Budget Assignment

Question: A consulting firm produces a service that requires the use of labor and materials. Each unit of service requires a standard labor time of 30 minutes (0.5 hours). The average pay rate for a labor hour is 20. The consulting firm considers all materials that are required for the service as variable overheads (OH), the cost of which is directly associated with the labor hours worked. It has been estimated that variable OH rate is 10 per service hour. The budgeted and actual costs, revenue and units for the month November are given in the table below: Original Budget Actual Units of Service 1,500 1,600 Sales Revenue 120,000 124,400 Labor hours 750 860 Labor cost 15,000 20,210 Variable OH costs 7,500 8,170 Fixed Cost 68,000 68,000 Total Cost 90,500 96,380 Operating Profit 29,500 28,020 1. Calculate the flexed budget and the key variances between budgeted and actual results. 2. Reconcile the original budget and present the relationship between the budgeted and the actual profit for the month November 3. Discuss the calculated variances, and provide suggestions for better cost management. Answers: 1. Flexible Budget:- Particulars Budgeted data for 1,500 units(I) Flexible budget for 1,600 units(II) Actual data for 1,600 units(III) Sales revenue(Note 1) 120,000 128,000 124,400 Units 1,500 1,600 1,600 Selling price per unit(Note 2) 80 80 77.75 Labour hours 750 800 860 Labour hours per unit(Note 3) 0.5 0.5 0.5375 Labour cost(Note 4) 15,000 16,000 20,210 Labour cost per hour(Note 5) 20 20 23.5 Variable overhead cost(Note 6) 7,500 8,000 8,170 Variable rate per hour(Note 7) 10 10 9.5 Fixed cost 68,000 68,000 68,000 Profit(Note 8) 29,500 36,000 28,020 Note: 1-Sales revenue For (I)-1,500*80 For (II)-1,600*80 For (III)-1,600*77.75 Note: 2-Selling price per unit For (I)-120,000/1,500 For (II)-128,000/1,600 For (III)-124,400/1,600 Note: 3-Labour hours per unit For (I)-750/1,500 For (III)-800/1,600 For (III)-860/1,600 Note: 4-Labour cost For (I)-750*20 For (II)-800*20 For (III)-860*23.5 Note: 5-Labour cost per hour For (I)-15,000/750 For (II)-16,000/800 For (III)-20,210/860 Note: 6-Variable overhead cost For (I)-750*10 For (II)-800*10 For (III)-860*9.5 Note: 7-Variable rate per hour For (I)-7,500/750 For (II)-8,000/800 For (III)-8,170/860 Note: 8-Profit For (I)-120,000-15,000-7,500-68,000=29,500 For (II)-128,000-16,000-8,000-68,000=36,000 For (III)-124,400-20,210-8,170-68,000=28,020 Key variances between budgeted and actual:- Sales price variance-128,000-124,400=3,600(adverse) Direct labour total variance-16,000-20,210=4,210(adverse) Variable overhead total variance-8,000-8,170=170(adverse) 2. According to the flexible budget, the profit for 1,600 units should have been 36,000. But in actual, the profit is 28,020. The difference has arisen because of variances in sales revenue as well as labour cost as well as variable cost. The difference in budgeted profit can be calculated as under: There is difference in profit is of 7,980. There is as shortfall in profit. The shortfall is caused because of adverse variances. All the three variances calculated are adverse. Due to which the profit is adverse. The calculation is shown below: 7,980=3,600+4,210+170. 3. The variances calculated are sales price variance, direct labour total variance and variable overhead total variance. All the three variances are adverse. Variable expenses and labour expenses are incurred in excess of what should have been actually incurred. The selling price is less compared to the budgeted selling price. Units are same. Therefore, the sales price variance is adverse. Now to achieve the targeted sales revenue, company should try to sell units in an area which can provide the targeted selling price per unit. To increase the selling price is a tough decision to make as it can affect the sales units. Therefore, improving sales value variance is a difficult task. Another two adverse variances are direct labour total variance and variable overhead total variance. The cost incurred is more than what should have been actually spent as per budgeted data for standard production. Labour cost per hour is 20 while actual labour cost per hour 23.5. To make the variance positive, the labourers should be given incentives and motivation to produce more units in one hour so that per unit labour cost can be decreased. The most relevant variance to the business is variable overhead cost variance. Because, it depends upon the variable cost incurred by the company. Variable expenses incurred can be reduced to some extent by the organisation. Labour and sales variance cant be controlled as compared to variable overhead. Variable overhead can be controlled by the company. Company should analyse day to day expenses carefully so that it can cut off expenses somewhere. Maintenance expenses, supplies, material expenses should be controlled to cut off variable expenses. References:- ANON, N.D., variance analysis, Accessed on 4th February 2015, https://accounting-simplified.com/management/variance-analysis/ANON, N.D., variance analysis, Accessed on 4th February 2015, https://classes.bus.oregonstate.edu/spring-07/ba422/Management%20Accounting%20Chapter%205.htm