BUDGETING, STANDARD COSTS AND VARIANCE ANALYSIS • A budget is a quantitative summary of the expected consequences of the organization’s operating activities
Advantages of Budgeting • Compels planning • Provides P id performance f criteria it i
• Budgeting is the process of preparing budgets to meet an organization’s objectives
• Promotes coordination and communication
• Variance analysis compares actual and budgeted performance
©Rajiv D. Banker, April 2010
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Master Budget Organization Goals
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Capital Spending Plan
Sales Plan
Inventory Policy
Materials Purchasing Plan
Production Plan
Labor Hiring and Training Plan
Productive Capacity
Administrative Spending Plan
Expected Financial Results
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Budget Development •
Who should participate in and be responsible for the development of budgets?
•
Who should lead the budget development and approval process?
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Managing the Budget Process Many organizations use a cross-functional budget team to manage and oversee the budgeting process • The budget team usually reports to a budget committee which generally includes the chief executive officer •
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Budgeting Styles
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• Authoritative budgeting is a budget style in which superiors tell subordinates what their budget will be • Participative budgeting is a method of budget setting that involves a joint decision making process in which all parties agree about setting the budget targets ©Rajiv D. Banker
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What Budgeting Style Is Most Effective in Accomplishing the Organization’s Mission ? [A] [B] [C] [D]
Authoritative budgeting Participative budgeting Neither, need to go “beyond budgeting” It depends on the context
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Budget Games • Managers have been known to play budgeting games in which they attempt to manipulate information and targets to achieve as high a bonus as possible • Stretch targets are targets that require a large increase in a goal over the next budgeting period ©Rajiv D. Banker
Standard Costs
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Standard costs are benchmarks based on standards established in advance for the quantity and price of resources How high should we set the standard? Should it be easy or difficult? ©Rajiv D. Banker
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Managing By Exception
Efficient and Attainable Standard
Cost variance analysis enables managers to focus attention on items with large variances that suggest actual results are not in compliance with standards
Performance
Cost Variances Variances are differences between actual and standard costs; control is exercised by managers attempting to understand why a difference occurred
Perceived unattainable
Perceived attainable
Level of Standard ©Rajiv D. Banker
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Managers Should Focus On: (A) Unfavorable variances when actual costs exceed standard costs (B) Favorable variances when actual costs are much less than standard costs (C) Both of the above (D) Neither
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Investigating Causes
Flexible Budgeting
• Understanding the causes of unfavorable variances helps take corrective actions to control high costs • Understanding the causes of favorable variances helps repeat that performance in subsequent periods and in other parts of the organization
• Budget targets for operating costs are adjusted to reflect differences between actual sales or production volume and budgeted g volume • Budgeted fixed costs are not adjusted • Budgeted variable costs are adjusted in the proportion of the ratio of actual volume to budgeted volume
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Astor Company
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Astor Company budgets $20,000 in fixed overhead and $4 per unit in variable overhead. For April, Astor expected to produce 6,000 units but because of unexpectedly high demand actually produced 77,000 000 units units. The actual total overhead cost was $45,000. Would a flexible budget performance report for April indicate that Astor was above or below budget? 19
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Direct Cost Variance Analysis
Flexible Budget Variance
Total variance $ 1,000 U
Units Variable overhead @ $4 Fixed overhead Flexible budget Actual cost Variance
Flexible Budget 7,000
Original Budget 6,000
$ 28,000 20,000 $48,000 45,000 $ 3,000F
$24,000 20,000 $44,000 45,000 $1,000U
Actual cost (actual cost of actual production) $45,000
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Original budget
(standard cost of actual production) $48,000
(standard cost of budgeted production) $44,000
Flexible budget variance $3,000F
Volume variance $4,000U
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Price and Quantity Variances AP
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Price Variance = AQ (AP – SP)
SP
Flexible Budget Cost 0 AP = actual price SP = standard price ©Rajiv D. Banker
Flexible budget cost
Quantity Variance = SP (AQ – SQ) SQ
AQ
AQ = actual quantity SQ = standard quantity for actual production
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At Superior Company, the standard time required to assemble one motor is 0.25 hours. The standard wage is $13 per hour. During the last month, employees produced 2,700 motors and worked 640 labor hours at a total cost of $8,000. Compute Superior’s labor rate variance. [A] [B] [C] [D]
Labor Wage Rate Variance = AQ (AP – SP) = AQ AP – AQ SP = $8,000 – 640 $13 = $8,000 – $8,320 = $320 F
$675 unfavorable $320 favorable $337.50 unfavorable $700 favorable
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Limitations of Standard Cost Systems
What Is More Important?
• Usefulness is restricted largely to settings in which the technology and business environment are stable
(A) Labor efficiency (reduce costs)
• Overreliance on managing with a standard cost system creates a mind-set of just “meeting the standards”
(B) Labor effectiveness (focus on customers)
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Elimination of Direct Labor Variance Reporting
Laborious Accounting
• 7 “experimental” plants where reporting was stopped • 11 “control” plants where it continued
• Detailed accounting of labor costs to directly identify those costs with individual jobs is laborious • Emphasis on retrospective comparison of actual and standard labor costs may motivate workers to not spend time on coming up with innovative ideas to improve products and processes
Reporting Change Labor Productivity
Experimental Control
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Month ©Rajiv D. Banker
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Elimination of Direct Labor Variance Reporting • Resulted in a steep (11%) decline in labor productivity • Resulted in an improvement in quality and d li delivery time i • Cost savings from lower reject rate were only 16% of the costs of lower labor productivity • Labor cost variance analysis system was reintroduced ©Rajiv D. Banker
“Take-Home” Message • Traditional budgeting and variance analysis systems can play a useful role • But,, it is important p to recognize g their limitations and develop improved systems
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