Understanding Variances

As mentioned in chapter 8, one of the objectives of the budget is to provide a mechanism for ongoing measurement and control of the production operation. The budget shows expected performance. Actual results are compared to this benchmark to evaluate past performance and to direct future activities. The variances between budgeted and actual results identify specific activities that did not perform as expected (whether negatively or positively). Managers who use variance analysis are essentially applying a management- by-exception philosophy. Individual organizations will determine variances that reflect their own processes and managerial interests, but these variances all follow the approach outlined here. Firms will also vary in the extent to which variances are reported. Some firms use a few variance measures for the overall production organization whereas others calculate variances for individual departments or even individual work areas. As mentioned in chapter 5, it is important to distinguish between controllable and noncontrollable costs when using budgets for control and evaluation.