Budget variance definition
/What is a Budget Variance?
A budget variance is the difference between the budgeted or baseline amount of expense or revenue and the actual amount. These variances usually arise because it is so difficult to predict the future, but may also be due to political issues associated with the formulation of budgeted revenues and expenses. The budget variance is favorable when the actual revenue is higher than the budget or when the actual expense is less than the budget. In rare cases, the budget variance can also refer to the difference between actual and budgeted assets and liabilities.
Causes of a Budget Variance
A budget variance is frequently caused by bad assumptions or improper budgeting (such as using politics to derive an unusually easy budget target), so that the baseline against which actual results are measured is not reasonable. In other cases, operating conditions since a budget was formulated may be the chief cause of a variance. For example, a decline in the economy may have triggered a slide in customer purchases, resulting not only in a sales decline, but also in expense cuts by management. There may also be cases in which changes in the amount of expenses incurred will unavoidably be different from the budgeted amount. For example, a business may not be able to fill a position for an extended period of time, resulting in a lower compensation expense than expected.
Presentation of Budget Variances
Some budget variances can be eliminated through the simple aggregation of line items in the budget. For example, if there is a negative electricity budget variance of $2,000 and a positive telephone expense budget variance of $3,000, the two line items could be combined for reporting purposes into a utilities line item that has a net positive variance of $1,000.
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Controllable Budget Variances
Those budget variances that are controllable are usually expenses, though a large portion of expenses may be committed expenses that cannot be altered in the short term. Truly controllable expenses are discretionary expenses, which can be eliminated without an immediate adverse impact on profits. Examples of controllable expenses are training and maintenance expenses.
Uncontrollable Budget Variances
Those budget variances that are uncontrollable usually originate in the marketplace, when customers do not buy the company's products in the quantities or at the price points anticipated in the budget. The result is actual revenues that may vary substantially from expectations.
Example of a Budget Variance
ABC Company had budgeted $400,000 of selling and administrative expenses, and actual expenses are $420,000. Thus, there is an unfavorable budget variance of $20,000. However, the budget used as the baseline for this calculation did not include a scheduled rent increase of $25,000, so a flaw in the budget caused the variance, rather than any improper management actions.