Cost Management: A case scenario with calculations

Author: Iloka Benneth Chiemelie

Published: 15th-December-2014

A consulting firm produces a service that requires the use of labor and materials. Each unit of service requires a standard labor time of 30 minutes (0.5 hours).  The average pay rate for a labor hour is £20. The consulting firm considers all materials that are required for the service as variable overheads (OH), the cost of which is directly associated with the labor hours worked. It has been estimated that variable OH rate is £10 per service hour.

The budgeted and actual costs, revenue and units for the month November are given in the table below:

	Original Budget	Actual
Units of Service	1,500	1,600
Sales Revenue	£120,000	£124,400
Labor hours	750	860
Labor cost	£15,000	£20,210
Variable OH costs	£7,500	£8,170
Fixed Cost	£68,000	£68,000
Total Cost	£90,500	£96,380
Operating Profit	£29,500	£28,020

1.       Calculate the flexed budget and the key variances between budgeted and actual results.

	Actual	Flexed budget	Variance	Favorable?
Units of Service	1,600	1,600	-	-
Sales Revenue	£124,400	£124,400	-	-
Labor hours	860	800	60	Yes
Labor cost	£20,210	£32,000	£11,790	No
Variable OH costs	£8,170	£8,000	£170	Yes
Fixed Cost	£68,000	£68,000	-	-
Total Cost	£96,380	£108,000	£11,620	No
Operating Profit	£28,020	£16,400	£11,620	No

2. Reconcile the original budget and present the relationship between the budgeted and the actual profit for the month November

The reconciliation process = budget + favorable variance and –unfavorable variance

	Original Budget	Actual
Units of Service	1,500	1,600
Sales Revenue	£120,000	£124,400
Labor hours	810	860
Labor cost	£3,210	£20,210
Variable OH costs	£7,670	£8,170
Fixed Cost	£68,000	£68,000
Total Cost	£78,880	£96,380
Operating Profit	£17,880	£28,020

there is a negative relationship between the budgeted and actual profit of the budget profit is lower than the actual profit, which means that expense might have been highly forecasted as compared with the actual outcome.

3. Discuss the calculated variances, and provide suggestions for better cost management (target length 300 words).

The variance shows that while the flexed labour hour is lower than the actual labour hour, the cost of labour is actually higher for the flexed budget. Additionally, while the flexed overhead cost is lower than the actual overhead cost, the total flexed cost is actually higher. The implication is that activities in the flexed budge are lower than in the actual budget, but the incurred cost is higher, which influences the operating profit negatively as it can be noticed that the flexed cost has a lower operating profit when compared with the actual operating profit.

Basically, the above analysis shows that the cost of difference is because of the high level of rigidity in the costing measures of the original budget. This is because the original budget follows strictly the defined cost plans in terms of the labour hour, labour cost and overhead cost. However, the actual budget shows that flexibility can influence the overall operating profit positively.

Thus, beyond budgeting is recommended as the best cost management approach. The beyond budgeting institute (n.d) defined beyond budgeting as a command and control budgeting strategy that is designed to create a management model which is more empowering and adaptive. It is more about rethinking how managers can manage the organization in the modern world where innovative management models seem to be the only means of ensuring sustainable competitive advantage. This form of budgeting releases people from the burdens of stiff bureaucracy and high control of how budgets should be designed, by creating an atmosphere of flexibility which ushers in high trust on the staffs by giving them needed information, time to think, reflect, share, learn and improve their overall performance.

On the ground of the above discussion, it can be seen that beyond budgeting allows for flexibility, which provides management with the opportunity of associating cost based on defined activities instead of fixing cost for each activities. Thus, they can better control the cost by deciding at any given point either to increase or decrease the cost value with changes in activities – giving them needed control of the accounting measures.

References

Beyond budgeting institute (n.d), “what is beyond budgeting?” Available at: http://www.bbrt.org/beyond-budgeting/bbwhat.html [Accessed on: 1-1-2014].