Page 188 - Finance for Non-Financial Managers

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The Annual Budget: Financing Your Plans
Inefficiency Can Cost Money in Many Ways
If you look closely at Figure 10-4 and if you were to calculate
unit costs for budgeted production vs. actual production, you would 169
notice that the budgeted unit labor cost was $65 per unit
($32,500/500) but the actual labor cost came out to $71.25 per unit
($28,500/400). How can that be when the costs vary with production
quantities? The answer is that labor is inefficient when it doesn’t func-
tion at the levels for which the workforce was designed.The labor
force in this case didn’t use its time efficiently, but still got paid for the
time spent, with the result that the actual direct labor cost incurred
was more per unit than budgeted.
Looking at the variable overhead, a similar situation exists. Budgeted
overhead per unit was $150, but actual overhead was $160. Since
overhead allocation typically follows labor cost, this increase results
from allocating overhead to the inefficient labor that was charged but
didn’t produce anything.

also true. If conditions do not vary greatly, such as in an admin-
istrative department with largely fixed costs, a flex budget would
simply be a lot more work and provide very little benefit.

Variance Reporting and Taking Action

In Chapter 8 we explored variances from standard manufactur-
ing cost and how they help us identify and correct production
inefficiencies. In the manufacturing environment, standard cost
is the budget, in effect, for making a single unit of product.
Nonmanufacturing companies and the other departments in a
manufacturing company don’t use standard costs, per se, but
they use budgets, and variance analysis serves the same pur-
pose for them as for the plant.
Variance reporting is a variation on the traditional manage-
ment concept of management by exception, as defined in
Chapter 8. The purpose of variance reporting is to enable man-
agers to be more time-efficient in locating and correcting prob-
lems by creating reports that focus primarily on the problems,
or exceptions. So the report is laid out to calculate and highlight
differences between actual costs and budgeted costs. Figure