Budgets

Business AS · Finance and accounting. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

A budget is a detailed financial plan for a future period, with targets for revenue, costs or output. Budgets share out resources between departments, give managers targets, and let the business control and monitor spending by comparing actual results with the plan.

Budgets can be set in different ways. An incremental budget takes last year's figure and adjusts it. A flexible budget changes with the actual level of output. Zero budgeting starts each budget at nothing, and every item of spending must be justified.

A variance is the difference between a budgeted figure and the actual figure. What matters is the effect on profit: favourable if profit is higher than planned, adverse if it is lower.

Rules to remember

Variance = actual figure − budgeted figure; then label it favourable (F) or adverse (A).
Revenue or profit: actual above budget = favourable; actual below budget = adverse.
Costs: actual below budget = favourable; actual above budget = adverse.
Incremental budget = last period's budget plus or minus a percentage. Quick to set, but past waste is carried forward.
Flexible budget: flexed variable cost budget = budgeted cost per unit × actual output.
Zero budgeting: every budget starts at zero and all spending is justified. It removes waste but takes a lot of management time.
Benefits of budgets: planning, coordination, control, motivation through targets. Drawbacks: inflexible, can demotivate if imposed or unrealistic, may encourage short-term thinking or wasteful spending to use up the budget.

Common mistake

Students call every "actual higher than budget" result favourable. For costs it is adverse, because higher costs reduce profit. Always ask what the difference does to profit.

Worked example

Budgeted revenue was $200,000 and actual revenue was $212,000. Budgeted costs were $150,000 and actual costs were $165,000. Find each variance and the profit variance.

Revenue variance = 212,000 − 200,000 = $12,000 favourable (more revenue than planned).
Cost variance = 165,000 − 150,000 = $15,000 adverse (more cost than planned).
Budgeted profit = 200,000 − 150,000 = $50,000; actual profit = 212,000 − 165,000 = $47,000.
Profit variance = 47,000 − 50,000 = $3,000 adverse (also 12,000 F − 15,000 A).

Answer: Revenue $12,000 favourable, costs $15,000 adverse, profit $3,000 adverse.

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