Chapter 13

Accounting for control

Objectives of the lecture
•What is budgetary control?
•What is a flexible budget?
•How are different variances calculated?
•Variance analysis example
•Making budgetary control effective
•Problems with variances and standards
•Behavioural issues of budgetary control
The budgetary control process

Prepare budgets

Perform and collect information on

actual performance

Respond to variance between

planned and actual performance
and exercise control
Feedback process Heedback loop' for next
- year

Prepare budget Adjust

Compare actual
Perform Adjust performance with
budget and take
action on deviations
Collect information
Feedback
on actual performance
Standard Cost (used to prepare budget)

Product Unit Cost

£
Materials 40m x £1/m 40
Labour 2.5hrs x £8/hr 20
Total Standard Cost 60
 Setting standards

Who sets the standards?

How is information gathered?

(Examining processes or past standards)

What kind of standards should be used?

(Ideal and practical)

Who sets the standards? – They are a collective effort of various individuals
including management accountants, industrial engineers, human resource
managers, sales managers, other service department managers and employees.
What are Variances?
•A variance is the effect of a factor on the
budgeted profit.
• A variance which will have the effect of increasing
profit above that which was budgeted
for, is known as a favourable variance (F).
• A variance which will have the effect of
decreasing profit below that which was budgeted
for, is known as an adverse variance (A).
Relationship between the budgeted and actual profit

Budgeted profit

plus

All favourable variances

minus

All adverse variances

equals

Actual profit
The main variances we will look at are:
Sales variance

Volume variance Selling price variance

Direct material variance

Usage variance Material price variance

Direct labour variance

Efficiency variance Labour rate variance

Fixed Costs Variance

Flexible budget
Flexing the budget means revising it to what the budget
would be if the planned level of output is equal to the
actual level.
Budget Flexed Actual
Output (units) 1,100 1,150 1,150
Sales £110,000 £113,500
Raw materials (£44,000) (£46,300)
Labour (£22,000) (£23,200)
Total Contribution 44,000 44,000
Fixed overheads (£20,000) (£19,300)
Operating profit £24,000 £24,700
Flexible Budge
Budget Flexed Actual
Output (units) 1,100 1,150 1,150
Sales £110,000 £115,000 £113,500
Raw materials (£44,000) (£46,000) (£46,300)
(44,000 kg) (46,000 kg) (46,300 kg)
Labour (£22,000) (£23,000) (£23,200)
(5,500 hr) (5,750 hr) (5,920 hr)
Fixed overheads (£20,000) (£20,000) (£19,300)
Operating profits £24,000 £26,000 £24,700
Standard Price and costs per unit Actual

Selling price per unit £100 £100 £98.7

Material cost per kg £1 £1 £1
Material per unit 40 kg 40 kg 40.26 kg
Labour rate per hour £4 £4 £3.92
Labour hours per unit 5 hours 5 hours 5.15 hours
Flexible Budge
Flexed
Output (units) 1,150
Sales £115,000 = 1,150 units * standard price of £100
Raw materials (£46,000) = 1,150 units * 40 kg per unit * £1 per kg
46,000 kg = 1,150 units *40 kg per unit
Labour (£23,000) = 1,150 units * 5 hrs per unit * £4 per hr
5,750 hrs = 1,150 units * 5 hrs
Fixed overheads (£20,000)
Operating profits £26,000

Standard price and costs

Selling price per unit £100
Material cost per kg £1
Material per unit 40 kg
Labour rate per hour £4
Labour hours per unit 5 hours
Sales Variances

Sales volume variance is the difference between the

original budget and flexed budget profit figures.
£26,000 - £24,000 = £2000 (F)

Sales price variance is the difference between the actual

sales figures and flexed budget figures.
£115,000 - £113,500 = £1500 (A)
or (Actual price - Budget price) x Actual output
(£98.696 - £100) x 1.150 = £1,500 (A)
Direct material variance
The difference between actual direct material and flexed
direct material is called total direct material variance:
£46,300 - £46,000 = £300 (A)
Direct material usage variance = (Actual usage - Flexed
usage) x budget material cost per unit
(46,300kg - 46,000kg) x 1 £/kg = £300 (A)

Material cost per unit variance = (Actual cost - Budget

Cost) x actual usage
(1 £/kg - 1£/kg) x 46,300kg = £0
Direct labour variance
The difference between actual direct labour and flexed
direct labour is called total direct labour variance
£23,200 - £23,000 = £200 (A)

Labour efficiency variance = (Actual labour hours -

flexed labour hours) x budget labour rate
(5,920 hours - 5,750 hours) x 4 £/hour = £680 (A)

Labour rate variance = (actual labour rate - budget labour

rate) x actual labour hours
(3.92 £/hour - 4 £/hour) x 5920 hours = £480 (F)
Fixed overheads variance = Actual overheads -Budget
overheads
£19,300 - £20,000 = £700 (F)
Reconcile the original budget profit with the actual one:

Budget profit £24,000

Add: All favourable variances
Sales volume £2,000
Direct Labour rate £480
Fixed overhead £700 £3,180
£27,180
Less: All adverse variances
Sales Price £1,500
Direct material usage £300
Direct labour efficiency £680 £2,480
Actual Profit £24,700
 Reasons for variances
It is important to add context and explain why variances have occurred.

In our example:
Sales volume (F) and selling price is (A). It is likely that price reduction has
led to higher volume of sales, and given the overall variance of sales is positive, it
could be argued that the desired result was achieved when reducing the selling
price.

Materials usage (A): it could be because of the performance of production

department i.e. not using the material efficient, or poor-quality material, or that the
standard was wrong?

Labour efficiency (A): it could be because of poor supervision, standard (hrs/unit)

set too high or hired lower skilled labour. This could be the case, given the labour
rate has fallen, giving a favourable variance of labour rate.

Fixed overheads expenditure (F): it could be for a number of reasons depending

on what is included in the Fixed Costs, for example, rent, Supervisors Salaries,
Insurance?
(see textbook p. 535-536 for further examples)
 Making budgetary control effective

Serious attitude taken to the system

Clear demarcation between areas of managerial responsibility

Budget targets that are challenging yet achievable

Established data collection, analysis and reporting routines

Reports aimed at individual managers

Fairly short reporting periods

Timely variance reports

Action taken to get operations back under control

Problems with variances and standards

Standards can quickly become outdated

Factors beyond the control of the manager

may affect a variance

Difficult to demarcate management

responsibilities

No incentive to achieve beyond the

standard

Standards may create perverse incentives

Behavioural issues of budgetary control

Budgets can improve job satisfaction

and performance

Demanding, yet achievable, budget targets can

motivate more than less demanding ones

Unrealistically demanding targets can

adversely effect managers’ performance

Participation of managers in setting their targets

can improve motivation and performance