Variances

Every year, our firm plans a budget of expenses and revenue.  While this is particularly useful in strategic planning, it is also helpful in performance evaluation.   Noted differences between actual and planned revenue and expenses, known as variances, are classified by the accounting department as favorable or unfavorable.  If the difference benefits the company the variance is deemed favorable.  And vice versa is true for detrimental variances.  Below are examples:

Favorable Variances	Unfavorable Variances
Actual Sales > Expected Sales	Actual Sales < Expected Sales
Actual Costs < Expected Costs	Actual Costs > Expected Costs

However, this classification of variances as favorable or unfavorable can be very misleading.  This week, my accounting lecture noted as deceptive the unfavorable allocation of increased labor costs resultant of increased widget sales.  When the actual labor costs are greater than the expected costs, technically this variance is unfavorable.  But the inverse is actually true because this cost increase will be offset by increased revenue from the sale of the “extra” widgets produced.

Additionally, I would argue that increased sales noted as favorable may be deceiving as well.  Increased sales of widgets at my firm may require that we import products at a cost higher than our contracted selling price.  While technically favorable in the accounting department, the overall effect of the increased sales can be fiscally damaging.  Beyond the financial considerations, the fact that it was necessary to import products to meet demand may lead our customers to question our reliability. If taken to the extreme, this doubt could jeopardize future contract negotiations.

Therefore, the classification of variances as favorable or unfavorable is purely academic.  If implemented in a business setting, context consideration is mandatory.