Chapter 17
Budgetary Control
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Overview
• Budgetary control
• Variance analysis
– Flexible budgets
– Sales variances
– Cost variances (price & efficiency)
• Criticism of variance analysis
• Cost control
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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
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Typical budget v actual report
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Variance report for a single cost
Budget
Actual
Variance
$80,000
$73,500
$6,500 Favourable
40,000 @ $2 35,000 @ $2.10
Can we compare budget and actual where the underlying activity is different?
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Flexible budgets
• A budget that is flexed, i.e. standard costs per
unit are applied to the actual level of business
activity
Original
Flexed
Budget
Budget
Actual
Variance
$80,000
$70,000
$73,500
$3,500 Adverse
40,000 @ $2 35,000 @ $2 35,000 @ $2.10
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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.
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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
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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
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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?
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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
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Budget v. actual report
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Flexible budget
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Variance report
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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).
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Sales variances
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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.
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Calculating price and usage
variances
2nd: (Aq x Ap) – (Sq x Ap)
= Alt. Quant Variance
Alt., 1st: (Sq x Ap) – (Sq x Sp)
= Alt. Price Variance
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
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Materials usage variance
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Materials price variance
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Materials price and usage variance: Plastic
SQ x SP
AQ x SP
AQ x AP
9000 x 2 = 18000 @
£1.50
£27,000
19,000 @ £1.50
£28,500
19,000 @ £1.40
£26,600
Usage variance
Price 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)
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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.
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Labour efficiency variance
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Labour rate variance
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Labour efficiency & rate variance: Skilled
SQ x SP
AQ x SP
AQ x AP
9000 x 6 = 54,000 @
£15
£810,000
55,000 @ £15
£825,000
55,000 @ £15.25
£838,750
Efficiency variance
Rate variance
£15,000 A
£13,750 A
1,000 hours @ £15
Total variance
55,000 hours @ 0.25
£28,750 A
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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.
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Variable overhead efficiency variance
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Variable overhead spending variance
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Variable overhead variance
SQ x SP
AQ x SP
AQ x AP
9000 x 6 = 54,000 @
£5
£270,000
55,000 @ £5
£275,000
55,000 @ £5.15
£283,250
Efficiency variance
Spending variance
£5,000 A
£8,250 A
1,000 hours @ £5
Total variance
£13,250 A
55,000 hours @ 0.15
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
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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
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Reconciling the variances
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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
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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
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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.
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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.
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Cost control
• 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.
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Cost improvement
• 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?
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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
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Accounting for Managers, 4th edition,
9781119979678
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