Quantitative Analysis in Budgeting analyses fixed and variable cost elements from total cost date using high/ low method; explains how to estimate the learning rate and learning effect; applies the learning curve to a budgetary problem; discusses the reservation with the learning curve; applies expected values and explains the problems and benefits and explains the benefits and dangers of using spreadsheets in budgeting.
Quantitative Analysis in Budgeting
a) Analyse fixed and variable cost elements from total cost data using high/low method.
The high-low method is a “quantitative technique for analyzing costs into their fixed cost and variable cost elements.” It is used to separate the total cost into fixed and variable costs.
Here are the steps to be followed when using the high-low method:
- Step 1: Review records of costs in previous periods
- Select the period with the highest activity level
- Select the period with the lowest activity level
- Step 2: Adjust by indexing up or down
- Step 3: Determine the following:
- Total costs at high activity level
- Total costs at low activity level
- Total units at high activity level
- Total units at low activity level
- Step 4: Find the variable cost per unit (v)
- Formula: (Total cost at high activity level – Total cost at low activity level) ÷ (Total units at high activity level – Total units at low activity level)
- Step 5: Find the fixed cost
- Formula: (Total cost at high activity level) – (Total units at high activity level x variable cost per unit)
b) Estimate the learning rate and learning effect
Learning curve theory is used in situations where the workforce improves in efficiency when they gain more experience. Where there is a learning curve, there is a learning rate and a learning effect.
The learning rate is “expressed as a percentage value.”
The learning effect is that “as the workforce learns from experience how to make the new product, there is a big reduction in the time to make additional units.”
c) Apply the learning curve to a budgetary problem, including calculations on steady states.
There are two main approaches that are used to calculate the learning curve:
- The Tabular approach – uses a table to calculate the cumulative average time per unit and the total time to produce all the units produced so far
- The Algebraic approach
To calculate the learning curve using the algebraic approach, the following formula is used:
Formula: Y = axᵇ
- Y is the cumulative average time per unit to product x units
- x is the cumulative number of units
- a is the time taken for the first unit of output
- b is the index of learning (logLR/log2)
- LR is the learning rate as a decimal
The steady state is the point at which no further improvements can be made.
d) Discuss the reservations with the learning curve.
Some of the reservations with the learning curve can be seen in the conditions that must apply:
- “There is a significant manual element in the task being considered.
- The task must be repetitive.
- Production must be at an early stage so that there is room for improvement.
- There must be consistency in the workforce.
- There must not be extensive breaks in production, or workers will ‘forget’ the skill.
- Workforce is motivated.”
e) Apply expected values and explain the problems and benefits.
Expected values are used in budgeting to “determine the best combination of expected profit and risk.” Probabilistic budgeting “assigns probabilities to different conditions” to find out the expected value of the budgeted profit.
The problems with using a probabilistic budget are:
- It can be more time consuming that preparing fixed budgets
- It represents a weighted average of expectations and may not reflect an outcome that is actually expected to happen
- It has little practical value for planning or control purposes and the costs may be more than the benefits gained
f) Explain the benefits and dangers inherent in using spreadsheets in budgeting.
The benefits of spreadsheets are:
- They are easily accessible
- Formulae can be used
- Allows different budget options to be used and analysed
- They can make the process easier and faster
The dangers of spreadsheets are:
- An error in a formula can affect the entire document
- Mistakes can be made and models can easily be corrupted
- Encourages over dependence
- Allows for extensive data manipulation which could cause user to go overboard
- They do not factor qualitative factors
- Lack of security
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- Preparing for ACCA F5 Performance Management
- A1: Specialist Cost and Management Accounting Techniques | Activity Based Costing (ACCA F5)
- A2: Specialist Cost and Management Accounting Techniques | Target Costing (ACCA F5)
- A3: Specialist Cost and Management Accounting Techniques | Life Cycle Costing (ACCA F5)
- A4: Specialist Cost and Management Accounting Techniques | Throughput Accounting (ACCA F5)
- A5: Specialist Cost and Management Accounting Techniques | Environmental Accounting (ACCA F5)
- B1: Decision Making Techniques | Relevant Cost Analysis (ACCA F5)
- B2: Decision Making Techniques | Cost Volume Profit Analysis (ACCA F5)
- B3: Decision Making Techniques | Limiting Factors (ACCA F5)
- B4: Decision Making Techniques | Pricing Decisions (ACCA F5)
- B5: Make or Buy and Other Short Term Decisions | Pricing Decisions (ACCA F5)
- B6: Dealing With Risk and Uncertainty in Decision Making | Pricing Decisions (ACCA F5)
- C1: Budgeting and Control | Budgetary Systems and Types of Budget (ACCA F5)