Executive summary
This report focuses on the projected and actual performance of the company products and the business as a whole in the various periods. Twelve months are covered, from January to December of 2014. To assess the business position, five computation reports have been prepared on Excel Worksheets. Please find these worksheets attached for your perusal. They are the purchases budget, sales budget, operating expenditure budget, profit and loss statement, and cash flow statement. Additionally, I have prepared a variance report based on both the budgeted and actual positions. The reports indicate a healthy company financially. However, shareholders will likely ask for more input from management to increase profits.
Background of the company
The paper analyzes Abu Dhabi National Energy Company (TAQA). The company was established in 2005. The headquarters of the company is in Abu Dhabi, UAE. The company is owned by the government and the shares of the company are listed on the Abu Dhabi Securities Exchange with the ticker symbol TAQA. The company was established in 2005 and it operates in the oil industry. Currently, the company has two subsidiaries these are TAQA North and Bratani. Further, the company has employed about 2,800 people. The company focuses on the generation of power, desalination of water, manufacturing, and storage of gas and oil. The first product that will be analyzed is oil and gas. Oil and gas account for about 47% of the total revenue earned by the company. The second product is power while the third product is water. The total of water and power accounts for 53% of the total revenues. The total loss for the year that ended on 31 December 2013 amounted to AED1, 768 million. The paper seeks to prepare a master budget for the company.
Master budget
A master budget is a collection of various operational budgets (Block & Hirt 2007). The components of the master budget are discussed in the subsequent section.
Sales budget and schedule of cash receipts
This section will show the expected number of units that will be sold, the selling price per unit and the total sales for each of the twelve months. The expected number of units will be estimated using percentages of total sales for the year (Collier 2010). Based on the calculations, the budgeted sales for the year amount to AED11, 250,000 thousand in the year 2014. In addition, the amount of cash that will be collected during each month will also be presented in the table below.
Abu Dhabi National Energy Company
Sales budget
For the year ended 31st December 2014:
Schedule of cash receipts
For the year ended 31st December 2014:
Assumptions
Activity-Based Systems determine the real cost of overhead before assigning the costs to such activities. Therefore, a company allocates costs to those units that require the activity. The approach appreciates the fact that at any point, the company’s activities will occasion cost, which will vary with production levels. Therefore, the costs should be assigned to the products that require such activities to arrive at a more accurate measure. The distinguishing feature of Activity Based Costing is that it links the output of the manufacturing entity to the cost of all activities involved in production. Value-added activities could be determined using this approach. The manufacturing entity can proceed to eliminate activities, which are not adding value to the product. This will improve the manufacturing system’s performance.
Production budget
The budget will give an estimate of the total production that is required during the year. The values will be arrived at by adding the estimated sales to the desired ending inventory. The sum of the two will give the required monthly production. The desired inventory at the beginning of the period will be deducted to obtain the number of units that must be produced (Seal, Garrison & Noreen 2011).
Abu Dhabi National Energy Company
Production budget
For the year ended 31st December 2014:
Assumptions
ABC would not be acceptable for external reports due to methods employed in determining the allocations. The use of interviews is likely to lead to costs, which are unrealistic or biased in the eyes of the external financial statement user. Objective and verifiable data should be used instead to increase the confidence of users of such statements. The method used in arriving at costs using ABC is also not acceptable by outside parties. The calculation of activity-based costs may exclude some costs, which are not directly linked to the production process.
The controller must consider the activities, which are common to all the departments and the level of resources used by the departments while performing those manufacturing activities. The controller must also consider the level of interaction of those departments. The discrepancy in the cost is probably due to the difference in the nature of activities carried out by the departments. The controller should therefore use a common allocation base for all the departments.
Direct materials budget and schedule for cash disbursement
This section will give an estimation of the number of units of raw materials that will be used in the production and the total amount that will be used to be spent on the purchase of the raw materials. In addition, the monthly amount of money that will be used for the purchase of the raw materials will be estimated (Hilton 2010).
Abu Dhabi National Energy Company
Direct materials budget
For the year ended 31st December 2014:
Schedule for cash disbursement
For the year ended 31st December 2014:
Assumptions
Reasons for Absorbing Overheads on Pre-Determined Bases
Overhead cost per unit is based on estimates. Therefore, it is almost unavoidable that at the end of the accounting period an under-absorption or over-absorption occurs in the overhead actually realized. The estimated cost of overheads and level of activity may not match what was actually realized in the period under consideration. The predetermined cost per unit is charged at the end of period profit or loss. Hence, it is essential to check the amount under- or over-absorbed (charged) and make an adjustment in the accounts.
It is the prerogative of Management to know the level of expenditure on overheads. If left unchecked, the amount spent on overheads can increase every accounting period, which may eat into the profit of a company. This may also have a negative bearing on competitiveness. Managers need to know both the overhead expenditure per cost center or department and the overhead costs per unit.
Overhead cost per unit is based on estimates. Therefore, it is almost unavoidable that at the end of the accounting period an under-absorption or over-absorption occurs in the overhead actually realized. The estimated cost of overheads and level of activity may not match what was actually realized in the period under consideration. The predetermined cost per unit is charged at the end of the period profit or loss. Hence, it is essential to check the amount under- or over-absorbed (charged) and make an adjustment in the accounts.
It is the prerogative of Management to know the level of expenditure on overheads. If left unchecked, the amount spent on overheads can increase every accounting period, which may eat into the profit of a company. This may also have a negative bearing on competitiveness. Managers need to know both the overhead expenditure per cost center or department and the overhead costs per unit.
Direct labor budget
The direct labor budget seeks to provide an estimation of the total direct labor cost for the year. The value is arrived at by multiplying the total hours of direct labor that is required for production and the cost of direct labor per hour (Horngren, Foster, Datar, Black and Gray 2011).
Abu Dhabi National Energy Company
Direct labor budget
For the year ended 31st December 2014:
Manufacturing overhead budget
The manufacturing overhead budget gives an estimation of the amount of cash disbursement for the manufacturing overhead. The budget combines both the variable and fixed manufacturing overhead. The fixed manufacturing overhead includes items such as training and development costs, taxes, salaries for supervisors, and depreciation of equipment among others (Horngren, Harrison, Oliver, Best, Fraser, Tan & Willett 2012).
Abu Dhabi National Energy Company
Manufacturing overhead budget
For the year ended 31st December 2014:
With activity-based costing, you take all activities required to produce an item into consideration. This can include R&D, testing, purchasing, set up of machines, packaging, and cleaning and maintenance. These are all necessary to produce an item; however, they may not be taken into consideration when using the traditional method of costing.
Activity-Based Costing leads to the generation of activity rates. Activity rates are vital to management since they enable management to determine with great accuracy the cost involved in production. The management can quickly estimate the cost of producing at a certain level using activity rates. Activity rates are also important in determining the efficiency of production. The management can use these rates to determine which activities add most value to the production process. The production process can thus be improved by eliminating non-value-add activities. This allows for a flexible process, which companies can modify to reduce the negative effects of some activities. Activity rates also offer management information, which greatly improves their decision-making ability. Hence, ABC can be instrumental to managers at a manufacturing plant, for example, car production.
Ending finished goods inventory budget
The budget for ending finished inventory will give an estimation of the value of closing stock for the entire year. The value of ending inventory will be arrived at through a multiplication of the unit cost of the product by the number of units of finished goods remaining unsold at the end of the year. It is worth mentioning that two approaches will estimate the per unit product cost. These are absorption and marginal costing. The budgeted cost of sales will be estimated after the calculation of ending inventory. The other components of the cost of sales were calculated in the section above.
Absorption costing
Abu Dhabi National Energy Company
Ending finished goods inventory budget
For the year ended 31st December 2014:
Assumptions
It is assumed that the ending inventory is related to the incoming inventory through existing policies. They include reordering periods among others.
Variable costing
Abu Dhabi National Energy Company
Ending finished goods inventory budget
For the year ended 31st December 2014:
Assumptions
The budgeting ending inventory and cost of sales using absorption costing yielded higher results than the marginal costing approach. The result is consistent with the study materials (Noreen, Brewer & Garrison 2014). Assumptions, in this case, are similar to the assumptions when dealing with a manufacturing budget.
Selling and administrative expense budget
The budget will give an estimate of the amount that will be spent on selling and administrative expense. The budget combines both fixed and variable selling and administrative expenses. Some of the items that will be included in the budget are bad debts and the amount spent on renting premises such as warehouses (Abraham, Glynn, Murphy & Wilkinson 2010).
Abu Dhabi National Energy Company
Selling and administrative expense budget
For the year ended 31st December 2014:
Assumptions
Sales are expected to grow at a certain rate. The rate of growth of sales is determined by management for the sake of budget preparations. In this case, sales grow at a 15% rate annually. The rate is divided by 12 to reflect monthly growths.
Cash budget
The cash budget is quite significant because it combines all the output of the other budgets discussed above. The budget seeks to determine whether the company will have adequate cash that meets all the running expenses. Therefore it will reveal whether the company will require additional funding and to what extent (Brigham & Michael 2009; Williams, Haka, Bettner, & Carcello, 2010).
Abu Dhabi National Energy Company
For the year ended 31st December 2014:
Assumptions
Preparing a cash budget enables a company to avoid cash-flow problems that could cripple the business. All cash expenses, regardless of whether they are revenue or capital are included in this budget. Into The Night is expected to have more cash inflows than outflows during this quarter. The company also expected to close the quarter with a positive bank balance.
The actual cash position was quite different from the budget. The company collected less from debtors in January and March and paid much more to Sundry creditor Smith and other creditors. Much more was also spent on operating expenses and capital expenditure. This resulted in a negative variance. However, the closing bank balance was still positive.
Conclusion and Recommendations
The budgets used in this report are accurate since they are based on industry data and the company’s previous quarter. The negative sales variance caused by poor oil and gas sales affected all the other budgets. The company is spending too much on purchasing oil and gas as shown by the negative purchases variance. Operating expenses did not vary much from the budget. This could be an indicator of the company’s proper expense management skills. Oil and gas contribute more to profit or loss than other products due to high sales volumes.
The company needs to focus on selling more oil and gas as they contribute to profit more than other products. There is potential for more sales. The company should raise its target from the current 15% of the market. Secondly, the company should re-think its cost allocation method and consider switching to ABC from the sales-volume-based system. Finally, the company should consider negotiating with its creditors to allow for longer credit periods. This will enable matching of the debtors’ and creditors’ policies.
References
Abraham, A, Glynn, J, Murphy, M & Wilkinson, B 2010, Accounting for managers, South-Western Cengage Learning, USA.
Block, S & Hirt, G 2007, Foundations of financial management, McGraw-Hill/Irwin, USA.
Brigham, E & Michael, J 2009, Financial management theory, and practice, South-Western Cengage Learning, USA.
Collier, P 2010, Accounting for managers, John Wiley & Sons, USA.
Hilton, R, 2010, Managerial Accounting, McGraw Hill/Irwin, USA.
Horngren, C, Foster, G, Datar, S, Black, T and Gray, P 2011, Cost accounting: A managerial emphasis, Prentice Hall, United Kingdom.
Horngren, C, Harrison, W, Oliver, S, Best, P, Fraser, D, Tan, R & Willett, R 2012, Accounting, Pearson, Australia.
Noreen, E, Brewer, P & Garrison, R 2014, Managerial accounting for managers, McGraw-Hill, USA.
Seal, W, Garrison, R & Noreen, R 2011, Management accounting, McGraw Hill, New York.
Williams, J, Haka, S., Bettner, M., & Carcello, J. (2010). Financial & managerial accounting: The basis for business decisions. USA: Mc Graw-Hill.