Budgets and variances
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Budgets and variances
Part A: Flexed and actual budget
Original budget and actual budget
| Actual | Static (Original Budget) | |
| Units | 810 | 800 |
| £ | £ | |
| Sales revenue | 753,300 | 760,000 |
| Less | ||
| Direct materials | (192,500) | (192,000) |
| Direct labour | (221,000) | (200,000) |
| Fixed overheads | (130,000) | (128,000) |
| Operating profit | 209,800 | 240,000 |
Actual budget and flexed budget
| Actual | Flexed | |
| Units | 810 | 810 |
| £ | £ | |
| Sales revenue | 753,300 | 769,500 |
| Less | ||
| Direct materials | (192,500) | (194,400) |
| Direct labour | (221,000) | (202,500) |
| Fixed overheads | (130,000) | (129,600) |
| Operating profit | 209,800 | 243,000 |
Part B: Variances
| Actual | Flexed | Variance | Favourable / unfavourable | |||
| Units | 810 | 810 | ||||
| £ | £ | £ | ||||
| Sales revenue | 753,300 | 810 x 930 = 753,300 | 769,500 | 810 x 950 = 769,500 | -16,200 | U |
| Less | ||||||
| Direct materials | (192,500) | 810 x 237.65 = 192,500 | (194,400) | 810 x 240 = 194,400 | -1,900 | F |
| Direct labour | (221,000) | 810 x 272.8 = 221,000 | (202,500) | 810 x 250 = 202,500 | 18,500 | U |
| Fixed overheads | (130,000) | 810 x 160.5 = 130,000 | (129,600) | 810 x 160 = 129,600 | 400 | U |
| Operating profit | 209,800 | 243,000 | -33,200 | U |
Part C: Business Report
A flexible budget is used in making a comparison between the actual results and the original budget. Variances are computed in order to measure how the company performed during a certain period. It is worth mentioning that in a flexible budget, the fixed costs remain constant while the semi-variable and variable costs change consistent with a standard that is preset at the commencement of a given period (Stephenson & Porter 2011). Whenever a flexible budget is adjusted to actual activity level, it is called a flexed budget. This is the budget that the company would have prepared at the start of the accounting period, had the top managers of the company known the exact actual output (Marple, 2009).
Generally, computing variances could be helpful in understanding why the actual results were different from the expectations and it is important to create a flexible budget. Flexed budget adjusts the original/static budget for the actual production volume or sales (Mak & Roush 2014). In the Orchid Limited case, a company which manufactures furniture, the original/static budget presumed that a total of 800 units would be produced and sold in a given month. The flexed budget rearranges the original/static budget to reflect the new number, making all the appropriate adjustments to expenditures and sales basing upon the unanticipated change in volume. In order to prepare a flex budget, it is important to have the original/static budget, properly understand cost behaviour, and know the actual number of goods that were made and sold. Orchid Limited had a great accounting period as actual sales came to 810 units.
The budget of Orchids Ltd is flexed in order to find out the amount of overhead that this firm should have, supposing that 810 units are made. Some costs are variable given that they alter in response to the levels of activity, whereas some other costs remain the same and are fixed. For instance, direct materials and direct labour are variable costs whereas other costs remain the same and are fixed, for instance fixed overheads (Garret 2010). Direct materials and direct labour are variable costs since the more furniture Orchid Ltd makes, the more labour and materials it needs. Conversely, overhead costs such as fixed overheads are fixed because in spite of the number of furniture made, the costs would remain the same. In the original/static budget, making 800 furniture units would result in variable cost per unit of £240 for direct materials and £250 for direct labour. To calculate the value of the flexed budget, the variable cost per unit is multiplied by the actual production volume. For income items such as operating profit and revenue in the case of Orchid Ltd, the flexed budget variance is favourable whenever the actual figures exceed the flexed budget figures and vice versa. On the other hand, for cost items, excess of flexed budget figures over actual figures implies favourable variance and vice versa.
| Budget (Flexed) | Actual (Result) | |
| Output | 810 units | 810 units |
| Sales variances | Variance 16,200 769,500 | 753,300 |
| Direct material variances | Variance 1,900 194,400 | 192,500 |
| Direct labour variances | Variance 18,500 202, 500 | 221,000 |
| Fixed overhead variance | Variance 400 129,600 | 130,000 |
| Budget (Original) | Actual (Result) | |
| Output | 800 units | 810 units |
| Sales variances | Variance 6,700 760,000 | 753,300 |
| Direct material variances | Variance 500 192,000 | 192,500 |
| Direct labour variances | Variance 21,000 200, 000 | 221,000 |
| Fixed overhead variance | Variance 2,000 128,000 | 130,000 |
Sales variances
Total variance between actual sales and original budget is £6,700 (Unfavorable). This is caused by:
- Sales volume (activity) variance: in the original budget, 800 units had been planned. In the actual sales, 810 units were made. Sales volume variance is 10 units since 10 more units were sold, which favourable.
- Sales price variance: in the original budget, the planned selling price was £950 per unit. In the actual sales, the selling price was 753,300 / 810 = £930. Therefore, the variance is because the sales price per unit of furniture was reduced by £20, which is unfavourable.
Direct material variances:
- Usage/Price: in the flexed budget, direct material should have cost £194.400, but it did cost just £192,500. Therefore, the usage/price is £1,900, which is favourable. However, in the original/static budget, the planned cost of direct material was £192,500 but the actual cost was £192,500. As such, the usage/price is £500 which is unfavourable. The variance is because of an increase in market prices, poor buying, and purchase of higher quality materials which were more costly.
Direct labour variances:
- Efficiency: in the flexed budget, direct labour should have cost £202, 500 but in the actual result it cost £221,000. Thus the efficiency/rate is £18,500 – unfavourable. In the original budget, the management planned £200,000 for direct labour but it cost £221,000, the efficiency/rate being £21,000 which is unfavourable. The cause for this could be the hiring of better employees, poor negotiation of employee salary, an increase in market labour rates, poor equipment which keep breaking down, lower quality materials that are not easy to utilize efficiently, or poorer training (Yahya-Zadeh 2012).
Fixed overhead variance:
- Spending: since fixed costs are fixed, flexing is unnecessary to account for dissimilar activities. Nonetheless, the overspend of £2,000 is unfavourable and an adverse effect.
To improve its cost control, it is recommended that Orchid Ltd should maintain the price per unit of furniture to at least £950; it should not reduce the price per unit. Secondly, labour efficiency should be improved by procuring high-quality new technology machinery that do not keep breaking down; high-quality materials should be employed since they can be used efficiently; and the company should ensure tough negotiation in employee pay. To improve material usage variances, high-quality materials should be used and there has to be better management of materials. Sales price variances could be reduced through market price increase, and planned increase in prices (Stephenson & Porter 2011).
References
Garret, K 2010, ‘Spotlight on variance analysis’, Accountancy, 106, 1167, pp. 88-89, Business Source Complete, EBSCOhost, viewed 27 June 2015.
Mak, Y, & Roush, M 2014, ‘Flexible Budgeting and Variance Analysis in an Activity-Based Costing Environment’, Accounting Horizons, 8, 2, pp. 93-103, Business Source Complete, EBSCOhost, viewed 27 June 2015.
Marple, RP 2009, ‘Combining the forecast and flexible budgets’, Accounting Review, 21, 2, p. 140, Business Source Complete, EBSCOhost, viewed 27 June 2015.
Stephenson, T, & Porter, J 2011, ‘Comparing Budgets to Performance’, Strategic Finance, 93, 2, pp. 36-43, Business Source Complete, EBSCOhost, viewed 27 June 2015.
Yahya-Zadeh, M 2012, ‘Comprehensive variance analysis based on ex post optimal budget’, Academy Of Accounting & Financial Studies Journal, 16, pp. 65-85, Business Source Complete, EBSCOhost, viewed 27 June 2015.
