A budget is a very important tool in management. It is described as a plan of action for a certain period, it describes the expected level of activity, and the resources needed to achieve that level of activity. Budgets can be prepared on a departmental basis or on an organizational basis but in whatever case, each department must have its own budget. Budgets must be prepared in line with the goals and objectives of an organization (Weygandt, Kimmel & Kieso, 1995). A budget plays important role in the organization, which includes providing guidance to a course of action, motivating managers, improving communication, enhancing control among other things.
The budgeting process is a continuous process and it has four major stages. The first stage is to establish the goals and objectives of the organization because budgets must be prepared in line with the goals of an organization. The second stage is setting the production, marketing and financial estimates for the period in which the budget is being prepared for. The third stage involves breaking down the budget into smaller budgets to ensure easy management and control of the main budget. The fourth stage is budget management, variance analysis and control. This is a critical stage since it compares the actual outcome and the expected outcome to determine whether any action is required (Ryan, 1995).
In this assignment, we will conduct a budget variance analysis for the Radiology department to determine the effectiveness of the department. This is majorly a stage four activity and it entails comparing the actual outcome against the expected or planned outcome. A variance in a budget is found when the actual outcome is different from the planned outcome (Hansen, Mowen & Guan, 2007). Such variance can be favorable (F) or adverse (A). A favorable variance exists when the actual expenditure is less than the planned expenditure or when the actual production targets are more than the expected units are. On the other hand, an adverse variance exists when the actual expenditure is more than the planned expenditure or when the actual units produced are less than the units budgeted for. The adverse variance needs the most attention from members because it shows lack of effectiveness of a department.
Budget Variance Analysis of the Radiology Department
Variance analysis is a method of comparing actual outcomes against expected outcomes. The need for this comparison is to enable corrective action to be taken in advance. Calculation of variances is simple since it involves comparing the actual outcome to the budgeted outcome and then classifying the variance as either favorable or adverse (Ryan, 1995). Then the variances for different components are summed up in order to determine whether the overall variance is favorable or adverse.
Various types of variances exist. For instance, there is the material quantity variance, labor rate variance, Labor efficiency variance among others. Material quantity variance occurs whenever there is a variance between the actual materials that are used by the firm and budgeted materials. Labor rate variance is a variation of the actual amount spent on employees from the budgeted wages. Labor efficiency variance is the deviation of actual total labor hours from the budgeted total labor costs measures the variation of the actual total labor hours from the total planned labor hours. Material price variance is the difference between the total monetary expenditure and the actual monetary expenditure of a project.
The process of variance analysis involves four steps, which are flexing the budget, analyzing the variances, identifying the causes and taking the appropriate actions. Flexing the budget is important since making the comparison of costs for different levels of output does not make sense (Hansen, Mowen & Guan, 2007). A revised budget should be prepared to express the original budget for the level of activity attained. After coming up with the revised budget, a variance analysis can be done and a classification on whether the variance is adverse or favorable is done. Then an investigation into the causes of the variance is done in order to enable the making of decisions.
In the case of the Radiology department, the actual number of procedures is different from the budgeted number of procedures. There is, therefore, a need to flex the budget to remove the impact of the change in number of procedures. Flexing the budget will give the revised budget, which reflects how the budget could have been if the department had budgeted for the number of procedures attained.
The variance analysis for the Radiology department can be summarized in the table below:
Table 1: Variance analysis of Radiology department
|Budgetary component||Original Budget||Revised/Flexed Budget||Actual outcome||variance||Classification of variance|
|Variable Costs||$ 1,320,000||$ 1,100,000||$ 1,200,000||$ 100,000||Adverse|
|Fixed costs||$ 600,000||$ 500,000||$ 600,000||$ 100,00||Adverse|
|Total costs||$ 1,920,000||$ 1,600,000||$ 1,800,000||$ 200,000||Adverse|
Table 2: Analysis of variance in cost components
|Budget Component||Budgeted figure||Actual figure||Variance||Variance classification|
|Average cost per Unit||$ 16||$ 18||$ 2||Adverse|
|Variable cost per unit||$ 11||$ 12||$ 1||Adverse|
|Fixed cost per unit||$ 5||$ 6||$1||Adverse|
After flexing the budget, it is clear that there are adverse variances in the department. The favorable variance recorded by the manager was because the department recorded fewer procedures than expected. The department had budgeted for 120,000 procedures but the actual procedures were 100,000. There is therefore needed to come up with a revised budget for 100,000 procedures to be able to do objective variance analysis. After developing the revised budget, we find that the department would have to spend less in variable costs and fixed costs at the actual outcome depending on the amounts that had been budgeted for.
A further look at the various cost components shows an adverse variance since the actual average cost, variable cost, and fixed costs per unit are more than the budgeted components. According to the budget, the department could have spent $ 1,100,000 and $ 500,000 in variable and fixed costs respectively. The department however spent $ 1,200,000 and $ 600,000 in variable and fixed costs, which gives adverse variances of $ 100,000 for both cost classifications. The overall variance for the department is $ 200,000 adverse.
Evaluation of the Effectiveness of the Radiology Department
Effectiveness means attaining the desired level of output or meeting set goals and objectives (Weygandt, Kimmel & Kieso, 2009). An organization or a department is said to be effective when it meets or surpasses the goals set in the budget. In budget analysis, the effectiveness of a department is attainment of a favorable variance or in a situation where the actual outcome is the same as the budgeted outcome. A department is said not to be effective if the actual costs are less than the budgeted costs or if the actual units produced, are less than the units budgeted for.
Before concluding whether a department is effective or not, one must have an understanding of the causes of variance in the activities of a department. According to Ryan, there are various causes of variance, which include wrong calculations or estimates in the budget, wrong data and estimates about the actual outcome, and changes in assumptions of the budget to reality (1995). Other causes of invariance may be natural causes, which are beyond the control of the management. Examples of such include in prices of raw materials, increase in labor costs among other reasons. The department has no control over these factors. They cannot be used to evaluate the effectiveness of a department (Ryan, 1995).
Whether the department is effective or not is an issue that can be politicked about due to the different causes of variances. The managers of the department can argue that the variances in prices were due to changes in prices of required materials and labor cost changes, factors which are beyond the control of the management. A conclusive evaluation of the effectiveness of the department can be done after establishing the causes of increases in variable, fixed and average costs per unit (Hansen, Mowen & Guan, 2007).
The preliminary conclusion is that the department is not effective since it has not attained the desired level of cost. The average cost per unit, variable cost per unit, and fixed cost per unit are more than the revised budget figures. The actual total variable costs and total fixed costs are more than the costs for the revised budget thus the department is not effective.
Budget analysis is a tool for measuring the performance of a department or an organization against the set targets. This is required to make the necessary corrective action. Budget analysis is, therefore, an important step in budgeting that should be conducted carefully. In preparation of budgets, managers should ensure that the budget is realistic since an unrealistic budget could mislead an organization (Weygandt, Kimmel & Kieso, 2009).
It is impossible to make appropriate decisions after budget analysis without a good knowledge of the true causes of variances in a department or an organization (Hansen, Mowen & Guan, 2007). The role of identifying the true causes of variances can be left to operational managers after accountants have done the budget analysis. The accounting or the finance department’s role is to make a quantitative analysis of variances in the budgets. It is the role of operations managers to give an analysis on the causes of variances to the management to facilitate decision-making.
Hansen, D. R., Mowen, M. & Guan, L. (2007). Cost management: accounting & control. New Jersey: Cengage Learning.
Ryan, B. (1995). Strategic Accounting for Management. London: Cengage Learning EMEA.
Weygandt, J., Kimmel, P. & Kieso, D. (2009). Managerial Accounting: Tools for Business Decision Making. New York: John Wiley and Sons.