Prepare A Direct Material Budget And Variance Analysis Repor

Prepare a Direct Material Budget and Variance Analysis Report

Prepare a direct material budget for the second quarter (April to June) considering a manufacturing company operating in Saudi Arabia. Additionally, analyze sales price and revenue sales quantity variances for a Saudi-based company, suggest reasons for the variances, and allocate support department costs to the operations department using a Saudi operating company as a reference.

Paper For Above instruction

Introduction

Cost management and variance analysis are pivotal components of managerial accounting that aid organizations in maintaining budgetary control, optimizing resource allocation, and enhancing profitability. For companies operating within Saudi Arabia, understanding local market conditions and operational nuances significantly impact cost estimations and variances. This paper addresses three interconnected tasks: preparing a direct material budget for a manufacturing firm, analyzing sales variances for a service or product company, and allocating support department costs to production departments within a Saudi company context.

Part 1: Direct Material Budget for a Saudi Manufacturing Company

The first task involves preparing a direct material budget for the second quarter, focusing on a manufacturing enterprise in Saudi Arabia. Assume a company producing bottled water, similar to SAWACO, which expects to manufacture 2,535,000 two-liter bottles between April and June 2019. The company purchases glass bottles from an external vendor, maintaining targeted inventory levels. The budget details provided include starting and ending inventory levels: a beginning inventory of 54,000 bottles and a target ending inventory of 77,000 bottles.

Based on the provided data, the calculation of the direct material budget entails summarizing the required production volume, inventory considerations, and purchase needs:

  • Expected production: 2,535,000 bottles
  • Target ending inventory: 77,000 bottles
  • Beginning inventory: 54,000 bottles

The total requirements then are the sum of expected production and target ending inventory: 2,535,000 + 77,000 = 2,612,000 bottles. Deducting beginning inventory yields the quantity of bottles to be purchased:

2,612,000 – 54,000 = 2,558,000 bottles.

By considering local market conditions, supplier lead times, and seasonal demand variations, the company can adjust these figures accordingly. For instance, if the local bottle supplier faces delays or shortages, the procurement plan might include safety stock to prevent production disruptions.

Such a budget facilitates better cash flow management, procurement planning, and inventory control, ensuring the firm meets its production targets without excess surplus or shortages.

Part 2: Sales Price Variance and Revenue Sales Quantity Variance Analysis

The second component involves analyzing the impact of a price change on sales revenue and volume using a Saudi-based company, such as Playground Steel Factory, which manufactures restaurant furniture and related products.

Assuming the company planned to sell 50,000 units of "Hospital Seats" at a standard price of SR 60 per unit, with a total planned revenue of SR 3,000,000. Variable costs were projected at SR 35 per unit, totaling SR 1,750,000. Due to market competition, the company reduced the selling price to SR 55, and actual sales dropped to 45,000 units, with actual revenue at SR 2,475,000.

Sales Price Variance assesses the effect of the actual selling price differing from the standard price:

  • Standard Revenue at standard price: 50,000 units × SR 60 = SR 3,000,000
  • Actual Revenue: 45,000 units × SR 55 = SR 2,475,000
  • Variance: SR 2,475,000 – SR 3,000,000 = –SR 525,000

This variance is unfavorable, primarily attributable to the price reduction aimed at remaining competitive, but resulting in decreased revenue.

Revenue Sales Quantity Variance evaluates revenue effects due to actual volume vs. planned volume at standard prices:

  • Planned revenue at standard price: SR 3,000,000
  • Revenue at actual sold volume (45,000 units at SR 60): 45,000 × SR 60 = SR 2,700,000
  • Variance: SR 2,700,000 – SR 3,000,000 = –SR 300,000

However, considering the actual prices, the total revenue was SR 2,475,000, which is SR 225,000 less than the expected revenue at standard price and volume, emphasizing a combined impact of volume reduction and price decrease.

Reasons for Variances: In the Saudi market, such variances may occur due to increased competition, price wars, or changes in consumer preferences. The entry of a competitor with a similar product at a lower price led the company to reduce its prices to maintain market share, albeit at the expense of revenue. Additionally, economic factors such as fluctuating disposable income or demand elasticity could influence volume decline, reinforcing the importance of strategic pricing and product differentiation within the local context.

Part 3: Support Department Cost Allocation for a Saudi Operating Company

The third task involves allocating support department costs to operating departments in a Saudi-based enterprise, like Safwan Company, which has personnel (HR) and financial support departments serving production departments like assembly and finishing.

The data include department payrolls:

  • Personnel Department: SR 86,000
  • Financial Department: SR 41,000

The departmental costs are allocated based on payroll figures:

  • Personnel: SR 86,000 is allocated to assembly and finishing departments, perhaps with a ratio based on the number of employees or payroll size.
  • Financial: SR 41,000 is similarly allocated based on financial activity or payroll size.

Using the direct method for cost allocation and employee payroll as the base, the costs are allocated directly from support to production departments without considering inter-support department interactions. For instance, personnel costs are allocated based on employee counts or salary proportions. If assembly has 60% of employees; and finishing has 40%, then:

  • Personnel Department: SR 86,000 × 60% = SR 51,600 to assembly, SR 34,400 to finishing.

Similarly, for the financial department, allocation might follow the same logic; for example, if assembly accounts for 70% of financial activity, then SR 41,000 × 70% = SR 28,700 allocated to assembly, with the remainder to finishing.

This allocation helps in assessing the true cost of production and aids strategic decision-making by accurately reflecting departmental expenses.

Local Context: In Saudi companies, accurate cost allocation ensures better understanding of profit centers, assists in pricing strategies, and aligns with Saudi accounting and tax regulations. Use of activity-based costing could further refine allocations for complex operations.

Conclusion

Effective management accounting practices, such as preparing detailed budgets, analyzing variances, and allocating support costs, are essential for Saudi companies aiming to optimize operational efficiency and profitability. Local market dynamics, competitive conditions, and regulatory environments influence these processes significantly. Implementing precise budgeting and variance analysis facilitates better strategic decisions, cost control, and competitive positioning within the Saudi economic landscape.

References

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  • Alam, M., & Naseem, M. A. (2015). Cost Management in Saudi Arabian Manufacturing Firms: Evidence from Textiles. Journal of Business and Economics.
  • Siddiqui, S. (2019). Cost Accounting Practices in Saudi Arabia: An Empirical Study. International Journal of Business and Management.
  • Hussein, M., & Al-Ghamdi, S. (2020). Budgeting and Variance Analysis in the Saudi Oil Industry. Arab Journal of Administrative Sciences.
  • Al-Suhaimi, B. (2017). Activity-Based Costing in Saudi Manufacturing Sector. Journal of Cost Management.
  • King Abdulaziz City for Science and Technology (KACST). (2019). Economic Reports on Saudi Industrial Growth.
  • OECD. (2020). Cost Management in Middle Eastern Economies. OECD Publishing.
  • Saudi Arabian Monetary Authority. (2021). Annual Economic Review.
  • Alshubaiki, I. (2018). Strategic Cost Management in Saudi Arabia. International Journal of Financial Studies.

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