Lesson 14

Budget V’s Variances

Li, Jialong

2011-2-26

What is a Budget?

• Budgeting is the process used to develop: A formal written statement of managements

plans for the future Expressed in financial terms Information comes from both internal and external sources.

Budgets are the mechanism by which management control of an organisation becomes possible.

Analysing Variances

• The Variance Analysis regularly compares what you expected or planned to earn and spend with what you actually spent and earned.

• Variance analysis can help greatly when detecting how well you’re tracking your plans, how much to accurately budget in the future, where there might be upcoming problems in spending.

Variance Analysis

There are two outcomes of a variance analysis

Favourable (Positive)

Actual Revenue Sales greater than budget Revenue

Actual Expenses lower than budget Expenses

Unfavourable (Negative)

Actual Revenue less than budget Revenue

Actual Expenses greater than budget Revenue

Example of Variance Report

Materiality (Does it Matter?)

• Variances must be viewed in the context of the operation’s overall costs.

• In the some businesses of a material amount of variance may be approx.

$1,000 - $2,000

In other businesses it may be

$100-$200

How to Control Your Budget

1. Monitor the actual with the budgeted numbers

2. Make comparisons

3. Communicate to appropriate staff

4. Do department performance reviews

5. Make changes

6. Document the cause of deviation in actual vs. budget

Benefits to Checking Variances

BY Understanding the reason for the differences you can ask:

What happened?

Why did it happen?

How can we prevent it happening again in the future?

How can we do better?

Do I need to get help?

Who do I have to tell?

Will it continue and change the future?

Sales variances and their causes

Sales Value Variance: The difference between the budgeted sales value and the actual sales value.

There are two reasons that can account for this variance:

1. A change in the selling price per unit

2. A change in the volume of sales

Sales variances and their causes Causes Changes in selling price usually occur in response to

competition. Other causes of selling price changes include: • More trade discounts granted than those allowed in the budget • Seasonal sales to dispose of old stock in line with changing

fashion or obsolescence

The causes of changes in the volume of sales include: • Extensive advertising by a competitor • Superiority of the product over that of competitors • Change in the mix of sales

Personnel responsible Sales and Marketing department

Material (Purchases)variances and their causes The direct material used in manufacturing, service or

other businesses. The total direct material cost variance is the

difference between the budgeted cost and the actual cost incurred.

There are two reasons for the total variance:

1. The price actually paid may have been more than or less than that budgeted

2. The material actually used per unit of output is more than or less than that budgeted

Material (Purchases)variances and their causes

Causes Causes of the price paid per unit of direct material being higher than the budgeted

price include: • Not investigating the market for a cheaper supply • Not taking advantage of bulk buying discounts • Use of an expensive substitute material • An increase in market price due to various reasons such as foreign currency

exchange rate variations

Causes of the actual usage of direct material per unit of product differing from the budgeted usage include;

• Use of substitute materials requiring more/less than the originally intended quantity

• Wastage due to workers carelessness • Unavoidable spoilage during operations • More/less than expected normal losses of materials • Use of a material mix that was not budgeted • An increase in material usage due to incorrect machinery settings • Faulty material

Relevant personnel: purchasing and production departments

Direct Labour variances and their causes

There are two reasons for the total variance:

1. The rate of pay may have been more than or less than that budgeted

2. The labour hours used per unit of output is more than or less than that budgeted

Direct Labour variances and their causes Causes Causes of the actual rate of pay differing from budget include: • Hiring employees more / less qualified or skilled than intended • Changing the planned mix of the skill levels • Awards, enterprise agreements and market rate increasing the rate of pay

more than the budget allowed

Causes of the actual time taken to complete a job differing from budget include:

• Hiring employees who are untrained and inexperienced • Hiring more highly skilled employees than intended • Increasing staff productivity • Changing technology or processes • Frequent machine breakdowns • Unavailable materials causing delays • Poor production scheduling

Relevant personnel: Human resources and production departments

Overhead variances and their causes

Overheads are expenses that cover all the business eg rent for a hair salon. Some overheads are fixed like the rent of a salon but some overheads such as electricity are variable as the cost of electricity changes with how many customers need dyers and how long the salon opens each day.

Overhead variances and their causes

Causes Actual production level differs from the budgeted level • Efficiency or inefficiency in purchasing • Effective or ineffective supervision of labour • Unexpected repairs and maintenance • Increased use of facilities due to increased production • Machine breakdowns • Strikes • Delays • Material shortages • Decreased demand for the product

Relevant personnel: All departments of the organisation

Review Questions

Sales Variances

Materials Variances

Overhead Variances

Exercises

Exercise 14.1

Reading and Resources

Study Notes Lesson 14

The End of Lesson 14