Page 181 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Management Control Systems

Notes or not. Another limitation of variance analysis is that, as the performance reports become
aggregated, offsetting variances might mislead the user of the information.

Example: A manager might notice that the business unit manufacturing cost performance
was as budgeted. However, there may be good performance at one plant which is offsetting
poor performance at another plant.
If a variance is significant, but uncontrollable (such as unexpected inflation), there may be no
point in investigating it. Performance reports show only what has happened; they do not show
the future effects of actions that the manager has taken.

Example: Reducing the budget for employee training increases the current profitability,
but may result in adverse consequences later.

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Caution Since variance analysis is limited to those events that are recorded in the accounts,
many important effects of those events are not reflected in current accounting transactions.
Fixed (Static) and Flexible Budget: Control, in order to be effective, requires a standard or a
target with which actual performance can be compared for the purpose of measurement of the
results for timely action, if necessary.
If Master Budget is fixed (Static) i.e., it has a singled planned volume level and is not adjusted or
altered after it is drawn up, regardless of change in volume, cost drivers or other conditions
during the budget period.
A flexible budget (as called as variable budget) is a budget that is adjusted for changes in the
level of the cost (or revenue) driver. The flexible budget is based on knowledge of how revenue
and costs should behave over a range of the driver.

Because actual sales will probably differ from budgeted sales in the master budget, a flexible
budget is better simply because it presents more projections of sales and so has a bitter chance of
getting it right. The flexible budget provides the data for studying patterns of behaviours of
revenues and costs. These patterns may be of interest to management, but no pattern can emerge
from a single column static budget. Flexible budget is a budget that recognises the difference
between fixed, variable and semi-variable costs, in relation to the level of activity attained.
Fixed expenses are not controllable at the departmental manager’s level, such expenses are
allowed in total without being factored by the percentage of activity. In case of variable expenses,
the expenses will vary indirect proportion to output; allowance will be given in direct proportion
to the level of activity attained in respect of such expenses.

Notes Semi variable expenses will vary with volume but not in direct proportion because
of the incidence of certain fixed elements.

Task Take any hypothetical example of your own and calculate any two variances.

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