In the last lecture, we covered how variances are calculated. Now we look at the reasons for variances occurring. This helps the budget holder to interpret and analyze the variance. There are many reasons for the variances and the most common ones are as follows. Poor profiling, Miss coding and errors, processing delays, poor planning assumptions increases or decreases in demand or unforeseen events. We will discuss each one in detail.
Poor profiling is one of the most common reasons for variances. The variants around arises because the pattern of the expenditure or income budget has not incorrectly distributed across the year. Sometimes simple expenditure have a very clear profile, for example, costly utility bills, monthly salaries, etc. However, other items may be more random in nature or occur as a one off event. Many accounting systems divide budgets equally between the 12 months of the year resulting in what we call a straight line profile, shown here as the green line. The actual expenditure may be very different as shown by the blue line.
This results in variances every month, which may not be of concern if the budget holder understands that the differences are arising due to timing. This is important therefore for budget holders to be aware of their budget profiles, particularly for large budgets. The management reports that show variances are usually produced from an accounting system. management reports depend on financial data being accurately entered into the accounting system, irrespective of the system being used. However, sometimes errors occur. These errors could involve, for example, mis coding to an incorrect department, business unit cost center or to an incorrect item such as stationery coded to uniforms.
Also wrong amounts been entered the budget hole that should ensure errors are correctly when they come to light. Processing delays may arise for many reasons. But the result is that the information being used to calculate a variance is incomplete. This can result in the budget holder misinterpreting the variances and making an incorrect decision about their budget. Unfortunately, budget holders may be unaware of delays when they're monitoring their budgets. This situation can be partly avoided if they communicate with the accountants or the finance staff who produced the management information on a regular basis, such that they know whether or not the information monitoring is up to date and complete.
Variances arises the difference between the actual and the budget. The budget figures will be based on assumptions which ideally relate to a business or service plan. The budget should be set to achieve specific objectives and the budget holders should be aware of what these are. In some cases, budgets are based on law figures, which may or may not be appropriate for the current year. Occasionally, budgets are reduced to achieve savings, sometimes without consideration to the impact on service delivery targets, which can only be achieved with a larger budget. Such planning assumptions will result in variances and budget holders need to be aware of the plan for their budget and to ensure they understand the assumptions that have been made.
If the plan or the assumptions are unknown to the budget holder, they should set out their own targets for the budget that they've been allocated to been in line with the organizational expectations and based them on some assumptions which they can then monitor. Some budgets are demand lead, and are therefore highly influenced by increases In decreases in demand, these demand fluctuations will lead to variances. For example, a budget for care for older people may be based on a specific number of clients for the year. If the demand exceeds this number, there will be a variance as the amount actually spent will exceed the budget. Income budgets are often equally as affected by demand, especially when charges are being levied to the public. For example, an income target may be set on the expectation that a certain number of people will pay for it.
Yes. However, if demand for the service declines, the income budget will be underachieved. It is therefore important for budget holders to know the assumptions behind such budgets, so they can quickly identify trends reflected in the variance and analyze the overall impact on their budget. Finally, unforeseen and unplanned events are very likely to cause variances as they would not have been budgeted for some organization whole what we call contingencies for such occurrences