R plc is an engineering company that repairs machinery and manufactures replacement parts for machinery used in the building industry. There are a number of different departments in the company including a foundry, a grinding department, a milling department and a general machining department. R plc prepared its budget for the year ending 31 December 2003 using an incremental budgeting system. The budget is set centrally and is then communicated to each of the managers who have responsibility for achieving their respective targets. The following report has been produced for the general machining department for October 2003:

Budget Actual Variance

Number of machine hours 9,000 11,320 2,320 (F)

$ $ $

Cleaning materials 1,350 1,740 390 (A)

Steel 45,000 56,000 11,000 (A)

Other direct materials 450 700 250 (A)

Direct labour 29,000 32,400 3,400 (A)

Production overheads 30,000 42,600 12,600 (A)

_______ _______ ______

Total 105,800 133,440 27,640 (A)

_______ _______ ______

The Manager of the general machining department has received a memo from the Financial Controller requiring him to explain the serious overspending within his department.

The manager has sought your help and, after some discussion, you have ascertained the following:

• The cleaning materials, steel and other direct materials vary in proportion to the number of machine hours.
• The budgeted direct labour costs include fixed salary costs of $4,250; the balance is variable in proportion to the number of machine hours.
• The production overhead costs include a variable cost that is constant per machine hour at all activity levels, and a stepped fixed cost which changes when the activity level exceeds 10,000 machine hours. A further analysis of this cost is shown below:

Activity (machine hours) 3,000 7,000 14,000

Costs ($) 13,500 24,500 45,800

Required:

(a) Prepare a revised budgetary control statement using the additional information that you have obtained from the Manager of the general machining department.

(b) (i) Explain the differences between an incremental budgeting system and a zero based budgeting system.

(ii) Explain why R plc and similar organisations would find it difficult to introduce a system of zero based budgeting.

(c) Explain the benefits of involving the managers of R plc in the budget setting process, rather than setting the budget centrally as is R plcs current policy.