Question

In: Accounting

How are standards and variances used in budgeting and budget analysis?

  • How are standards and variances used in budgeting and budget analysis?

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Expert Solution

A standard budget contains fixed revenue and expense budget information. It doesn't provide for any variability within the amount of units sold, price points, activity levels, so forth. As such, a customary budget represents one best estimate of the longer term performance of a business through the budgeting period. This approach works best when the business model is comparatively simple, revenues rarely deviate from expectations, and expenses are highly predictable. Conversely, it functions poorly in an exceedingly more fluid business environment that's harder to predict. the quality budget is often utilized in a centralized command-and-control environment, since it allows senior management to evaluate the performance of the organization as compared to one forecast of future results.

A standard budget is typically amid variance analysis, which measures the differences in actual revenues and expenses from expectations. These variances could also be used because the foundation for a system of performance bonuses. If bonuses are supported variances, this forces employees to follow the budget, whether or not subsequent changes within the market make it obvious that the corporate really should be diverging from the decide to follow new opportunities as they arise. The linkage of bonuses to the budget also implies that employees are more likely to pad their budgets to create them easier to attain. Padding means revenue targets are set artificially low, while expense targets are set too high.

Though the quality budget concept is extremely wide-spread, it suffers from the singular failing of only planning for one outlook on the longer term, which any business is extremely unlikely to exactly reach. There are several viable alternatives to the current variety of budget that avoid the one option approach, which are:

Continuous budgeting. The budget is revised every month to feature a brand new month to exchange the one that has just been completed. this can be a time-consuming approach, but does afford incremental changes to the budget.

Flex budgeting. The flex budget alters expense levels automatically, depending upon the particular revenues achieved.

Rolling forecast. instead of employing a budget the least bit, consider revising a high-level forecast at frequent intervals. Doing so requires little labor, and more accurately reflects short-term expectations.

In short, the quality budget is that the traditional method for deriving a budget, but it's severely limited, and if followed too rigorously, doesn't allow a business to require advantage of latest opportunities on short notice.

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