IGNOU : M.COM : MCO 5 : UNIT 10 : Q - 3. Explain Why is a variable costing format useful for performance evaluation?

 Ans. According to National Institute of Bank Management, performance budgeting technique is, “ the process of analyzing, identifying, simplifying and crystallizing specific performance objectives of a job to be achieved over a period, in the framework of the organizational objectives, the purpose and objectives of the job. The technique is characterized by its specific direction towards the business objectives of the organization.”

The main objectives of performance budgeting are :

i) to coordinate the physical and financial aspects,

ii) to improve the budget formulation, review and decision making at all levels of management,

iii) to facilitate better appreciation and review by controlling authorities as the presentation is more purposeful and intelligible,

iv) to make more effective performance audit possible, and

v) to measure progress towards long term objectives which are envisaged in a development plan.

Performance budgeting requires preparation of periodic performance reports. Such reports compare budget and actual data, and show variances. Their preparation is greatly facilitated if the authority and responsibility for the incurence of each cost element is clearly defined within the firm’s organisational structure. The responsibility for preparing the performance budget of each department lies on the respective department head. Periodic reports from various sections of a department will be required by the departmental head who will submit a summary report about his department to the budget committee. The report will be in the form of comparison of budgeted and actual figures both periodic and cumulative. The purpose of preparing these reports is to promptly inform about the deviations in actual and budgeted activity to the person who has the necessary authority and responsibility to take necessary action to correct the deviations from the budget.

Thus, performance budgeting lays immediate stress on the achievement of specific goals over a period of time. However, in the long-run it aims at continuous growth of the organisation so that it continues to meet the dynamic needs of its growing clientele. It enables the organisation to be sensitive and adaptive, preventing it from developing rigidities which may retard the process of growth.

A comparison of the master budget with the flexible budget and with actual results forms the basis for analyzing difference between plans and actual performance. The difference between operating profits in the master budget and operating profits in the flexible budget is called an activity variance. When the change from the master budget to the flexible budget is due to changes in sales volume, the activity variance is known as the sales volume variance. The variance may be favourable or unfavourable variance.