accounting for control
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ACCOUNTING
FOR CONTROL
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The Control Process
Setting of objectives
Recording the results of the system
Comparison of plan with actual
Communication of deviations for
adjustment Feedback (negative /positive)
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Systems
Open loop systems
Closed loop systems Deterministic systems
Adaptive systems
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Objectives and the control process
The purpose of a control system is to ensurethat actions are in accordance with the firms
plans to achieve its objectives.
Ideally a system of control should be capableof making comparisons between expectations(as embodied in budgets and plans) and actualperformance so that these comparisons serveas a basis for determining the correctresponses to operating results.
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Budgets
Accounting plans which normally serve the
dual purpose of:
Quantifying the objectives of theenterprise
Providing a basis of control i.e. by
acting as a yardstickfor performanceevaluation
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Accounting for control
Budgetary control
Flexible budgets
Variance analysis understanding sales & cost variances
criticism of variance analysis
Cost control Applying different perspectives
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Budgetary control
ensuring that actual financial results are in linewith targets
Feedback: investigating variations between actual
results and budgeted results and takingappropriate corrective action
A favourable variance occurs where income exceedsbudget and/or expenses are lower than budget.
An adverse variance occurs where income is less thanbudget and/or expenses are greater than budget
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Flexible budgets
Original Flexed
Budget Budget Actual Variance
$80,000 $70,000 $73,500 $3,500 Adverse
40,000 @ $2 35,000 @ $2 35,000 @ $2.10
A budget that is flexed, i.e. standard costs
per unit are applied to the actual level of
business activity
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Variance analysis
Comparing actual performance against
plan, investigating the causes of the
variance and taking corrective action toensure that targets are achieved
For each responsibility centre,
product/service and for each line item
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Variance analysis process
Ascertain the budget and phasing foreach period
Report the actual spending
Determine the variance between budgetand actual (and determine whether it iseither favourable or adverse)
Investigate why the variance occurred
Take corrective action
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Variance analysis
Is the variance significant?
Is it early or late in the year?
Is it likely to be repeated?
Can it be explained (and
understood)? Is it controllable?
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Variance analysis
Types of variance
sales variances: price and quantity of
product/services sold
material variances: price and quantity of
materials used
labour variances: wage rate and production
efficiency
overhead variances: spending and efficiency
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Variance report
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Price and usage variances
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Sales variances
Sales price variance
Actual quantity 9,000@ actual price $175 $1,575,000
Actual quantity 9,000@standard price $170 $1,530,000
Favourable price variance $45,000
Sales quantity variance
Budget quantity 10,000- Actual quantity 9,000 1,000
@ standard margin $19.50Unfavourable quantity variance $19,500
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Material variances
Variance analysis
By Usage & price
Total variance
For each material (price & usage may offset)
Total usage (total of all materials) Total price variances (total of all materials)
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Labour variances
Variance analysis
By Efficiency & rate
For each type of labour: e.g. skilled & semi-skilled
Total variance
For each labour type (efficiency & rate mayoffset)
Total usage (total for all labour)
Total rate variances (total for all labour)
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Overhead variances
As variable overheads will commonly be basedon labour hours, the reasons for a labourefficiency variance will also relate to variable
overhead variance, although the reasons for aspending variance may be different
As fixed costs are independent of volume, thefixed cost variance is always a spendingvariance
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Reconciling variances
ReconciliationOriginal budgeted net profit 70,000
Sales variances
Favourable price variance 45,000
Unfavourable quantity variance -19,500 25,500
Materials variances
Total usage variance - adverse -5,000Total price variance - favourable 2,800 -2,200
Labour variances
Total efficiency variance - adverse -7,500
Total rate variance - adverse -13,750 -21,250
Overhead variancesAdverse efficiency variance -5,000
Adverse spending variance -8,250 -13,250
Fixed cost spending variance -5,000
Total variances -16,200
Actual net profit 53,800
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Understanding variances
Efficiency variances Poor productivity Poor production
planning
Out-of-date bill ofmaterials or labourrouting
Poor quality materialthat requires greater
skill to work The availability of
labour with the rightskills
Price variances
Changes in supplierprices not yet
reflected in the bill ofmaterials
A negotiated wageincrease that has not
been included in thelabour routing
Poor purchasingpractices
Unplanned overtime
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Understanding variances
Interdependencies
Between efficiency and price
Between materials and labour
Poor quality materials may result in more
labour hours
Untrained labour may result in more wastage
of materials
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Criticism of variance analysis
Variance analysis
emphasises variable costs in a
manufacturing environmentIn the non-manufacturing sector,
overheads form the dominant part of
the cost of producing a service and soprice and usage variance analysis has a
limited role to play
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Criticism of variance analysis
Reducing variances based on standard costs can bean overly restrictive approach in a TQM, JIT orcontinuous improvement environment
tendency to aim at the more obvious costreductions (cheaper labour and materials) ratherthan issues of quality, reliability, on-time-delivery,flexibility, etc.
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Cost control
Cost control
reducing costs while maintaining
the same levels of productivity ormaintaining costs while increasinglevels of productivity through
economies of scale or efficienciesin producing goods or services
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Cost improvement
Cost improvement
ensure that limited resources are effectively
utilised
best achieved by understanding the causes ofcosts the cost drivers
Business process re-engineering
Examining cross-departmental activities to identifyduplication and quality problems
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Conclusion
Flexible budgets
Calculate
Sales price/quantity variances
price/usage variances for material efficiency/rate variances for labour
Efficiency/spending variances for overhead
Possible causes of variances and interdependencies
Limitations of variance analysis
Cost control