How do variance reports compare budgeted and actual results to control business performance?
Preparing variance reports comparing budgeted and actual figures, classifying variances as favourable or unfavourable, and explaining their use in evaluating and controlling business performance
A focused VCE Accounting Unit 4 Area of Study 2 answer on variance reports. Defines favourable and unfavourable variances, prepares a variance report comparing budget against actual, and explains how managers investigate variances to control performance and improve future budgeting.
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What this dot point is asking
VCAA wants you to prepare a variance report comparing budgeted and actual figures, classify each variance as favourable or unfavourable, and explain how variance analysis is used to evaluate and control business performance.
What a variance report does
A variance report is the control stage of budgeting. Having forecast results with a budget, the business records actual results, then compares the two so managers can act on the differences.
Favourable and unfavourable variances
The classification depends on the effect on net profit, not on whether the number rose or fell:
- Revenue items: a variance is favourable when actual revenue exceeds budget, and unfavourable when actual revenue falls short.
- Expense items: a variance is favourable when actual expense is below budget, and unfavourable when actual expense exceeds budget.
Investigating variances
Not every variance needs action. Managers focus on variances that are large in dollar terms or large as a percentage of the budget, a practice called management by exception. For a significant variance, the questions are:
- Was the budget assumption wrong, or was performance better or worse than expected?
- Is the cause controllable (such as inefficient staffing) or uncontrollable (such as a supplier price rise)?
- Should a strategy change, or should the budget be revised?
For example, the favourable sales variance above may reflect a successful promotion, but the unfavourable cost of sales variance may show suppliers raised prices or more inventory was wasted. Linking variances together gives a fuller picture than reading each in isolation.
Using variances to control performance
Variance analysis closes the planning loop. It tells the owner where actual performance diverged from plan, prompts corrective action where the cause is controllable, and improves the accuracy of the next budget by revealing where assumptions were unrealistic. Over time, tighter budgeting and active investigation of variances support better control of profit and cash.
Exam-style practice questions
Practice questions written in the style of VCAA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
2020 VCAA1 marksA business prepared a variance report from the Income Statement for the month ended 31 July 2020. Sales were budgeted at 140 000 (variance 68 000 and actual was 2 000). State which variance would be described as favourable.Show worked answer →
A variance is favourable when the actual result is better for profit than the budget.
The **Sales variance of 140 000) were higher than budgeted ($130 000), which increases profit.
(By contrast the Cost of Sales variance of $2 000 is unfavourable in isolation, because actual cost exceeded budget.) For the 1 mark, identify the Sales variance as the favourable one.
2020 VCAA4 marksSales were budgeted at 140 000; Cost of Sales was budgeted at 70 000. Explain how the owner of the business should interpret these graphs and suggest what appropriate action they could take based on this data.Show worked answer →
Interpret the two variances together, then recommend investigating the cause before acting.
Interpretation: Sales were 2 000 above budget (unfavourable on its own). However, the higher Cost of Sales is most likely a direct consequence of selling more (greater volume requires buying more inventory), so the two variances should be read together rather than separately.
Action: the owner should investigate the cause of each variance, checking whether the extra Cost of Sales is due only to higher volume (acceptable, and consistent with the higher sales) or to higher cost per unit or a lower mark-up (which would need action, such as renegotiating supplier prices or reviewing selling prices).
The favourable sales result should also be used to set more accurate future budgets. Marks reward linking the variances, recognising volume as the likely cause, and recommending investigation or corrective action.