7.5 Explain How Budgets Are Used to Evaluate Goals
2 min read•june 18, 2024
is a crucial tool for managers to evaluate performance and identify areas for improvement. By comparing actual results to budgeted amounts, companies can pinpoint discrepancies in revenue and expenses, guiding decision-making and future planning.
Static and offer different perspectives on performance. While provide a fixed point of comparison, flexible budgets adjust for actual activity levels, allowing for more nuanced analysis of efficiency and cost control. Understanding these differences is key to effective budget management.
Budgeting and Variance Analysis
Variance analysis for performance issues
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- compares actual results to budgeted amounts to identify differences between expected and actual performance
- Types of variances include:
- result from differences between actual and budgeted revenues due to changes in sales volume (units sold) or price per unit
- result from differences between actual and budgeted expenses due to changes in cost per unit or efficiency (units produced per input)
- Significant variances should be investigated to identify the root cause and determine if corrective action is needed
- Variance analysis is a key component of , helping managers assess how well goals are being met
Static vs flexible budget comparisons
- Static budgets are based on a single level of activity and do not adjust for changes in actual activity level, making them useful for comparing actual results to original expectations
- Flexible budgets adjust budgeted amounts based on actual level of activity, making them useful for evaluating management's ability to control expenses given the actual level of activity
- Comparing static and flexible budgets:
- include the effect of changes in activity level (sales volume or production volume)
- isolate the effect of changes in efficiency or cost per unit by adjusting for the actual activity level
Variance interpretation for planning
- occur when actual results are better than budgeted amounts
- Examples: actual revenues exceed budgeted revenues (higher sales) or actual expenses are lower than budgeted expenses (cost savings)
- occur when actual results are worse than budgeted amounts
- Examples: actual revenues are lower than budgeted revenues (lower sales) or actual expenses exceed budgeted expenses (cost overruns)
- Variances can guide future planning and budgeting decisions:
- Areas of strong performance may present opportunities for expansion or investment
- Areas of weak performance may require improvement or cost reduction efforts
- Future budgets should be adjusted based on past performance and expected changes in activity levels, prices, or costs
Budget Control and Performance Measurement
- involves monitoring actual performance against the budget and taking corrective action when necessary
- focuses attention on significant deviations from the budget, allowing managers to prioritize their efforts
- are specific metrics used to measure progress towards organizational goals and objectives
- involves comparing performance to industry standards or best practices to identify areas for improvement
Key Terms to Review (15)
Benchmarking: Benchmarking is the process of comparing an organization's products, services, or practices to those of industry leaders or competitors in order to identify areas for improvement and set performance targets. It is a crucial tool for both financial and managerial accounting, as well as for evaluating organizational goals, responsibility center performance, and overall performance measurement.
Budget Control: Budget control is the process of monitoring and managing the actual expenditures and revenues against the budgeted amounts to ensure that organizational goals and objectives are being met. It involves comparing actual performance to the planned budget and taking corrective actions if necessary.
Expense Variances: Expense variances refer to the differences between the budgeted and actual expenses incurred by a business. These variances are used to evaluate the effectiveness of a company's budgeting process and identify areas where costs may be higher or lower than expected, which can inform future budgeting decisions.
Favorable Variances: Favorable variances refer to the positive differences between actual and budgeted or standard performance in a business. These variances indicate that the actual results are better than the expected or planned outcomes, suggesting that the organization has achieved its goals more efficiently than anticipated.
Flexible Budget Variances: Flexible budget variances are the differences between actual results and the flexible budget amounts, which are adjusted based on the actual level of activity or volume. These variances help managers evaluate performance by isolating the effects of uncontrollable factors, such as changes in sales volume, from the effects of controllable factors, such as cost management.
Flexible Budgets: Flexible budgets are a type of budget that adjusts to changes in activity levels or volume, allowing for more accurate performance evaluation and cost control. They are particularly useful in situations where the level of activity or output can fluctuate, as they provide a more realistic basis for comparison to actual results.
Key Performance Indicators (KPIs): Key Performance Indicators (KPIs) are quantifiable measures used to evaluate the success of an organization, department, or individual in meeting objectives and goals. KPIs provide a focus for strategic and operational improvement, create an analytical basis for decision-making, and help organizations measure progress towards their targets.
Management by Exception: Management by exception is a control technique where managers focus their attention on addressing significant deviations from planned performance rather than monitoring every aspect of an operation. The core idea is to prioritize addressing issues that fall outside of normal or expected parameters, allowing managers to be more efficient and effective in their oversight responsibilities.
Performance Evaluation: Performance evaluation is the process of assessing and measuring an individual's or organization's progress towards achieving specific goals or objectives. It is a critical component in both financial and managerial accounting, as it helps organizations identify areas for improvement, allocate resources effectively, and make informed decisions about future strategies.
Revenue Variances: Revenue variances refer to the differences between the actual revenue generated by a business and the budgeted or expected revenue. These variances provide insights into the performance of a company's sales and marketing efforts, and help identify areas for improvement or potential issues that may need to be addressed.
Static Budget Variances: Static budget variances refer to the differences between actual results and the predetermined, fixed budgeted amounts, without considering the effects of changes in activity levels or volume. These variances provide insights into the organization's performance by highlighting areas where actual results deviate from the original budgeted targets.
Static Budgets: A static budget is a type of budget that is prepared based on a single, predetermined level of activity or volume. It does not change with actual activity levels, and is used to evaluate performance by comparing actual results to the fixed, predetermined budget.
Unfavorable Variances: Unfavorable variances refer to the differences between actual results and budgeted or standard performance, where the actual results are less favorable than the planned targets. These variances indicate that the organization's performance has fallen short of its goals and expectations.
Variance analysis: Variance analysis is the process of comparing budgeted financial performance to actual financial performance to identify discrepancies. It helps managers understand why variances occur and how to address them for better future planning.
Variance Analysis: Variance analysis is a management accounting technique used to identify and evaluate the differences between actual and expected or budgeted performance. It provides insights into the causes of these variances, enabling managers to make informed decisions and take corrective actions to improve operational efficiency and financial performance.