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Strategic Plan and Budgeting Process of Organic Foods Ltd.

Unit Learning Outcomes covered in this assessment

The purpose of this assignment is to assess the following Learning Outcomes:

  1. Demonstrate advanced understanding of management accounting in the contemporary business environment
  2. Develop and apply appropriate approaches to generate cost information for business decisions
  3. Describe and explain the role of performance management in the analysis of business performance

Analyse and apply diverse performance measures to a range of performance management problems

Organic Foods Ltd, a manufacturer of breakfast cereals and healthy snack bars, has experienced several years of steady growth in sales, profits and dividends, while maintaining a relatively low level of debt. The board of directors has adopted a long-term strategy to maximise the value of the shareholders’ investment. To achieve this goal, the board established the following financial objectives for the next five years:

  • increase sales by 12 per cent per year
  • increase profit before taxes by 15 per cent per year
  • maintain long-term debt at a maximum of 16 per cent of assets.

These financial objectives have been attained for each of the past three years. At the beginning of last year the president of Organic Foods, Andrea Donis, added a fourth financial objective: maintaining cost of goods sold at a maximum of 70 per cent of sales. This goal was also attained last year.

The company’s budgeting process is to be directed towards attaining these goals in the forthcoming year. This is a difficult task as the economy is in the middle of a prolonged recession. In addition, the increased emphasis on eating healthy foods has driven up the price of ingredients used by the company at a much greater rate than the expected rate of inflation. John Winslow, management accountant at Organic Foods, has responsibility for preparation of the budget for next year. Winslow has assured Donis that he can prepare a budget that will satisfy all of the financial objectives. Winslow will do this by overestimating the ending inventory and reclassifying fruit and grain inspection costs as administrative rather than manufacturing costs. The actual statements for last year and the budgeted statements for next year that Winslow prepared are as follows:


Organic Foods Ltd
Income statement
 Last year actual ($)Next year budget ($)
Sales1 700 0001 895 500
Less Variable costs:  
Cost of goods sold  1 020 000  1 149 450
Selling and administrative    180 000    175 000
Contribution margin500 000571 050
Less Fixed costs:  
Manufacturing    170 000   189 550
Selling and administrative    120 000    140 000
Profit before taxes210 000241 500





Organic Foods Ltd
Balance sheet
 Last year actual ($)Next year budget ($)
Assets:  
Cash20 000   34 000
Accounts receivable120 000136 000
Inventory600 000730 000
Plant and equipment (net of accumulated depreciation)  3 260 000  3 200 000
Total 4 000 0004 100 000
Liabilities:  
Accounts payable220 000244 000
Long-term debt640 000616 000
Shareholders’ equity:  
Ordinary shares800 000800 000
Retained earnings  2 340 000 2 440  000
Total4 000 0004 100 000


The company paid dividends of $55 440 last year, and the expected tax rate for the coming year is 34 per cent. 

Required 

While strategic planning can involve a horizon of three or more years, the budgeting process is short-term planning, both areas are crucially important for business success. Using information from the above scenario and other sources (e.g. journal articles, books, book chapters, online sites etc.), and write a report to present at the next senior management meeting. Your report should incorporate the following: 

  1. the role of budgeting process at Organic Foods Ltd and explain how it relates to the strategic planning process. To support your discussions, you should also demonstrate the: 
  2. understanding of the master budgets 
  3. understanding of the operational budgets and financial budgets 
  4. interrelationship between strategic planning and budgeting process

[To achieve this task, you are expected to review journal articles, books, book chapters, online sites etc.]

  1. evaluate whether or not John Winslow’s budget attains each of the financial objectives. Use the following format for your answer:
  2. objective
  3. attained/not attained
  4. calculations (present all calculations as an attachment to the report)
  5. discuss whether or not the adjustments contemplated by John Winslow are unethical. To support your discussions, you should also demonstrate the understanding of the ethical conduct of professional accountants [Tips: information can be found in the APES 110 Code of Ethics for Professional Accountants]

Report format:

  1. Cover page
  2. Executive summary
  3. Table of contents 
  4. Introduction
  5. Body 
  6. Conclusion
  7. Appendix
  8. Reference list (4-6 references must be cited)

Answer

Report and Presentation

Organic Foods Ltd.

Executive Summary

This report provides an analysis and evaluation of the strategic plan and budgeting process of Organic Foods Ltd. This report also provides a detailed analysis of the budget prepared by the company’s management accountant, John Winslow, for the coming year.

Method of analysis was comparison of company’s last year’s performance with current year budget, evaluation the prepared budget in the light of objectives set under the strategic planning and measuring the efficiency & ethical compliance of the budget prepared.

Analysis of company’s budgeting process presents all the relevant and significant aspects of the company’s internal planning and operations in an elaborate manner. It also helps the management in understanding the good and bad effects that the planning and budgeting had on company’s performance in a particular period. Through this report, the management and the users will be able to understand the strengths and weaknesses in the company’s operations and in its internal controls.

The purpose of this project is to identify the accuracy, effectiveness and ethical compliance of the budget, evaluate the strengths and weaknesses of the internal planning and budgeting system of the company, analyze the key improvement areas and recommend steps of improvement, if required. 

  1. Introduction

Organic Foods Ltd. is a manufacturer of breakfast cereals and healthy snack bars. In the previous years, Organic Foods Ltd. has had a steady increase in its sales, revenue, profits and dividends. The management has also managed to maintain a fairly low amount of debt.  Keeping in mind the short term performance, the Board of Directors developed a long term strategic growth plan for the company for a period of 5 years. After the application of this 5 year strategic plan, the management was able to attain its pre-established targets for the first 3 continuous years -

  • Sales- An increase of 12% per year
  • Profits- An increase of 15% per year
  • Long-term debts- 16% of total assets or less

In the 4th year, Andrea Donis, the president of Organic Foods, proposed to add an additional target to the list of pre-established targets, which was to maintain the cost of goods sold at 70% of sales or less. The management was able to achieve all these four goals successfully in the 4th year as well. 

 However, the management and Board of directors feel that it could be difficult to attain these goals in the 5th year, the reason being that economy is currently suffering a prolonged recession. Apart from this, with increasing awareness among people for healthy eating and healthy living, the demand for organic and gluten-free items has gone up in the market. This has caused a substantial increase in the price of the raw materials in the organic food industry. Hence, it is a challenge of the company to attain these goals without compromising on the quality of the product.

As the management accountant of the firm, there are several ways or recording and presenting the financials that does impact the cost of production and profit of the firm.  Cost of production of a product can only change if the value any of these items change- Opening Inventory, Direct expenses and Closing inventory.


John Winslow’s approach includes two of the above mentioned items, i.e. Direct expenses and closing inventory. Direct expenses increases the cost of production; hence by reclassifying fruit and grain inspection costs as administrative rather than manufacturing costs, he is decreasing the direct expenses. 

Closing inventory decreases the cost of production; hence by overestimating the ending inventory, he is increasing the amount of closing stock. Therefore, decreasing the cost of production.

  1. Strategic Planning using budgeting process

Budgets and strategic planning are not substitutes; rather they are complimentary to each other. A company need both of them to effectively achieve its organizational goals. A strategic plan is used to lay down objectives and provide direction, guidelines and planning to achieve those objectives.  Whereas budget is a detailed financial plan to achieve the financial and operational goals of an organization. It is used to forecast the potential cost, revenue and cash-flow to achieve the goals laid down in the strategic plan- [Svetlana Mihaila (June 2015]. Strategic plan is a wider statement which includes the entire method starting from setting of objective to measuring the actual results with the pre-established goals; budgeting is a narrower concept as it is only a small part of the strategic planning process. However, without budgeting, the planning process in meaningless. 

Let us discuss the important budgets a company can utilize to effectively finish the planning process [The Mootley Fool (Jan 26, 2018)] -

  1. Master Budget- Master budget is the combined budget of the company which is used by the key personnel to take decisions for long term strategies as well as short term operations. It is a combined budget of all other budgets like sales budget, purchases budget, production budget, overhead expenses budget, direct material and labour budget, general and administrative expense budget, capital budgets, cash budgets, financial statements, etc.
  2. Operating Budget – An operating budget consists of the budgeted expenses and revenues of the company for the current year. E.g. A sales or production budget, fixed and variable cost budget.
  3. Financial Budget – A financial budget includes the budgeted financials statement of profit & loss and the budgeted Balance Sheet of the firm. 

All of these budget are of equal importance when it comes to the strategic planning. The budgeting process includes discussing the requirements and expectations with all the department heads, learning about the past trend inside the organization as well as in the industry, taking in consideration all the potential contingencies during the period of strategic plan and then calculating the anticipated expenses, incomes and cash-flows.  

  1. The role of budgeting process at Organic Foods Ltd.             

Organic Foods Ltd. has successfully attained the set goals for the past 4 years but for the last period, it is a challenge for the management to attain the targets because economy is suffering from a recession. The cost of the raw materials in the organic food industry has also risen beyond expectations due to high demands. Therefore, budgeting for the coming period is of utmost importance because there are high risks for the company to fail at the plan.

Through budgeting, the management will be able to coordination the activities between all the departments to the company’s strategic plan. It helps in decision-making and delegating the responsibilities till the lowest level of workers to attain their departmental as well the overall organizational goal [Jeff Radtke and Raymond Anderson (May, 2017)]. Apart from this, budget will also provide the management and the BOD of Organic Foods Ltd. a basis to evaluate how efficiently the goals were met as compared to the budget and analyzing the reasons of deviations of actual performance with the original budget. It will also encourage all the departments to become more efficient as they will be aware what they have to achieve.                                                            

  1. A detailed review of John Winslow’s budget
  2. Objective: There are 4 major objectives that the management has set for the 5th year of the plan. They are as follows-
  3. An increase of 12% in sales revenue from the past year
  4. An increase of 15% in profits from the past year
  5. Maintaining the long-term debts of the company at maximum of 16% of total assets
  6. Maintain the cost of goods sold at 70% of sales or less

Analysis: Let us discuss the budget prepared by John Winslow in detail.

Goals attained/not attained: The approach adopted by the management accountant surely resulted in some changes in presentation and the overall impact on the budget is also satisfying. 

  1. The increase required in sales revenue is 12% of the last year sales. The budgeted sales shows an increase of 11.5% from last year, which is almost close to the desired target.
  2. The increase required in profit before taxes is 15% of the last year profits. The budgeted profit shows an exact increase of 15% from last year, which is what the management has targeted to achieve.
  3. The anticipated long term debt for next year is 15.02% of the total assets of the company. The required margin is 16% or less and the budget meets the requirement.
  4. Budgeted COGS for the coming year is 60.6% of the total sales. The required margin is 70% or less and the budget meets the requirement.
  5. Code of Ethics for Professional Accountants            

The adjustments contemplated in the budget by John Winslow is not entirely ethical. 

As per APES 110 (Code of Ethics for Professional Accountants) para- 220, the accountant should not have any personal interest or conflict regarding the firm’s performance in a certain period, which Jon Winslow didn’t have. As per para 130 [APESB (December, 2010)], he should always act with due diligence and with best of his knowledge. He shouldn’t be biased towards his evaluation and representation of the company’s financial statement and present the accurate picture of company’s performance to the users of accounts.

Classifying the manufacturing cost as administrative cost will not have an impact on the overall/net profits of the firm on the basis of which the dividends would be distributed, but it would impact the COGS and gross profit of the firm. This is against the full disclosure principle also. 

Additionally, overvaluing the closing inventory of the firm goes against more than one accounting principles and APES guidelines for the accountants. It will over-estimate the profits and the total assets.

However, it is also to be understood that budget of a company is only for its internal uses. The company might or might not achieve the budgeted targets. Also, if these practices will be repeated for the preparation of financials, then it would be unethical.

  1. Conclusion

The budget prepared by Jon Winslow for the coming year is in line with the objectives of the firm. However, the accountant and the management need to practice full disclosure and ethically prepare the final statements so as to adhere to the guidelines of APES.

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