accounting for control

7/28/2019 Accounting for Control

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ACCOUNTING

FOR CONTROL


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The Control Process

Setting of objectives

Recording the results of the system

Comparison of plan with actual

Communication of deviations for

adjustment Feedback (negative /positive)


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Systems

Open loop systems

Closed loop systems Deterministic systems

Adaptive systems


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Objectives and the control process

The purpose of a control system is to ensurethat actions are in accordance with the firms

plans to achieve its objectives.

Ideally a system of control should be capableof making comparisons between expectations(as embodied in budgets and plans) and actualperformance so that these comparisons serveas a basis for determining the correctresponses to operating results.


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Budgets

Accounting plans which normally serve the

dual purpose of:

Quantifying the objectives of theenterprise

Providing a basis of control i.e. by

acting as a yardstickfor performanceevaluation


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Accounting for control

Budgetary control

Flexible budgets

Variance analysis understanding sales & cost variances

criticism of variance analysis

Cost control Applying different perspectives


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Budgetary control

ensuring that actual financial results are in linewith targets

Feedback: investigating variations between actual

results and budgeted results and takingappropriate corrective action

A favourable variance occurs where income exceedsbudget and/or expenses are lower than budget.

An adverse variance occurs where income is less thanbudget and/or expenses are greater than budget


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Flexible budgets

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

A budget that is flexed, i.e. standard costs

per unit are applied to the actual level of

business activity


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Variance analysis

Comparing actual performance against

plan, investigating the causes of the

variance and taking corrective action toensure that targets are achieved

For each responsibility centre,

product/service and for each line item


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Variance analysis process

Ascertain the budget and phasing foreach period

Report the actual spending

Determine the variance between budgetand actual (and determine whether it iseither favourable or adverse)

Investigate why the variance occurred

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

product/services sold

material variances: price and quantity of

materials used

labour variances: wage rate and production

efficiency

overhead variances: spending and efficiency


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Variance report


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Price and usage variances

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Sales variances

Sales price variance

Actual quantity 9,000@ actual price $175 $1,575,000

Actual quantity 9,000@standard price $170 $1,530,000

Favourable price variance $45,000

Sales quantity variance

Budget quantity 10,000- Actual quantity 9,000 1,000

@ standard margin $19.50Unfavourable quantity variance $19,500


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Material variances

Variance analysis

By Usage & price

Total variance

For each material (price & usage may offset)

Total usage (total of all materials) Total price variances (total of all materials)


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Labour variances

Variance analysis

By Efficiency & rate

For each type of labour: e.g. skilled & semi-skilled

Total variance

For each labour type (efficiency & rate mayoffset)

Total usage (total for all labour)

Total rate variances (total for all labour)


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Overhead variances

As variable overheads will commonly be basedon labour hours, the reasons for a labourefficiency variance will also relate to variable

overhead variance, although the reasons for aspending variance may be different

As fixed costs are independent of volume, thefixed cost variance is always a spendingvariance


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Reconciling variances

ReconciliationOriginal budgeted net profit 70,000

Sales variances

Favourable price variance 45,000

Unfavourable quantity variance -19,500 25,500

Materials variances

Total usage variance - adverse -5,000Total price variance - favourable 2,800 -2,200

Labour variances

Total efficiency variance - adverse -7,500

Total rate variance - adverse -13,750 -21,250

Overhead variancesAdverse efficiency variance -5,000

Adverse spending variance -8,250 -13,250

Fixed cost spending variance -5,000

Total variances -16,200

Actual net profit 53,800


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Understanding variances

Efficiency variances Poor productivity Poor production

planning

Out-of-date bill ofmaterials or labourrouting

Poor quality materialthat requires greater

skill to work The availability of

labour with the rightskills

Price variances

Changes in supplierprices not yet

reflected in the bill ofmaterials

A negotiated wageincrease that has not

been included in thelabour routing

Poor purchasingpractices

Unplanned overtime


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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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Criticism of variance analysis

Variance analysis

emphasises variable costs in a

manufacturing environmentIn the non-manufacturing sector,

overheads form the dominant part of

the cost of producing a service and soprice and usage variance analysis has a

limited role to play


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Criticism of variance analysis

Reducing variances based on standard costs can bean overly restrictive approach in a TQM, JIT orcontinuous improvement environment

tendency to aim at the more obvious costreductions (cheaper labour and materials) ratherthan issues of quality, reliability, on-time-delivery,flexibility, etc.


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Cost control

Cost control

reducing costs while maintaining

the same levels of productivity ormaintaining costs while increasinglevels of productivity through

economies of scale or efficienciesin producing goods or services


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Cost improvement

Cost improvement

ensure that limited resources are effectively

utilised

best achieved by understanding the causes ofcosts the cost drivers

Business process re-engineering

Examining cross-departmental activities to identifyduplication and quality problems


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Conclusion

Flexible budgets

Calculate

Sales price/quantity variances

price/usage variances for material efficiency/rate variances for labour

Efficiency/spending variances for overhead

Possible causes of variances and interdependencies

Limitations of variance analysis

Cost control

accounting for control

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