## **Learning Outcomes**

After studying this article, you will be able to explain the reconciliation of budgeted to actual profit using operating statements, identify and calculate basic and advanced variances, split variances into planning and operational components, and understand the use and structure of operating statements in the context of performance management.

## **ACCA Performance Management (PM) Syllabus**

For ACCA Performance Management (PM), you should be able to use operating statements to reconcile budgeted profit to actual profit and analyse performance using advanced variance techniques. In particular, revision should focus on:

- The preparation and explanation of operating statements for profit reconciliation
- Calculation and interpretation of variances (including sales, cost, overhead, and advanced variances)
- Splitting variances into planning and operational elements
- The necessity of flexing budgets for fair performance appraisal
- The use of these reconciliations for meaningful variance investigation and management performance assessment

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Why is a flexed budget necessary for an effective profit reconciliation in standard costing?
2. What is the difference between a planning variance and an operational variance?
3. In an operating statement, how should favourable and adverse variances be presented when reconciling budgeted to actual profit?
4. Can all variances be attributed to controllable factors? Explain briefly.

## **Introduction**

Reconciling budgeted profit to actual profit is a key technique in variance analysis for the ACCA PM exam. This structured reconciliation links planned outcomes to actual results, exposing the individual financial impact of sales and cost variances. The result is a transparent operating statement that both explains profit movements and highlights areas needing management attention.

> **Key Term: Operating Statement**
> A financial statement that reconciles budgeted (usually flexed) profit to actual profit by analysing the effect of all significant sales and cost variances.

## The Operating Statement: Purpose and Principles

An operating statement is the standard format for explaining how profit (or contribution) moved from budgeted to actual levels during a period. The statement starts from the flexed budgeted profit, then adds or subtracts all relevant variances, and arrives at the actual profit. Each variance represents the impact of a specific factor—sales price, sales volume, material price, material usage, labour rate, labour efficiency, and overhead costs.

> **Key Term: Flexed Budget**
> A budget that has been adjusted to reflect the actual activity achieved, ensuring all cost and revenue comparisons in variance analysis are meaningful.

Never use the original (fixed) budget for reconciliation unless actual output matches the plan. A flexed budget ensures assessment is based on like-for-like figures.

## Presenting Variances: Favourable and Adverse

Each variance in the operating statement should be marked as either favourable (F) or adverse (A). Favourable variances indicate a movement that has improved profit compared to the budget; adverse variances indicate a reduction in profit.

Operating statements clearly show:

- The contribution of each variance to profit changes
- Where sales or cost performance has deviated from expected
- Which variances require further investigation or management action

> **Key Term: Variance**
> The difference between actual and budgeted performance for a cost or revenue item, classified as favourable (F) or adverse (A).

## Advanced Variance Analysis and Reconciliation

More advanced boards of variance analysis split traditional cost variances into detailed categories—such as mix and yield for material and labour, or sales mix and sales quantity for revenue. These allow for deeper understanding of operational performance and the true causes of profit differences.

Flexing the budget is critical for all advanced variance analysis. Failure to do so means management performance assessments could be inaccurate or misleading.

### **Worked Example 1.1**

A company has a flexed budget profit of \$14,000 for the period. During the month, the following variances arose:

- Sales price variance: \$2,000 F
- Sales volume profit variance: \$1,000 F
- Material price variance: \$500 A
- Material usage variance: \$1,500 F
- Labour rate variance: \$800 A
- Labour efficiency variance: \$700 F
- Fixed overhead expenditure variance: \$1,200 F
- Fixed overhead volume variance: \$600 A

Prepare an operating statement reconciling flexed budget to actual profit.

> **Answer:**
> Start with flexed budget profit: \$14,000  
> Add: Sales price variance \$2,000 F → \$16,000  
> Add: Sales volume profit variance \$1,000 F → \$17,000  
> Subtract: Material price variance \$500 A → \$16,500  
> Add: Material usage variance \$1,500 F → \$18,000  
> Subtract: Labour rate variance \$800 A → \$17,200  
> Add: Labour efficiency variance \$700 F → \$17,900  
> Add: Fixed overhead expenditure variance \$1,200 F → \$19,100  
> Subtract: Fixed overhead volume variance \$600 A → \$18,500  
> Actual profit: \$18,500

### **Exam Warning**

Do not compare actual profit to the original (fixed) budget if the level of activity has changed. Always prepare a flexed budget as the starting point of the reconciliation. This is a frequent source of lost marks in the exam.

## Planning and Operational Variances

Not all variances are equally useful for assessing managers. Conventional variances combine two effects: changes due to unforeseen external events or unrealistic plans, and changes due to management’s actual performance. Advanced techniques split total variances into:

- **Planning variances:** The part of the variance arising because the original standard or budget was wrong (e.g., sudden price increases, new regulations).
- **Operational variances:** The element arising from actual operations, measured against a realistic, up-to-date standard. These are controllable and can fairly be used for performance appraisal.

> **Key Term: Planning Variance**
> The portion of a total variance resulting from a change in budgeted standards due to factors outside management’s control or inaccurate original planning.
>
> **Key Term: Operational Variance**
> The part of a total variance caused by the way actual operations were conducted, relative to a revised standard that reflects current conditions.

Splitting variances enables a fairer assessment of managers, by distinguishing controllable from uncontrollable factors.

### **Worked Example 1.2**

Suppose budgeted wage rate was \$12/hour for the year. In month 7, a new labour agreement raised the wage to \$13/hour for the rest of the year. In August, 1,500 hours worked; all workers were paid \$13.

Calculate and split the labour rate variance into planning and operational elements.

> **Answer:**
> Total rate variance = (Standard – Actual) × Actual hours = (\$12 – \$13) × 1,500 = \$1,500 A  
> Planning variance = (\$12 – \$13) × 1,500 = \$1,500 A (due to updated wage agreement)  
> Operational variance = \$0—since, given the new wage, management paid the correct agreed rate.

## Structure of a Reconciliation Statement

A standard reconciliation (operating) statement will typically show:

1. Flexed budget profit (or contribution) based on actual output
2. Add: all favourable variances (e.g., sales price, volume, cost savings)
3. Subtract: all adverse variances (e.g., cost increases, inefficiency)
4. Split variances into planning and operational components where relevant
5. Arrive at actual profit, matching the figure in the financial accounts

This transparent structure links every significant item directly to its impact on profit.

### **Worked Example 1.3**

Budgeted flexed profit: \$10,000  
Sales price variance: \$1,400 A  
Sales mix variance: \$700 F  
Sales quantity variance: \$800 F  
Material price variance: \$900 F  
Material usage variance: \$600 A  
Labour rate variance: \$1,200 A  
Labour efficiency variance: \$400 F  
Fixed overhead cost variance: \$600 F

Show the full operating statement reconciliation.

> **Answer:**
> Start: \$10,000
>
> - Sales price: \$1,400 A → \$8,600
> - Sales mix: \$700 F → \$9,300
> - Sales quantity: \$800 F → \$10,100
> - Material price: \$900 F → \$11,000
> - Material usage: \$600 A → \$10,400
> - Labour rate: \$1,200 A → \$9,200
> - Labour efficiency: \$400 F → \$9,600
> - Fixed overheads: \$600 F → \$10,200
>
> Actual profit: \$10,200

## **Summary**

Reconciliation of budgeted to actual profit is essential for clear performance analysis. The flexed budget, followed by all key variances (including advanced and split variances), produces a transparent statement tracing profit movements step-by-step. Only by using proper flexing and advanced variance analysis can managers and exam candidates fairly assess performance and identify genuine areas for improvement.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Explain the purpose and format of operating statements for reconciling profit
- Prepare a stepwise reconciliation from flexed budget to actual profit, including all significant variances
- Clearly distinguish between planning and operational variances for fair manager appraisal
- Recognise the importance of using a flexed budget for meaningful variance analysis
- Interpret both basic and advanced variances within the reconciliation statement structure

## **Key Terms and Concepts**

- Operating Statement
- Flexed Budget
- Variance
- Planning Variance
- Operational Variance

Advanced variances and reconciliation - Reconciliation of budgeted to actual profit