Unit 9 Assignment 1: Budget Variance Analysis

Unit 9 Assignment 1: Budget Variance Analysis

Charles L. Williams

BUS3060 – Fundamentals of Finance and Accounting

Capella University

Dr. Nancy Odett

Date: June 10, 2012

Budget Variance Analysis 1

Budget Variance Analysis

Imagine that for the second quarter in a row, profits are down at Waterfall division.

Division Management budgeted $250,000 in profits for the 2nd quarter but actual results

were only $197,000 in profits. The division management insists that the budgets were

developed realistically but admits sales were down. The division has been under pressure to

improve profitability. Corporate Management has asked you to identify the primary cause of

the shortfall â€" revenue or costs?

Address the following as you develop your answer to Corporate.

1. How will you approach your analysis of the situation?

The budgeted profit of the Company is $250000 while the actual profit is $197000.

The unfavorable variance in the profit should be analyzed by finding out the reasons for the

variance and the persons who are responsible for the unfavorable variance and what are the

steps that need to be taken to improve the profitability. Also the analysis should be made

whether realistic budget/standard has been set and whether there is any need for correcting

the standard.

2. What variance analysis and / or trends would be helpful to evaluate?

Standard costing can be used to evaluate the difference in terms of revenue, direct

material cost, direct labor cost, variable overheads, and fixed overheads. Budgeting can be

used to evaluate the reasons for the differences between the budgeted amount with respect to

revenue and cost and the actual revenue and cost. Further, responsibility accounting can also

be used to fix the responsibility for the unfavorable variance.

3.What are three possible situations that could be the cause for the shortfall in profits?

Budget Variance Analysis 2

Profit variance = budgeted profit-actual profit. When budgeted profit is more than

actual profit, then profit variance is unfavorable. The three possible situations for the short

fall in profits:

1. Less sales volume. If the company could less number of sales units (volume) than the

budgeted number of units, then it will result in unfavorable sales volume variance. For

example, if the company has set the target for sales department to sell 100000 units for one

quarter and if the sales department could sell only 85000 units, then the profit will short to the

extent of 15000 units.

2. More material price: If the material was purchased at rate higher than the standard

price, then it will result in increase in costs and thereby resulting in unfavorable profit

variance. For example, if the standard price of raw material is $20 per kg and if the raw

material was purchased at the price of $21, then it will increase the direct material cost and

reduce the standard profit.

3. High usage of material. If there is high usage of material because of purchase of

inferior quality or abnormal wastage of material because of inefficiency of inexperienced

labor force, then it will increase the material cost.

3. What actions would you recommend for these three possible situations?

The company should make efforts to increase the sales volume by making more

advertisements and sales promotional methods and should provide sales incentives to the

sales force to attain the targets. The purchasing department should plan in such a way that

a. bulk orders are being placed to get the economical price

b. at the right quality being purchased and

c. steps are being made to avail the discount. Purchasing department should not make rush

orders and should not get the material at the inflated rate. The workers should be trained in

such a way that they product the finished goods without wastage.

Budget Variance Analysis 3

4. What recommendations would you make to management to improve the budget process for

next year?

The management while setting up the standards should have detailed discussion with

all departmental heads and standards should be of realistic one .The standard should not be

one which is almost impossible to achieve. For example, while setting material usage

standard, proper provision should be given for normal spoilage and in case of setting labor

time; provision should be made for normal fatigue and rest. Likewise, while setting sale price

and volume standard, the sales head and sales force should be given the opportunity to inform

about the actual market position and detailed market study should be undertaken to set the

realistic and achievable standard.

Budget Variance Analysis 4

References

Capella University. (2003). Fundamentals of finance and accounting. New York, NY:

McGraw-Hill. ISBN: 978007360778.

Weiner, D. P. (2009). Financial accounting as a second language. Hoboken, NJ: John Wiley

& Sons. ISBN: 9780470043882

Libby, R., Libby, P. A., & Short, D. G. (2011). Financial accounting (7th ed.). New York,

NY: McGrawHill. ISBN: 9780077892661.