Budgeting, budgetary control and standard costing with variance analysis
Domain 3 tests budget construction, budgetary control and the calculation and interpretation of standard costing variances. Expect functional budget schedules, a cash budget, flexible budget comparisons and variance reconciliations.
Budgeting framework
- The principal budget factor (limiting factor) sets the order of budget preparation; it is usually sales demand.
- A budget manual and budget committee coordinate preparation. Budgets may be incremental, zero-based or rolling.
- Production budget = sales units + closing inventory - opening inventory.
- Material usage budget = production × standard usage; material purchases = usage + closing inventory - opening inventory.
- The cash budget records receipts and payments by timing; depreciation is excluded. The master budget comprises the budgeted income statement, statement of financial position and cash budget.
Budgetary control
- A fixed budget is not comparable with actual output; flex the budget to actual output before calculating expenditure variances.
- Variances are adverse or favourable; investigate by exception, weighing the cost of investigation against the benefit.
- Participative budgeting can reduce slack but takes longer; imposed budgets are quicker but may demotivate.
Standard costing variances
- Material price = (standard price - actual price) × actual quantity. Material usage = (standard quantity for actual output - actual quantity) × standard price.
- Labour rate = (standard rate - actual rate) × actual hours. Labour efficiency = (standard hours for actual output - actual hours) × standard rate.
- Fixed overhead expenditure = budgeted fixed overhead - actual fixed overhead. Fixed overhead volume = (actual output - budgeted output) × standard fixed overhead per unit.
- Sales price and sales volume variances complete the operating statement.
Worked example
The standard is 3 kg at GHS4 per kg, i.e. GHS12 per unit. Output is 1,000 units. Purchases and usage are 3,200 kg costing GHS12,160, i.e. GHS3.80 per kg. Material price variance = (4.00 - 3.80) × 3,200 = GHS640 favourable. Material usage variance = (3,000 - 3,200) × GHS4 = GHS800 adverse. Total material variance = GHS160 adverse. Check: standard cost 1,000 × GHS12 = GHS12,000; actual cost GHS12,160; adverse GHS160. The favourable price was more than offset by excess usage.
Traps
- Using actual quantity for the usage variance or standard quantity for the price variance.
- Flexing sales but not costs.
- Adding opening inventory in the production or purchases budget.
- Reversing the fixed overhead volume variance sign.
- Treating every favourable variance as good; cheap material may cause adverse usage.
- Omitting opening and closing inventory from purchase budgets.