Orchid Ltd.: Business Report

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Summary

An entity should prepare budgets because they enable the management plan for the future. Budgeting should be carried out in all units because it aids in delivering important information on matters that deal with the capabilities of resources. Further, a budget encourages coordination across various departments. Thus, if the company carries out proper budgeting, then it serves as an effective tool for planning and controlling. This business report gives the outcome of the original, flexed, and actual budget that is prepared for the company. Also, it shows results of sales, materials, labor and fixed overhead variances. Finally, the report discusses the possible causes of the variances and provides suggestions on how the entity can improve cost control.

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Financial results

Comparison of budgets

Table 1 in the appendix section shows a comparison of the three budgets. The results show that the actual operating profit was lower than the projected earnings.

Variances

Analysis of the variances will be carried out to establish the cause of the poor performance. Table 2 in the appendix section shows a summary of the variances. The variances are discussed below.

Sales

Under sales, there were variances in both the price and volume. The budgeted selling price per unit was $950 while the actual selling price was $930. Thus, the tables were sold at a price lower than the budgeted price. This caused an adverse variance of £16,200 as shown in working 2 below. In most entities, the selling price of a product is determined by the sales and marketing departments. A number of factors are often taken into account when coming up with the prices. However, the economic conditions and competition often necessitate businesses to change the budgeted price. This creates variances. In this case, the actual price was lower than the budgeted price. Besides, the decline in price did not stimulate a significant increase in demand that can offset the decline in price. Therefore, the overall effect was a decline in the amount of revenue generated.

In terms of sales volume variance, the company had budgeted for 800 tables yet it sold 810 tables. The increase in the number of tables sold can be partly explained by the decline in price by £20. Apart from price, some of the other factors that can affect the quantity sold are marketing activities, competition, trade restrictions, market share of the company, and distribution channels among other factors (Graham, Smart & Meggison 2010). Thus, sales volume variance amounted to £4,600 as shown in working 1. This was favorable. The sum of the sales price and volume variance was adverse of £11,200.

Direct materials

Working 3 shows that the company had a favorable direct material price variance amounting to £17,500. This can be attributed to a drop in the price of material from £30/m to £27.5/m. This can be an indication that the price level for materials dropped in the market. The decline can also be caused by improved negotiation of price by the procurement department. Also, the purchase of low-quality materials can also explain the decline in prices. Another reason that can explain the drop in prices is discounts received on large purchases. Finally, the implementation of better procurement practices such as the comparison of quotations from several suppliers can cause a decrease in prices (Hansen, Mowen & Guan 2009).

The direct material usage variance was adverse at £2,072.73. This implies that the actual material used was greater than the budgeted consumption. This indicates inefficiency in the use of materials. The first reason that can explain the adverse position is an increase in the wastage of materials. This can be caused by either the use of unskilled workers or the dilapidation of production equipment. The second reason is the purchase of materials that have a lower value than the standard quality. Finally, a problem in the production process can also cause inefficiency in the use of materials. The sum of these variances results in a favorable position of £15,427.27.

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Direct labor

The budgeted labor rate was £25 per hour while the actual rate was £26 per hour. Working 4 shows that the company had an adverse labor rate variance amounting to £8,500. The adverse position can be explained by a number of factors. The first factor is an increase in the minimum wage. This has the effect of increasing the wages that are paid by the company. Another reason can be an effective negotiation with the labor unions. These unions represent the interest of employees. Therefore, if they negotiate for higher wages, then the employees are likely to gain. Another reason is the inefficiency in hiring by the human resource department. The final reason is the hiring of more skilled workers. Skilled workers are often paid higher than semi-skilled and unskilled workers.

The company also had a favorable direct labor efficiency variance of £17,788.46. This shows that the production unit was efficient in using the abilities of the workers. Thus, the favorable position indicates improved productivity of direct labor. Some of the reasons that can cause the improved efficiency are training of the workforce, especially on the use of enhanced production methods, use of better materials that are easy to handle, thus reducing the number of hours spent when producing a unit of output, hiring of more skilled workers, and a higher learning curve achieved than projected during budgeting. Thus, the sum of direct labor rate and efficiency variance yields a favorable position amounting to£9,288.46 (Drury 2008).

Fixed overhead

Working 5 shows that the actual fixed overhead incurred by the company exceeded the budgeted amount by £2,000. This result is unfavorable because it shows that higher fixed overhead costs were incurred than the planned costs. The adverse position can be caused by a number of factors. The first factor is inefficiency in the management of fixed overhead. The second reason is an unplanned expansion of the business undertaken during the accounting period. This expansion can cause an increase in fixed overheads. The last factor is planning errors. For instance, changes in the risk profile of the entity can cause the insurance risk premium to go up. This also has the effect of increasing the value of fixed overhead. It is worth mentioning that the level of production should not have an effect on this variance.

Suggestions

The above discussion reveals that the company did not meet its target of the selling price of the commodities, material usage, labor rate, and fixed overhead. Efficiency can be improved by replacing old machines with new ones, regular maintenance of machines so as to reduce material wastage, training of employees and the hiring of more skilled workers, proper planning of fixed overhead, replacement of dilapidated machines, and purchase of high materials of high quality (Atrill & McLaney 2013).

References

Atrill, P & McLaney, E 2013, Accounting and finance for non-specialists, Pearson Publishing, Harlow.

Drury, C 2008, Management and cost accounting, South-Western Cengage Learning, Boston.

Graham, J, Smart, S & Meggison, W 2010, Corporate finance: linking theory to what companies do, South-Western Cengage Learning, Boston.

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Hansen, R, Mowen, M & Guan, L 2009, Cost management: accounting & control, South-Western Cengage Learning, Boston.

Appendices

Table 1 – budgets.

Original Budget Flexed Budget Actual budget
Sales £760,000 £769,500 £753,300
Variable costs
Direct materials £192,000 £194,400 6,480m £192,500 7,000m
Direct labor £200,000 £202,500 8,100hrs £221,000 8,500 hrs
Fixed overhead £128,000 £128,000 £130,000
Total cost £520,000 £524,900 £520,000
Operating profit £240,000 £244,600 £209,800

Table 2 – variances.

Notes Favorable Unfavorable
£ £ £
Original budgeted profit 240,000
Sales volume variance W1 2,400 2,400
Standard profit (flexed budget) 244,600
Operating variances
Sales price variance W2 16,200
Materials: Price W3 17,500
Materials: Usage W3 2,072.73
Labor: Rate W4 8,500
Labor: Efficiency W4 17,788.46
Fixed overhead: Spending W5 2,000

Workings

Actual selling price = Actual sales revenue / actual number of units sold

= 753,300 / 810

= £930

Actual cost of direct materials

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= £192,500 / 7,000m

= £27.5/m

Actual cost of direct labor

= £221,000 / 8,500m

= £26/h

Working 1

Sales volume variance

Original budget result

Sales 800 units * £950 £760,000
Variable costs
Direct materials 8m * £30/m * 800 units £192,000
Direct labor 10 hours * £25/hr * 800 units £200,000
Fixed overhead £160 * 800 units £128,000
Total cost £520,000
Operating profit £240,000

The calculations in the original budget are based on 800 units and standard costs. The sales amount to £760,000 while total cost amounts to £520,000. The resulting profit is £240,000.

Actual budget

The preparation of this budget will be based on the actual results.

Sales 810 units * £930 £753,300
Variable costs
Direct materials £27.5/m * 7,000 m £192,500
Direct labor £26/hr * 8,500 hours £221,000
Fixed overhead £160 * 800 units £130,000
Total cost £520,000
Operating profit £209,800

Flexed budget

Preparation of the flexed budget is based on the standard cost and the actual number of tables manufactured.

Sales 810 units * £950 £769,500
Variable costs
Direct materials 8m * £30/m * 810 units £194,400
Direct labor 10 hours * £25/hr * 810 units £202,500
Budget fixed overhead £160 * 800 units £128,000
Total cost £524,900
Operating profit £244,600

Sales volume variance = Operating profit (original budget) – operating profit (flexed budget) = £240,000 – £244,600 = -£4,600

The results are favorable. The calculations are based on the assumption that the material and labor cost per unit of sales revenue were as originally budgeted for.

Working 2

Sales price variance

= (Actual quantity * actual price) – (Actual quantity * standard price)

= (£930 * 810) – (£950 * 810)

= £753,300 – £769,500

= £16,200 (adverse)

Working 3

Direct materials

Price

= (Actual quantity * actual price) – (Actual quantity * standard price)

= (£27.50 * 7,000) – (£30 * 7000)

= 192,500 – 210,000

= £17,500 (favorable)

Usage

= (Actual quantity * standard price) – (Standard quantity * standard price)

= (£30 * 7000) – (7,069.09 * £30)

= £210,000 – £212,072.73

= £2,072.73 (adverse)

Working 4

Direct labor variances

Rate

= (Actual quantity * actual price) – (Actual quantity * standard price)

= (£26 * 8,500) – (£25 * 8,500)

= 221,000 – 212,500

= -£8,500 (adverse)

Efficiency

= (Actual quantity * standard price) – (Standard quantity * standard price)

= (£25 * 8,500) – (7,788.46 * £25)

= £212,500 – £194,711.54

= £17,788.46 (favorable)

Working 5

Fixed overhead variance

Spending

=Actual overhead – budgeted overhead

= £130,000 – £128,000

= £2000 (adverse)

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