ACC1001 · Accounting Fundamentals
Budgeting & Costing
Budgeting & Costing covers planning in monetary terms — the role of budgets, the cash budget, variance analysis (favourable vs unfavourable) and the behavioural choice between authoritative and participative budgets — then cost classification: direct vs indirect, product vs period, indirect-cost allocation, and cost-based vs market-based pricing. It is examined by classifying and explaining: label a variance F or U, sort a cost into the right cell, and explain why misclassifying distorts pricing.
What this chapter covers
- 011. The role of budgets: monetary plans for a future period; budgets interrelate into the master budget
- 022. The cash budget: opening cash + receipts − payments = closing cash; deficit vs surplus actions
- 033. Variance analysis: Variance = Actual − Budget
- 044. Favourable (income above / expense below) vs unfavourable (income below / expense above)
- 055. Behavioural aspects: authoritative (top-down) vs participative (negotiated) budgets and slack
- 066. Cost classification: direct (traceable) vs indirect (allocated overhead)
- 077. Product costs (manufacturing, sit in inventory) vs period costs (expensed now)
- 088. Indirect-cost allocation and cost-based vs market-based pricing
Variance analysis — favourable vs unfavourable
- +2Fees: Variance = Actual − Budget = 92,000 − 80,000 = $12,000. Income is above budget, so this is Favourable (F).
- +1Wages: 38,000 − 34,000 = $4,000. An expense above budget, so Unfavourable (U).
- +1Materials: 9,000 − 11,000 = $2,000. An expense below budget, so Favourable (F).
- +1State the rule: income above budget or expense below budget = Favourable; income below budget or expense above budget = Unfavourable.
- +1Add the nuance: a variance is not 'good' or 'bad' by sign alone — some unfavourable variances are acceptable (e.g. higher wages to win extra work that lifted fees), so investigate the cause before judging.
Key terms
- Budget
- A management-accounting plan in monetary terms for a future period. Individual budgets interrelate into the master budget, usually starting from the sales or fees budget; budgets may be fixed or rolling.
- Cash budget
- A projection of future cash receipts minus payments: Closing cash = Opening cash + Receipts − Payments. A projected deficit signals the need to arrange finance; a surplus can be invested.
- Variance analysis
- Variance = Actual − Budget. Favourable (F) means income above budget or an expense below budget; Unfavourable (U) means income below budget or an expense above budget. The sign is judged by income-vs-expense, not direction alone.
- Authoritative vs participative budget
- Authoritative budgets are set top-down, which can lower morale; participative budgets are negotiated with lower managers, building buy-in but risking budgetary slack (deliberately easy targets).
- Direct vs indirect cost
- A direct cost is traceable to the cost object (direct materials, direct labour). An indirect cost (overhead) cannot be traced and must be allocated (factory rent, supervisor salary, depreciation).
- Product vs period cost
- Product costs are the direct and indirect costs of manufacture; they accumulate as inventory (an asset) and become cost of sales (an expense) only when sold. Period costs are non-manufacturing costs (admin, marketing, IT) expensed in the period incurred.
Budgeting & Costing FAQ
How do I tell a favourable variance from an unfavourable one?
Look at whether the item is income or an expense, not just whether the number went up. A variance is favourable when income is above budget or an expense is below budget, and unfavourable when income is below budget or an expense is above budget. So an expense coming in under budget is favourable even though it is a negative variance. And remember an unfavourable variance is not automatically bad — its cause matters.
What is the difference between a product cost and a period cost?
Product costs are the direct and indirect costs of making a product — they are capitalised into inventory (an asset) and only become an expense (cost of sales) when the product is sold. Period costs are non-manufacturing costs such as administration, marketing and IT; they are expensed in the period they are incurred. Misclassifying between them distorts both reported profit and the cost figures used to set prices.
What is the difference between authoritative and participative budgeting?
An authoritative budget is imposed top-down by senior management. It is quick and consistent but can damage morale because lower managers have no input. A participative budget is negotiated with the managers who must meet it, which builds commitment and buy-in but risks budgetary slack — managers building in easy targets to make themselves look good. The choice is a behavioural trade-off between control and ownership.
Why does cost classification affect pricing?
Because prices are often built up from cost. If you misclassify a cost — treating a product cost as a period cost, or an indirect cost as direct — you compute the wrong cost for a product or service, which feeds into the wrong price. That can lead a business to keep unprofitable lines or drop profitable ones. Whether you use cost-based pricing (cost plus a mark-up) or market-based pricing (what customers will pay), costs must still be covered, so getting classification right is essential.
Exam move
Split this dense topic into its two halves and drill each. For budgeting, lock in the variance sign convention (income above or expense below = favourable) and practise labelling a table of variances quickly, always adding the judgement line that a U variance is not automatically bad. Know the cash-budget identity and what a deficit or surplus implies, and be able to contrast authoritative and participative budgeting on morale, buy-in and slack. For costing, master the two cuts — direct/indirect and product/period — and especially that product costs sit in inventory until sold; then explain how misclassification distorts cost and pricing. Because Monash assesses by classifying and explaining, rehearse worked classifications with reasons, taking wording from the lecture slides.
