Managerial accountants use variance analysis to explain deviations from budgeted performance, explains Accounting-Simplified.com. Budget variances can have several possible root causes. Variance analysis isolates the actual cause in order to assign responsibility to the proper party and improve future projections.
For example, several possible causes may exist when a company's actual wages exceed its budgeted wages, such as unexpectedly high wage rates, decreased productivity, unanticipated idle time or increased output, notes Accounting-Simplified.com. Isolating and measuring the root cause allows senior management to then hold the responsible department accountable. Senior managers can address the issue with human resources if wages are higher than expected, or with the production department if there is excessive idle time.
Variance analysis has its limits, indicates AccountingTools. Accounting staff conducts the analysis at the end of accounting periods. This may be too late for organizations that prefer to identify and correct variances in real time. Some root causes may not be identifiable from financial statements, and accountants may need to locate and examine additional records.
Some budgets contain arbitrary projections that reflect business compromises rather than true expectations. Investigating variances from such budgets may yield little insight for the company. As a result, some companies prefer to use horizontal analysis rather than variance analysis to identify trends and interpret financial performance.