In this video, we walk through 4 FAR practice questions teaching about calculating variances between budget and actual results. These questions are from FAR content area 1 on the AICPA CPA exam blueprints: Financial Reporting.
The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
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Calculating Variances Between Budget and Actual Results
When managing finances, one of the most important tools for performance evaluation is comparing budgeted results with actual results. This process, known as variance analysis, helps businesses and organizations identify differences between what was expected (the budget) and what was actually achieved. Variances provide crucial insight into operational efficiency and financial management, allowing businesses to adjust strategies and make informed decisions.
What is a Budget to Actual Variance?
A budget to actual variance is simply the difference between budgeted figures (what a company planned for) and actual figures (what the company actually achieved). This comparison can be applied to revenue, expenses, and profits, helping to identify whether performance is better or worse than expected.
The formula to calculate a variance is: Actual Results – Budgeted Results
Once calculated, variances are classified as either favorable (F) or unfavorable (U), depending on whether the difference benefits the company or not.
Favorable vs. Unfavorable Variances
- A favorable variance occurs when actual results are better than budgeted expectations. For revenue, this means actual revenue is higher than budgeted revenue. For expenses, this means actual expenses are lower than budgeted expenses.
- An unfavorable variance occurs when actual results are worse than budgeted expectations. For revenue, this means actual revenue is lower than budgeted revenue. For expenses, this means actual expenses are higher than budgeted expenses.
It’s important to note that favorable variances aren’t always positive numbers, and unfavorable variances aren’t always negative numbers. It depends on whether the variance is for revenue or an expense. For example, a $5,000 positive variance in revenue is favorable, but a $5,000 positive variance in expenses is unfavorable.
Key Variances Explained
Sales Variance
Sales variance measures the difference between budgeted and actual sales. It helps identify whether a company’s revenue-generating activities met expectations.
Example:
- Budgeted Sales: $200,000
- Actual Sales: $180,000
Sales Variance: $180,000 – $200,000 = ($20,000 unfavorable)
In this case, the actual sales are $20,000 lower than expected, leading to an unfavorable variance, as the company earned less revenue than planned.
Materials Expense Variance
Materials expense variance compares the budgeted cost of materials to the actual cost incurred. This can help determine if a company is overspending on raw materials or using them inefficiently.
Example:
- Budgeted Material Cost: 10,000 pounds at $5 per pound = $50,000
- Actual Material Cost: 10,500 pounds at $6 per pound = $63,000
Materials Expense Variance: $63,000 – $50,000 = ($13,000 unfavorable)
Here, the company spent $13,000 more than expected on materials, an unfavorable variance due to both higher quantity and cost per pound.
Net Income Variance
Net income variance is the difference between the budgeted net income (revenue minus expenses) and the actual net income. This variance shows if overall profitability met expectations.
Example:
- Budgeted Net Income: $50,000
- Actual Net Income: $55,000
Net Income Variance: $55,000 – $50,000 = $5,000 favorable
In this scenario, the company generated $5,000 more net income than budgeted, resulting in a favorable variance. This indicates overall business performance exceeded expectations.
Why Variance Analysis is Important
Variance analysis is a powerful tool for managing finances. By identifying where actual performance deviates from the budget, management can investigate the causes and take action to correct inefficiencies, reduce costs, or capitalize on strengths. It provides insight for decision-making, whether it’s cutting back on waste, renegotiating supply contracts, or re-adjusting sales targets.
Conclusion
Understanding variances between budget and actual results is essential for effective financial management. Whether it’s sales, expenses, or net income, calculating and analyzing variances helps businesses monitor their performance, manage resources efficiently, and make strategic decisions. Recognizing that favorable and unfavorable variances depend on the context—whether it’s revenue or expenses—is key to interpreting financial performance accurately. By applying these principles, businesses can stay on top of their financial health and work toward their goals with greater clarity.