in to the concept- variances

7/30/2019 IN TO THE CONCEPT- VARIANCES

1/43

1

IN TO THE CONCEPT- VARIANCES

A variance is the study of difference between actual result and expected performance.

The expected performance is also called budgeted performance, which is a point of

reference for making comparisons.

Variances lie at the point where the planning and control functions of management

come together. They assist managers in implementing their strategies by enabling

management by exception. This is the practice of focusing management attentions on

areas that are not operating as expected (such as a larger shortfall in sales of a product)

and devoting less time to areas operating as expected. In other words, by highlighting

the areas that have deviated most from expectations, variances enables manager to

focus their efforts on the most critical areas.

If the actual cost is much higher than budgeted, the variances will guide managers to

seek explanations and to take early corrective action, ensuring that future operations

result in less scrap and rework.

Sometime a large positive variance may occur, such as a significant decrease in

manufacturing cost of the product. Managers will try to understand the reasons for this

decrease, for example, better operator training or changes in manufacturing method, so

these practices can be appropriately continued and transferred to other divisions within

the organization.

Variances are also used in performance evaluation and to motivate managers.

Sometime Variance analysis suggests that the company should consider a change in

strategy. For example, large negative variances caused by excessive defect rates for a

new product may suggest a flawed product design. Managers may than want to

investigate the product design and potentially change the mix of products being

offered.


2/43

2

Variance analysis contributes in many ways to making the five step decision process

more effective . It allows managers to evaluate performance and learn by providing a

framework for correctly assecing current performance. In turn managers take

corrective actionto ensure that decisions are implemented correctly and that previously

budgeted result are in fact attained.

Variance also enables managers to generate more informed predictions about the

future, and thereby improve the quality of five step decision making process.

Favorable and unfavorable Variances:

Favorable: Has the effect, when considered in isolation, of increasing operating

income relative to the budget amount. Favorable means actual revenues exceed

budgeted revenues.

An unfavorable variance: has the effect, when viewed in isolation of decreasing

operating income relative to the budgeted amount. Unfavorable variances are also

called adverse variances in some countries.

Price variance and Efficiency variance for direct cost input

To gain further insight, almost all companies subdivide the flexible budget a variance

for direct cost input into two more detailed variances:-

A price Variance that reflect the difference between an actual input price and a

budgeted input price.


3/43

3

An efficiency variance that reflect the difference between an actual input quantity and

a budgeted input quantity.

The information available from these variances helps managers to better understand

past performance and take corrective action to implement superior strategies in the

future. Managers generally have more control over efficiency variances than price

variance. Thats because the quantity of input used is primarily affected by the factors

inside the company, but price changes are primarily due to market forces outside the

company.


4/43

4

Management uses of Variances:

Management and accountants use variances to evaluate performance after decisions are

implemented, to trigger organizational learnings, and to make continuous

improvements. Variances serve as an early warning system to alert management to

existing problems or to prospective opportunities. Variance analysis enables managers

to evaluate the effectiveness of the actions and performance of personnel in the current

period, as well as to fine tune strategies for achieving improved performance in the

future. To make sure that managers interprete variances correctly and make

appropriate decision based on them , managers need to regognize that variances can

have multiple causes IN TO THE CONCEPT- VARIANCES

A variance is the study of difference between actual result and expected performance .

The expected performance is also called budgeted performance , which is a point of

reference for making comparisons.

Variances lie at the point where the planning and control functions of management

come together. They assist managers in implementing their strategies by enabling

management by exception.This is the practice of focusing management attentions on

areas that are not operating as expected(such as a larger shortfall in sales of a product)

and devoting less time to areas operating as expected. In other words , by highlighting

the areas that have deviated most from expectations , variances enables manager to

focus their efforts on the most critical areas.

If the actual cost are much higher than budgeted , the variances will guide managers to

seek explanations and to take early corrective action, ensuring that future operations

result in less scrap and rework.

Sometime a large positive variance may occure , such as a significant decrease in

manufacturing cost of the product. Managers will try to understand the reasons for this

decrease , for example , better operator training or changes in manufacturing method ,


5/43

5

so these practices can be appropriately continued and transferred to other divisions

within the organization.

Variances are also used in performance evaluation and to motivate managers .

Sometime Variance analysis suggest that the company should consider a change in

strategy. For example, large negative variances caused by excessive defect rates for a

new product may suggest a flawed product design. Managers may than want to

investigate the product design and potentially change the mix of products being

offered.

Variance analysis contributes in many ways to making the five step decision process

more effective . It allows managers to evaluate performance and learn by providing a

framework for correctly assessing current performance. In turn managers take

corrective action to ensure that decisions are implemented correctly and those

previously budgeted results are in fact attained.

Variance also enables managers to generate more informed predictions about the

future, and thereby improve the quality of five step decision making process


6/43

6

Objectives of the Study

Major

To study the cost allocation and Profit margin Projection in the contractual workTo study the reasons for variations in Projected profitability and Actual ProfitUnderstanding the cost allocation methodologyUnderstanding the effect of variation factors on Cost and Profit

Supportive

To gain the overall idea about the organization workingTo gain a firsthand knowledge about the Budgeting and the functioning with

Budgeting .

To have an effective exposure of the actual working situation and problems.To study the rules and practices implemented and its effect.To see the applicability and usability of theory which have been taught to us during

the first year of the course.

To find out the financial performance of the organization.To find out the importance of finance in business.To know what all studies are made before setting up Budget of a contractual work. Appreciate the potential enhancement of financial control which may result from

availability of detailed variance information;

Appreciate how a system of detailed variance analysis may exacerbate the arguedgeneral shortcomings of standard costing and budget variance analysis, along with

arguments about the relevance of such systems in modern operating environments.


7/43

7

Hypothesis of the study:

Variance Analysis helps to maintain the financial position of the organization.

Variance Analysis is the tool for financial analysis.

Variance Study support the organization for evaluating the performance duringthe different situation.


8/43

8

Gammon India Limited

(Builders to the Nation)

Gammon India Limited, the only Indian Construction Company to have been

accredited with ISO 9001 certification for all fields of Civil Engineering Works

including design, stands out as the gateway for Technological and Engineering

excellence in Civil Engineering fields. Gammon's dedicated and experienced team of

planners, designers and construction engineers are ever ready to contribute their

expertise together and turn vision into reality. This has led us to the position of one of

the leading engineering and construction companies in India.

Gammon India is not only the largest civil engineering construction company in India,

but can lay claim for the largest number of bridges built in the whole of

Commonwealth. With over seventy years of tradition in the field of construction.

Gammon is a name that is inextricably woven into the fabric of India.

As builders to the nation, Gammon has made concrete contributions by designing and

constructing bridges, ports, harbours, thermal and nuclear power stations, dams, high-

rise structures, chemical and fertilizer complexes environmental structures, cross

country water, oil and gas pipelines. Gammon has accomplished this by fusing

tremendous engineering knowledge with innovative skills, harnessing men and

materials to build structures.

Structures that stand out as living testimonies to the victory of man over nature.

Structures conceived and built by minds in constant search of new methods, ideas,

applications and solutions. Because Gammon believes that today's solutions will not be

adequate tomorrow.

This insatiable quest has led Gammon to pioneer Reinforced and Prestressed Concrete,

Long span bridges, Under water concreting using the Colcrete process, Thin shell


9/43

9

structures, Non-Shrinking concrete, Aluminium trusses for launching precast,

prestressed beams and many more.

These resounding achievements have won Gammon the status of an R&D Institution -

an unequalled honour for an unmatched Performance.

The planners, designers and construction specialists at Gammon have proved their

competence and innovative skills here and abroad. And driving them to seek, to build

and not to yield, is a team of professionals at the Head Office led by the Chairman &

Managing Director, Mr. Abhijit Rajan.

Gammon India Limited at Tiroda Civil and Chimney Works

Gammon India Limited is the construction company working at Adani Power

Maharashtra Limited for the construction of Multiflue and Twin flue Chimney and

Miscellaneous Civil and Structural works. It has a contract for almost all Major Civil

job construction. It has its concrete production establishments and all type of

Mobilizations for carrying this work. Gammon has its all establishment at Tiroda

Project under the Leadership of Mr. Pankaj Srivastava.

Gammon at this project is working for number complex structures in power plant such

as Transmission yard building, Boilers, Coal Handling Plant, Chimney, Pump-House,

Crusher House etc.of civil works such. The schedule and job codes for its operations

for this Project are as follows:-


10/43

10

Sr.

No.

Job

Code

Work Specification Start

Date

Completion

Date

Total

Duration

(Months)

1 8716 Construction of Multiflue

RCC Chimney for Phase

1,2,3

2 8717 Construction of

Misslaneous Civil and

Architactural Works for

phase 1,2,3

3 8834 Construction of Twin flueChimney For Phase 4 &5

4 8842 Construction of

Misslaneous Civil and

Architactural works for

Phase 4 & 5

Contractual Value For the each job

Sr. No. Job Code Job Value (in Lacs)

1 8716

2 8717

3 8834

4 8842


11/43

11

Authority Structure at Tiroda Project

Sr.No Staff

1 P.M. 1

2 D.M.-I 2

3 D.M.-II 5

4 A.M.-I 20

5 A.M.-II 30

6 Officers 5

7 Staff 70

1 2

3

45

10

Staff Ratio

P.M.

DM-I

DM-II

AM-I

AM-II

Execution

Project Leader

(Pankaj Srivastava)

Common Departments for All

Planning Billing Execution Safety Admin/ PR Accounts Store

Deputy Manager-I

Deputy Manager-II

Assistant Manager-I

Assistant Manager-II

Officers

Staff


12/43

12

Job Description

As already defined Gammon India Limited is a construction company therefore

at this project Also it has a job of all type of construction works due to the large

scope of work. Job involves the large number of workforce including skilled and

unskilled labours. Our major construction jobs at this project includes the

concrete work. Therefore we incur the large proportion of expenses on labour

for Wages , On material (Sand, Aggregate, Cement etc). Apart from this, work

includes number of machineries which require fuel and other sources of power.

Supportive departments have been established at site to support the productive

activities such as Safety Department, admin department, welfare department etc.

All these supportive departments incure the cost which are included in Yellow

Sheet and Blue Sheet Expenses.

Blue Sheet Expenses- Direct Cost Involve in Project Yellow Sheet ExpensesIndirect Costs involved in Project

Billing of the contract is made at monthly basis with client and after certification of the

work we get the payments at Head Office through artigeous. At head office provisions

and HO Expenses are deducted and then remaining fund is transferred to the Site for

making payments to direct and indirect cost.


13/43

13

Research Methodology

Analytical Research Methodology is been used for undertaking the study.

Under this method the secondary data been provided by the company finance and

Planning department. This data was analyzed up to the marks of the methodology

thought under the curriculum and suitable for the variance analysis. Study

undertakes the concepts of Budget preparation and actual expenditures with their

impact on profitability .

Apart from the secondary data personal interviews has been carried with the

people involved in the process of Budget creation and the Billing and Execution

team to carry opinions on the reflection of variances.

Study has carried under the following structure:

1.Formulating the research Problem:Study been undertaken to study the problem of variances in expected

profitability and actual profitability. To the great extent it is beenexperienced that most of the project works faces problems of profit

differences due to changes in budgeted and actual price and efficiency

variances.

2. Extensive literature survey:The study has been carried under the concepts of the budget creation andthe variance measurement methodologies.


14/43

14

3. Development of working Hypothesis:It is been general tendency to evaluate the variances due to the cost

differences in project work. This study has been undertaken to know the

actual reasons in the problems.

4. Research Design:Research study has been carried during the one year of placement period

therefore it includes the practical knowledge and data gathered from the

internal sources within period. Research has been carried under the proper

guidance of the Planning &Billing, Accounts, and Execution heads at

Gammon India Limited, Tiroda.

5. Sample Design:Research has been carried on the deliberated samples suitable and useful

for the study.

6. Data Collection:Study is based on the data collected through planning, billing and Accounts

department of Gammon India limited, Tiroda. It includes data based on the

observation, Personal Interviews, and log books of company.

7. Execution of the study:After collecting the valid and systematic data from the first hand

information whole study has been provided the shape.


15/43

15

8. Analysis of data;Analysis of the data has been made on the three levels of the variance as

follows:

First Level Second Level Third Level

9. Hypothesis testing: Presented results has been comrared with thehypothesis made for the study and it is found reasonable that due to the

price/cost differences most of the variances arises in the contractualworks.


16/43

16

Implementing Corporate Cost Allocation At Gammon India Limited

To provide information for economic decision To motivate managers and other employees To justify cost or compute reimbursement amounts To measure income and asset

Criteria To Cost Allocation

Cause And Effect Benefit received Fairness and equity Ability to bear

Cost Allocation and Costing System

Corporate Costo Treasury Costo Human Resourse Managemento Corporate Administration cost

Divison Costo Direct Costo Indirect Cost

Model Used in Calculating of Variances

We will take a closer look at the variance by examining Gammon Indias accounting

system. This study is exhibited in the chapters called levels followed by the numbers


17/43

17

denotes the amount of detail shown by a variance analysis. Level1 reports the least

detail, level2 offer more information and so on.

Gammon India Limited being a construction compony produces the concrete as its

major source of generating profit at project. Apart from this it also serves number of

other construction services to its client. In this study its main objective i.e. Concrete is

considered for calculating the variance and to come at the decision regarding reason at

end.

A)STATIC BUDGET AND STATIC BUDGET VARIANCES

B) FLEXIBLE BUDGET VARIANCES AND SALES VOLUME VARIANCES

STATIC BUDGET AND STATIC BUDGET VARIANCES

Note 1:

The data here present is based o the rates and prices quoted and collected by the

company for its project. It does not make differences for the quality variances as

compony produces the variety of concrete quality and other services therefor the

calculation and result presented here are the representation of only main product.

Note2:

We also assume that all other chain function, such as marketing and distribution.

Note3:

We also assume that all quantity produce during the six months starting from july-2010

to December -2010. Therefor all direct material are purchased and used in the same

budget period and there is no direct material inventory at either the beginning or the

end of the period.


18/43

18

Gammon India Limited three variable cost categories. The budgeted variable cost per

cubic meter of concrete for standard concrete mix are as follows:

Cost Category Variable Cost Per Cubic Metere

Direct Material Cost 61%

Direct Manufacturing Labour cost 22%

Production Overheads 4%

Total Variable Cost 87%

The number of cubic meter is the cost driver for the direct material, Direct

manufacturing overheads, and production overheads. The relevant cost of driver isfrom 0-20000 cubic meter concrete production in the month of july-2010

Budgeted and actual data for the july-2010 are as follows:

Budgeted selling price 2000 Rs. Per Cubic Meter

Budgeted production and sales 20000 Cubic Meter

Actual production and sales 16000 Cubic Meter

Fixed cost for 0-20000 Range 1600000 Rs.

Level 1 Analysis

A Actual

Result (1)

Static

Budget

Variance

(2)=(1)-(3)

Static

Budget (3)

B

Production

(cub.mtr)

16000 4000(U) 20000

Revenues 32000000 8000000(U) 40000000


19/43

19

Variable Cost

Direct

Material

65% 20800000 3600000(F) 24400000 61%

Direct

Manufacturing

Lobour

23% 7360000 1440000(F) 8800000 (22%)

Variable

Manufacturing

Overheads

3% 960000 640000(F) 1600000 (4%)

Total Variable

Cost

91% 29120000 5680000(F) 34800000 87%

Construction

Margin

2880000 2320000(U) 5200000

Fixed Cost 1600000 0 1600000

Operating

Income

1280000 2320000(U) 3600000

F=Favorable effect on operating income;

U=unfavorable effect on operating income;

Budgeted Contribution Margin:-5200000/40000000=13%

Actual Contribution Margin:- 2880000/32000000=9%

Budgeted Operating Income:- 360000/40000000=9%

Actual Operating Income:-1280000/32000000=4%

Rs.2320000 U Static Budget

Variances


20/43

20

Loss of Revenue, Contribution, and Operating Profit in Year

Projection for the loss es at the rates presented above amount in rupees

Budgeted Actual Difference Remark

Production 240000 192000 48000 Less Sale

Revenue 480000000 384000000 96000000 Less Revenue

Expenses 417600000 368640000 48960000 High

Proportion

Contribution 62400000 15360000 47040000 Less

contribution

Operating

Income

43200000 15360000 27840000 Less Profit

Result:

1. Rs.27840000 Loss in one year.2. Increase in Contract Time Period due to less production. Extra Time to recover

the less production will be:

Extra Time: 48000/14000=3.42 Months

3. Increase in Time will result more increase in fixed cost amounting to rs. FixedCost Increase=1600000*4 Months=6400000Rs.

The static budget or master budget is based on the level of output planned at the

start of the budget period. The master budget is called a static budget because

the budget for the period is developed around a single (static) planned output.


21/43

21

FLEXIBLE BUDGET VARIANCES AND SALES VOLUME VARIANCES

A flexible budget calculates budgeted revenue and budgeted cost based on the

actual output in the budgeted period. The flexible budget is prepared at the end

of the period, After the actual production known. The flexible budget is theHypothetical budget that present to prepare the next correct forecast.

Given Data For Analysis of Level 2 Variance Calculation

The budgeted selling price is the same Rs. 2000 per cubic meter ofconcrete

The budgeted variable cost are same The budgeted fixed cost is also same

The only difference between the static budget and flexible budget is that static budget

is prepared for the planned output of 20000 cubic meter of concrete, where as the

flexible budget is based on the actual output of 16000 cubic meter concrete. The static

budget I being flexed or adjusted from 20000 production to 10000 production. Theflexible budget for 1000 production assume that all cot are either completely variable

or completely fixed with respect to the number of concrete production.

Preparation of Flexible budget takes following three steps:-

1. Identify Actual Quantity of Output2. Calculate the flexible budget for revenues based on budgeted selling price and

actual quantity of output.

Flexible Budget Variable:Rs.2000*20000 Cubic Meter

=Rs. 40000000

3. Calculate the flexible budget for cost based on the budgeted variable cost perunit , Actual quantity of output and budgeted fixed cost.


22/43

22

Flexible Variable Cost

Flexible Budget Variable Cost: Amount (Rs.)

Direct Material((2000*61%)*20000) 24400000

Direct Material Labor(2000*22%)*20000) 8800000

Variable manufacturing overhead 1600000

Total flexible budget variable cost 34800000

Flexible budget fixed cost 1600000

Flexible budget total cost 36400000

Level 2 Analysis

Actual

Result (1)

Flexible

Budget

Variances

(2)=(1)-(3)

Flexible

Budget

(3)

Sales

Volume

Variances

(4)=(3)-(5)

Static

Budget

Production

(cub.mtr)

16000 0 16000 4000 20000

Revenues 32000000 0 32000000 8000000 40000000

Variable Cost

Direct Material 20800000 1280000(U) 19520000 4880000(F) 24400000 61

Direct

Manufacturing

Labor

65% 7360000 320000(U) 7040000 1760000(F) 8800000 22

VariableManufacturing

Overhead

23% 960000 320000(F) 1280000 320000(F) 1600000 4%

Total Variable

Cost

3% 29120000 1280000(U) 27840000 69600000(F) 34800000 87


23/43

23

Contribution

Margin

91% 2880000 1280000(U) 4160000 1040000(U) 5200000

Fixed Cost 1600000 0 1600000 1600000 1600000

Operating Income 1280000 2864000(U) 4144000 544000 3600000

Sales Volume Variances:

Sales Budget Variance for Operating Income :

=Flexible Budget amountStatic Budget Amount

=4144000-3600000

=544000 Rs. Unfavorable

Therefor could be one or more reason for the above unfavorable variances that could

be:-

The overall demand for the concrete is not at the rate that was anticipated. Budgeted production volume were set without careful analysis of market

contribution.

Variable cost may not be forecasted with accurate increment. Less efficiency may be used at working. Efforts may not be utilized to its forecasted level.

Flexible Budget

Variances Rs.

2864000

Static Volume

Variances Rs. 544000

Static Budget Variances

Rs.2320000


24/43

24

Price Variances:

The formula for computing the price variances is:

Price Variance=(Actual price of input-budgeted price of input)*Actual

quantity of input

Direct Material Variances

=(1300-1220)*16000

=320000 Rs. Unfavorable

Variable Manufacturing Overheads price Variances

=(60-80)*16000

=320000Rs. Faborable

Total Price Variances

Direct Material Price Variances -1280000

Direct Manufacturing Labor Price Variances -320000

Variable Manufacturing Overheads Price

Variance

+320000

Total Price Variances (Unfavorable) +1280000


25/43

25

Findings from the study:

By identifying progress from a preceding position we are better informed regarding the

effects of our actions and have a clearer understanding of the effect of any future action

we take. Knowing how much is being spent each month enables a manager to consider

whether action needs to be taken to spend more or less in the future. THIS PROCESS IS

ONLY WORTHWHILE IF THE BUDGET IS REALISTIC. ANALYSING

VARIANCES AGAINST AN UNREALISTIC BUDGET IS POINTLESS. However, in

a well run organisation the comparison between actual and budget is used as the basis for

deciding the appropriate action.

This study sets out how the analysis is used to maximum effect. The process is really

part of the normal control process.

WHAT CAUSES BUDGET VARIANCES?

There are four key reasons and it is important that good managers recognise thedifferences, because the action required is may be completely different in each case.

The four reasons are:

1. Faulty Arithmetic in the Budget Figures2. Errors in the Arithmetic of the Actual Results3. Reality is Wrong4. Differences between Budget Assumptions and Actual Outcome Each of these will

be examined in turn.


26/43

26

Faulty Arithmetic in the Budget Figures

It is perfectly possible to have an error in the budget. This includes errors of commission

or duplication as well as pure arithmetic. One action is to make a note to ensure it does

not happen again when the next budget is being done. Other action depends on the error.

Assume the budget stated no overdraft would necessary and it now appears one is

required because the sales forecast was used to predict cash inflows rather than the

debtor payments. There are two options: Go to the bank and ask for an overdraft, or take

some other action to improve cashflow to stay within the budget cash figure. The

original budget numbers will need to be changed to reflect the new circumstances and

future reporting should be against the revised budget (often called a reforecast or latest

estimate.) Action is required but it may not be within the area where the error was made.

AVOID: "There's a hole in the roof but we can't fix it because we haven't got a budget

for repairs!!!"

Errors in the Arithmetic of the Actual Results

It is perfectly possible for the actual results to be reported wrongly. This includes the

use of the wrong category, omission of costs, double counting of income etc. One well

known way of staying within budget is to throw away any invoices received from

suppliers, or charge them to someone else's account code. This sort of deliberate action

makes a nonsense of budgetary control and must be avoided. The corrective action once

this is discovered is to prevent it happening again. Improvements in management

education and/or control procedures are recommended. One extra consideration is that

in order to correct the error the cumulative results will need to be corrected. This means

either putting through a correction in the next period, which will then also be wrong, or

adjusting the past results to correct the error. Failing to note that the correction can cause

misleading results can lead to wrong decisions being made. AVOID: "The Accounts


27/43

27

figures are always different from ours so we ignore them and keep our own records."

Reality is Wrong

Sometimes the Actual results are useless as an indicator. A strike or natural disaster

will have an impact on results. This does not mean that the budget process in future

should include an allowance for this happening again. (However in large organisations

it is normal to allow for the impact of a disaster centrally as a contingency even if it is

not budgeted at operating unit level.) If necessary, insurance should be taken out. If

business is disrupted for two weeks, then it is pointless to compare the remaining two

weeks of the month against a full month's budget. Produce a realistic budget for only

two weeks and compare against that to establish true performance under normal

circumstances. AVOID: "The variances are distorted because of.......so its not my

fault."

Differences between Budget Assumptions and Actual Outcome

This is the key issue and the one which involves the use of variance analysis

techniques. Remember that all budgets contain errors in the assumptions. No one

knows the future outcome for certain. The important thing is not to apportion blame by

looking backwards, but to look forwards and take action to improve the future in the

light of experience. The action to be taken depends on the circumstances. However,

punishing deviation from budget is the best way of destroying the budget process.

Managers will spend up to budget, conceal data, make the actual fit the budget in order

to avoid blame. This is particularly true in large multi-national organisations. The

emphasis must be on what can we do about it, rather than why the results are different


28/43

28

Multiple causes of variances

Managers must not interpreate variances in isolation of each other. The causes

of variances in one part of the value chain can be the result of decision made in

another part of the value chain.

1. Poor design of the product and processes

2. Poor work on the production line because of underskilled workers or faultymachines.

3. Inappropriate assignment of labor or machines to specific jobs.

4. Congestion due to schedule a large nember of rush orders .

5. Different quality products.


29/43

29

Suggestions:

In construction project operation, often there is a project cost variance in terms of the

material, equipments, manpower, subcontractor, overhead cost, and general condition.

Material is the main component in construction projects. Therefore, if the material

management is not properly managed it will create a project cost variance. Project cost

can be controlled by taking corrective actions towards the cost variance. The objective

of this research paper is to identify the main cause of the cost variance and to

recommend the corrective actions. The approach to serve that objective is by

conducting surveys to high rise building construction projects in order to identify the

cause of project cost variance in material purchasing, and by interviewing experts in

order to obtain recommendations in taking corrective actions. Method Analysis used in

this research is Delphi method. The result of the research shows that the corrective

action towards the variance of the material purchasing cost is actually a preventive

action (before process).

The competitive business nowadays especially in construction industry, demands the

increasing quality of construction service companies. There are some steps that can bedone to improve that quality, for instance, by taking corrective actions in the

construction project operation. Those corrective action in the operation phase could be

a Project Control system, consist of cost, quality and time. Control of the project cost

consists of material cost control, equipments, manpower, subcontractor, overhead cost

and general condition. In construction project operation, often there is a project cost

variance. One of the most influencing variables in project cost variance is material.

Generally, in construction projects, material and equipment are the two major

components, which is about 50-60% of the total project cost


30/43

30

It is found that material cost mostly could spend 60% of the total construction project

cost, but this matter is often neglected. As a comparison, in manufacturing, material

management cost at that time is budgeted 1% from the total project cost, while in

construction; it is only budgeted 0.15%. Because of the ineffective material

management at that time, therefore in some cases of office building construction, it

causes the increasing amount of time or work delay up to 18% of the expected time,

creating a cost variance. Project cost can be controlled by taking corrective actions

towards the cost variance. Materials management is defined as a management system

that is required in planning and controlling the quality & quantity of the material,

punctual equipment placement, good price and the right quantity as required.

Three important phases that holds the key to a successful materials management are;

materials purchasing, materials usage, waste controlling and storage. Cost control is

not only to supervise the cost & data from the field, but also to analyze the data to

make a corrective action before it is too late. Corrective action needs the ability to

make a decision of what steps to be done, to make priority of how to correct the

problems, etc. This paper discusses about the main problem of the variance of cost

construction materials management and to recommend corrective actions towards thatvariance. The scope of this research is limited to the variance of the construction work

at power Plant at Tiroda.

Recommended corrective actions for the material Cost Variance

Sr. no. Cost Variance Cause Corrective Action

Planning and Scheduling

1 Poor forecasting of

field condition,

weather and event in

the future

Conducting detailed and perfect surveys towards the

field condition and previous weather data


31/43

31

2 Poor planning in

scope of work

Accurately study the job items, sequences and

methods of the job activities

3 Poor material

scheduling

(inaccuracy)

Prepare a detailed materials schedule planning in

accordance with scope of work

4 Poor estimation and

budgeting of

materials cost

Prepare an accurate and detailed budgeting based on

direct market surveys

5 Poor development

and application of the

standard workprocedure

Evaluate the available standard method in

accordance with the scope of work, situation,

condition and environment

6 Poor market

prediction

Conduct a pre survey in accordance with market to

enable making the right price estimation

7 Poor data and

information of

activity and materials

Conduct data acquisition to make a good and

complete data & information

Organization & Personnel

1 Lack of support from

head office

Employ a correct procedure and apply the procedure

with high level of discipline.

2 Lack of funds Optimize cash flow in accordance with the

requirements.

3 Ineffective

communication

system

Planning and applying Management Information

System (MIS)

4 Inefficient system

procedure and

Routine evaluation of all procedures to adjust

procedures effectiveness and efficiency


32/43

32

bureaucracy

5 Poor decision making

process

Conduct routine/regular coordination meeting and

develop a procedure regarding decision making.

6 poor coordination of

functions in project

organization

Develop a good, simple and easy to understand

system to regulate coordination procedures and

responsibility of units.

7 Wrong placement of

personnel in project

organization structure

Conduct proper Personnel selection for the position

needed based on comprehensive work experience

and training check and relevant skill tests.

8 Poor interpersonal

communicationability

Develop an excellent and effective communication

system that has a fix procedure.

Procurement

1 Scarcity of materials

in the market

Utilize material optimization/material substitution

and adjust price accordingly based on the material

selected.

2 Changes of materialssource condition

towards the project

location

Propose Material substitution or Material Priceadjustment.

3 Deviation of quality

materials purchased

and ordered

All clauses regarding procurement must clearly

define the responsibilities, rights and penalties.

4 Delay of materials

payment

Develop an excellent payment schedule to prevent

delay in material delivery.

5 Changes of the

company purchasing

Develop fixed procedure


33/43

33

policy

6 Deviation of

scheduling

Develop detailed and accurate schedule to facilitate

easy and controlled scheduled execution.

7 Poor purchasing

strategy in selecting

vendors

Conduct comprehensive and careful selection of

suppliers, which consider supplier daily capacity and

material quality.

Delivery

1 Delay of materials

shipment to location

Procurement Schedule (including delivery) must be

routinely monitored

2 Changes of materials

condition during

shipment process

Must have material maintenance procedure during

procurement/delivery.

3 Shipping cost

variance

Delivery cost is determined based on budget

requirements.

4 Poor accessibility

during shipping

process

Must have proper temporary storage facilities.

Storage and Storage Facilities

1 High number of

stealing in

warehouses

Provide state of the art security system to support

competent and honest security personnel.

2 High potency of fire

in warehouses

Provide the necessary equipments for storage fire

safety and provide training for safety personnel.3 Delay of posting in

inventory system

Create Storage and facility management, material

maintenance procedure and discipline storage unit.

4 Overstocking

materials in

Create Storage and facility management, material

maintenance procedure and discipline storage unit.


34/43

34

warehouses

5 High number of

materials damage in

warehouses

Create good storage system conform to warehouse

standards for material storing.

6 Poor supervision in

warehouses

Conduct periodic storage control.

Usage

1 Inefficient usage of

materials in location

Develop effective material usage procedure and

material usage control

2 High frequent

materials movement

Develop accurate material transfer method and

adequate temporary facilities site

3 Frequent rework due

to mistakes

Clear design with good material plan contents and

according to scope of work

4 Lack of

understanding

towards the

characteristic of worklocation

Environmental and site evaluation sequence

5 Lack of

transportation

Provide accurate estimation for mobile equipment

plan and placement schedule

6 Inefficient utilization

and cutting of

materials

Provide bar bending/ cutting schedule

7 Wrong materials

utilization

Provide clear work method with available facilities

Change Order

1 Incomplete drawing Develop evaluation during tender explanation


35/43

35

design meeting

2 Frequent out-of-

sequence job flow

Provide accurate and detail execution schedule

3 Schedule

compression

Perform work according to schedule and identify

change of order and adjust accordingly to schedule.

4 Owner intervention

during process

Clear and well defined clauses in contract regarding

responsibilities and duties to prevent unnecessary

disruption.

Monitoring and Control

1 Lack of coordination

meeting in the field

Operation that regulate Coordination meeting

2 Poor report system Develop procedure and execute the procedure with

discipline.

3 Lack of Information

System role (MIS-IT)

Develop appropriate Information system with proper

communication procedure.

4 Poor companys

administration anddocumentation

system

Provide Manual and procedure that govern

administration and documentation.

5 Poor evaluation and

decision making

system

Conduct coordination meeting for project evaluation

to reach effective and accurate decision making.

6 Poor inventory

control towards stock

of materials

Create a procedure and implement the procedure

with discipline.

External Factors

1 High number of Well Implementation of Safety and security system


36/43

36

materials and

equipment

loss/stealin

and discipline in material utilization

2 Frequent changes of

economic condition

Periodic evaluation of project. Create addendum to

minimize losses and impact from planning if needed.

3 Frequent changes of

rules and regulations

Make contract changes with binding condition and

according to the applicable agreement.

4 High frequent of

unpredictable

situations during

construction (forcemajeure, natural

disaster, politics, etc)

Include force majeure clausal in contract to predict

and anticipate unexpected conditions.

5 Poor condition of

weather and climate

Apply accurate construction method

6 High competition Improve effectiveness, efficiency and productivity

by implementing SWOT analysis.

CONCLUSION

Corrective actions are applied to the causes of variance by observing the risk factor,

both the highest and lowest risk factors, in an effort to prevent deviation in material

management. Comprehensive understanding of field issues and problems are required

before giving corrective actions recommendation. That way, the effect due to the cost

variance can be presented in detail and according to the real condition. Experts

recommended corrective actions are corrective actions taken from past events. These

actions are preventive actions. Research shows that the cause of material cost


37/43

37

variance, risk ranking and recommended corrective actions can be organized into a

knowledge base which can be developed into a computerized

knowledge base management system. This prototype knowledge base management

system will yield output in terms of recommended corrective action to cost variance.

Recommendation will depend on factors which have the highest risk ranking.

Corrective actions towards the cause of variance are recommended by observing the

risk level of material cost variance.


38/43

38

LIMITATIONS ON THE COMMON VARIANCES

(1) There are specific physical circumstances that distinguish the project sitefrom its surroundings.

(2) These unique circumstances would create an unnecessary hardship for theContracting firm if the usual standards were imposed.

(3) Variances are only for use in unusual, individual circumstances.

(4) Furthermore, consideration of a variance must focus upon the contractualstandard.

(5) Conditions must be imposed on a variance when necessary to avoid aparticular variance to be included or not to be included in calculations.

(6) A variance does not change the quality of the contractual


39/43

39

Conclusion:

Managers realize that a standard is not a single measure but rather a range of possible

acceptable input quantities , costs, output, quantities,or prices. Consequantly ,they

expect small variances to arise. A variance withinan acceptable range is considered tobe an in control occurrences and calls for no investigation or action by managers.

So when would manager need to investigate variances?

Frequently , managers investigate variances based on subjective judgements or rules of

thumbs. For critical items,such as productdefects even a small variances may prompt

investigation and actions. For other items , such as direct material costs ,labor costs

and repair cost , companies generally have rules such as investigate all variancesexceeding rs.50000 or 25% of budgeted cost, whichever is lower.

Performance Measurement Using Variances

Managers often use variance analysis when evaluating the performance of

their subordinates. Two attributes of performance are commonly evaluated:

1. Effectiveness : the degree to which predermined objective or target is metfor example , sales,customers satisfaction and quality

2. Efficiency: The relative amount of input used to achieve a given outputlevel the smaller the quantity of input used to make a given number ofcell phones or the greater the number of cell phones made from a given

quantity of input , the greater the efficiency.

As we discussed earlier , managers must be sure they understand the causes of a

variance before using it for performance evaluation. Suppose a purchasing manager


40/43

40

has just negotiated a deal that result in a favourable variance for any or all of the

following reasons:

1. The purchasing manager bargained effectively with suppliers.

2. The purchasing managers secured a discount for buying in bulk with fewerpurchase orders. However ,buying larger quantities than necessary for the short

run resulted in excessive inventory.

3. The purchasing manager accepted a bid from the lowest priced supplier afteronly minimal efforts to check quality amid concerns about the suppliers

material.

Managers benefits from variances analysis because it highlights individual aspects of

performance. However , if any single performance measure (for example, a lobor

efficiency variance or a consumer rating report) receives excessive emphasis ,

managers will tend to make decision that will cause the particular performance

measure to look good. These actions may conflict with the companys overall goals,

inhibiting the goals from being achieved . This faulty perspective on performance is

usually arises when top management designs a performance evaluation and reward

system that does not emphasize total company objectives.

Organizational Learning

The goal of variance analysis is for managers to understand why variance arises, to

learn and to improve future performance. For instance , to reduce the unfavorable

direct material efficiency variances , managers may seeks improvements in product

design , in the commitment of workers to do the job right the first time, and in the


41/43

41

quality of supplied materials, among other improvements. Sometime an unfavorable

direct material efficiency variance may signal a need to change product strategy,

perhaps because the product can not be made at a low enough cost.

Variance analysis should not be a tool to play the blame game (that is, seeking a

person to blame for every unfavorable variance) . Rather it should help the company

learn about what happened and how to perform better in the future.

Managers need to strike a delicate balance between the two uses of variances we have

discussed : performance evaluation and organizational learning. Variances analysis is

helpful for performance evaluation but an overemphasis on performance evaluation

and meeting individual variance targets can undermine learning and continuous

improvement. Why? ? Because achieving the standard becomes an end in and of itself.

As a result , managers will seek targets that are easy to attain rather than that are

challenging and that require creativity and resourcefulness. For example, if

performance evaluation is overemphasized , manager will prefer an easy standard that

allows worker ample time to manufacture a product; he will then have little incentive

to improve processes and methods to reduce manufacturing time and cost.

An overemphasis on performance evaluation may also cause managers to take actions

to achieve the budget and void an unfavourable variance, even if such action could hurt

the company in the long run. For example, the manufacturing manager may push

workers to produce more within the time allowed , even if this action could lead to

poorer quality product being produced , which could later hurt revenues. Such negative

impacts are less likely to occur if variance analysis is seen as a way of promoting

organization learning.


42/43

42

BIBLIOGRAPHY:

1) Websites:(a) www.gammonindia.com(b)Wikipedia

2) Magazines & Journals3) Books:

(a)Cost Accounting- Charles T. Horngren, Srikant M. Datar,George Foster, Madhav V. Rajan, Christopher Ittner. (Pearson)

(b)Indian Financial System- Vasant Desai

(c)Financial Management- S Rastogi
http://www.gammonindia.com/http://www.gammonindia.com/http://www.gammonindia.com/


43/43

in to the concept- variances

Documents