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Managers can use variance analysis to create a cycle of continuous improvements by repeatedly identifying causes of variances, initiating corrective actions and evaluating results of these actions. Companies use this technique to pinpoint overspending and underspending during production and categorize into two sections – price variances and quantity variances. ‘Price variances occur when a company pays more for a production input, such as materials or labor, where quantity variances occur when the company uses more of the input than expected.’ (Freedom) Using variance analysis can leave no room to track continuous improvement. Calculating variances determines if a various in favorable or unfavorable but the information doesn’t tell if the variance in improving or getting worse. Companies often utilize Kaizen budgeting to improve their processes and reducing costs. Kaizen budgeting makes continuous improvement goals explicit. https://www.accountingtools.com/articles/what-is-kaizen-budgeting.html https://yourbusiness.azcentral.com/should-variances-used-company-accounting-purposes-21475.html Hongren’s Cost Accounting Chapter 7

Answer 1

The case talks about 2 aspects of budgeting- kaizen budgeting approach and variance analysis approach.

Kaizen is a concept of continuous improvement. It focuses on achieving small improvements in the process to achieve better results. In kaizen budgeting approach, the focus in on improving processed and reducing costs. These improvements and their dollar impact is accounted for in the budget. In kaizen practice, a target for cost reduction or process improvements is set at the beginning of the year. The expected cost reductions are incorporated into the budget plan for the year. Hence, it puts a tangible value on the results expected from the kaizen process. This approach can be employed at any process or business. However, in a rapidly changing business environment, such as software development, research etc., the changes are of disruptive nature rather than incremental smaller changes. Hence, the contribution of kaizen in total cost improvement is often small. In mature industries, such as lumber, steel, manufacturing etc., the technology does not change as rapidly. Once a new technology is introduced, it incremental effect on cost reduction is limited. Hence, small incremental changes for cost reduction and process improvement have a bigger share in total cost savings for such businesses. The limitation of this approach is the pressure for continuous improvement can be high on the managers.

Variance analysis is focused in understanding the source of deviation in a process. This process has a standard set in advance for a process. In a manufacturing process for example, it would have a set range of cost for inputs of production. It focuses the effort on any process where the inputs are not being utilized as per the set standards. A higher or lower usage of labor, material or a higher or lower cost of raw material are the typical topics of study for variance analysis. The focuses on the deviation from standard and any process which is continuing within the standard limits of inputs is not analyzed in greater details. This approach is more suitable for manufacturing process which require precision such as chemical production, drug production etc. It has certain limitations. It does not focus on the deviation in the process which are due to improvements. It penalizes improvements as well deterioration equally. Its focus is on maintaining the status quo and standards rather than improvement on the current stage. Additionally, it has a limited usefulness in determining the trends in the deviations. However, the later limitation can be accommodated by modifying the record keeping practices.

In a way both the approaches appear contradictory to each other. One focuses on methodical deviation from the standard to achieve better results while other focuses on sticking to the current process with no room for improvement. However, if used in a correct way, they can complement each other. Variance analysis can be used to understand the deviation from the original standard process and to analyze how much of this deviation could be attributed to improvements from the kaizen budgeting. It can also be used to smartly to capture a trend in the deviations and to recalibrate the budget periodically. This allows for real time tracking and impact analysis of good and bad deviations. Additionally, in any process, there are parts which require exact replication and have no room for deviation and also some parts which are eligible for continuous improvements. Both kaizen budgeting and variance analysis can be used to complement each other in this aspect.