Variance Analysis

1. Role of Budget in Performance Monitoring

• Budgets are prepared as part of the planning process.
• Once finalized, the budget document is shared with respective managers.
• Managers are expected to perform their activities in line with the budget.
• Periodically, actual performance is measured and compared with budgeted values.

2. Comparison of Budget vs. Actual

A. Macro-Level Comparison

• Budgeted cost vs. actual cost for each department is compared.
• Deviations are reported to the budget committee.
• Department heads must:
  • Explain the reason for deviations.
  • Present an action plan to control or correct the deviation.

B. Micro-Level Comparison

• Focuses on identifying root causes of deviation.
• Appropriate control actions are initiated.
• Comparisons are made against predefined standards.

3. Standard Costing

• Standards are developed for:
  • Material quantity required per unit.
  • Labor hours per unit.
  • Machine hours per unit.
• For service companies, standards refer to time taken to deliver a service.
• It is easier to develop standards in manufacturing companies compared to service companies.

4. Role of Activity-Based Costing (ABC)

• ABC outputs can be used as standards.
• ABC measures the resources and time required for each activity.
• If ABC is implemented, it enhances the accuracy of standard development.

5. Budget as a Tool for Setting Standards

• Budgets also help in setting standards for indirect costs and overheads.
• Example: While discussing job costing, we used budgeted overhead rates.
• During budgeting:
  • Each department uses standards for cost estimation.
  • The budget then aggregates all cost items to provide a total department cost.

6. Next Steps

• This session will focus on:
  • Developing standards in more detail.
  • Comparing actuals vs. standards.
  • Understanding how variances are computed and analyzed.