The paper is focused at preparing an operating budget and analyzing the actual performance of the fictional pet supplies manufacturer, Peyton Approved. The process of constructing the overall operating budget consisted in preparing a series of interlinked budgets, such as a sales budget, production budget, manufacturing budget, selling expense budget, and finally, general and administrative expense budget. The actual performance of the organization was reviewed by applying a variance analysis and reporting appropriate variances for materials and labor to internal stakeholders.
It was determined that both variances for direct materials and labor were unfavorable from the company’s management standpoint. Actual quantity of direct materials used exceeded the planned volumes by 3,620 units, resulting in $28,055 unfavorable efficiency variance of direct materials usage. On the other hand, the actual unit costs of direct material correspond with the budgeted amount, therefore there is no price variance for these expenses. Actual costs of labor is lower compared to the planned level as the company has spent $15 per labor hour instead of $16. Thus, there is a favorable price difference for labor costs, amounting to $33,000. However, there is also a significant unfavorable efficiency variance in the amount of $48,000, which was caused by the increased quantity of labor hours (33,000 as compared to the planned level 30,000).
In general, occurred budget variances can be caused by planning erros, changes in business environment, or changes in the company’s performance. In case of the Peyton Approved, all discussed budget variances can be considered significant as they account for more than 5% of actual budget of the considered items (labor costs and direct materials costs). Therefore, the company’s management has to conduct a thorough audit of the underlying reasons for these variances. However, potential reasons of the occurred labor rate variance (favorable) include declined labor market rates and employment of staff with lower qualifications. Hypothesized causes of the occurred labor efficiency variance (unfavorable) include poor training of employees, low quality of materials and equipment used in the production process and employment of people with insufficient qualifications for this work. Finally, potential reasons for the occurred material usage variance (unfavorable) include poor management of inventory or low quality of purchased materials.
To sum up, the current assignment aimed to construct an operating budget and compare actual operational results to the budget. Delivarables of this project included the operating budget constructed based on the provided inputs (the Final Project Part I Student Worksheet), budget variance analysis (the Budget Variance Student Worksheet) and brief discussion of potential implications of the occurred variances. Hypothetical causes of each price and efficiency variance were identified.
- Nobles, T. L., Mattison, B. L., Matsumura, E. M. (2014). Horngren’s financial and managerial accounting (5th ed.). Upper Saddle River, NJ: Pearson Education, Inc.