Budgeting Basics and Beyond

8.1. Usefulness of Variance Analysis

Standards and variance analyses resulting from them are essential in financial analysis and decision making.

Advantages of Standards and Variances

• Aid in inventory costing

• Assist in decision making

• Sell price formulation based on what costs should be

• Aid in coordinating by having all departments focus on common goals

• Set and evaluate divisional objectives

• Allow cost control and performance evaluation by comparing actual to budgeted figures. The objective of cost control is to produce an item at the lowest possible cost according to predetermined quality standards.

• Highlight problem areas through the "management by exception" principle

• Pinpoint responsibility for undesirable performance so that corrective action may be taken. Variances in product activity (cost, quality, quantity) are typically the production manager's responsibility. Variances in sales orders and market share are often the responsibility of the marketing manager. Variances in prices and methods of deliveries are the responsibility of purchasing personnel. Variances in profit usually relate to overall operations. Variances in return on investment relate to asset utilization.

• Motivate employees to accomplish predetermined goals

• Facilitate communication within the organization, such as between top management and supervisors

• Assist in planning by forecasting needs (e.g., cash requirements)

• Establish bid prices on contracts

Standard costing is not without some drawbacks, such as the possible ...