Chapter 8: Budgets and Variance Analysis

What does standard costing do?

Provides detailed info to management about why actual performance differs from expected performance

What are 5 things standard costing can be used for?

- to assist in budget setting and evaluating performance

- to act as a control device by highlighting those activities that do not conform to plan and thus alerting managers to those situations that may need corrective action

- to provide a prediction of future costs to be used in decision-making

- To simplify the task of tracing costs to products for inventory valuation

- to provide a challenging target that individuals are motivated to achieve

What does standard costing do?

Provides detailed info to management about why actual performance differs from expected performance

What are 5 things standard costing can be used for?

- to assist in budget setting and evaluating performance

- to act as a control device by highlighting those activities that do not conform to plan and thus alerting managers to those situations that may need corrective action

- to provide a prediction of future costs to be used in decision-making

- To simplify the task of tracing costs to products for inventory valuation

- to provide a challenging target that individuals are motivated to achieve

Standard cost

the planned unit cost of a product or service

What are the 4 types of cost standards?

Basic standards, Ideal standards, Attainable standards and Current standards

Basic standard

long-term standards which remain unchanged over a period of years. Their sole use is to show trends over time for items such as material prices, labour rates and labout efficiency.

They are also used to show the effect of using different methods over time.

These are the least used and least useful type of standard

Ideal standard

based upon perfect operating conditions. No wastage, no scrap, no breakdowns, no stoppages.

Used to find cost savings when you're in search of perfect quality. These standards have the most adverse motivational impact because they're unlikely to be achieved

Attainable standards

Most frequently encountered type of standard. Based on efficient, but not perfect, operating conditions.

Allowance for things such as normal/expected material losses, fatigue and machine breakdowns, but based on a high performance level

Current standards

Based on current levels of efficiency. The main disadvantage here is that there's no incentive to improve

2 pros of standard costing

- may be based on either marginal or absorption costing

- provide an easier method of accounting since it enables simplified records to be kept. (on a standard cost card)

5 reasons to prepare budgets

1. to forecast future activity levels

2. to communicate goals and objectives

3. to plan for the use of resources - materials, labour, money

4. to control the different departments

5. to motivate by setting achievable targets

What is a rolling budget?

a budget kept continuously up to date by adding another accounting period when the earliest accounting period has expired

4 pros of rolling budgets

1. Planning and control based on a more accurate budget

2. reduce uncertainty in budgetting since focus on short-term

3. there's always a budget that extends into the future

4. forces management to reassess budget regularly

6 cons of rolling budgets

1. costly and time consuming since regularly updated

2. may demotivate employees as budget is always changing

3. danger that the budget may just become the last budget 'plus or minus a bit'

4. increase in budgetting work may lead to less control of actual results

5. version control issues, as each month in full year numbers will change

6. confusion as to what numbers the business is working towards

Fixed budget

a budget produced for a single activity level

Flexed/flexible budget

a budget that changes as volume of activity changes, by recognising cost behaviour patterns

(budget goes up based on how variable costs increase with units. fixed costs stay the same, unless stepped)

Functional budget

a budget of revenue/expenditure which applies to a particular function of the business. The main functions are:

- sales

- production

- raw material usage

- raw material purchases

- labour

- variable and fixed overheads

- non-manufacturing overheads

Variance

The difference between the budget and actual results - the variance can be adverse or favourable

Adverse variance

this occurs when the actual costs exceed the budgeted costs or when the actual revenue is less than the budgeted revenue

Favourable variance

When the actual cost is less than the budgeted cost or the actual revenue is more than the budgeted revenue

What will managers consider when deciding which variances to invenstigate?

- size of variance

- cost of investigating the variance

- adverse or favourable?

- Ability to correct

Sales variances

- price changes (selling products at a different price)

- volume changes (higher/lower volume are sold than expected)

but volume is already accounted for in flexed budgets

Material variances

- price changes (price per unit of material is different)

- usage changes (change in amount of material used)

- quality (using higher quality material will cost more)

- combination of quality and quantity (higher quality may cost more but may lead to less wastage)

Labour variances

- rate changes (higher grade of labour requires higher remuneration)

- efficiency/hours worked to produce output

- overtime (overtime is often paid at a higher rate)

Fixed overhead variance

this shouldn't happen, so would be due to incorrect budgeting of expenditure

How can sales variances be subdivided?

- variance due to the quantity sold (volume variance)

- variance due to the price changes (price variance)

How can material variances be subdivided?

- variance due to quantity of materials used (usage variance)

- variance due to price paid for materials (price variance)

How can labour variance be subdivided?

- variance due to hours worked (efficiency variance)

- variance due to rate paid per hour (rate variance)