Basis for Analysis
Orchid Ltd. is a small furniture manufacturing company that faces issues related to the increased cost of manufacturing. The management feels that if the company does not control the rising cost of manufacturing, the company’s profit may decline in the future (Walther & Skousen 2009). The current report provides key findings from the budget analysis and identifies different variances recorded between the actual budget and the flexed budget. The management of the company must understand that the preparation of budgets is a crucial step in planning for different business activities. It can help the management in identifying changes in its cost with different levels of production and sales. Therefore, it is important for the management to anticipate fixed and variable costs of production efficiently to avoid an unfavourable situation.
Actual and Flexed Budgets
The analysis is divided into two parts including (1) preparation of actual and flexed budgets and (2) identification of variances in price, volume, and overhead. It could be noted that the actual budget profit based on the planned sales of 800 units was less than the flexed budget profit. The reason is that the company generated more sales revenue and its costs were spread over more units sold. There are two types of cost involved in production namely variable costs and fixed costs (Lalli 2011). The variable costs change with the increase in sales. Therefore, the management should ensure that the company manages its variable costs effectively by renegotiating its existing contracts with suppliers and improving the working efficiency of employees.
Variance Analysis
The variance analysis is performed in this report by comparing the standard costs of production with the actual cost to determine variances in price, volume, and overhead (Wyatt 2012).
Sales Variance
The sales variance analysis indicated that the volume variance as favourable as the company recorded more sales than the actual budget. However, the price variance as unfavourable. The actual price was lower than the standard price that resulted in an unfavourable effect on the company’s business. The actual price was calculated by dividing the actual sales revenue by the actual units sold.
Direct Materials Variance
The direct materials variance indicated that the volume variance as unfavourable. The company used more direct materials to generate higher sales. Since the cost associated with direct materials is variable, therefore its impact on the company’s profitability is expected to increase with a favourable change in sales. The company should try to reduce its variable material cost. The price variance of direct materials is favourable as the company was able to allocate its standard cost over a higher number of units sold. The actual price was calculated by dividing the actual direct material cost by the actual units sold by the company.
Direct Labour Variance
The direct labour variance indicates that the company’s labour spent more hours for selling additional ten units of furniture. It indicated a major weakness of the company as it was not able to control its direct labour cost. The company should monitor the working schedule and identify reasons for the increase in the number of labour hours. The variance of working hours was significant that resulted in an unfavourable efficiency variance. Furthermore, the analysis indicated that the price variance related to direct labour was also unfavourable. The reason was higher actual labour cost per hour and the unfavourable increase in labour hours.
Fixed Overhead Variance
The fixed overhead also changed as the company sells additional units of furniture. The fixed overhead variance was unfavourable but it was acceptable as the company generated higher sales.
Conclusion
It could be concluded from the analysis that the increase in sales resulted in both favourable and unfavourable variances in price and volume of production inputs. The management needs to focus on cost elements that had unfavourable variances to manage its costs efficiently and effectively.
Appendix
Budgeting
Sales Variance
- Volume variance = Standard Price * (Actual Sales – Standard Sales)
- Volume variance = 950 * (800 – 810) = 9,500 F
- Price variance = Standard Quantity * (Actual Price – Standard Price)
- Price variance = 800 * (930 – 950) = £16,000 U
- Actual price = Actual sales revenue / Actual units sold = 753,300 / 810 = £930
Direct Materials Variance
- Volume variance = Standard Price * (Actual Quantity – Standard Quantity)
- Volume variance = 30 * (810 – 800) = 300 U
- Price variance = Actual Quantity * (Actual Price – Standard Price)
- Price variance = 810 * (237.65 – 240) = £1,903.5 F
- Actual price = Actual direct material cost / Actual units sold = 192,500 / 810 = £238
Direct Labour Variance
- Efficiency variance = Standard Rate * (Actual Hours – Standard Hours)
- Efficiency variance = 25 * (8,500 – 8,100) = 10,000 U
- Price variance = Actual Hours * (Actual Rate – Standard Rate)
- Price variance = 8,500 * (26 – 25) = £8,500 U
- Actual price = Actual direct material cost / Actual units sold = 221,000 / 8,500 = £26
Fixed Overhead Variance
- Fixed Overhead Variance = Actual Amount – Flexed Amount
- Fixed Overhead Variance = 128,000 – 129,600 = £1,600 U
Reference List
Lalli, WR 2011, Handbook of budgeting, John Wiley & Sons, Hoboken.
Walther, LM & Skousen, CJ 2009, Budgeting and decision making, Bookboon, London.
Wyatt, N 2012, The financial times essential guide to budgeting and forecasting: how to delivery accurate numbers, Pearson Education Limited, Harlow.