ACC1002 Accounting

Week 11 Lecture
Laura Mazzola

Required Reading A&L Chapter 9, Budgeting (p.298-306 this week; pp.282-298 last
week)
Budgeting
 Learning Outcomes
After this week you should be able to:
• Explain how budgets can be compared to actual results to allow
control (variance analysis)
• Prepare a flexed budget
• Calculate and discuss sales, materials, labour and fixed overhead
variances
• Discuss benefits and challenges of variance analysis

3
 Introduction
• Budgetary control is a typical component of an MCS

• Flexed budget – actual output at standard rates*

• The basic price and usage variances for materials, labour and
variable overhead can be calculated by analysing the flexed budget variance
• Variances for fixed overhead (when absorption costing is used) are calculated in
a different way

we need to identify whar shouldve happen and wha

reflect buget is that we need to reflect in the difference

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 Introduction
• *Standard costs are predetermined costs or costs which should be incurred in
efficient operating conditions
• Standard cost is the planned unit cost of the products, components or services
produced in a period.

when we preapre a budget we refer to a standard cost.

TH enalysis will help us to identiyfy the diferences betwed ou planned and our actual
performance

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 Introduction
BUDGETED
STD
COST
COST

These relate to an entire

STD cost gives cost activity, operation. Eg. If BDG
expectations per unit of output is 1000 and STD cost
activity. The cost information per unit is £20, then BDG
is given on a per unit basis. costs will be £20,000.

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 Introduction
• Standard costing systems: purposes

• Give an estimation of future costs that can be used for decision-

making purposes.
• Provide a “standard” target which individuals are motivated to achieve.
• Assist in setting budgets and evaluating managerial performance.
• Act as a control mechanism through which to monitor those activities which do
not conform to plan.

is used to stimate what re future cost will be in the future in a perio of time
This will help us to produce a target we need to chieve and to motivate the managemnt
by setting a budget and some achieves we are abke to identify in what aspects we ned to put focus on to
achieve the goals

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 Introduction

In identifying standard costs a correct balance between ideal vs.

practical standards should be achieved.

1) BASIC COST STANDARDS: costs are left constant and unchanged

over long periods; We take the info from previous periods. IF LAST YEAR IT WAS 5 POUNDS ILL USE THAT TO PUT tha
same price this year. It helps but its not that efficent because if we have some ineficencys and we take that
same price we will take that ineficency into our budget
2) IDEAL STANDARD: represent “optimum performance”.
optimun perfomance. What are the optimal condition of which that things should develop

3)CURRENTLY ATTAINABLE COST STANDARD: costs that should

be incurred under efficient operating conditions (easier to achieve then ideals)
This one s the one which we ormally use, this is not the perfect one but it is efficent

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 Variance Analysis
• The differences between actual and budgeted costs are called
‘variances’
• Variances are calculated by comparing actual costs & income with
the budgeted (planned) costs & income
the actual outcome is beter than the
– when something goes better than planned, there will be a planned one

FAVOURABLE VARIANCE – therefore the profit will be greater

– when something goes worse than planned, there will be an

ADVERSE VARIANCE – therefore the profit will be less

Adverse variances imply: selling less, selling at a lower price, having more cost than
budgeted
Favourable variances imply: selling more, selling at a higher price, having less cost than
budgeted
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 Variance Analysis

original budget

Is standar price the hisotic

cost?

THE DIFFERENCE BETWEEN ACTUAL COST AND ACTUAL OUTPUT IS THE

STANDAR COST

an exmaple is that it could help us

understand if we are using much more
mterials of what we have prescribed
If we are using more than planned, less
or more

the overall material variance is the difference between price variance and
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efficency variance
 Variance Analysis

Variance
analysis

Material Labour Fixed overheads

Sales variances
variances variances variance

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 Variance Analysis

• All elements of income and cost can be subject to variance

analysis:
variance analysis is not the solution to the porblem is just the way to
– Sales identify the red flag of the variance.
If we want to know what are the things thare going wrong we need a
– Materials further analysis
– Labour Wen we have identify the areas we need to work on we could identify
what decisons we need to make
– Fixed Overheads

• Variance Analysis is a valuable tool for management as it allows it to:

– Identify areas of the business that are failing to meet performance targets
(management by exception)
– Identify areas that are performing well (what can be learned)
– Make practical changes to increase profit e.g., change supplier, re-design product
– Identify where budget assumptions have not been correct and should be updated

it can be changind supplier, how we can reduce the use of material instead of labour
It could be that we are completly worng in the original variance

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 Preparing a flexed budget
Budget Actual
Output for month 1,000 units 900 units What has driven that
we have sale less
(production & sales)
£ £
Sales revenue 100,000 £100 each 92,000 £102.22 each
Raw materials (40,000) (40,000 metres) (36,900) (37,000 metres)
Labour (20,000) (2,500 hours) (17,500) (2,150 hours)
Fixed overheads (20,000) (20,700)
Operating profit 20,000 16,900
¿What has drivven this differences?

See A&McL for a detailed example

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 Preparing a flexed budget
Preparing a flexed budget simply means revising the budget for the actual level
of output
For example, if you knew that output was going to be 900 units, what would
have been budgeted for sales revenue, raw materials etc.?
Only the output changes – the budgeted selling prices, estimated usage per
product, and costs per unit stay the same – what were these?

Budget Workings to flex to

Output for month 1,000 units 900 units
(production & sales)
£ £
Sales revenue 100,000 £100 each 900*£100 each
Raw materials (40,000) (40,000 metres) 900* (40,000/1000)
Labour (20,000) (2,500 hours) 900* (20,000/1000)
Fixed overheads (20,000) (Should stay the same!)
Operating profit 20,000 Sum of the above

1. identityf standar unit and then calculate with all of the units we are using
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 Preparing a flexed budget
Original Flexed Actual
Budget Budget

Output 1,000 units 900 units 900 units

£ £ £
Revenue 100,000 90,000 £100 92,000 £102.22
Materials (40,000) (36,000)(36000 metres) (36,900) (37000 metres)
Labour (20,000) (18,000)(2,250 hours) (17,500) (2,150 hours)
F/overheads (20,000) (20,000) (20,700)
Op. profit 20,000 16,000 16,900

This quickly identifies budgeted income & costs for actual activity

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 Preparing a flexed budget
Original Flexed Actual
Budget Budget

Output 1,000 units 900 units 900 units

£ £ £
Revenue 100,000 90,000 £100 92,000 £102.22
Materials (40,000) (36,000)(36000 metres) (36,900) (37000 metres)
Labour (20,000) (18,000) (2,250 hours) (17,500) (2,150 hours)
F/overheads (20,000) (20,000) (20,700)
Op. profit 20,000 16,000 16,900

This quickly identifies budgeted income & costs for actual activity

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 Sales Variances
Overall, there is a difference of £2,000 between sales under the flexed budget
(£90,000) and actual sales (£92,000). The difference is favourable (revenue is
higher than we would have expected – positive impact on profit).
As we know the flexed budget and actual are based on 900 units, this variance
arises because of a difference in the sales price

• Sales price variance:

Actual sales – standard revenue for actual sales (flexed budget sales)
£92,000 - £90,000 = £2,000 F
or: 900 (£102.22 – £100) = 900 (£2.22) = £2,000 F

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 Sales Variances
But what about the fact that we sold fewer units than expected? To understand
this, we use the
• Sales volume variance:
the impact of this in our overall profit--> sales volume variance

We compare our original budget and our flexed bufget op. porfit--> we compare the original
and what should´ve been

Budgeted profit – standard profit for actual sales (flexed budget)

£20,000 – £16,000 = £4,000 A

This variance uses the overall profit (not sales price) to estimate the impact of the
change on profit – which should be of interest to managers

This is an adverse variance as profit is lower because of the lower sales in units

Note that because profit is used here, sales price variance plus sales volume
variance do not equal the difference between originally budgeted and actual
revenue
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 Preparing a flexed budget
Original Flexed Actual
Budget Budget

Output 1,000 units 900 units 900 units

£ £ £
Revenue 100,000 90,000 £100 92,000 £102.22
Materials (40,000) (36,000)(36000 metres) (36,900) (37000 metres)
Labour (20,000) (18,000) (2,250 hours) (17,500) (2,150 hours)
F/overheads (20,000) (20,000) (20,700)
Op. profit 20,000 16,000 16,900

This quickly identifies budgeted income & costs for actual activity

overheads don´t change. 19

 Fixed Overhead Variances

There is a difference of £700 between budgeted and flexed

budgeted fixed overheads (£20,000) and actual overheads
(£20,700). The difference is adverse (cost is higher than we would
have expected – negative impact on profit). this variances can be driven by quantity
Example is rent... we always ay the aam ebut
then they cange the rent and now i need to pay
more.

Why does budgeted FOH = flexed budget FOH?

Because FOH should not change for changes in activity (definition of
fixed costs, Chapter 7).

So, any variance here relates to cost being more or less than
budgeted

Why might this be the case? Is further investigation/action needed?

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 Preparing a flexed budget
Original Flexed Actual
Budget Budget

Output 1,000 units 900 units 900 units

£ £ £
Revenue 100,000 90,000 £100 92,000 £102.22
Materials (40,000) (36,000)(36000 metres) (36,900) (37000 metres)
Labour (20,000) (18,000) (2,250 hours) (17,500) (2,150 hours)
F/overheads (20,000) (20,000) (20,700)
Op. profit 20,000 16,000 16,900

This quickly identifies budgeted income & costs for actual activity

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 Labour Variances
There is a difference of £500 between flexed budgeted direct
labour (£18,000) and actual labour (£17,500). The difference is
favourable (cost is lower than we would have expected – positive
impact on profit).
Total labour variance is the difference between
the actual direct labour cost
and
the direct labour cost according to the flexed budget

This variance excludes the impact of making 100 more units, and
we would then need to understand:
• Are we using less labour per product than expected?
• Is labour cheaper per hour than expected?
• Why might this be the case?
• Is further investigation/action needed?
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 Preparing a flexed budget
Original Flexed Actual
Budget Budget

Output 1,000 units 900 units 900 units

£ £ £
Revenue 100,000 90,000 £100 92,000 £102.22
Materials (40,000) (36,000)(36000 metres) (36,900) (37000 metres)
Labour (20,000) (18,000) (2,250 hours) (17,500) (2,150 hours)
F/overheads (20,000) (20,000) (20,700)
Op. profit 20,000 16,000 16,900

This quickly identifies budgeted income & costs for actual activity

23
 Materials Variances
There is a difference of £900 between flexed budgeted direct
materials (£36,000) and actual materials (£36,900). The
difference is adverse (cost is higher than we would have expected
– negative impact on profit).

Total materials variance is the difference between

the actual direct materials cost

and

the direct materials cost according to the flexed budget

(= budgeted or standard usage for the actual output)

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 Materials Variances

But where we have enough information, we can also work out

what element of this relates to price of materials per unit being
different to budgeted (price variance), and what relates to using
more material per product (usage variance)

• Materials Price Variance is defined as:

(Actual Price – Budgeted price) x actual quantity

• Materials Usage Variance is defined as:

(Actual quantity – Flexed quantity for Act production) x budgeted price
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 Materials variances
Example
• The Standard (budgeted) cost of material for Mars Ltd is £18 per kg. Standard
(budgeted) usage is 11kg per unit. The business plans to produce over the year
3,000 units.

• At the end of the year the business has produced 3,000 units using 42,000 kg at
a cost of £672,000

Requirement:

• Calculate the Material Price Variance and the Material Usage variance, showing
at the same time the Total Materials Variance.

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 Materials variances
Example
Standard (budgeted) cost of material is £18 / kg
Standard (budgeted) usage is 11kg / unit
Planned output is 3,000 units
Therefore, budgeted cost = 3,000 x 11kg x £18 = £594,000 actual

What actually happened:

3,000 units were made using 42,000 kg at a cost of £672,000 variance

So Actual price (cost) per/kg = (672,000/42,000) or £16/kg

Material price variance:

= (Actual Price – Budgeted price) x actual quantity

OR (actual price x actual qty) – (budgeted price x actual quantity)
= £672,000 – (£18 x 42,000)
= £672,000 – £756,000
= £84,000 Favourable (F) actual cost is less than budgeted
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 Materials variances
Example
Standard (budgeted) cost of material is £18 / kg
Standard (budgeted) usage is 11kg / unit
Planned output is 3,000 units
Therefore, budgeted usage= 3,000 x 11kg = 33,000 kg

What actually happened:

3,000 units were made using 42,000 kg

Flexed quantity for actual output = 3000 units @ 11kg / unit = 33,000kg
Actual usage = 42,000 already given to us

Material usage variance:

=((Actual quantity – Flexed quantity for Act production) x budgeted price
= (42,000-33,000) x £18
= 9,000 x £18
= £162,000 Adverse (A) actual cost will be higher than budgeted
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 Materials variances
Example
• The total materials variance is:
sales department

– Material price: 84,000 (F) why? who should we ask?

– Material usage: 162,000 (A) why? who should we ask?
– Total variance: 78,000 (A)

• Check this variance:

– Standard cost for actual output =

3000 units @ 11kgs/unit = 33,000kgs @ £18 per kg = 594,000
– Actual cost of output = 672,000
– Variance = 78,000 (A)

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 Favourable & Adverse Variances

• A favourable materials variance could be explained by:

– A fall in material prices since the standard was set

– A rise in productivity per kg of material since standard was set

– Less material being used per unit than the standard indicates

• An adverse materials variance could be explained by:

– A rise in material prices since the standard was set

– A fall in productivity per kg of material since standard was set

– More material being used per unit than the standard indicates
efficency labour, ussage material
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 Making Variance Analysis Useful

• Advantages:
– Can be used for performance appraisal
– Indicates which department is responsible for the variance
– Allows ‘management by exception’

• Disadvantages:
– The existence of a variance says little about its cause
– Although variances can be split into several parts, this does not mean that all the
causes of the variance have been identified because there are interdependencies
between the variances
– Variances simply indicate where more investigation is needed

• Should only be carried out if benefits outweigh costs

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 Making Variance Analysis Useful

plan, monitor and achieve our oglas

set targets that are achievable

• Requirements
3. motivate our employeess

In order to motivate, we need to set goals that re achievables

– Clear responsibility for budgeted areas e.g., who is responsible for materials price?
– Challenging but not impossible targets
– Regular, established reporting – e.g., monthly, available quickly after month end
– Provision of information relevant to specific manager’s responsibilities
– Investigation/action taken where variances are found

• Behavioural issues:
– Budgets are a useful tool to communicate information and monitor performance
– Budgets that are perceived as impossible, or too easy to meet, will not motivate
good performance
– Participation in the process can help with motivation

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Some examples from
MyAccountingLab
 Example 1 MyAccountingLab:

1st thing is to define what shoul´ve been our outcome

flexed budget for sales revenue: 84000/1200=700 per unit*1250=875000 flexed sales revenue

flexed budget of raw material:

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Example 2 MyAccountingLab:

What is the actual profit for the​ period?

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Extended Example 2 MyAccountingLab:

What if the question told you actual profit was £62,000 and you had to work out
the original budget profit?

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Example 3 MyAccountingLab:
Caspian manufactures kettles

Calculate the:
1. Sales volume variance
2. Sales price variance
3. Direct materials variance
4. Direct labour variance
5. Fixed overhead variance
In each​ case, indicate whether the variance is favourable​ (F) or adverse​ (A).
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 Learning Outcomes
After this week you should be able to:
• Explain how budgets can be compared to actual results to allow
control (variance analysis)
• Prepare a flexed budget
• Calculate and discuss sales, materials, labour and fixed overhead
variances
• Discuss benefits and challenges of variance analysis

38
 Next Steps
• Atrill and Mc Laney 2022 (Chapter 9, p.298-306
this week; pp.282-298 last week)
• Computer class W11

• My Accounting Lab
- Practice Homework Week 11
- Assessed Homework Week 11

Deadline for Practice Homework: 1st Dec by 11.59 pm

Deadline for Assessed Homework: 1st Dec by 11.59 pm
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Q&A