administrative receivership differs from liquidation in that an administrative 
  receiver is appointed over all of the assets and undertakings of the company. 
  This means that an administrative receiver can normally only be appointed by 
  the holder of a floating charge. Usually an administrative receiver will be an 
  accountant with considerable experience of insolvency matters.
  
  Retention of title clause
  
  A ‘retention of title’ clause can be written into agreements with customers. 
  Such a clause expressly states that the buyer doesn’t obtain ownership of the 
  goods unless and until payment is made. Accordingly, if the buyer goes out of 
  business before paying for the goods, the supplier can retrieve them. If payment 
  is not made goods can be stopped in transit and a lien secured on the goods 
  by the seller.
  Official receivers do not need the authority of an insolvency practitioner to 
  determine if a claim is valid. If an official receiver sells goods that are subject to 
  a valid retention of title claim then the supplier can sue the official receiver for 
  

  damages as ownership of the goods still belong to the supplier

  Application activity 6.2
  

  1. Describe the role of a contract in law legislating the credit
  2. Discuss on Terms and conditions associated with granting credit
  

  3. Enumerate Legal and administrative procedures for debt collection

  Skills Lab 6
  

  Student will visit a bank operating nearest the school especially in the 
  credit department and ask questions related to the credit with the aim of 
  knowing the procedure or the process of offering the credit and the low 
  

  legislating the credit.

  End of unit assessment 6
  

  Question :

  Discuss on Importance of liquidity management 
  What is the purpose of analyzing the financial statements evaluating credit 
  worthiness?
  It is known that the relationship between a seller of goods and a buyer of 
  goods is a contract what is a contract and what is its importance in Law 
  legislating the credit and remedies for breaches?
  

  Discuss on Bankruptcy and insolvency in

  
  

  
  

  
  

   

• UNIT7:CREDIT MONITORING SERVICES

  Question :

  What do you understand about Irrecoverable and doubtful debts?

  In debt collection process it is advised to use telephone call when 

  you are collecting debts from customers, what are elements a 

  particular attention should be given to?

  After explaining a reminder letter, explain when a final reminder 

  letter should be used in debt collection process!

  Key unit competence: To be able to evaluate credit recovery

  Introductory activity:

  
  

  Questions:

  1. How many images found in this introductory activity?
  2 What is the function of each image in this introductory activity
  

  3. In summary what this image tells you?

  Management Accounting | Experimental Version | Student Book | Senior Six

  7.1.Monitoring Credit
  

  Learning Activity 7.1
  

  
  

  NTRODUCTION 

  TO ACCOUNTING

  Management Accounting | Experimental Version | Student Book | Senior Six

  7.1.Monitoring Credit

  QUESTION:

  How many individuals found in this image?
  What do you think is the function of the business man and other individuals 
  in the same image
  What do you think the business man is looking for?
  In summary what this Image is talking about?
  
  

  7.1.1. Credit service 

  Credit represents an agreement to receive goods, services or money now and 
  pay for them in the future.
  Only you can decide how to spend your money and whether you will use credit. 
  These decisions should be based on your ability to repay credit debt, not just on 
  what you want to buy at the moment. To help you decide whether to use credit, 
  consider the advantages of credit.
  

  Advantages of Credit

    Management Accounting | Experimental Version | Student Book | Senior Six 

  Using credit has some advantages.

  Convenience: Using credit cards when you travel or shop is more convenient 
  than carrying cash. It also provides a handy record of transactions. Using a 
  credit card also may give you some bargaining power if there is a dispute or 
  disagreement involving a purchase.
  Use other people’s money: During the time between when you buy something 
  with credit and when you pay the bill, you’re actually using someone else’s 
  money rather than your own cash.
  Meet emergencies: Unexpected costs such as car repairs or health needs 
  can be met quickly with credit.
  Use something while you pay for it: You can enjoy using something you 
  need as you pay for it.
  Get something you can’t afford now: If you can’t afford to pay cash for a car 
  or other large purchase, using credit allows you to get it now.
  May get better service on something bought on credit: If you haven’t paid 
  for something entirely and a problem arises, it may be easier to get the service 
  needed.
  Take advantage of sales: If you truly have a need for something on sale and 
  don’t have the cash to get it, credit allows you to get it now.
  7.1.2. Age analysis and Financial Ratios
  In the age analysis and financial ratios, we consider the regular monitoring of 
  receivables to identify any potential issues. This may in turn prompt a more indepth enquiry similar to the initial granting of credit decision.
  Transactions with credit customers
  Once it has been agreed with a customer that they may trade on credit terms 
  with the business, an account will be set up for that customer in the receivables 
  ledger. The entries in this account will be invoices and credit notes sent to the 
  customer and receipts from the customer.
  One of the roles of the credit control team will be to monitor, on a regular basis, 
  the transactions on each receivable’s account and, in particular, the balance on 
  the account
  

   Placing an order

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  The first step in monitoring of a credit customer’s activities is at the initial stage 
  of each transaction when the customer places an order for more goods. When 
  the initial agreement was made with the customer to trade on credit terms, a 
  credit limit will have been set by the credit controller for that customer.
  Credit limit refers to the maximum amount that should be outstanding on the 
  customer’s account in the receivables ledger at any point in time.
  When a customer places an order, check that value of the order does not take 
  the customer’s account over their credit limit. If the value of the order means that 
  the customer’s balance exceeds the credit limit then this must be discussed 
  with customer. 
   Review of customer account
  As well as checking that each order does not mean that the customer’s balance 
  exceeds their credit limit, each customer’s account should be monitored on a 
  regular basis. The review should involve looking for debts that are not being 
  paid within the stated credit terms and old debts that have not been paid at all.
  In order for this review of customer accounts to be meaningful, it is important 
  that the customer accounts are kept up to date and accurate so that the correct 
  balance and position can be seen at any point in time.
  Aged receivables analysis
  An aged receivables analysis is a method of internal communication that splits 
  the total balance on a customer’s account into amounts which have been 
  outstanding for a particular period of time. For example:
  Current-up to 30 days
  31 to 60 days
  61 to 9 days
  Over 90 days
  Using the aged receivables analysis
  The regular review of the aged receivables analysis should highlight the following 
  potential problems
  Credit limit exceeded
  Slow payer
  Recent debts cleared but older outstanding amounts
  
  Management Accounting | Experimental Version | Student Book | Senior Six
  Old amounts outstanding but no current trading
  Credit limit exceeded
  If the review of the aged receivables analysis indicates that a customer’s 
  credit limit has been exceeded then this must be investigated. If a customer 
  is highlighted in the aged receivables analysis as having exceeded his credit 
  limit then, normally the customer will be told that no further sales will be made 
  to him until at least some of the outstanding balances have been paid. In some 
  circumstances, liaison between the receivables ledger and the sales department 
  may result in an increase in the customer’s credit limit.
  Slow payers
  Some business can be identified from the aged receivables listing as being 
  slow payers: they always have amounts outstanding for, say 31-60 days and 
  61-90 days, as well as current amounts.
  In these cases consideration should be given to methods of encouraging the 
  customer to pay earlier. This could be in the form of a reminder letter or telephone 
  call or perhaps the offer of a settlement discount for earlier payment.
  Reminder letter: A reminder letter is a formal communication to encourage 
  payment.
  Recent debts cleared but older amount outstanding
  
  If a customer is generally a regular payer and fairly recent debts have been 
  cleared, but there is still an outstanding, this will normally indicate either a query 
  over the amount outstanding or a problem with the recording of the invoices, 
  credit notes or payment received. 
  Old amounts outstanding and no current trading
  This situation would be of some concern for the credit control team. It would 
  appear that the customer is no longer buying from the business but still owes 
  money from previous purchases. In this case the customer should be contacted 
  immediately and payment sought. If no contact can be made with the customer, 
  or there is a genuine problem with payment (such as bankruptcy or liquidation) 
  consideration should be given to writing off the debts as irrecoverable.
  The 80/20 Rule
  The 80/20 Rule is a generally observed effect. In general, 80% of the value of 
  amount owed by the customers will be represented by 20% of the customer 
  

  accounts.

  Management Accounting | Experimental Version | Student Book | Senior Six

  According to The 80/20 Rule, if the largest accounts (making up 20% of 
  customers) are reviewed frequently, this should mean that approximately 80% 
  of the total of receivables balances is regularly reviewed.
  The remaining smaller balances, making up only 20% of the receivables total, 
  can then be reviewed on a less-frequent basis.
  This is not an absolute law but just an observed tendency-all it means is that 
  population of data have concentrations-there is no reasons why it should be 
  exactly 80/20-it could be 70/30 for instance.
  Materiality
  Materiality is another approach when analyzing the receivables is to prioritize 
  the receivables ledger by taking into account the materiality or significance of 
  the debt. Thus, overdue debts below a certain amount should be ignored until 
  larger, more significant debts have been pursued as priority.
  This allows specific areas to be targeted by the credit control function of a 
  business to minimize losses due to irrecoverable debts or to improve cash flow. 
  It also takes into account that some debts may not be worth pursuing as the 
  time and costs involved may outweigh the likely benefits.
  Increase in credit limit
  There will be occasions when a customer specifically requests an increase in 
  credit limit. It may happen that the customer wishes to place an order which 
  will exceed the credit limit. The aged receivables listing can be a useful tool 
  in making a decision about any increase in credit limit, as it allows the credit 
  controller to see the trading history of the customer, whether or not they have 
  kept within their current limit in the past and paid according to their credit terms.
  Period of credit: It can be useful for a business to be able to determine the 
  average period of credit taken by its customers in total. If those figures are 
  compared over time then any improvement or deterioration of credit control 
  procedures can be observed. The most common method of measuring the 
  average period of credit is using the accounts receivable collection period.
  7.1.3. Incidence of Bad and doubtful debts
  
  The aged receivables analysis can also be used to identify debts which might 
  be irrecoverable. These consist of ‘bad’ or ‘irrecoverable debts’. Any debts that 
  are not paid will, of course, have a negative impact on the cash flow of the 
  organizations as working capital will be reduced by the comparative amount of 
  

  balances unpaid.

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  rrecoverable and doubtful debts: An irrecoverable debt is one where it is almost 
  certain that the monies will not be received. A doubtful debt is one where there 
  is some doubt over the eventual receipt of the money, but it is not such a clear 
  case as an irrecoverable debt. The reason for the distinction between the two 
  is that in the financial accounting records an irrecoverable debt is written off, 
  and no longer appears in the ledger or on the statement of financial position, 
  whereas a doubtful debt has an allowance or a provision made against it-so it 
  still appears in the ledger, and on the statement of financial position where it is 
  neither off against the receivables balance.
  
  Identification of irrecoverable and doubtful debts
  The following indicate the potential irrecoverable debt:
  Evidence of long-outstanding debts from the aged receivables analysis
  A one-off outstanding debt when more recent debts have been cleared
  Correspondence with customers, e.g. Disputes
  Outstanding older debts and no current business with the customer
  A sudden or unexpected change in payment patterns
  Request for an extension of credit terms
  Press comment
  Information from the sales team
   Information about potential irrecoverable debts
  If a member of the credit control team discovers that a debt is highly likely to be 
  classified as irrecoverable or doubtful then it will probably not be that person’s 
  responsibility to write the debt off or set up an allowance against it. This is 
  normally the role of more senior member of the accounting function, as this will 
  impact on the preparation of the financial statement of a business.
  
  Professional ethics and irrecoverable and doubtful debts
  Writing off debts as irrecoverable will have an effect on reported profits and 
  issues can arise when debts are written off in one period and then subsequently 
  written back in another period in an attempt to smooth profits between 
  accounting periods.
  Accounting for debts should reflect the financial reality of the situation and 
  be dealt with adhering to the fundamental ethical principles of integrity and 
  

  objectivity. This means that the accounting should be completed with honesty

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  and without any conflict of interest when reporting results of a business.
  

  Application activity 7.1
  

  1. What do we need to consider in the age analysis and financial 
  ratios in credit monitoring?
  2. Which of the following might typically be highlighted by 
  analysis of an aged receivables listing?
  a. Slow payers
  b. Settlement discounts taken
  c. Exceeding a credit limit
  d. Potential irrecoverable debts
  e. Credit terms
  f. Items in dispute
  3. If customer accounts in the receivables ledger are not kept 
  accurately up to date then this can cause a number of 
  problems. Which one of the following is not one of those 
  problems?
  A. Problem items may not be highlighted in the aged receivables 
  listing.
  B. Incorrect statements may be sent out to customers
  C. The correct goods may not be dispatched to the customers
  D. Orders may be taken which exceed the customer’s credit 
  

  limit

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  7.2 Collection Option and Procedure
  

  Learning Activity 7.2
  

  

  Questions: 

  How many persons are in this image?
  What is the role of each person in this image?
  

  What do you think about this image in summary?

  7.2.1. Negotiation with the customer

  Most businesses will have a policy, whether formal or informal regarding the 
  collection of debts and the processes that will take place to chase up any 
  outstanding amounts. Adherence or otherwise to this policy should be the 
  starting point for customer communications and negotiations.
   Debt collection process
  Debt collection process starts with sending out of the sales invoice on which 
  the credit terms should be clearly stated. Thereafter, a variety of external 
  communications would be sent to the customer to encourage them to pay within 
  

  the credit terms and, for those overdue debts, a further series of reminders.

  Management Accounting | Experimental Version | Student Book | Senior Six

  A typical debt collection process can be illustrated:

  

  • Sales invoice

  Once a sale has been made a sales invoice can be sent to the customer. This 
  should be promptly sent, as soon as the goods or services have been provided, 
  and should clearly state the payment period agreed.
  • Statements
  Most businesses will then send a monthly statement to the customer, showing 
  the balance at the end of that month and how that is made up, including invoices, 
  credit notes and payment received.
  • Telephone calls
  An overdue debt is one which has not been paid within the stated credit period. 
  Once a debt has become overdue it is common practice to telephone the 
  customer to enquire about the situation, determine whether or not there is a 
  query over the amount due and agree when the debt will be paid.
  When making this type of telephone call, particular attention should be given to 
  the following matter:
  Discussion with the customer should always be courteous
  The precise amount of the debt should be pointed out, and the fact that it is 
  overdue
  It should be established whether there is any query with regard to the debt and, 
  if so, any appropriate action agreed to resolve the query
  If there is no query then a date for payment of the debt should be established
  

  It is important to keep precise notes of what has been agreed in a telephone

  Management Accounting | Experimental Version | Student Book | Senior Six

  conversation with a customer, as this may need to be confirmed by a letter. For 
  example, if a customer agrees over the telephone to clear an outstanding amount 
  by paying in 4 installments then this should be confirmed to the customer in 
  writing.
  • Reminder letters
  If there has been no response to the telephone calls requesting payment of 
  overdue amount then this is followed up with a reminder letter.
  The reminder letter will be sent out when the debts are a certain amount of time 
  overdue. The timescale of the reminder letter will depend up on organization’s 
  policy towards debt collection but usually it is sent out seven days after a debt 
  becomes overdue. Accordingly, if an invoice is sent to a customer with 30-days 
  credit terms, then the first reminder letter will be sent out of 37 days after the 
  invoice.
  Example of a typical first reminder letter is given below:
  Date: 
  Dear Sir/Madam,
  Account number: XXXXXXXX
  I do not appear to have received payment of the invoices detailed below. I trust 
  that this is an oversight and that you will arrange for immediate payment to be 
  made. If you are withholding payment for any reason, please could contact me 
  

  urgently and I will be pleased to assist you.

  
  

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  The option for the business at this point is generally

  To put the debt into the hands of debt collection agency

  To take the customer to court for payment

  To suspend any further sales to the customer by placing the customer on a stop 

  list until payment is received

  An example of a typical stop list letter is given below:

  Date: 

  Dear Sir/Madam,
  Account number: XXXXXXXX
  Further to our invoices detailed below, and our previous correspondence I do 
  not appear to have received payment. I trust that this is an oversight and that you 
  will arrange for immediate payment to be made. If you are withholding payment 
  for any reason, please could you contact me urgently and I will be pleased to 
  

  assist you

  

  I regret that unless payment is received within the next seven days I will have 
  no alternative but to stop any further sales on credit to you until the amount 
  owing is cleared in full. If you have already made payment, please advise me and 
  accept my apology for having troubled you. Please note that if we are forced to 
  take a legal action you may become liable for the costs of such action which, if 
  successful, may affect your future credit rating.
  Yours sincerely,
  Controller
  • Setting Up a Stop List
  When all other avenues for encouraging payment according to the terms have 
  been exhausted, and it is sure that this is a long term issue, it is time to set up 
  a stop list.
  A stop list is effectively a blacklist of clients who are no longer to be supplied 
  in lieu of missed, late or incomplete payments. It is crucial that a stop list is 
  shared effectively with everyone in the organization, so everyone knows who is 
  on the list and to ensure they don’t provide any further goods or services whilst 
  

  payment remains outstanding.

  Management Accounting | Experimental Version | Student Book | Senior Six

  It is important to decide the terms of your stop list, and again share them with all 
  members of staff. The most common use is to record a list of customers who are 
  overdue on payment and whose access to new goods or services is restricted, 
  until such time as all outstanding payments have been made in full.
  • External means of debt collection 
  Customers with poor payment behavior and cases where collecting outstanding 
  receivables proves particularly difficult, can cost incalculable amounts of both 
  time and money. At times, the burdens they place on a company’s receivables 
  accounting become completely disproportionate to the debts in question. In 
  such situations, it is advisable to outsource debt recovery to external service 
  providers, who handle these specialized commercial and legal tasks in their 
  function as governmentally regulated legal-services professionals.
  In particularly difficult cases, collection services providers enforce claims by 
  exerting the necessary pressure. As experts in collecting third-party claims 
  in a businesslike manner, these companies have access to the instruments 
  necessary for successful debt recovery.
  7.2.2. Methods of debts collection
  With good credit management and control procedures in place, money will 
  normally be received from credit customers. Sometimes encouragement such 
  as reminder letters or telephone calls will be needed but payment should 
  eventually be received.
  There are specific methods that a business can use to minimize the possibility of 
  ether the loss of the debt or resorting to legal procedures. They include among 
  others:
  a) Liaising with debt collection agencies and solicitors
  b) Factoring
  c) Invoice discounting
  d) Debt insurance
  e) Settlement discounts
  a) Debt collection agencies and solicitors
  Debt collection agencies or credit collection agencies are commercial 
  organizations that specialize in the collection of debts. Most collection agencies 
  are paid by results and charge a percentage of the debts collected for the 
  business, although some require an advance subscription do their services.
  

  The use of appropriate methods for collecting the debts may include:

  Management Accounting | Experimental Version | Student Book | Senior Six

  Collection by telephone and letter
  Collection by personal visits
  Negotiation of a payment plan with the customer
  They are effective methods of collecting debts that are providing difficult to 
  obtain in the normal course of trading. As collection agencies tend to be viewed 
  as a normal business service they are unlikely to have an adverse impact on the 
  relationship between the business and its customers. However, the collection 
  agency does, of course, charge a fee for its services.
  Solicitor services can be utilized in the initial stages of the debt collection process 
  by sending a ‘Solicitor letter’ requesting payment. This can be a cost-effective 
  method of collection as many customers will settle on receipt to avoid further 
  legal action. If the customers refuse to pay, solicitors will have the knowledge 
  and experience to start the formal legal remedies that are available.
  b) Factoring services
  Factoring is a financing service provided by specialist financial institution, often 
  subsidiaries of major banks, whereby money can be advanced to a company on 
  the basis of the security of their trade receivables. A factor normally provides 3 
  main services and a company can take advantage of some or all of these:
  Provision of finance
  Administration of receivables ledger 
  Insurance against irrecoverable debts
  Provision of finance factor
  When sales on credit are made by a business, there will be a period of time 
  elapsing before the money for those sales is received from the business’s credit 
  customers. Many businesses may find that they require the cash sooner than 
  the customers are prepared to pay, for example to pay suppliers or reduce an 
  overdraft. This is particularly the case for fast growing companies.
  The factor advances a certain percentage of the books value of the trade 
  receivables, often about 80% as an immediate payment. The trade receivables 
  are then collected by the factor and the remaining 20%, less a fee, handed over 
  to the business when the amounts are received by the factor.
  There is obviously a charge for this service and this will tend to be in two parts:
  

  A service charge or commission charge

  Management Accounting | Experimental Version | Student Book | Senior Six

  An interest charge on amounts outstanding 
  One further hidden costs of factoring can be a loss of customer confidence 
  or goodwill, as customer will be aware that the business has factored its trade 
  receivables; this may have a negative impact on future relations. Many customers 
  will view the use of a factor as indication that a business is in financial difficulty, 
  

  despite the increasing use if factoring within business.

  Administration of the receivables ledger by a factor

  Many factoring arrangements go further than simply providing finance on the 
  security of the trade receivables; they will take over the entire administration of 
  the receivables ledger. This will tend to include the following:
  Assessment of credit status
  Sending out sales invoices and receipts
  Sending out statements
  Sending out reminders
  The benefit to the business is not only a cost-saving from not having to run its 
  own receivables ledger but also the expertise of the factor in this area. A fee will, 
  of course, be charged for this service-normally based upon on a percentage of 
  

  invoices.

  c) Insurance against irrecoverable debts
  Without recourse factoring, if a factor has total control over all aspects of 
  credit management of the receivables ledger then they may be prepared to offer 
  a without recourse factoring arrangement.
  This means that the factor has no right to claim against the business if a customer 
  doesn’t pay. Effectively, the factor is bearing the risk of any irrecoverable debts 
  

  and, naturally, will charge a higher fee for accepting this additional risk.

  With recourse factoring-In other circumstances the business will retain the 
  risk of irrecoverable debts and this is known as with recourse factoring.
  d) Invoice discounting
  Invoice discounting- One of the costs of factoring is the potential loss of 
  customer goodwill if it is known that the business is using factor to collect its 
  debts. The reason for this is that some customers may infer cash flow problems 
  from the use of a factor, which may not give them confidence to continue trading 
  

  with the business.

  Management Accounting | Experimental Version | Student Book | Senior Six

  An alternative therefore, is invoice discounting which is a service related to 
  factoring. Invoice discounting is where the debts of a business are purchased 
  by the provider of the service at a discount to their face value. The discounter 
  simply provides cash up front to the business at the discounted amount, rather 
  than have any involvement in the business receivable ledger.
  Under a confidential invoice discounting agreement the business is still 
  responsible for collecting its own debts. As a result, invoice discounting is often 
  chosen by the businesses which wish to retain control of their own receivables 
  ledger.
  The cost to the business is the discount at which the trade receivables are 
  purchased. Invoice discounting can be used for a portion of the trade receivables 
  only and is therefore other used for a short-term or one-off exceptional cash 
  

  requirement 

  Application activity 7.2
  

  Questions 

  Briefly give and explain a typical debt collection process
  Enumerate methods of debt collections
  

  After explaining what is Factoring list 3 Factoring services

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  7.3. Preparation of performance report and 

  recommendation to management

  Learning Activity 7.3
  

  
  

  Questions:

  1. How many persons do you see in this image?
  2. After observing this image, what is the role of each person?
  

  3.What this picture talk about?

  7.3.1. Internal reporting and write-offs

  A credit report is a statement that has information about the credit activity and 
  current credit situation such as credit paying history and the status of the credit 
  accounts.
  Lenders also use the credit report to determine whether customer continue to 
  meet the terms of an existing credit account. Credit reports often contain the 
  

  Personal information and Your Credit accounts

   A credit write-off and why it is necessary 

  Management Accounting | Experimental Version | Student Book | Senior Six
  

  A write-off is an accounting term for the formal recognition in the financial 
  statements that a borrower’s asset no longer has value. Usually, credits are 
  written off when they are 100 percent provisioned and there are no realistic 
  prospects of recovery. These credits are transferred to the off-balance sheet 
  records. Therefore, a write off is mandated when an account receivable 
  cannot be collected.
  Once a view is formed that a receivable may be potentially doubtful, or perhaps 
  even definitely unrecoverable, steps should be taken to report the manner 
  internally, and to provide for the doubtful debt, or intended write it off entirely.
  Illustration 
  A company has a receivable outstanding amounting to Frw 2.4 million including 
  VAT at 18%. The company is able to claim 90% of unpaid debts under their 
  debt insurance policy. Assume the VAT element can be claimed from the tax 
  authorities.
  Calculate the amount that can be claimed under the policy and any amount to 
  be written off as irrecoverable.
  Answer:
  (2.4 million/1.18*0.18)=366,102 VAT
  The net value of the invoice is 2,033,898.
  To be claimed under credit insurance:
  (Frw 2,400,000 - Frw 366,102)*90% * 2.033, 898= Frw 1,830,508
  To be written off as irrecoverable: Frw 2,033,898 - Frw 1,830,508 = Frw 
  203,390 
  7.3.2. Presentation of Internal and external recommendation
  When presenting information to management, it is important to show any findings 
  or conclusions clearly. When looking at finance costs, such as the settlement 
  discount cost which is offered to customers to encourage early payment, it is 
  good practice to show the costs and benefits in implementing such a policy. 
  For example, the benefit of the discount will hopefully result in a better liquidity 
  position after taking into account the cost of the discount.
  
  Management Accounting | Experimental Version | Student Book | Senior Six
  
  Application activity 7.3
  
  

  Questions 

  What do you understand about a credit report?
  When an account receivable cannot be collected what will be the last step 
  

  in credit collection?

  Skills Lab 7

  Student will visit a company selling goods and services on credit and ask 
  questions related to the credit collection such as; the procedure or the 
  

  process of credit offering and credit collection. 

  End of unit assessment 7
  

  Question :

  What do you understand about Irrecoverable and doubtful debts?
  In debt collection process it is advised to use telephone call when 
  you are collecting debts from customers, what are elements a 
  particular attention should be given to?
  After explaining a reminder letter, explain when a final reminder 
  

  letter should be used in debt collection process!

  Management Accounting | Experimental Version | Student Book | Senior Six
  

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  Management Accounting | Experimental Version | Student Book | Senior Six
  

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  eleventh edition : prentice hall

  S3.2 Management Accounting study text by ICPAR Version 2019
  https://corporatefinanceinstitute.com/resources/financial-modeling/
  

  forecasting-methods/

  Management Accounting | Experimental Version | Student Book | Senior Six

  
  
  

   

  
  

• Topic 8