In a recent accounting period, Ismail Company experienced a SAR30,000 unfavorable variance for variable production costs. Explain the meaning of an unfavorable variance. Suggest two possible How are budgets related to organizational strategies?

QUESTION

The accountant for Kadhim Inc. is preparing the budgets for operating department support service costs. Maintenance costs are allocated based on square feet, and cafeteria costs are allocated based on number of employees. The following data have been collected:

Khaleel Compagny produces three products A, B and C. During the year the joint costs of processing the coffee were SAR270,000. Production and sales value information were as follows:

In a recent accounting period, Ismail Company experienced a SAR30,000 unfavorable variance for variable production costs. Explain the meaning of an unfavorable variance. Suggest two possible

How are budgets related to organizational strategies?

ANSWER

The Significance of Unfavorable Variances in Accounting and their Impact on Organizational Performance

Introduction

In the realm of accounting, variances play a crucial role in assessing the performance of an organization. They provide valuable insights into deviations from expected outcomes, enabling businesses to make informed decisions and take corrective actions. This essay explores the meaning of an unfavorable variance, discusses two possible causes for such variances, and examines the relationship between budgets and organizational strategies.

Meaning of an Unfavorable Variance

An unfavorable variance refers to a discrepancy between the actual costs incurred and the budgeted or expected costs (Ryan et al., 2000). It indicates that the actual costs exceeded the projected costs or that the revenues fell short of the anticipated levels. In the case of Ismail Company’s variable production costs, the unfavorable variance of SAR30,000 suggests that the actual costs were higher than the budgeted costs.

Possible Causes for an Unfavorable Variance

 Inefficient Resource Utilization: One possible cause for an unfavorable variance in production costs is inefficient resource utilization. This could involve excessive wastage of raw materials, suboptimal use of labor, or inefficient machinery maintenance (Bierman et al., 1961). Such factors can result in increased costs, lower productivity, and ultimately, unfavorable variances.

 External Factors: External factors beyond the organization’s control can also contribute to unfavorable variances. Fluctuations in the price of raw materials, changes in market conditions, or unexpected disruptions in the supply chain can all impact production costs. For example, if the cost of a crucial raw material unexpectedly increases, it can lead to unfavorable variances in production costs.

The Relationship between Budgets and Organizational Strategies

Budgets serve as a crucial link between organizational strategies and financial planning. They provide a framework for aligning resources, setting targets, and evaluating performance. Here’s how budgets are related to organizational strategies:

 Goal Alignment: Budgets translate the strategic goals of an organization into measurable financial targets. They allocate resources to different departments and projects based on strategic priorities. By setting budgetary constraints and targets, organizations ensure that their financial resources are utilized in line with their strategic objectives.

Performance Evaluation: Budgets act as benchmarks for evaluating the performance of departments, projects, or individuals. By comparing actual results against budgeted targets, organizations can identify areas of success and areas requiring improvement. This evaluation process allows for better decision-making, such as identifying cost-saving opportunities or reallocating resources to more profitable activities.

Resource Allocation: Budgets facilitate resource allocation by providing a clear overview of financial needs and constraints. They help organizations prioritize investments, allocate funds to different departments or projects, and make informed decisions about resource allocation. This ensures that financial resources are utilized optimally and in line with organizational strategies.

Strategic Planning and Adaptation: Budgets also play a crucial role in strategic planning and adaptation. By analyzing budget variances, organizations can identify trends, patterns, and potential risks (Abernethy et al., 1999). Unfavorable variances can highlight areas where adjustments are needed to align with changing market conditions, customer demands, or competitive pressures. Budgets provide a financial framework for strategic decision-making and help organizations adapt to evolving circumstances.

Conclusion

In conclusion, unfavorable variances in accounting indicate deviations from expected costs or revenues. These variances can be caused by factors such as inefficient resource utilization or external market conditions. Budgets serve as a bridge between organizational strategies and financial planning, allowing for goal alignment, performance evaluation, resource allocation, and strategic planning. By closely monitoring and analyzing variances, organizations can enhance their decision-making processes, improve performance, and align their financial activities with their strategic objectives.

References

Abernethy, M. A., & Brownell, P. (1999). The role of budgets in organizations facing strategic change: an exploratory study. Accounting, organizations and society, 24(3), 189-204.https://www.sciencedirect.com/science/article/pii/S0361368298000592 

Bierman, H., Fouraker, L. E., & Jaedicke, R. K. (1961). A use of probability and statistics in performance evaluation. The Accounting Review, 36(3), 409.https://search.proquest.com/openview/e972d5081702640c164b19ccc7598110/1?pq-origsite=gscholar&cbl=1816369 

Ryan, D., & Wentzel, K. (2000). The influence of attributions and budget emphasis on framing and risk preferences under conditions of unfavorable budget variances. In Advances in Accounting Behavioral Research (Vol. 3, pp. 133-152). Emerald Group Publishing Limited.https://www.emerald.com/insight/content/doi/10.1016/S1474-7979(00)03029-5/full/html