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Budgeting is concerned with the implementation of the long term plan for the year ahead. It gives clear indication of what is expected to be achieved during the budget period. It also knows as a quantitative expression of a plan of action and also a plan of action express in financial term.
A budgeting is the quantitative expression of a period of a proposed plan of action by management for a specified period and an aid to coordinating what needs to be done to implement that plan. A budget generally includes both financial and nonfinancial aspects of the plan, and it serves as blueprint for the company to follow in an upcoming period. A financial budget quantifies management expectations regarding income, cash flows, and financial positions. Nonfinancial budgets are units manufactured or sold, number of employees, and number of new products being introduced to the marketplace.
Budgeting is concerned with the implementation of the long-term plan for the year ahead. Because of the shorter planning horizon budgets are more precise and detailed.
Budgets serve a number of useful purposes. There include, planning, coordinating, communicating, motivating, controlling, evaluating.
The budgeting process ensures that managers do plan for future operation, and that they consider how conditions in the next year might change and what steps they should take now to respond to these changed conditions. This process encourages managers to anticipate problems before they arise, and hasty decisions that are made on the spur of the moment based on expediency rather than reasoned judgment, will be minimized.
Coordination, the budget serves as a vehicle through which the actions of the different parts of an organization can be brought together and reconciled into a common plan. Without any guidance, managers may each make their own decisions, believing that they are working in the best interests of the organization. For example, the purchasing manager may prefer to place large orders so as to obtain large discount. The production manager will be concerned with avoiding high stock levels and the accountant will be concerned with the impact of the decision on the cash resources of the business. Budgeting compels managers to examine the relationship between their own operations and those of rather departments and in the process, to identify and resolve conflicts.
Communication is one of the useful purposes in budgeting process. If an organization is to function effectively, there must be definite lines of communication so that all the parts will be kept fully informed of the plans and the policies, and constraints to which the organization is expected to conform. Everyone in the organization should have a clear understanding of the part they are expected to play in achieving the annual budget. This process is ensuring that the individuals are made accountable for implementing the budget. Beside the budget, the communication between managers is expectations.
Motivating is helping managers to strive to achieve the organization goals. The budget can be useful for influencing managerial behavior and motivating managers to perform in line with the organization objectives. A budget provides a standard that under certain circumstances, a manager may be motivated to strive to achieve. However, budgets can also encourage inefficiency and conflict between managers. Motivation also a tool to assists managers in managing their departments; it can act as a motivational device by providing a challenge.
A budget assists managers in managing and controlling the activities for which they are responsible. By comparing the actual results with the budgeted amounts for different categories of expenses, managers can ascertain which costs do not conform to the original plan. This process enables managers to operate a system of management by exception which means that a manager attention and effort can be concentrated on significant deviations from the expected results. By investigating the reasons for the deviations, managers may be able to identify inefficiencies such as the purchase of inferior quality materials. When the reasons for the inefficiencies have been found, appropriate control action should be taken to remedy the situation.
Variance analysis is usually associated with explaining the difference between actual costs and the standard costs allowed for the goods output. For example, the difference in material costs can be divided into a materials price variance and a materials usage variance. The difference between the actual direct labor costs and the standard direct labor costs can be divided into a rate variance and an efficiency variance. The difference in manufacturing overhead can be divided into spending, efficiency and volume variances. (http://blog.accountingcoach.com/variance-analysis-standard-cost) The price variance identifies whether the company paid too much for each unit of input-perhaps it paid more per pound of the input than it had planned. The quantity variance identifies whether the company used too much of the input-perhaps it used too many pounds of the raw materials for the number of products it manufactured.
Variance analysis helps management to understand the present costs and then to control the future costs of the company. Variance analysis is also used to explain the difference between the actual sales and the budgeted sales. Example includes price variance, sales volume variance and sales mix variance.
Variances are not ends in themselves but springboards for further analysis, investigation, and action. Variances also permit the supervisory personnel to defend themselves and their employees against failures that were not their fault. A variance provides the yardstick to measure the fairness of the standard, allowing management to redirect its effort and to make reasonable adjustments. Action to eliminate the causes of undesirable variances and to encourage and reward desired performance lies in the field of management, but supervisory and operating personnel rely on the accounting information system for facts which facilitate intelligent action toward the control of costs.( http://www.accountingformanagement.com/usefulness_of_variances.htm)
The costs of the materials which are used in a manufactured product are determined by two factors, the price paid for the materials and the quantity of materials used in production. Material variances include material price variance, material usage variance and total material usage.
The material price variance is equal to the difference between the standard price (SP) and the actual price (AP) per unit of materials multiplied by the quantity of materials purchased (QP)
Actual price may exceed standard prices because of a change in market conditions that cause a general price increase for the type of materials used. An adverse price variance may reflect a failure by the purchasing department to seek the most advantageous sources of supply. A favorable price variance might be due to the purchase of interior quantity materials, which may lead to inferior product quantity.
The material usage variance is equal to the difference between the standard quantity (SQ) required for actual production and the actual quantity (AQ) used multiplied by the standard material price (SP)
The material usage variance is normally controllable by the manager of ht e appropriate production responsibility centre. It causes of material usage variances include the careless handling of materials by the production personnel, the purchase of inferior quality materials or changers in methods of production.
The total material variance is the difference between the standard material cost for the actual production and the actual cost.
The cost of labour is determined by the price paid for labour and the quantity of labour used. A price and quantity variance will also arise for labour. The labour variance includes wage rate variance, labour efficiency variance and total labour variance.
The wage rate variance is equal to the difference between the standard wage rate per hour (SR) and the actul wage rate (AR) multiplied by the actual number of hours worked (AH).
The wage rate variance may due to a negotiated increase in wage rates not yet having been reflected in the standard wage rate. Labour rate variance may also occur because a standard is used that represents a single average rate for a given operation performed by workers who are paid at several different rate.
The labour efficiency variance is equal to the difference between the standard labour hours for actual production (SH) and the actual labour hours worked (AH) multiplied by the standard wage rate per hour (SR).
The labour efficiency variance is normally controllable by the manager of the appropriate production responsibility centre and may be due to a variety of reasons. For example, the use of inferior quantity materials, different grade of labour, new equipment or tools and changes in production processes will all affect the efficiency of labour.
The total labour variance is the difference between the standard labour cost (SC) for the actual production and the actual labour cost (AC)
The total variable overhead variance is the differences between the standard variable overhead charger to production (SC) and the actual variable overheads incurred (AC) when variable overhead vary with direct labour or machine hours of input the total variable overhead variance will be due to a price variance arising from actual expenditure being different from budgeted expenditure or a quantity variance arising from actual direct labour or machine hours of input being different from the hours of input.
The variable overhead expenditure variance is equal to the difference between the budgeted flexed overhead (BFVO) for the actual labour hours of input and the actual variable overhead cost incurred (AVO).
The variable overhead efficiency variance is the difference between the standard hours of output (SH) and the actual hours of input (AH) for the period multiplied by the standard variable overhead rate (SR)