In this session, you learnt about budgetary control and variance analysis.

You first understood

the concept of budgets and objectives of budgetary control. Then, you learnt about the
classification of budgets. Next, we discussed the various benefits and limitations of budgetary
control and then focused on cost variance and the different types of cost variance.

A budget refers to a financial plan for a business that is prepared in advance. Once the budget
is prepared, the different aspects of the business are managed on the basis of this budget.

Budgets

Budget can be categorised on the basis of the following aspects:

● Time
○ Long-term budgets: 5 years or more
○ Short-term budgets: 1 to 3 years
○ Current budgets: 1 year, split further into quarterly and monthly budgets
● Function
○ Sales budget
○ Production budget
○ Materials quantity budget and materials purchase budget
○ Labour time budget and labour cost budget
○ Overheads budget
○ Finance, HR, marketing and IT budgets
○ Master budget, which incorporates all the individual budgets and comprises
budgeted profit and loss, balance sheet and cash flow
● Flexibility
○ Fixed budget: A fixed budget remains unchanged throughout the year,
irrespective of the change in the level of capacity utilised or activity performed. It
does not change on the basis of output.
○ Flexible budget: A flexible budget is designed to change with the actual level of
capacity utilised or activity performed. It changes on the basis of output. A flexible
budget requires the classification of costs into fixed, variable and semi-variable
costs.

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 Budgetary Control

You learnt the following aspects of budgetary control:

● Laying down objectives or plans in terms of monetary and quantitative terms to be

achieved in future
● Monitoring actual performance against established budgets
● Making course corrections

Some of the objectives of budgetary control are as follows:

● Achieve organisational objectives/targets

● Assign responsibilities to executives
● Measure actual performance against targets
● Control performance by taking corrective actions in execution or strategy

You also learnt that a forecast is a budget that is revised based on new information available
regarding a company, an industry or an economy. You learnt about the advantages and
disadvantages of adopting control measures in the company based on forecasts.

Here are the advantages:

● It sets targets that need to be achieved in a certain period in order to grow and increase
the returns offered to the shareholders.
● Information shared across the organisation generates goal congruence.
● It sets limits for maximum spend and minimum revenues.
● Expenses above the budgeted amounts are controlled through approvals.
● Management by exception
● Budgets are established in an iterative process

The disadvantages are as follows:

● High budgets may be set to circumvent approvals and show better results.
● Past inefficiencies may continue.
● Improper use of budget drivers (such as quantity sold, number of sales visits linked to
sales, and maintenance cost per square foot) may lead to unattainable or relaxed budget
targets.
● Over-reliance on budget drivers or excessive analysis does not result in proportionately
incremental benefits in the form of cost savings.

Cost Variance and Variance Analysis

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Variance refers to the difference between the actual result and the expected performance.
Variance may arise due to multiple reasons, such as rise or fall in goods or services, quality of
products or services, slow or short supply of raw materials, etc. Budget, and profit and loss
accounts are compared to obtain the variance.

You need to remember the following points while calculating variance:

● For sales
○ Variance from budget or plan that is, Actual – Budget/plan
● For costs/expenditure
○ Variance against Budget or plan, that is, Actual – Budget/Plan

Cost variances are grouped into three categories depending on the type of cost:

● Material cost variance

● Labour cost variance
● Overhead cost variance

Potential causes of variance are as follows:

● Efficiency: Efficiency or usage variance refers to the difference in the yield of an input:

○ Such variance could arise due to the inefficient use of inputs.

○ This could be due to poor quality of the supplied materials or inefficient storage
that leads to loss or deterioration in quality.
○ Factors that contribute to variance in efficiency depend upon the nature of the
business and the process of operation.

● Expenses: Variance in expenses (other than material and labour) can arise on account
of the following:

○ There may be a difference in value/volume owing to variable expenses. For

example, sales commission as a percentage of sales is variable, and the variable
value or the volume of sales may lead to variance.
○ Difference in rate can also be a cause. For example, electricity is largely fixed,
and variance could be a result of an increase in rates by the electricity
department.

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