Case Study: Background
Budgeting is one of the most widely used and implemented costing methods that help the organisation set a path or direction to move towards for the upcoming production cycle (Atkinson, 2012). Budgeting is the method whereby the management forecasts and sets a goal of production and sale. Keeping this goal in mind the estimates for the resources which would be necessary in the production of goods are made. The estimates made are both for the units and amount (Berry, 2009).
The management makes a budget in order to set a path or a direction to help them move forward towards a set goal (Boyd, 2013). When the actual production work starts and the expenses really start to incur, they may not be the same as the budgeted figures. The amounts budgeted by the management will differ from the actual results. There are various reasons for differences in the budgeted and actual figures of the company. The budgets are made on forecast, it is not necessary same results will be obtained. The costs included in the budgets by the management are based on estimated rates (Datar, 2015). The cots which are actually incurred cannot be anticipated from before. The demand set by the management may be under or over achieved, depending on the market conditions and customer requirements. Therefore, a budgeted is just a skeleton which helps to provide form to the working for a management (Datar, 2016). When the actual results are incurred, they are based on market factors. These result in creation of variances from the budgeted figures.
From the calculations of variances for the figures of cost and revenues between the flexible budget and the actual figures, we see that many of the elements have variances more than 5%.
The items of costs and revenues which have unfavourable variances are listed below, along with reasons for such variances:
- Cost of Faux wood for Residential blinds: the management budgeted that 2.5 meters of faux wood would be required for production of each unit of residential blinds at $28 per meter, but the actual consumption was of 3.5 meters per unit at the rate of $32 per meter. Due to higher consumption and higher rate there was an unfavourable variance of 60%.
- Cost of fabric and faux wood for commercial blinds- the management estimated use of 5 meters of fabric at the rate of $75 per meter for each unit of commercial blind, but they actually used 6 meter at the rate of $73, this created an unfavourable variance of 17%. The use of faux wood was estimated at 3.5 meters at the rate of $70 per meter, the actual consumption was for 3.8 meter at the rate of $71 per meter, which resulted in unfavourable variance of 10%
- Manufacturing labour cost for Residential blinds: the management estimated that 5 hours of manufacturing labour for unit of residential blind at the rate of 40 per hour will be consumed, but the actual labour consumed was for 7 hours per unit at $42 per hour. This resulted in the unfavourable variance of 47%.
- Manufacturing labour cost for commercial blinds: the management estimated that 10.5 hours of manufacturing labour for unit of commercial blind at the rate of 40 per hour will be consumed, but the actual labour consumed was for 11 hours per unit at $42 per hour. This resulted in the unfavourable variance of 10%.
- The revenue from commercial blinds was expected to be raised at $2660 per unit, but actually $2415 per unit was only charged. This resulted in loss of revenue of $245 per unit for 415 units, which resulted in unfavourable variance of 9%
The elements with favourable variances are listed below:
- Assembly labour cost for residential blinds: the management estimated use of 2.5 hours of assembly for each unit of residential blind for $52 per hour, but only 2.4 hours at the rate of $50 per hour was consumed which resulted in a favourable variance of 8%
- Assembly labour cost for commercial blinds: the management estimated use of 4 hours of assembly for each unit of commercial blind for $52 per hour, but only 3.8 hours at the rate of $50 per hour was consumed which resulted in a favourable variance of 9%.
- Variable overhead for residential blinds: the variable overhead charged was charged using activity based costing. Also for the purpose of budgeting activity based costing has been applied. Due to this there is no variance in the overhead calculation.
- Variable overhead for commercial blinds: the variable overhead charged was charged using activity based costing. Also for the purpose of budgeting activity based costing has been applied. Due to this there is no variance in the overhead calculation.
The cases of favourable variances are good for the company. They represent savings done by them with respected to set level of costs. The unfavourable variances on the hand represent the extra cost incurred by the management than the set limits. There are various steps that can be taken by the management in order to ensure limited cost (Horngren, 2012). The management can set incentive options for the departments who execute the projects with the allocated resources. This will drive the employees to work more efficiently with the given resources and will prevent extra material cost. The management should also opt of methods which will helps to reduce wastages. A proper check on labours hours should be made in order to ensure that the idle hours are not more than budgeted (Menifield, 2014). Limiting the idle hours will promote productive hours and result in savings of labour cost. The management should also use activity based costing in order to recover actual overheads, use of traditional costing may lead to over pricing of the product which will affect the demand and revenue (Noreen, 2015). Steps to ensure lower costs and higher revenues should be taken by the management in order to avoid unfavourable variances.
Conclusion
From the discussion above we can see it is not necessary that the management would consume the budgeted levels of materials and labour hour. There may be extra or less consumption of resources when the actual production starts. The rates pre-determined may also change in the real scenario, which might result in extra costs or savings. Therefore, while creating a forecast for the company, the management should try to incorporate certain percentages of uncertainty also. This will help them keep up with the market results and result in lower variances. Also, there are various cost controls measures which should be opted in order to minimise the costs.
Atkinson, A. A. (2012). Management accounting. Upper Saddle River, N.J.: Paerson.
Berry, L. E. (2009). Management accounting demystified. New York: McGraw-Hill.
Boyd, W. K. (2013). Cost Accounting For Dummies. Hoboken: Wiley.
Datar, S. (2015). Cost accounting. Boston: Pearson.
Datar, S. (2016). Horngren’s Cost Accounting: A Managerial Emphasis. Hoboken: Wiley.
Horngren, C. (2012). Cost accounting. Upper Saddle River, N.J.: Pearson/Prentice Hall.
Menifield, C. E. (2014). The Basics of Public Budgeting and Financial Management: A Handbook for Academics and Practitioners. Lanham, Md.: University Press of America.
Noreen, E. (2015). The theory of constraints and its implications for management accounting. Great Barrington, MA: North River Press.
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