Lesson 1, Topic 1
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1.3. Recording actual income and expenditure to identify variances

ryanrori January 25, 2021

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Budget variance is the difference in the projected budget and the achieved budget, and is usually expressed as a percentage. Analysis of budget variance allows such discrepancies to be identified and serves as the basis for corrective actions. 

The income and expenditure statement is a statement detailing how you are performing when you use your net income.  

The following is an example Income and Expenditure for an individual – Maria.

Maria earns R5000.00 per month. She does extra work over weekends, which earns her another R600. She spends her money as follows:

Monthly% of Total Expenditure
IncomeExpenses
DescriptionAmountItemCost
SalaryR5000.00Pay for rent / bondR1000.0020%
Weekend WorkR600.00School feesR500.0010%
FoodR500.0010%
ElectricityR300.006%
TelephoneR250.005%
TransportR250.005%
Medical AidR300.006%
InsuranceR100.002%
Burial SocietyR100.002%
EntertainmentR500.0010%
Car instalmentR800.0016%
Car maintenanceR200.004%
SavingsR200.004%
Total IncomeR5600.00Total ExpenditureR5000.00100%

A comparison of projected and achieved budgets is stated in a performance report in the business environment. Performance reports are usually compiled and released on a quarterly basis, but may be done more often. 

A typical example follows: 

Sales Department Performance Report of Controllable Expenses (for Current Quarter): 

Achieved(Actual)Projected(Budget)Variance% Variance
Employee SalariesR955,055R980,350R25,2952.6%
Employee BenefitsR220,600R235,450R14,8506.3%
SuppliesR41,722R43,500R1,7784.1%
Phone ServicesR22,963R23,750R7873.3%
Contracted ServicesR176,974R155,500(R21,474)-13.8%
MaintenanceR26,548R30,200R3,65212.1%
TravelR82,683R75,500(R7,183)-9.5%
EntertainmentR27,496R25,500(R1,996)-7.8%
MiscellaneousR17,738R20,000R2,26211.3%
TotalsR1,571,779R1,589,750R17,9711.1%

Notice the Projected Budget for each category of expense. These represent the target amounts after extensive budget planning. There were three areas over budget where losses were incurred: 

  • contract services (- 13.8 %). 
  • travel (- 9.5 %). 
  • entertainment (-7.8 %). 

It is the function of the department manager to investigate these variances with an eye toward correcting them. The overall budget, however, did produce a surplus (R 17,971 or 1.1 % of the projected budget). 

Remember that you need to take any increases in your expenses (or income) into account, by calculating increase percentages correctly:

Calculating increase percentage

The following are examples of increases based on percentage:

  1. Suppose your monthly net salary (R3000.00) has been increased by 8%. What will your monthly net salary be?
  • 8% of R3000 = R3000 X 8% = R240
  • New salary will be Original salary + Increase = R3000 + R240 = R3240
  1. What will your income be after 3 years if your net salary (R36 000.00) was increased by 8% every year?
  • Beginning of second year = R36 000 + 8% = R36 000 + R2880 = R38 880
  • Beginning of third year = R38 880 + 8% = R38 880 + R3110.40 = R41 990.40
  1. Suppose ESKOM has increased tariffs by 3% and TELKOM’s tariffs have increased by 5%. If you were spending R352.00 on electricity, calculate the amount you will spend on electricity based on the new tariffs.
  • R352.00 + 3% = R352.00 + R10.56 = R362.56
  1. If you were spending R250.00 on telephone, how much will you spent now based on the percentage increase?
  • R250.00 + 5% = R250.00 + R12.5 = R262,50

Remember that you need to use methods of calculation that are appropriate to the problem type, such as calculating commission – should you earn this:

Calculating commission 

A commission is a fee or allowance given to a sales person or agent in exchange for services rendered, often some percentage of the sales s/he is responsible for.

Example:

Assume your commission is 25% of sales. Your sales were R2000, 00. What is the value of the commission owed to you?

Commission = 0.25 X R2000 = R500

Methods of controlling a budget

Budgets are formal quantitative statements of the resources set aside for carrying out planned activities over given periods of time. As such, they are widely used means for planning and controlling activities at every level of the organization. There are a number of reasons for their wide usage: 

  • First, budgets are stated in monetary terms, which are easily used as a common denominator for a wide variety of organizational activities – hiring and training personnel, purchasing equipment, manufacturing, advertising, and selling. 
  • Second, the monetary aspect of budgets means that they can directly convey information on a key organizational resource – capital – and on a key organizational goal – profit. They are, therefore, heavily favored by profit oriented companies. 
  • Third, budgets establish clear and unambiguous standards of performance for a set time period – usually a year. At stated intervals during that time period, actual performance will be compared directly with the budget. Deviations can be detected quickly and acted upon. 

In addition to being a major control device, budgets are one of the major means of coordinating the activities of the organization. The interaction between managers and subordinates that takes place during the budget development process will help define and integrate the activities of organization members. 

Producing information in management accounting form, e.g. the budget, is expensive in terms of the time and effort involved. It will be very wasteful if the information once produced is not put into effective use. 

Control systems can be devised to monitor organizational functions or organizational projects. Budgets can be used to control systems, such as:

  • Controlling, a function involves making sure that a specified activity (such as production or sales) is properly carried out. 
  • Controlling a project involves making sure that a specified end result is achieved (such as the development of a new product or the completion of a building). 

There are five parts to an effective cost control system. These are also considered to be methods of controlling a budget: 

  1. preparation of budgets 
  2. communicating and agreeing budgets with all concerned 
  3. having an accounting system that will record all actual costs 
  4. preparing statements that will compare actual costs with budgets, showing any variances and disclosing the reasons for them, and 
  5. taking any appropriate action based on the analysis of the variances in d) above.

Action(s) that can be taken when a significant variance has been revealed will depend on the nature of the variance itself. Some variances can be identified to a specific department and it is within that department’s control to take corrective action. Other variances might prove to be much more difficult, and sometimes impossible, to control. 

Variances revealed are historic. They show what happened last month or last quarter and no amount of analysis and discussion can alter that. However, they can be used to influence managerial action in future periods.