Comparison between actual results and budgets

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Introduction to comparison between actual results and budgets

This chapter looks at how information comparing actual and budgeted results (or actual and previous periods’ results) can be calculated and used.

The purpose of making comparisons

Comparison between actual results and budgets are made to:

• Control performance. For example, if costs are higher than expected, management action might be able to bring them back into line.
• Judge managers’ performance. If budgets are not met then managers might have underperformed.
• Improve next time’s budget. If actual and budget are different it might be that the budget was wrong and needs to be corrected for next time.

Comparisons between actual results for this year and last year’s results are made to:

• Understand how performance might be improving or deteriorating.
• Judge managers’ performance.
• To identify unusual changes as these could indicate accounting errors.

Comparisons between actual results for this period and those of the corresponding period (for example May 2013 to May 2012) allow changes to be identified sooner than waiting until the end of a financial year.

Without comparison of some sort it is difficult to judge performance and to apply corrective action.

The forecasting/budgeting process and the concept of feed forward and feedback control

Typical steps in the budgeting process are:

1. Form a budget committee. This committee has representatives from the major functional areas of the organisation. A committee is needed because it is unlikely that any single person will have all the information available that is needed.
2. Gather or create forecast data. For example, predictions about next year’s sales quantities and prices will have to be made.
3. Identify the principle budget factor or limiting factor. This is the factor which prevents larger and larger profits being made. It might be sales volume, raw material availability, machine time or the number of employees. The entire budget has to be scaled to the principal budget factor
4. Create functional budgets: sales, production, purchasing, advertising, wages and so on.
5. Create a master budget: a budgeted statement of financial position, a budgeted income statement and a cash flow budget.

A budget will then feedback and feed forward control to be exercised:

Feedback control: for example, sales in February were lower than budgeted. Therefore a correction is needed to try to bring sales for March back up to those budgeted.

Feed forward control: for example, the cash flow budget predicts a cash shortage September. Therefore take action now to deal with that problem, perhaps by reducing expenditure or negotiating a larger overdraft.

In feedback control an event requiring attention has already occurred; in feed forward control the event has not yet occurred.

Feedback control can be positive or negative:

Negative feedback: reduce the deviation from plan, such as reducing costs that are over budget.

Positive feedback: increase the deviation from plan, such as trying to sustain sales that are better than budget.

Appropriate data for comparison

When comparing results to budgets or to prior periods it is important to use appropriate data otherwise comparisons and conclusions are likely to be invalid. For example, if there is significant inflation from one year to the next, a straight comparison of the two years’ figure could imply an improvement in results when in fact there is only an inflationary effect.

Similarly, there is little point comparing this year’s cost to last years if a change in manufacturing methods has taken place so that production is radically different.

Comparison of sales figure could also need care. For example, export sales could be subject to exchange rate movements which could distort simple comparisons of revenue.

Fixed, flexible and flexed budgets

A fixed budget is drawn up for one level of activity only.

A flexible budget is drawn up in advance for several levels of activity. Often the levels chosen are where the behaviour of costs change and the flexible budgets make it easier to draft budgets at other levels of activity

A flexed budget is drawn at the level of activity achieved.

Example

For output of 1 – 10,000 units fixed costs are $50,000. Thereafter they step-up to $80,000.

For output up to 15,000 units variable costs are $20/unit. Units in excess of this have variable costs of $24/unit.

Selling price per unit = $30

What would be the budget at a sales and production level of 16,000 units?

Sales

Variable production costs

Contribution

Fixed costs

Profit

Answer to Example