Question

Why is the identification of favorable and unfavorable variances so important to a company? How can the identification of the variances help management control costs? Please explain.

As you are considering the flexible budgeting topic of the week, it is important for you to look at this analysis as a significant contribution to the management of the company. Knowing what the bottom line profit or loss is important. But what is more important is to understand how your actual results varied in terms of units sold versus how the actual cost of each unit differed from the budget.

Answer 1

Variance analysis is the quantitative investigation of the difference between standard cost and actual cost incurred during a period of time.

For example if our budget for sales is $12000 and actual sales are $10, 000.The difference between $2000 .

the identification of favourable and unfavourable variances is important because:

- It helps in evaluating how the business is working as a whole or functional or departmental level.

- It determines whether the budgeted results are achieved or under achieved.

- In case the standards are not met then the root cause is found how to bring down the cost and improve profit.

- For example if the expenses exceeds the budgeted cost then the company must cut down the maintenance cost through negotiation or by purchasing a new machinery.

We make budgeting based on future forecasting for certain assumptions or various methods and techniques but we are never hundred percent sure about it. So at times actual results varied as compared to budgeted. The factors are identified and considered for future budgeting process.