Budgets and Variance: Understanding Concepts and Case Study of Orchid Limited

This assignment explains the concepts of budgets and variance analysis and how they can be used by management to control costs. It includes a case study of Orchid Limited, a furniture production company facing declining revenue and increasing costs. The types of budgets, advantages of budgeting, and variance analysis are discussed in detail. The variances of various functions of the company are calculated and analyzed. The conclusion emphasizes the importance of variance analysis in cost control and resource allocation.

Budgets and Variance
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Executive Summary
The following assignment will help us understand the concepts of budgets and variance
analysis, and how they can be used by the management of the companies to control cost. We
have a case study of Orchid limited, which has been used by us to understand these concepts
more properly.
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Contents
Introduction................................................................................................................................4
Types of budget..........................................................................................................................5
Advantages of budgeting............................................................................................................6
Variance analysis.......................................................................................................................7
Sales variance – volume and price:........................................................................................7
Direct material – units and Amount:......................................................................................7
Direct Labour – usage and Amount:......................................................................................8
Fixed Overhead –Amount:.....................................................................................................8
Conclusion................................................................................................................................10
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Introduction
Budgeting is an important tool which helps the management set a path to work on for the
coming period. If used properly budgeting can help reduce costs and also help in increasing
efficiency (Berry, 2009). It is just like a diet plan which, instead it tells the management how
much to spend. In the given scenario we have been provided with the budgeted and actual
data of Orchid limited. The company is engaged in production of high quality furniture.
Recently the company has been facing decline in revenue and increase in costs. Using the
budgeted data of the company we can help the management understand the variances, which
will help them take appropriate decisions (Boyd, 2013).
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Types of budget
There are various types of budgets. The company can use the budget which is most suitable
to its requirements (Datar, Cost accounting, 2015). Budgeted can be classified into many
types, there are budgets which are made for various activities, budgets based on requirements
and other types. The two basic types of budgets are fixed budgets and flexed budgets. The
fixed budgets are the type of budgets data for which cannot be adjusted later (Datar,
Horngren's Cost Accounting: A Managerial Emphasis, 2016). Flexed data on the hand are
very flexible and they can be made for various levels of inputs. We have made a fixed and a
flexible budget for the company:
Budget
Particulars Actual Flexed
Units 800 810
Sales 7,60,000 7,69,500
Less:
Direct materials 1,92,000 1,94,400
Direct labour 2,00,000 2,02,500
Fixed overheads 1,28,000 1,29,600
Operating
profit 2,40,000 2,43,000
The fixed budget of the company was made for 800 units, whereas the flexible budget was
adjusted to be made for 810 units which were actually sold by the company.
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Advantages of budgeting
Budgeting is a tool that helps the company creates a forecast for the income and expenses. It
helps the management with decision making and also helps them with evaluation of the
performance (Holtzman, 2013). Budgeting helps to set goals which helps to provide the
management with a direction to move forward. Creating a budgeting leads to allocation of
resources which reduces wastages. It provides the teams a set of resources and helps the
management check there efficiency as to how they use these allocated resources. Allocation
of resources helps the company to control cost and reduce wastages (Horngren, 2012). In case
of shortfalls of the resources, cut backs from all the departments are made. Budgeting helps
the management compare the set goals with the goals actually achieved. This helps in
performance review of the company (Seal, 2012). Hence we see that budgeting can be very
useful if applied properly.
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Variance analysis
Variance analysis is the most common results of budgeting. Under variance analysis the
deviations of the management from the budgeted figures are analyse and reasons for them are
identified (Siciliano, 2015). Then the management tries to overcome these problems so that
they can chive lower costs and maximum profits.
For the given case we have calculated the variances of various functions of the company.
Using this variance we can find the reason for increased cost for the company.
Sales variance – volume and price:
When the budgeted revenues are more than the actual revenues, then it is a case of
unfavourable variance, when budgeted revenues are lower than actual revenues it is a case of
favourable variances:
Sales
Particular
s Budgeted Actual Variance
Units 800 810 10
Rate 950 930 -20
Amount 7,60,000 753300 -6700
From the above table we can see that the company had planned on selling 800 tables by it
actually sold 810 tables, more units were sold than planned hence favourable variance. But
the total revenue which was expected to earn was $760000 with 800 tables, but they actually
earned $753300 with 810 tables. They have sold the tables at reduced rate of $930 when they
planned to sell for $950 each. The revenue had unfavourable variance.
Direct material – units and Amount:
When the budgeted amount of the material used is more than the actual amount incurred then
it is a case of favourable variance. And when the budgeted amount of material used is less
than actual amount then it is a case of unfavourable variance:
Direct Material Usage
Particular Budgeted Actual Variance
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s
Units 6480 7000 520
Rate 30 27.5 -2.5
Amount 1,94,400 192500 -1900
From the above table we can see that the company planned on using 6480 units of material
but ended up using 7000 units for production of 810 units, this indicates that they used more
material than budgeted. The amount budgeted to spent on material was 194400 whereas they
actually spent $192500; this indicates savings of $1900 by the company.
Direct Labour – usage and Amount:
When the budgeted amount of the labour used is more than the actual amount incurred then it
is a case of favourable variance. And when the budgeted amount of labour used is less than
actual amount then it is a case of unfavourable variance.
Direct Labour Usage
Particular
s Budgeted Actual Variance
Units 8100 8500 400
Rate 25 26 1
Amount 2,02,500 221000 18500
From the above table we can see that the company planned on using 8100 hours for 810 units
of tables, instead it used 8500 hours. Also, the amount budgeted to spent on labour was
202500 whereas the company actually spent $221000; they spent $18500 more than set
amount. The rate decided was $25 per hour but they spent $26 per hour.
Fixed Overhead –Amount:
When the budgeted amount of the overhead used is more than the actual amount incurred
then it is a case of favourable variance. And when the budgeted amount of overhead planned
is less than actual amount then it is a case of unfavourable variance:
Fixed overheads
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Particular
s Budgeted Actual Variance
Amount 1,29,600 130000 400
The table above shows that the management planned on spending $129600 whereas they
spent $130000. They spent $400 more for fixed overheads, this indicates unfavourable
variance.
In order to control cost, the management should keep the usage of unit as per budgeted plan,
also the revenue charged form the customers should not fall below the budgeted selling price.
All this will help the management earn higher profits.
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Conclusion
Variance analysis is a very vital tool which can help the management plan on cost control. It
also helps to control wastage of resources which helps to reduce costs. Hence the
management should try and increase its efficiency in order to have higher revenues and lower
costs.
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Bibliography
Berry, L. E. (2009). Management accounting demystified. New York: McGraw-Hill.
Boyd, W. K. (2013). Cost Accounting For Dummies. Hoboken: Wiley.
Datar, S. (2015). Cost accounting. Boston: Pearson.
Datar, S. (2016). Horngren's Cost Accounting: A Managerial Emphasis. Hoboken: Wiley.
Holtzman, M. (2013). Managerial Accounting For Dummies. Hoboken, NJ: Wiley.
Horngren, C. (2012). Cost accounting. Upper Saddle River, N.J.: Pearson/Prentice Hall.
Seal, W. (2012). Management accounting. Maidenhead: McGraw-Hill Higher Education.
Siciliano, G. (2015). Finance for Nonfinancial Managers. New York: McGraw-Hill.
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