Learning Outcomes
After reading this article, you will be able to explain how standards are set for performance management, apply flexed budgets to compare actual with expected results, and prepare operating statements that fairly assess performance. You will distinguish between controllable and uncontrollable costs, understand the purpose of control reports, and use these techniques to calculate meaningful variances for the ACCA PM exam.
ACCA Performance Management (PM) Syllabus
For ACCA Performance Management (PM), you are required to understand both the setting of standards and the preparation of flexed budgets as the basis for accurate operating statements. In your revision, pay particular attention to:
- The process of setting standards for costs and revenues
- The use of flexed (flexible) budgets for control when actual output differs from plan
- Preparation and interpretation of operating statements comparing flexed budget and actuals
- The role of control reports in performance management and the principle of controllability
- Calculation and interpretation of variances using flexed budgets rather than fixed budgets
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.
- Why should actual costs be compared to a flexed (rather than a fixed) budget when output levels differ?
- What is the key difference between a standard costing system and a budgetary control system?
- A production manager’s labour cost is higher than budgeted because more units were produced than planned. Should this be considered poor performance? Briefly explain.
- What does an operating statement show, and why is it important for performance management?
Introduction
Accurate performance measurement in management accounting depends on comparing what actually happened with what should have happened, but only when both are based on the same level of activity. This requires the use of clearly set standards and the preparation of flexed budgets, alongside detailed operating statements and control reports that highlight controllable variances. This article provides the essential techniques you need to fairly assess actual performance, as required for the ACCA PM exam.
Key Term: standard
A standard is a predetermined, target value for cost, revenue, or resource usage, set as a benchmark for measuring actual performance.Key Term: flexed budget
A flexed budget is a budget that has been recalculated to reflect the actual level of activity achieved, using original standard rates and assumptions.Key Term: operating statement
An operating statement is a report that compares actual results to a flexed budget, showing variances and helping analyze performance for control purposes.
SETTING STANDARDS FOR CONTROL
Establishing clear, realistic standards for costs and revenues provides managers with meaningful targets and allows for fair measurement of performance. These standards should be:
- Based on expected efficient (but not perfect) performance
- Expressed in physical or monetary terms, depending on what is being controlled
- Used for preparing budgets and as the basis for later variance analysis
The key is to use "attainable" standards—challenging but realistic. Setting standards too high can demotivate, while setting them too low encourages complacency.
FLEXING: WHY COMPARE TO A FLEXED BUDGET?
Comparing actual costs and revenues to a budget is only useful if both relate to the same level of activity. If a manager produces 12,000 units when the original budget was for 10,000, actual variable costs will be higher simply because output was higher, not necessarily because of inefficiency.
A flexed budget adjusts the original budget to the actual output level using the standard costs. This ensures the comparison is fair and the resulting variances are meaningful.
Worked Example 1.1
A business set a budget to produce 5,000 units, expecting material costs of $8 per unit (variable) and fixed overheads of $6,000 per month.
In reality, it produced 5,800 units. Actual material costs were $47,000, and actual fixed overheads were $5,800.
Prepare a flexed budget and calculate the total variance.
Answer:
Step 1: Flex the original budget:
- Material costs: 5,800 units × $8 = $46,400
- Fixed overhead: $6,000 (fixed costs do not change with output) Step 2: Actual costs:
- Material costs: $47,000
- Fixed overhead: $5,800 Step 3: Calculate variances (Flexed budget minus Actual):
- Material costs: $46,400 – $47,000 = $600 Adverse
- Fixed overhead: $6,000 – $5,800 = $200 Favourable
- Total variance: $600 Adverse + $200 Favourable = $400 Adverse The business spent $400 more than should have been spent for the actual activity achieved.
Exam Warning
Never compare actual results to the original fixed budget if the activity levels are different. Always flex the budget to the actual output first. Failure to do so is a frequent cause of lost marks.
PREPARING OPERATING STATEMENTS AND CONTROL REPORTS
An operating statement summarizes how actual results compare to what was expected, after flexing the budget to the actual activity level. It shows the total variance between flexed budget and actual results, then breaks this down into detailed variances (price, usage, efficiency, etc.).
This process allows managers to see:
- Whether differences are due to changes in activity or efficiency
- Which variances are controllable by whom (e.g., price variances by purchasing managers, usage variances by production managers)
Key Term: controllability
The principle that managers should only be held responsible for results they can influence or control.
Worked Example 1.2
A company budgets direct labour at 2 hours per unit at $15 per hour, expecting to produce 1,200 units. In the period, 1,350 units were made, and labour costs totalled $41,600 for 2,780 hours.
Prepare an operating statement to show the total and detailed variances.
Answer:
Flexed labour budget for actual output:
- Hours allowed: 1,350 × 2 = 2,700 hours
- Budgeted labour cost: 2,700 × $15 = $40,500 Actual labour used: 2,780 hours at $41,600 Total labour variance: $40,500 (flexed) – $41,600 (actual) = $1,100 Adverse Break down:
- Rate variance: Actual hours × (Standard rate – Actual rate) = 2,780 × ($15 – $14.96) ≈ $112 Favourable
- Efficiency variance: (Standard hours – Actual hours) × Standard rate = (2,700 – 2,780) × $15 = (–80) × $15 = $1,200 Adverse The adverse total variance is mostly due to using more hours than expected for the output achieved.
THE PRINCIPLE OF CONTROLLABILITY AND CONTROL REPORTS
Control reports should focus only on costs and revenues under the manager’s control. For example, a production manager should be assessed on material usage (input per unit) but not on the purchase price if this is set by another department.
When reporting, it is important to:
- Clearly identify controllable and uncontrollable variances in control reports
- Use control information to take corrective action, support decision making, and motivate managers
Worked Example 1.3
The purchasing manager is appraised on:
- The total material expenditure for the factory
- Additional safety measures imposed by law
- A notional rental cost allocated by head office
Discuss which of these costs are controllable and appropriate for performance appraisal.
Answer:
- Material expenditure: Partly controllable (pricing, negotiation), but must exclude changes due to factors outside purchasing (e.g., increased usage by production, changes due to imposed standards).
- Safety measures: The manager can control the implementation but not the requirement itself.
- Notional rental cost: Allocated from head office, not controllable by the manager. Only costs the manager can directly influence should be used for appraisal.
Revision Tip
When revising, always flex budgets before calculating variances, and identify which manager controls each variance. Practicing this approach will ensure you are prepared for exam questions requiring operating statement analysis.
Summary
Setting clear, attainable standards and using flexed budgets ensures that operating statements and control reports provide a fair and accurate basis for variance analysis. By following the principle of controllability, performance assessments are focused on factors managers can influence. This approach is essential for effective performance management and for success in ACCA PM exam questions.
Key Point Checklist
This article has covered the following key knowledge points:
- The purpose and process of setting standards for costs and revenues in performance management
- Why fixed budgets must be flexed to actual activity levels for meaningful comparison
- How to prepare operating statements and identify total and detailed variances
- The importance of the controllability principle in assessment and control reports
- Application of these concepts to exam-style scenarios using clear, concise worked examples
Key Terms and Concepts
- standard
- flexed budget
- operating statement
- controllability