Definition
In the contexts of standard costing and budgetary control, a favourable variance refers to any deviation between actual and budgeted performance that leads to an increase in budgeted profit. This deviation may arise from higher-than-expected sales revenues or lower-than-anticipated costs.
Examples
- Sales Revenue Exceeds Projections: If an organization projected sales revenue of $50,000 for a quarter, but the actual sales revenue turns out to be $60,000, the $10,000 excess is a favourable variance.
- Lower Production Costs: Suppose an organization budgeted $30,000 for production costs but managed to keep actual production costs to $25,000, resulting in a $5,000 favourable variance.
Frequently Asked Questions (FAQs)
What causes a favourable variance?
A favourable variance can be caused by multiple factors, including higher-than-expected sales, cost savings initiatives, efficiency improvements, or unforeseen changes in the market that benefit the organization.
How is a favourable variance different from an adverse variance?
A favourable variance indicates a positive impact on the budgeted profit, while an adverse variance indicates a negative impact. For instance, spending less than budgeted is favourable, but spending more is adverse.
Yes, favourable variances can occur in both revenue and cost metrics. Higher than budgeted revenues or lower than budgeted costs both result in a favourable variance.
How is a favourable variance measured?
Favourable variance is measured by comparing actual performance data to budgeted or standard performance data. The difference is analyzed to determine if it positively impacts the budgeted profit.
Why is understanding favourable variance important?
Understanding favourable variance is crucial for effective financial management, allowing organizations to identify and replicate successful strategies, control costs, and optimize performance.
Standard Costing
Standard costing involves assigning predetermined estimated costs to units of production, services, or goods to analyze performance against those costs.
Budgetary Control
Budgetary control refers to the process organizations use to plan and control their budgets to ensure financial targets are met.
Adverse Variance
An adverse variance refers to a deviation from the budgeted performance that results in a negative impact on the budgeted profit.
Variance Analysis
Variance analysis is a detailed examination of the differences between budgeted and actual performance to understand the causes of variances.
Online Resources
- Investopedia: Variance Analysis
- Corporate Finance Institute: Budgetary Control
- AccountingTools: Standard Costing
Suggested Books for Further Studies
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren - A comprehensive look at cost accounting principles and practices, including variance analysis.
- “Management Accounting: Principles and Applications” by Jill Collis and Roger Hussey - This book covers various aspects of management accounting, with chapters dedicated to budgeting and variances.
- “Budgeting and Financial Management for Nonprofit Organizations” by Lynne A. Weikart, Greg G. Chen, and Ed Sermier - Detailed guidance on budgeting and financial control, including variance analysis, tailored for nonprofit organizations.
Accounting Basics: “Favourable Variance” Fundamentals Quiz
### What signifies a favourable variance in budgetary control?
- [x] A performance improvement that adds to the budgeted profit.
- [ ] Any variance that changes the original plan.
- [ ] A deviation that aligns with initial projections.
- [ ] A performance decrease that challenges budgeted profit.
> **Explanation:** A favourable variance signifies a performance improvement that adds to the budgeted profit, like achieving higher sales or incurring lower costs than expected.
### What might cause a favourable variance in a company's budget?
- [x] Cost-saving efficiencies and unexpected market benefits.
- [ ] Increasing anticipated costs.
- [ ] Falling short of sales targets.
- [ ] Delayed receiving payments from customers.
> **Explanation:** Cost-saving efficiencies and unexpected market benefits can lead to a favourable variance by reducing expenses or increasing revenues beyond budgeted amounts.
### How does a favourable variance impact financial reporting?
- [ ] It leads to a revision of the annual budget.
- [ ] It reduces forecasting accuracy.
- [ ] It is ignored in financial reports.
- [x] It increases the reported profit compared to the budget.
> **Explanation:** A favourable variance increases the reported profit compared to the budget because it reflects better-than-expected financial performance.
### When applying variance analysis, what is revealed by identifying a favourable variance?
- [x] Performance exceeded expectations positively affecting profit.
- [ ] Performance missed targets, reducing overall effectiveness.
- [ ] Financial targets are irrelevant.
- [ ] There are inaccuracies in standard costing.
> **Explanation:** Identifying a favourable variance reveals that performance exceeded expectations, positively affecting profit and indicating areas where strategies were successful.
### A favourable variance can result from which of the following?
- [x] Actual costs being lower than budgeted costs.
- [ ] Actual costs being equal to budgeted costs.
- [ ] Decreasing sales revenue.
- [ ] Inaccurate tax estimates.
> **Explanation:** A favourable variance can result when actual costs are lower than budgeted costs, leading to savings.
### How should managers respond to a significant favourable variance?
- [x] Analyze reasons and apply successful practices company-wide.
- [ ] Ignore it since it’s not problematic.
- [ ] Increase next year’s budget indiscriminately.
- [ ] Cut down on quality control measures.
> **Explanation:** Managers should analyze the reasons behind a significant favourable variance and apply these successful practices company-wide to replicate positive results.
### What effect does a favourable variance have on a budgeted profit margin?
- [ ] Decreases the budgeted profit margin.
- [ ] Keeps the budgeted profit margin unchanged.
- [x] Increases the budgeted profit margin.
- [ ] Negatively impacts the cash flow projection.
> **Explanation:** A favourable variance increases the budgeted profit margin as either more revenue is generated or fewer costs are incurred than planned.
### In which scenario is a favourable variance most likely to appear?
- [x] Sales exceed their targets while costs are kept low.
- [ ] Production costs overshoot budget projections.
- [ ] Sales fall short of initial estimates.
- [ ] All budget areas match their projections exactly.
> **Explanation:** A favourable variance is most likely to appear when sales exceed their targets while costs are kept low.
### What aspect primarily differentiates a favourable variance from an adverse variance?
- [ ] Its implications for cash flow.
- [x] Its impact on profit.
- [ ] The methods used in its calculation.
- [ ] The potential adjustments required for future budgets.
> **Explanation:** The primary differentiation is its impact on profit; a favourable variance increases profit whereas an adverse variance decreases profit.
### Why is it essential for organizations to monitor favourable variances?
- [ ] To reduce accurate forecasting.
- [ ] To maintain adherence to outdated standards.
- [ ] To limit employee bonuses.
- [x] To understand elements of successful performance and improve future projections.
> **Explanation:** Monitoring favourable variances is essential to understand what elements contributed to successful performance and to improve future projections.
Thank you for exploring the concept of favourable variance. Understanding this key accounting term can greatly aid your financial management skills and provide you with valuable insights for optimizing organizational performance!
