Describe a budget
A budget is a financial plan for a business or organisation that is prepared in advance.
Financial plan for a biz or org.
Prepared in advance.
High low method to determine fixed cost & variable cost.
Can only be used where variable cost is constant and there are no stepped fixed costs.
What is ‘contribution’
Why important
Selling price less variable cost.
Important in short-term decision-making
How is contribution calculated
Basically it’s the profit based on marginal cost...
So selling price minus marginal cost.
Describe variance
A variance is the budgeted/standard cost or revenue minus Actual cost or revenue.
What is a particular feature of budgets
Their use as a method of cost and revenue control.
This is done by comparing budget & actual to establish variance.
Variances can be either Favourable (F) or Adverse (A)
Management by exception...
...acting on variances that are exceptional (exceeding tolerance level)
Motivating employees
Budgets are an example of ‘Responsibility accounting’.
Managers and supervisors are responsible for their budgets but in order to be effective must participate in the budget-setting process.
Can be seen as carrot or stick.
How are variances summarized?
On a ‘budget report’.
These reconcile budget and actual cost for each cost element (materials, labour, expenses, overheads) and the budgeted revenues and show the variances.
Columns Budget; Actual; Variance; F or A.
Order for investigating variances is usually...
Large variance - F&A
Other A variances.
Any remaining F variances.
Small variances might not be worth investigating (cost of investigation might outweigh benefit)
Significant variances need referred to higher level of management.
Nb. Constant adverse/ favourable variances need investigated as budgeted costs/ revenues might have been set incorrectly.
Reporting cycle importance
Depends on time periods
Eg. If monthly then variances are likely to be reported in first 2 weeks of new period.
Revision of budgets
Carried out at regular intervals to take note of..
Cost increases caused by inflation.
Changes to quality and specification of materials.
Changes to work practices eg. Automation.
Changes to selling prices eg. Due to competition.
Controllable and non-controllable costs and revenues
Important to appreciate not all costs and revenues can be controlled directly by the managers and supervisors in the short term.
So need to distinguish between controllable and non-controllable costs.
In the long term all costs and revenues are controllable.
Monitoring of budget reports flow
Set budget amounts.
Compare budget amounts to actual.
Calculate total variance.
Analyse total variance.
Explain reasons for variance.
Take action.
Fixed budget
Flexible budget
Fixed - remains the same whatever the level of activity.
Flexible - changes with level of activity and takes into account different cost behaviour patterns.
Sales rev might vary so need to vary production costs also.
Note that per unit revenue and Variable cost per unit doesn’t change.
