Cost control

January 09, 2020

Umbrella has development departments in different locations. Each team reports to a development manager that every year prepares, using the incremental technique, an operating budget and gets it approved by the head of development manager. Here below an extract of what the operating budget for Jakarta development department looks like:

Expenses Budget
Salaries €900,000
Training €10,000
Travels €20,000
Bonuses €30,000
IT equipment €40,000
-
Total €1,000,000

As said before the same budget is prepared for all the other offices and the head of development is the manager in charge to approve them all. He prepares an aggregated development department budget for the entire group to get it approved by the chief technology officer (CTO). Operating budget for the whole development department looks like this:

Expenses Budget
Tokyo €1,500,000
Jakarta €1,000,000
Delhi €2,000,000
Seoul €3,000,000
Shanghai €4,000,000
-
Total €5,500,000

By applying a variance analysis on the above-mentioned budgets, we can compare forecasted values with actual results. Variance Analysis, in managerial accounting, refers to the investigation of deviations in financial performance from the standards defined in organizational budgets (Accounting Simplified, 2020). To do this we have to add a few columns on the tables we saw above and show the actual amount spent next to the amount budgeted before and calculate difference as absolute variance and as ratio between the two values.

From this comparison, reported in the following tables, we can see that for Jakarta development department actual costs for 2008 were 6.0% higher than forecasted. Salaries were higher because a new person was employed, and this was not planned. This unplanned hiring required also new IT equipment, more resources for training and travels. For this reason, these expense items were higher than expected. 2007’s economic results were better than predicted. Accordingly, performance bonuses paid in 2008 were more than in what was allocated in the budget for 2008.

Expenses Actual Budget Variance % Variance
Salaries €940,000 €900,000 - €45,000 -5.0%
Training €31,500 €30,000 - €1,500 -5.0%
Travels €24,000 22,500 - €1,500 -6.7%
Bonuses €60,000 €50,000 - €10,000 -20%
IT equipment €7,500 €5,000 - €2,500 -50%
Team building €1,757 €2,000 €425 21.3%
-
Total €1,069,575 €1,009,500 -€60,075 -6.0%

While paid performance bonuses were higher across the entire group. In some offices the overall variance was still adverse but impacted more some offices than others. The reason behind this difference is quickly explained: a new hire was planned in Shanghai but at the end the new employee was hired in Jakarta because it was impossible to recruit in the first location. The budget for this resource was virtually shifted from one location to another. During 2008, in the Seoul team, an employee resigned and was not replaced so costs decreased in that team (reported as favorable variance).

As said before, while this approach does not favour cost reduction, it is easy to manage and when applied to the entire development departments it allows a mix between a certain degree of flexibility and a good level of simplicity.


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Written by Claudio Maccari . Passionate developer and former windsurfer. You can read more about me here