Equipment Type

Three Responses to Equipment Budget Variances (page 2)

October 01, 2008

Method C. The fleet is divided into a number of operating fleets made up of the equipment used by a particular long-term project, operating division or operating company. The equipment division looks after and sets standards for managing the fleet as a whole, but it costs each operating fleet separately in order to produce an operating statement for each separate fleet. Any variance in the budget vs. actual cost performance for an operating fleet is consolidated into the project, operating division or operating company results for the unit that generated the variance.

This is a complex method of dealing with budget variances and relies on three things for success. First, transfers between operating fleets must be minimized, and machines must work in a particular operating fleet for the majority of their working life. Second, information and accounting systems must be able to cost each operating fleet separately. Third, there must be accurate and well-understood mechanisms to allocate and assign the cost of shared services, shops, and general overhead. Under the conditions set out in our example, we would know exactly which project, operating division, or operating company was responsible for how much of the $988,000 loss. Each unit would then consolidate the calculated amount into its own bottom-line results.

Many of the disadvantages associated with methods A and B disappear. Each operating manager experiences the true cost of the equipment actually used in his or her unit. No arbitrary reallocation of variances perceived to have been generated in another division occurs, and an environment is created where equipment managers work closely with operating managers to maximize utilization and reduce costs.

Of course, mechanisms must be in place to handle the transactions that occur when equipment is transferred from one operating fleet to another or when a machine works outside its home unit. Mechanisms must also be in place to assign the cost of shared services and overhead. The impact of the overhead allocation process — even when seen to be relatively arbitrary — pales when compared to the negative impacts of a perceived, unfair reallocation of a negative budget variance.

The budget-control process has to do with setting targets and motivating performance. Negative differences between budget and actual are usually seen as a measure of failure, and no one likes them to occur. But they do, and the way an organization reallocates or assigns them can have a real impact on motivation and behavior. Badly done, the negatives of each method can outweigh the positives.

Look at the system and determine if it matches responsibility, authority and accountability. It must be accurate, fair and equitable.

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Evaluate the Method
  Positive Impact Negative Impact
Method A) Budget variances are consolidated at a company level. Simple and straightforward. Equipment and operating divisions carry the full impact of their budgets and budgeting decisions. Equipment moves easily throughout the company and carries its cost with it. Neither project nor operating division managers are aware of true equipment costs. Everyone pays the same rate. Internal transfer prices become synonymous with equipment cost.
Method B) Budget variances are reallocated to projects or operating divisions based on equipment revenue. Expresses the fact that money is made in operations. Project or division managers do not accept arbitrarily reallocated variances coming from areas not under their control. They attack the system as unfair.
Method C) Budget variances are determined by operating fleet and reallocated to operating divisions. Variances are accurately calculated and reallocated for each operating fleet. Variances are carried by the organizational unit where the machines worked. Responsibility and accountability are matched within each unit. The cost of shared services, shops and overhead needs to be allocated to sub-fleet accounts. The creation of relatively static sub-fleets can lead to lower utilization and duplication of some services.

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