Budget Variances, Make-or-Buy Decisions & Performance Measures

The Budgeting Process

The budget process encompasses several key activities, including the initial budgeting steps, "make" or "buy" decisions, and non-financial performance measures. The initial budget process starts with the existing budget; the information in this budget should be verified and reconciled against actual performance. It is essential to confirm that the starting point is accurate.

The second step in the budgeting process is to determine the information flows and measures that will be used to create the budget. A budget depends on having accurate information, and this step is necessary to ensure that accuracy. The third step is to determine a methodology. When there is an existing budget and an ongoing business, that is usually the starting point, but there are still several different methodological choices available. The goal is to choose the approach that is optimal for the type of business and its situation. The final step is to make the projections for the coming year, quarter, or month.

Analyzing Budget Variances

The budget variances report shows that there was a direct materials variance, mainly reflecting efficiency. The price was static; however, efficiency was not, and the direct materials overage reflects that efficiency was lower than expected. A larger variance was found in direct labor. The cost of labor was lower, but efficiency was significantly lower as well.

One possible explanation is that the company has less experienced workers. These workers tend to cost less but also tend to be less efficient. Furthermore, they might make more mistakes, leading to reduced efficiency in the use of raw materials. This is the most likely cause of the variance and is at least worth investigating. Alternatively, the variance could be process-related, meaning that something in the process changed to make it less efficient — though that would not be reflected in the per-unit cost of labor. It is also worth considering whether the company may have produced more product because it sold more product; however, since the variance report does not clarify this, it is assumed that this is not what occurred.

Short-Run and Long-Run Responses to Variances

If the cause of the variance is related to onboarding, then in the short run there is little to be done. Those workers are likely getting up to speed, and their efficiency will approach expected levels over time. Onboarding is often a lengthy process, and the company must be cautious about making changes that affect the long run based solely on short-run results.

In the long run, however, the company may want to examine whether the onboarding process can be improved. If there are ways to bring new workers up to speed more quickly, that will help eliminate the kind of waste observed here. If the variance is instead process-related, the company will need to re-evaluate what changed and either adjust the budget to reflect the new norm or re-optimize the process to restore efficiency.

Conclusion

The review of the budget variance shows that labor and materials were above budget. There are a few possible explanations for this, and all will need to be explored. However, one explanation that fits all three variances is that the company onboarded more employees than usual, or experienced a slower-than-usual onboarding process. New employees tend to make more mistakes, cost less, and perform less efficiently.

If onboarding is indeed the reason for the budget variances, then no immediate corrective action is necessary, as those new employees should by now be improving and approaching expected efficiency levels. Ongoing monitoring, combined with a longer-term review of the onboarding process, represents the most prudent course of action.

References

Putra, L. (2014). Essential five steps on budgeting process. Accounting: Financial and Tax. Retrieved December 10, 2016, from