Surya Foods: A 'Saving' That Was Just Lower Volume
Surya Foods packs namkeen in 200 g pouches; the budget is stated in '000 cases. Top management set the annual budget by taking last year's costs and cutting 5% from every line, without consulting the plant. The static budget assumed 80,000 cases: material ₹64.00 lakh (₹80 per case), direct labour ₹24.00 lakh (₹30 per case), variable overhead ₹16.00 lakh (₹20 per case), fixed overhead ₹20.00 lakh, total ₹124.00 lakh. Actual output was 68,000 cases because a large institutional customer deferred its annual order. Actual costs were material ₹58.10 lakh, labour ₹21.76 lakh, variable overhead ₹14.28 lakh and fixed overhead ₹20.90 lakh, total ₹115.04 lakh; 13,600 labour hours were paid, at ₹160 per hour, and variable overhead was incurred on the same hours. The plant manager's review says 'we spent ₹8.96 lakh less than budget, so the plant has earned its bonus'. Purchasing is centralised at head office, which switched to a new supplier at ₹85 per kg against the standard ₹80 to secure faster delivery. The board wants a fair assessment before the bonus is declared.
1. Prepare a flexed budget at actual output, compute the variances and assess the plant manager's claim.
Read the worked answer
Flex the variable lines to 68,000 cases; leave fixed overhead at budget.
| Line | Static budget (80,000) | Flexed (68,000) | Actual | Variance |
|---|---|---|---|---|
| Material | 64.00 | 54.40 | 58.10 | 3.70 A |
| Direct labour | 24.00 | 20.40 | 21.76 | 1.36 A |
| Variable overhead | 16.00 | 13.60 | 14.28 | 0.68 A |
| Fixed overhead | 20.00 | 20.00 | 20.90 | 0.90 A |
| Total | 124.00 | 108.40 | 115.04 | 6.64 A |
The claim is invalid. Comparing actual ₹115.04 lakh with a static budget of ₹124.00 lakh compares 68,000 cases with 80,000 cases. If the plant had produced 80,000 cases at these unit costs it would have spent about ₹135 lakh, not ₹124 lakh. The apparent ₹8.96 lakh 'saving' is really a volume effect of ₹15.60 lakh (the flexed budget is ₹15.60 lakh lower than static) masked by ₹6.64 lakh of genuine adverse variance. On a like-for-like basis the plant overspent.
Labour and overhead detail. Standard hours = 68,000 × 0.20 = 13,600, exactly the hours paid, so there is no efficiency variance; the ₹1.36 lakh is pure rate: (160 − 150) × 13,600. Variable overhead has no efficiency variance either; the ₹0.68 lakh is spending: (105 − 100) × 13,600.
2. Split the material variance into price and usage, and decide how much of the total should be charged to the plant.
Read the worked answer
Quantities. Actual quantity = 58,10,000 / 85 = 68,353 kg. Standard quantity for 68,000 cases = 68,000 kg (1 kg per case, since ₹80 per case at ₹80 per kg).
Price variance = (85 − 80) × 68,353 = ₹3,41,765 adverse. Usage variance = (68,353 − 68,000) × 80 = ₹28,240 adverse. Check: 3,41,765 + 28,240 = ₹3,70,005 ≈ ₹3.70 lakh, matching the flexed-budget variance.
Allocation. About 92% of the material variance is price, and the buying decision sits with central purchasing, which chose the new supplier for delivery speed. Six paise per kg of usage is negligible and is within normal process tolerance. On a controllable basis the plant's material variance is essentially nil.
But do not stop there. The price variance is not automatically blameless: the standard price was ₹80 and no attempt was made to re-standardise after the supplier change. A price variance computed against a stale standard measures nothing useful, and the plant cannot manage a variance it does not control. The fair report shows two columns - controllable (usage, labour rate if locally negotiated, variable overhead spending) and non-controllable (material price, fixed overhead, volume). Charging ₹3.42 lakh of purchase price to a plant manager whose bonus depends on total cost guarantees that the report will be argued about rather than acted on.
3. Critique the way the budget was built and the way performance is being judged, and recommend a better process.
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Faults in the process
- Across-the-board 5% cut. A uniform percentage assumes every cost is equally reducible. It forces the plant to protect itself by padding next year's estimate, so the cut produces sandbagging rather than efficiency.
- No participation. The plant was never consulted, so it has no ownership and, predictably, defends itself with a static-budget comparison rather than a flexed one.
- Static budgeting in a variable business. An institutional order worth 12,000 cases decided the reported outcome. A budget that cannot distinguish volume from efficiency will always misassign credit.
- Bonus tied to a total-cost number. The plant manager is rewarded on items he cannot control and punished for a deferral he did not cause.
Recommended process
- Build the budget from standards: engineering study for material yield and labour time, activity-based drivers for overhead, and a separate fixed-cost budget negotiated with the cost centre that owns each line.
- Make the purchasing standard explicit, with a documented mechanism to re-standardise when a supplier changes, and require a quality and delivery evaluation alongside price.
- Report monthly on a flexed basis, with controllable and non-controllable variances shown separately; meet the plant manager on controllable items only.
- Introduce a rolling forecast so a deferred order triggers a re-forecast rather than a year-end argument.
- Base the bonus on controllable variances plus a small number of operating measures (yield, on-time delivery, customer complaints), so no single number can be gamed.