Variance is the difference between an actual result and a budgeted amount. Variances assist managers in their planning and control decisions. Management by exception is facilitated by variance analysis. Management by exception is the practice of concentrating on areas not operating as anticipated as per plan and giving less attention to areas operating as per plan. Areas with sizable variances are given managerial attention.
Static Budgets and Flexible Budgets
in the case of flexible budgets, planned or budgeted expenses are the actual out multiplied by unit costs or expenses. Flexible budget recognizes that there can be fluctuations in output and hence expenses also vary in a month or a year. Static budget concept which was the older concept did not incorporate this idea. In a static budget, both operating figures, unit expenses and hence total expenses were kept the same during the plan period. But flexible budget concept recognized that, if output goes down, the manager of a department has to cut down his variable expenses and similarly if output goes up he has spend more.
Variance Analysis from Static Budget
Variances can be divided into favorable and unfavorable variances. Example of favorable variance is increased in revenue. Example of unfavorable variance is increase in cost.
Steps in the Preparation of Flexible Budget
1. Determine budgeted selling prices, budgeted variable costs per unit and budgeted fixed costs
2. Determine the actual quantity of output
3. Determine the flexible budget for revenues based on budgeted selling price and actual quantity of output.
Variance Analysis - Components
Sales-volume variance = Flexible budget amount (actual sales) - Static budget among
Price and Efficiency variances
Price variance = (Actual price of input - Budgeted price of input) * Actual quantity of input
Efficiency variance = (Actual quantity of input used - Budgeted quantity of input allowed for actual output) *
Budgeted price of input
Two attributes of performance are commonly measured:
1. Effectiveness: the degree to which a predetermined objective or target is met.
2. Efficiency: the relative amount of input used to achieve a given level of output.
For more details, the chapter in Cost Accounting by Horngren et al.
Cost Accounting - Horngren et al., Book Information and Review
Originally posted in