What is variance analysis and how is it used in budgeting?

• A. Compare actual results to budget; analyze deviations to improve forecasting and performance.
• B. Forecast future results by ignoring actual outcomes.
• C. Set budgets after reviewing variances only.
• D. Use variances only for tax planning.

Answer: (A)

Variance analysis is the process of comparing what actually happened to what was budgeted and examining the differences to understand why they occurred and what to do about them. In budgeting, it helps you monitor performance, identify the causes of over- or under-spending (such as higher material costs, efficiency changes, or shifts in sales volume), and use those insights to refine forecasts and improve future budgets. By analyzing variances, you can decide where to take corrective action, adjust upcoming forecasts, and assign accountability, keeping planning closely tied to actual operations.

Ignoring actual results defeats the purpose of variance analysis. Using variances only to set budgets after reviewing them oversimplifies budgeting, which relies on planning and assumptions as well as past performance. Relying on variances solely for tax planning misses the main management and control function of variance analysis in budgeting.