Using Budgets to Achieve Organizational Objectives

1. Using Budgets to Achieve Organizational Objectives Chapter 10  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

2. Resource Flexibility • In many business decisions, especially decisions affecting the short-term, the firm’s capacity-related costs are considered as given and fixed • Relevant costs in the short run are flexible costs • Ideally, the supply of capacity resources is based on the amount needed to produce the projected volume of product • The budgeting process makes clear that some resources, once acquired, cannot be disposed of easily if demand is less than expected  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

3. The Budgeting Process (1 of 5) • The process that determines the planned level of most flexible costs • Budgeting for capacity-related resources is discussed as a separate topic in another chapter • Budgeting also includes discretionary spending such as for R&D, advertising, and employee training • These do not supply the firm with capacity but they do provide support for the organization’s strategy by enhancing its performance potential • Once authorized, discretionary spending budgets are committed or fixed; they do not vary with level of production or service  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

4. The Budgeting Process (2 of 5) • Budgets serve as a control for managers within the business units of an organization • Planning and control are the core of the design and operation of management accounting systems • Budgets play a central role in the relationship between planning and control • Budgets reflect in quantitative terms how to allocate financial resources to each part of an organization, based on the planned activities and short-run objectives of that part of the organization  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

5. The Budgeting Process (3 of 5) • Abudget is a quantitative expression of the money inflows and outflows that reveal whether a financial plan will meet organizational objectives • Budgeting is the process of preparing budgets • Budgets provide a way to communicate the organization’s short-term goals to its members  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

6. The Budgeting Process (4 of 5) • Budgeting the activities of each unit can • Reflect how well unit managers understand the organization’s goals • Provide an opportunity for the organization’s senior planners to correct misperceptions about the organization’s goals • Budgeting also serves to coordinate the many activities of an organization • In this sense, budgeting is a tool that forces coordination of the organization’s activities and helps identify coordination problems  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

7. The Budgeting Process (5 of 5) • Budgets help to anticipate potential problems and can serve to help provide solutions • Budgeting reflects the cash cycle and provides information to help the organization plan any borrowing needed to finance the inventory buildup early in the cash cycle • If budget planning indicates that the organization’s sales potential exceeds its manufacturing potential, then the organization can develop a plan to put more capacity in place or to reduce planned sales • Managers need to be able to anticipate problems since putting new capacity in place can take several months to several years  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

8. Forecasting Demandfor Resources (1 of 2) Budgeting involves forecasting the demand for four types of resources over different time periods: • Flexible resources that create variable costs (or flexible costs) • May be acquired or disposed of in the short term • Intermediate-term capacity resources that create capacity-related costs • For example, forecasting the need for rental storage space that might be contracted on a quarterly, semi-annual, or annual basis  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

9. Forecasting Demandfor Resources (2 of 2) • Resources that, in the intermediate and long run enhance the potential of the organization’s strategy • Discretionary expenditures, which include research and development, employee training, maintenance of capacity resources, advertising, and promotion • Long-term capacity resources that create capacity-related costs • For example, a new fabrication facility for a computer chip manufacturer, which might take several years to plan and build and might be used for ten years  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

10. Master Budget • Two major types of budgets comprise the master budget: • Operating budgets • Summarize the level of activities such as sales, purchasing, and production • Financial budgets • Identify the expected financial consequences of the activities summarized in the operating budgets  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

11. Operating Budgets (1 of 3) • The sales plan • Identifies the planned level of sales for each product • The capital spending plan • Specifies the long-term capital investments, such as buildings and equipment, that must be paid in the current budget period to meet activity objectives • The production plan • Schedules all required production • The materials purchasing plan • Schedules all required purchasing activities  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

12. Operating Budgets (2 of 3) • The labor hiring and training plan • Specifies the number of people the organization must hire or release to achieve its activity objectives, as well as all hiring and training policies • The administrative and discretionary spending plan • Includes administration, staffing, research and development, and advertising • These plans specify the expected resource requirements of selling, capital spending, manufacturing, purchasing, labor management, and administrative activities during the budget period  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

13. Operating Budgets (3 of 3) • Operations personnel use the plans represented in the operating budget to guide and coordinate the level of various activities during the budget period • Operations personnel also record data from current operations that can be used to develop future budgets  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

14. Financial Budgets • Planners prepare the financial budgets to evaluate the financial consequences of investment, production, and sales plans • Projected balance sheet • Projected income statement • Projected statement of cash flows • Planners use the projected statement of cash flows in two ways: • To plan when excess cash will be generated • They can use it to make short-term investments rather than simply holding cash • To plan how to meet any cash shortages  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

15. Demand Forecast • An organization’s goals provide the starting point and the framework for evaluating the budgeting process • To assess the plan’s acceptability, planners compare the tentative operating plan’s projected financial results with the organization’s financial goals • The budgeting process is influenced strongly by the demand forecast • An estimate of sales demand at a specified selling price  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

16. Developing the Demand Forecast • Organizations develop demand forecasts in many ways: • Market surveys conducted either by outside experts or by internal sales staff • Statistical models to generate demand forecasts from trends and forecasts of economic activity in the economy and the relation of past sales patterns to this economic activity • Assume that demand will either grow or decline by some estimated rate over previous demand levels • Regardless of the approach used, the organization must prepare a sales plan for each key line of goods and services  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

17. Importance of Sales Plans • The sales plans provide the basis for other plans to acquire the necessary factors of production: • Labor • Materials • Production capacity • Cash • Because production plans are sensitive to the sales plans, most organizations develop budgets on computers • Planners can readily explore the effects of changes in the sales plans on production plans  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

18. Level of Detail in Budget (1 of 2) • Choosing the amount of detail to present in the budget involves making trade-offs: • More detail in the forecast improves the ability of the budgeting process to identify potential bottlenecks and problems by specifying the exact timing of production flows • Forecasting and planning in great detail for each item can be extremely expensive and overwhelming to compute  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

19. Level of Detail in Budget (2 of 2) • Production planners use their judgment to strike a balance between • The need for detail • The cost and practicality of detailed scheduling • Planners do this by grouping products into pools • Each product in a given pool places roughly equivalent demands on the organization’s resources • Planning is simplified  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

20. The Production Plan • Planners determine a production plan by matching the completed sales plan with the organization’s inventory policy and capacity level • The plan identifies the intended production during each of the interim periods comprising the annual budget period • Interim periods may be defined as days, weeks, or months • Depending on how regularly the people managing the acquisition, manufacturing, selling, and distribution activities need information  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

21. Inventory Policy (1 of 3) • The inventory policy is critical and has a unique role in shaping the production plan • Planners use the inventory policy and the sales plan to develop the production plan • One policy is to produce goods for inventory and attempt to keep a target number of units in inventory at all times • This level production strategy is characteristic of an organization with highly skilled employees or equipment dedicated to producing a single product • Reflects a lack of flexibility  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

22. Inventory Policy (2 of 3) • Another inventory policy is to produce for planned sales in the next interim period within the budget period • Organizations moving toward a just-in-time inventory policy produce goods to meet the next interim period’s demand as an intermediate step in moving to a full just-in-time inventory system • Each interim period becomes shorter and shorter until the organization achieves just-in-time production • The scheduled production is the amount required to meet the inventory target of the level of the next interim period’s planned sales  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

23. Inventory Policy (3 of 3) • Another inventory policy is a just-in-time (JIT) inventory policy • In a JIT inventory strategy, demand directly drives the production plan • Production in each interim period equals the next interim period’s planned sales • A JIT inventory policy requires: • Flexibility among employees, equipment, and suppliers • A production process with little potential for failure  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

24. Aggregate Planning • Aggregate planning compares: • The production plan • The amount of available productive capacity • This comparison assesses the feasibility of the proposed production plan • It does not develop a detailed production schedule to guide daily production in the organization • It determines whether the proposed production plan can be achieved by the capacity the organization either has in place or can put in place during the budget period • Planners may need to consider ways to modify existing facilities  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

25. The Spending Plan (1 of 4) • Once planners identify a feasible production plan, they may make tentative resource commitments • The purchasing group prepares a plan to acquire the required raw materials and supplies • Since sales and production plans change, the organization and its suppliers must be able to adjust their plans quickly based on new information • At some point the plans have to be locked in place and no additional changes made • For example, commitment to a production schedule in a large automotive assembly plant occurs about eight weeks before production takes place • Provides managers the time to put raw materials supply in place and schedule the production  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

26. The Spending Plan (2 of 4) • The personnel and production groups prepare the labor hiring and training plans • Works backward from the date when the personnel are needed to develop hiring and training schedules that will ensure the availability of the needed personnel • When an organization is contracting, it will: • Use retraining plans to redeploy employees to other parts of the organization, or • Develop plans to discharge employees • Because they involve moral, ethical, and legal issues and may involve high severance costs, layoffs are usually avoided unless no alternative can be found  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

27. The Spending Plan (3 of 4) • Other decision makers in the organization prepare an administrative and discretionary spending plan • Summarizes the proposed expenditures on activities such as for R&D, advertising, and training • Discretionary expenditures provide the required infrastructure for the proposed production and sales plan • “Discretionary” means the actual sales and production levels do not drive the amount spent • The senior managers in the organization determine the amount of discretionary expenditures • Once determined, the amount to be spent on discretionary activities becomes fixed for the budget period and is unaffected by product volume and mix  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

28. The Spending Plan (4 of 4) • The appropriate authority approves the capital spending plan to acquire new productive capacity • A long-term planning process rather than the one-year cycle of the operating budget drives the capital spending plan • Capital spending projects usually involve time horizons longer than the period of the operating budget  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

29. Choosing Capacity Levels (1 of 4) Three types of resources determine capacity: • Flexible resources that the organization can acquire in the short term • If suppliers do not deliver the resources or deliver unacceptable products, production may be disrupted • Capacity resources that the organization must acquire for the intermediate term • Capacity resources that the organization must acquire for the long term • The level chosen reflects the organization’s assessment of its long-term growth trend  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

30. Choosing Capacity Levels (2 of 4) • Organizations develop sophisticated approaches to balance the use of short, intermediate, and long-term capacity to minimize the waste of resources • We may classify resource-consuming activities into three groups • Activities that create the need for resources (and resource expenditures) in the short-term • Activities undertaken to acquire capacity for the intermediate-term • Activities undertaken to acquire capacity needed for the long-term • Planners classify activities by type because they plan, budget, and control short, intermediate, and long-term expenditures differently  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

31. Choosing Capacity Levels (3 of 4) • Analysts evaluate short-term activities by considering efficiency and asking: • Is this expenditure necessary to add to the product value perceived by customers? • Can the organization improve how it does this activity? • Would changing the way this activity is done provide more satisfaction to the customer? • Choosing the production plan (i.e., choosing the level of the short-term activities) fixes the short-term expenditures that the master budget summarizes  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

32. Choosing Capacity Levels (4 of 4) • Analysts evaluate intermediate- and long-term activities by using efficiency and effectiveness considerations and asking: • Are there alternative forms of capacity available that are less expensive? • Is this the best approach to achieve our goals? • How can we improve the capacity selection decision to make capacity less expensive or more flexible? • Choosing the capacity plan (i.e., making the commitments to acquire intermediate and long-term capacity) commits the firm to its intermediate and long-term expenditures  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

33. Handling Infeasible Production Plans • Planners use forecasted demand to plan activity levels and provide required capacity • If planners find the tentative production plan infeasible, then they have to make provisions to: • Acquire more capacity, or • Reduce the planned level of production • Occurs when projected demand exceeds available capacity  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

34. Interpreting The Production Plan • Production is the lesser of: • Total demand • Production capacity • Demand is the quantity customers are willing to buy at the stated price • Production capacity is the minimum of: • The long-term capacity • The intermediate-term capacity • The short-term capacity  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

35. The Financial Plans • Once the planners have developed the production, staffing, and capacity plans, they can prepare a financial summary of the tentative operating plans • The projected balance sheet serves as an overall evaluation of the net effect of operating and financing decisions during the budget period • The income statement serves as an overall test of the profitability of the proposed activities • A cash flow forecast helps an organization identify if and when it will require external financing  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

36. The Cash Flow Statement The cash flow statement has three sections: • Cash inflows from cash sales and collections of receivables • Cash outflows • For flexible resources that are acquired and consumed in the short term • For capacity resources that are acquired and consumed in the intermediate and long term • Results of financing operations  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

37. Financing Operations • Summarizes the effects on cash of transactions that are not a part of the normal operating activities • Includes the effects of: • Issuing or retiring stock or debt • Buying or selling capital assets • Short-term financing • Often involves obtaining a line of credit, secured or unsecured, with a financial institution • The line of credit allows a company to borrow up to a specified amount at any time  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

38. Using The Financial Plans (1 of 2) • Organizations can raise money from outsiders by borrowing from banks, issuing debt, or selling shares of equity • Based on the information provided by the cash flow forecast, organizations can plan the appropriate mix of external financing to minimize the long-run cost of capital  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

39. Using The Financial Plans (2 of 2) • A cash flow forecast helps an organization • Identify if and when it will require external financing • Determine whether any projected cash shortage will be: • Temporary or cyclical • Can be met by a line-of-credit arrangement, or • Permanent • Would require a long-term loan from a bank, further investment by the current owners, or investment by new owners (or a combination)  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

40. What If Analysis • Using a computer for the budgeting process, managers can explore the effects of alternative marketing, production, and selling strategies • For example, a manager may consider raising prices, opening a retail outlet, or using different employment strategies • Alternative proposals like these can be evaluated in a what-if analysis • The structure and information required to prepare the master budget can be used easily to provide the basis for what-if analyses  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

41. Sensitivity Analysis (1 of 2) • What-if analysis is only as good as the model used to represent what is being evaluated • The model must be complete, it must reflect relationships accurately, and it must use accurate estimates • Otherwise, it will not provide good estimates of a plan’s results • Planners test planning models by varying the model estimates • If small changes in an estimate used in the production plan have a dramatic effect on the plan, the model is said to be sensitive to that estimate  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

42. Sensitivity Analysis (2 of 2) • Sensitivity analysis is the process of selectively varying a plan’s or a budget’s key estimates for the purpose of identifying over what range a decision option is preferred • Sensitivity analysis enables planners to identify the estimates that are critical for the decision under consideration  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

43. Variance Analysis (1 of 2) • To help interpret production and financial outcomes, organizations compare planned (or budgeted) results with actual results • A process called variance analysis • Variance analysis has many forms and can result in complex measures, but its basis is very simple: • An actual cost (or revenue) amount is compared with a target cost (or revenue) amount to identify the difference  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

44. Variance Analysis (2 of 2) • Accountants call the difference a variance • A variance represents a departure from what was budgeted or planned • An investigation will try to determine: • What caused the variance • What should be done to correct that variance  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

45. Sources of Budgeted Costs • Budgeted or planned costs can come from three sources: • Standards established by industrial engineers • Such as cost of steel that should go into the door of an automobile based on the door’s specifications • Previous period’s performance • For example, the cost of steel per door that was made in the last budget period • A benchmark, the best in class results achieved by a competitor • The cost of steel per comparable door achieved by the competitor that is viewed as the most efficient  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

46. Variances (1 of 4) • The financial numbers are the product of a price and a quantity component: • Budgeted amount = expected price * expected quantity • Actual amount = actual price * actual quantity • Variance analysis explains the difference between planned and actual costs by evaluating: • Differences between planned and actual prices • Differences between planned and actual quantities  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

47. Variances (2 of 4) • Accountants focus separately on prices and quantities because in most organizations: • One department or division is responsible for the acquisition of a resource • Determining the actual price • A different department uses the resource • Determining the quantity • A variance is a signal that is part of a control system for monitoring results • A variance provides a signal that operations did not go as planned  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

48. Variances (3 of 4) • Supervisory personnel use variances as an overall check on how well the people who are managing day-to-day operations are doing what they should be doing • When compared to the performance of other organizations engaged in comparable tasks, variances show the effectiveness of the control systems that operations people are using  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

49. Variances (4 of 4) • If managers learn that specific actions they took helped lower the actual costs, then they can obtain further cost savings by repeating those actions on similar jobs in the future • If they can identify the factors causing actual costs to be higher than expected, then they may be able to take the necessary actions to prevent those factors from recurring in the future • If they learn that cost changes are likely to be permanent, they can update their cost information when bidding for future jobs  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University

50. First-Level Variances • The first-level variance for a cost item is the difference between the actual costs and the master budget costs for that cost item • Variances are favorable (F) if the actual costs are less than estimated master budget costs • Unfavorable (U) variances arise when actual costs exceed estimated master budget costs  2003 Prentice Hall Business Publishing, PowerPoint supplement to Management Accounting, 4rd ed., Atkinson, Kaplan, and Young, prepared by Terry M. Lease, Ph.D., CPA, Sonoma State University