Ch. 7 Budget Project
7.2 Comparing Budget to Actual
Learning Objectives
At the end of this week students will be able to:
- Compare budget to actual numbers to make informed management decisions.
As you’ve learned, an advantage of budgeting is evaluating performance. Having a strong understanding of their budgets helps managers keep track of expenses and work toward the company’s goals. Companies need to understand their revenue and expense details to develop budgets as a tool for planning operations and cash flow. Part of understanding revenue and expenses is evaluating the prior year. Did the company earn the expected profit? Could it have earned a higher profit? What expenses or revenues were not on the budget?
Critically evaluating the actual results versus the estimated budgetary results can help management plan for the future. Variance analysis helps the manager analyze its results. It does not necessarily find a problem, but it does indicate where a problem may exist. The same is true for favorable variances as well as unfavorable variances. A favorable variance occurs when revenue is higher than budgeted or expenses are lower than budgeted. An unfavorable variance is when revenue is lower than budgeted or expenses are higher than budgeted.
| Favorable | Unfavorable |
|---|---|
| Actual Sales > Budgeted Sales | Actual Sales < Budgeted Sales |
| Actual Expenses < Budgeted Expenses | Actual Expenses > Budgeted expenses |
The company earned a profit during the third quarter, but what does that mean to the company? Simply having net income instead of a net loss does not help plan for the future. The third quarter static budget was for the sale of 1,500 units. Comparing that budget to the actual results shows whether there is a favorable variance or an unfavorable variance. A comparison of the actual costs with the budget for the third quarter has a favorable variance for all of the expenses and an unfavorable variance for everything associated with revenues.
| Information | Actual | Budget | Variance | U/F |
|---|---|---|---|---|
| Units Sold | 1,400 | 1,500 | (100) | Unfavorable |
| Sales Price | $75 | $75 | $75 | |
| Sales | $105,000 | $112,500 | ($7,500) | Unfavorable |
| Cost of Goods Sold | ||||
| Direct Material | 5,550 | 6,000 | 450 | Favorable |
| Direct Labor | 21,500 | 22,500 | 1,000 | Favorable |
| Variable Overhead | 4,100 | 4,500 | 400 | Favorable |
| Fixed Overhead | 28,900 | 29,000 | 100 | Favorable |
| Total Cost of Goods Sold | 60,050 | 62,000 | 1,950 | Favorable |
| Gross Profit | 44,950 | 50,500 | (5,550) | Unfavorable |
| Sales and Administrative | 21,050 | 21,750 | 700 | Favorable |
| Income Taxes | 985 | 1,000 | 15 | Favorable |
| Total Other Expenses | 22,035 | 22,750 | 715 | Favorable |
| Net Income (Loss) | $22,915 | $27,750 | ($4,835) | Unfavorable |
Using a budget to evaluate performance affects the bottom line as well as the individual expenses. The net income for the sale of 1,400 units is less than the budgeted net income for 1,500 units, but it does not indicate whether expenses were appropriate for 1,400 units. If there had been 1,600 units sold, the expenses would be more than the budgeted amount, but sales would be higher. Would it be fair to evaluate a manager’s control over their expenses using a static budget?
7.2a Homework
Using the financial project you created in LO 4.1 and the budget project you created in LO 7.1, determine which income statement accounts are favorable and unfavorable. Based on your findings, write a three paragraph report stating what changes as a manager you would make to the company.
There is not a right or a wrong answer for this homework problem. No two submissions should talk about the same thing.
