Question

Neptune Ltd produces and sells pizzas to supermarkets. Neptune has three main type of pizza: the Old Favourite (OF), the Young 'Un (YU) and the New Healthy (NH). The NH pizza is a new type of pizza for Neptune, based on 100% organic ingredients and packaged in a way which causes minimal damage to the environment. Demand for the NH has been unpredictable which has caused Neptune to adopt a rolling budget approach for forecasting purposes. The OF pizza operates in a very stable market. Sales growth is unlikely, the price of raw material is very stable and budgeted sales and profit targets are usually very accurate predictors of actual sales and profit targets. The OF pizza has used an incremental budgeting approach for several years. The YU pizza operates in a market where popularity can fluctuate and it can be very popular or unpopular depending mainly upon the tastes of children between ages 5 to 15, to whom it is targeted. The YU pizza has used an incremental budgeting approach for several years also. The actual figures for quarter 1 for the NH pizza are as follows: ACTUAL Q1 Revenue Cost of sales Gross profit Distribution costs Administration costs Operating profit $000 3,200 (2.300) 900 (300) I (250) 1 350 103 The budget agreed at the start of the year was: Q1 1 Q2 04 $000 $000 $000 $000 Revenue 3,150 3.450 3 .670 3,800 Cost of sales (2,000) (2,200) (2,350) (2,500) Gross profit 1,150 1,250 | 1,320 1,300 Distribution (280) (280) (285) (285) costs Administration (220) (220) (230) (230) costs Operating 650 750 805785 profit TOTAL $000 14.070 (9,050) 5,020 (1,130) (900) 2,990

Answer 1

(a)
	Actual	Budget	Budget	Budget	Budget	Budget
	Q1	Q2	Q3	Q4	Q1	Total
	($'000)	($'000)	($'000)	($'000)	($'000)	($'000)
Revenues	3,200.00	3,296.00	3,394.88	3,496.73	3,601.63	13,789.24
Cost of Sales	(2,300.00)	(2,373.12)	(2,444.31)	(2,517.64)	(2,521.14)	(9,856.21)
Gross Profit	900.00	922.88	950.57	979.09	1,080.49	3,933.03
Distribution Costs	(300.00)	(309.00)	(318.27)	(327.82)	(337.65)	(1,292.74)
Administrative Costs	(250.00)	(237.50)	(225.63)	(248.19)	(248.19)	(959.51)
Operating Profits	350.00	376.38	406.67	403.08	494.65	1,680.78
(b)
The profit produced by rolling budget approach has decreased to $ 1,680,780 as compared to the original budget
where it was projected at $ 2,990,000. The reason for the revised profit being reduced to about 60% of the original
budgeted profit are as under:
(i) The revised budgeted sales growth is lower in comparison to the original budgeted growth in sales.
(ii) The revised budgeted cost of sales at 71% of sales is higher than the original cost of sales which was 64%
(iii) The revised distribution and administrative costs at 16% of sales are higher than the original budgeted amount
at 14.50% of sales.
(c')
Incremental budgeting approach takes the actual numbers from the previous period and makes adjustments for the
factors which would affect the revenues and costs so as compute the figures for the future periods.Hence, looking at
the basis of computation, incremental budgets would be advisable in situations where factors affecting the budget,like,
growth in sales,cost of materials and other expenses are fluctuating a lot and cannot be projected for a longer period
of time.
Old Favourite Pizza - With unlikely sales growth and stable raw material prices,the factors affecting the revenues and
costs do not witness fluctuations.Hence,preparation of incremental budget is not necessary and advisable since the
actual figures are very similar to the budgeted figures. A static budget would give the same results and control as the
incremental budget and would require lesser effort as there would be no need to prepare incremental budget after
every quarter.
Young Un' Pizza - Since the popularity of YU pizza can witness fluctuations due to fluctuation in tastes of the end
customers,the figures of costs and revenues are needed to be updated on the basis of the latest available data and
trends. Hence, incremental budget approach is suitable and should be used to project the revenues and costs.Use of
incremental budget would help in updating the budget as per trends in the factors affecting costs and revenue based
on actual data available for the previous quarter.
(d)
Dysfunctional management behavior is defined as individual behavior which is in conflict with the goals of the
organization.It is termed as a negative behavior and has an adverse effect on achieving the organizational goals.
If the budget preparation process is not participative and flexible, it can lead to fixing of unrealistic standards in
preparation of budgets.
If the organization is not willing to recognize the need for flexibility,feedback on actual performance,incentives and
participation,it will loose the support of the lower and middle managers for achieving the budgeted targets.Hence,the
organization,in order to avoid the dysfunctional management behavior in budgeting,should take care that the budgeting
system of the organization should possess the following features:
(i) Participation of the stakeholders
(ii) Frequent feedback on performance
(iii) Flexible budgeting capability
(iv) Realistic standards
(v) Monetary and non monetary incentives