1. 1 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678 Chapter 17 Budgetary Control

2. Overview Budgetary control Variance analysis –Flexible budgets –Sales variances –Cost variances (price & efficiency) Criticism of variance analysis Cost control 2 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

3. Budgetary control Ensuring that actual financial results are in line with targets Feedback: investigating variations between actual results and budgeted results and taking appropriate corrective action A favourable variance occurs where income exceeds budget and/or expenses are lower than budget. An adverse variance occurs where income is less than budget and/or expenses are greater than budget 3 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

4. Typical budget v actual report 4 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

5. Variance report for a single cost Can we compare budget and actual where the underlying activity is different? 5 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

6. Flexible budgets A budget that is flexed, i.e. standard costs per unit are applied to the actual level of business activity 6 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

7. Advantages of the flexed budget The flexed budget identifies the two separate components of this variance: – $10,000 favourable variance (in terms of cost) because of the reduction in volume from 40,000 to 35,000 units at $2 each. This is offset by – $3,500 adverse variance because the 35,000 units produced each cost 10c more than the standard cost. These may be controllable by different managers. 7 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

8. Variance analysis Comparing actual performance against plan, investigating the causes of the variance and taking corrective action to ensure that targets are achieved –For each responsibility centre, product/service and for each line item 8 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

9. Variance analysis process 1.Ascertain the budget and phasing for each period 2.Report the actual spending 3.Determine the variance between budget and actual (and determine whether it is either favourable or adverse) 4.Investigate why the variance occurred 5.Take corrective action 9 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

10. Variance analysis Is the variance significant? Is it early or late in the year? Is it likely to be repeated? Can it be explained (and understood)? Is it controllable? 10 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

11. Variance analysis Types of variance –sales variances: price and quantity of finished product/services sold –material variances: price and quantity of raw materials used –labour variances: wage rate and production efficiency –overhead variances: spending and efficiency 11 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

12. Budget v. actual report 12 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

13. Flexible budget 13 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

14. Variance report 14 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

15. Sales variances The sales price variance is the difference between the actual price and the standard price for the actual quantity sold. The sales quantity variance is the difference between the budget and actual quantity at the standard margin (i.e. the difference between the budget price and the standard variable costs). 15 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

16. Sales variances 16 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

17. Cost variances The usage or efficiency variance is the difference between the standard and actual quantity, while holding the standard price constant, i.e. it tells us, at the standard or expected price, the excess material, labour or variable overhead consumed in producing the actual quantity of finished goods. The price or wage rate variance is the difference between the standard price and the actual price, while holding the actual quantity of material or labour used constant, i.e. it tells us, given the actual quantity of resource used, the additional price or wage rate paid in producing the actual quantity of finished goods. 17 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

18. Calculating price and usage variances Based on the Flexed budget Note: Standard quantity here refers to the quantity of materials or labour budgeted to produce the actual quantity of finished goods 18 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678 Alt., 1 st : (Sq x Ap) – (Sq x Sp) = Alt. Price Variance 2 nd : (Aq x Ap) – (Sq x Ap) = Alt. Quant Variance

19. Materials usage variance 19 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

20. Materials price variance 20 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

21. Materials price and usage variance: Plastic SQ x SPAQ x SPAQ x AP 9000 x 2 = 18000 @ £1.50 £27,000 19,000 @ £1.50 £28,500 19,000 @ £1.40 £26,600 Usage variancePrice variance £1,500 A (Table 17.8) £1,900 F (Table 17.9) 1000 pieces of plastic @ £1.50 Total variance 19000 pieces of plastic @ 10 cents £400 F (Table 17.7) 21 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

22. Understanding material variances Efficiency variance: – poor productivity; – out-of-date bill of materials; – poor quality materials. Price variance: – changes in supplier prices not yet reflected in the bill of materials; – poor purchasing. 22 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

23. Labour efficiency variance 23 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

24. Labour rate variance 24 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

25. Labour efficiency & rate variance: Skilled SQ x SPAQ x SPAQ x AP 9000 x 6 = 54,000 @ £15 £810,000 55,000 @ £15 £825,000 55,000 @ £15.25 £838,750 Efficiency varianceRate variance £15,000 A£13,750 A 1,000 hours @ £15 Total variance 55,000 hours @ 0.25 £28,750 A 25 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

26. Understanding labour variances Efficiency: – poor-quality material that required greater skill to work; – the lack of unskilled labour that was replaced by skilled labour; – poor production planning. Rate: – unplanned overtime payments; – a negotiated wage increase that has not been included in the labour routing. 26 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

27. Variable overhead efficiency variance 27 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

28. Variable overhead spending variance 28 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

29. Variable overhead variance SQ x SPAQ x SPAQ x AP 9000 x 6 = 54,000 @ £5 £270,000 55,000 @ £5 £275,000 55,000 @ £5.15 £283,250 Efficiency varianceSpending variance £5,000 A£8,250 A 1,000 hours @ £5 Total variance 55,000 hours @ 0.15 £13,250 A

30. Fixed cost variance Changes in quantity cannot influence fixed costs (which by definition are constant over different levels of production), so any variance must be the result of a spending variance. The variance is an adverse £5,000, because costs of £130,000 exceed the budget cost of £125,000 30 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

31. Overhead variances As variable overheads will commonly be based on labour hours, the reasons for a labour efficiency variance will also relate to variable overhead variance, although the reasons for a spending variance may be different As fixed costs are independent of volume, the fixed cost variance is always a spending variance 31 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

32. Reconciling the variances 32 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

33. Understanding variances Interdependencies –Between efficiency and price –Between materials and labour Poor quality materials may result in more labour hours Untrained labour may result in more wastage of materials 33 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

34. Limitations of variance analysis Variance analysis emphasises variable costs in a manufacturing environment where labour costs are typically a low proportion of manufacturing cost, but material costs are typically high and variance analysis has a role to play in many organizations that incur high costs for purchased goods (including retailers).  In the non-manufacturing sector, overheads form the dominant part of the cost of producing a service and so price and usage variance analysis has a limited role to play 34 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

35. Limitations of variance analysis Reducing variances based on standard costs can be an overly restrictive approach in a TQM, JIT or continuous improvement environment as the tendency may be to aim at the more obvious cost reductions (cheaper labour and materials) rather than issues of quality, reliability, on-time-delivery, flexibility, etc. 35 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

36. From variance analysis to cost control Organizations can use variance analysis in a number of ways to support their business strategy, most commonly by investigating the reasons for variations between budget and actual costs, even if those costs are independent of volume. These variations may identify poor budgeting practice, lack of effective cost control, poor purchasing practices, or variations in the usage or purchase price of resources that may be outside a manager’s control. 36 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

37. Cost control –reducing costs while maintaining the same levels of productivity or maintaining costs while increasing levels of productivity, typically through economies of scale or efficiencies in producing goods or services “Cost down” – working with suppliers to reduce the cost of purchased materials or components, improve purchasing processes, reduce inventory and eliminate waste. 37 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

38. Cost improvement –ensure that limited resources are effectively utilised –best achieved by understanding the causes of costs – the cost drivers Business process re-engineering –Examining cross-departmental activities to identify duplication and quality problems What is being done? Why is it being done? When is it being done? Where is it being done? How is it being done? 38 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678

39. Key points Flexible budgets Calculating –Sales price/quantity variances –Material price/usage variances –Labour efficiency/rate variances –Efficiency/spending variances for overhead Reconciling the variances Understanding the causes of, and interdependencies between variances Limitations of variance analysis Approaches to cost control 39 © 2012 John Wiley & Sons, Ltd, Accounting for Managers, 4th edition, 9781119979678