Budgeting Basics and Beyond

1.6. Actual Costs Versus Budget Costs

A budget provides an early warning of impending problems. The effectiveness of a budget depends on how sound and accurate the estimates are. The planning must take all factors into account in a realistic way. The budget figures may be inaccurate because of such factors as economic problems, political unrest, competitive shifts in the industry, introduction of new products, and regulatory changes.

At the beginning of the period, the budget is a plan. At the end of the period, the budget is a control instrument to assist management in measuring its performance against the plan so as to improve future performance. Budgeted revenue and costs are compared to actual revenue and costs to determine variances. A determination has to be made whether the variances are controllable or uncontrollable. If controllable, the parties responsible must be identified. Action must be taken to correct any problems.

A comparison should be made between actual costs at actual activity to budgeted costs at actual activity. In this way, there is a common base of comparison. The percentage and dollar difference between the budget and actual figures should be shown. A typical performance report for a division appears in Exhibit 1.3.

Authorized variances in cost budgets allow for an increase in the initial budget for unfavorable variances. This increase may result from unexpected wage increases, prices of raw materials, and so on. Allowance is given for cost excesses that ...