Once a budget has been implemented, businesses must review the budgets regularly to determine any areas that are not performing as expected. Then, corrective action can be taken by identifying the variances to ensure that the budget constraints are met.
There are two (2) main causes for variances between the original budget and the actual results
- The volume of activity is different.
- Spending or prices are different. 1
Enhance your understanding by watching the following 12-minute video.
Example
A firm of accountants produces the following performance report information for the quarter ended 31 March.
| Master Budget $ | Actual Results $ | Variance $ | |
|---|---|---|---|
| Fees received | 80,000 | 91,500 | 11,500 F |
| Salaries variable per hour | 38,000 | 40,000 | 2,000 U |
| Motor vehicle expenses – fixed | 600 | 750 | 150 U |
| Motor vehicle expenses – variable | 700 | 720 | 20 U |
| Advertising – fixed | 1,500 | 1,400 | 100 F |
| Advertising – variable | 2,200 | 2,500 | 300 U |
| Office expenses – fixed | 22,000 | 24,000 | 2,000 U |
| Total expenses | 65,000 | 69,370 | 4.370 U |
| Net profit | 15,000 | 22,130 | 7,130 F |
This report shows a favourable variance of $7,130 due to increased fees which have been offset by an increase in expenditure in some cases. However, the budget needs to be reworked to show what the expenses should have been, based on actual results, e.g. the income of $91,500.
The variable expenses are calculated as a proportion of total fees received (based on a flexible budget approach). The budgeted variable costs based on actual total fees received are calculated as follows:
Variable costs / Total Budgeted fees x Total Actual fees received
Salaries paid = $38,000/$80,000 x $91,500 = $43,463
Motor vehicle expenses = $600/$80,000 x $91,500 = $686
Advertising expenses = $2,200/$80,000 x $91,500 = $2,516
Example 27: Analysing variances ½
An example of the reworked performance report for the quarter ended 31 March is as follows:
Example
| Master Budget $ | Activity volume variance $ | Flexible budget $ | Actual Results $ | Flexible budget variance $ | |
|---|---|---|---|---|---|
| Fees received | 80,000 | 11,500 F | 91,500 | 91,500 | |
| Less variable expenses | |||||
| Salaries | 38,000 | 5,463 U | 43,463 | 40,000 | 3,463 F |
| Motor vehicle expenses | 700 | 14 F | 686 | 720 | 34 U |
| Advertising | 2,200 | 316 U | 2,516 | 2,500 | 16 F |
| Total variable expenses | 40,900 | 5,765 U | 46,665 | 43,220 | 3,445 F |
| Contribution margin | 39,100 | 5,735 F | 44,835 | 48,280 | 3,445 F |
| Less fixed expenses | |||||
| Motor vehicle expenses – fixed | 600 | 600 | 750 | 150 U | |
| Advertising – fixed | 1,500 | 1,500 | 1,400 | 100 F | |
| Office expenses | 22,000 | 22,000 | 24.000 | 2,000 U | |
| Total fixed expenses | 24,100 | 24,100 | 26,150 | 2,050 U | |
| Net profit | 15,000 | 5,735 F | 20,735 | 22,130 | 1,395 F |
Example 28: Analysing variances 2/2
There are various ways variance is measured:
- The purchase price variance is the difference between the actual price paid for an item bought and its estimated price multiplied by the actual number of items bought.
Purchase Price Variance =(Actual Price-Estimated Price)×Actual Number of Purchase - Fixed overhead spending variance is the difference between the actual fixed overhead expense incurred and the budgeted fixed overhead expense.
Fixed Overhead Spending Variance=Actual Fixed Overhead-Budgeted Fixed Overhead
Fixed overhead refers to costs that are not affected by a change in business activity (e.g. insurance, office expenses, rent). - Material yield variance is the difference between the actual amount of material used and the standard cost expected to be used, multiplied by the standard cost of the materials.
Material Yield Variance = (Actual Amount of Material Used-Standard Cost of Expected Unit Use) × Standard Cost Per Unit - Labour rate variance: Difference between the actual and expected cost of labour.
- Variable overhead spending: The difference between the actual and budgeted spending rates on variable overhead. Variable overhead refers to manufacturing costs that change depending on the changes in production output.
- Selling price variance: The difference between the actual and expected profit is caused by a change in the price of a product or service.
- Labour efficiency variance: The difference between the actual number of hours worked to produce a certain product, and the time the business allows to produce that certain product.
- Variable overhead variance: The difference between the actual and budgeted hours worked is applied to the standard variable overhead rate per hour.
Calculating variances and presenting performance reports is a control function of the budgeting process and is performed to identify and investigate any deviations. Actual figures should be checked initially to ensure there are no accounting errors.
Variances in costs can be linked to the purchasing, production and human resource departments. A materials price variance is the responsibility of the purchasing manager.
Unit costs may vary because:
- Suppliers have updated their price-lists
- Changes in the exchange rate, for example, imported goods
- Seasonal conditions affecting supply, e.g. agricultural products
- The purchase of substitute materials
- Orders have to be filled by an alternative supplier
A materials usage variance is the responsibility of the production manager and may be the result of:
- Changes to production methods, e.g. new technology
- Inexperienced staff members, e.g. lack of training
- The quality of the materials
A direct labour variance may be linked to both the production manager and the human resource manager and may include:
- Changes in production methods
- Increase in award rates of pay
- Breakdowns and stoppages
Fixed costs are usually outside the control of the departments above and are linked to the administration department. However, once the causes of the variances have been identified and analysed, the budget may need to be revised or strategies implemented to offset undesirable outcomes.4
Using your current work environment, or one you have recently worked in, refer back to your answers for learning activity three and reflect on how you monitor budget outcomes, analyse variances and their causes
- What steps could you take to give feedback to the organisations you work with with any procedural improvements that will support better budgeting and forecasting in future?
- List at least ways that you could embed continual improvement into your interactions with the companies your work with.
Make and keep notes for your future reference, as this information will support your assessment and professional practice.
