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.

Please do watch the video available in this week’s resources – you can turn the sound off and read the script on the right side if you need to. The lecturer has an excellent example that will help you.

Do you have an example that you can share? Sometimes that’s the best way to answer the question

Answer 1

A favorable budget variance shows that an actual result is better for the organization than the amount which was budgeted for the particular period. & An unfavorable budget variance shows that an actual result is worst that what is budgeted for the particular period.

In finance, unfavorable variance referes to a difference between an actual amount & budgeted amount in any financial category where the actual outcome is less favorable than the projected outcome.

Flexible budget helps you to understand the reason where we incurring excess cost, so that we take action on that immediately. so that our budget cost will be in control.

Management should investigate the significant reason for flexible budget variance-
-Supplier may raise price for their product or raw material which will increase the companies cost.
-Quality improvement can increase cost for the company.
-Suppose budget is based on unrealistically ambitious.

Flexible budget indicates where we need to control the cost.
where cost in non-controllable at that point management need to be careful before preparing the flexible budget.

In flexible budget variance we can bi-furcate controllable cost & non-controllable cost, so that management should take controllable cost & take necessary action on that to reduce to the extent of budget.