Variance Analysis
Our variance analysis example and practice exercise use the flexible budget approach. A flexible budget is one that is created using budgeted revenue and/or budgeted cost amounts. A flexible budget is adjusted, or flexed, to the actual level of output achieved (or perhaps expected to be achieved) during the budget period. A flexible budget thus looks toward a range of activity or volume (versus only one level in the static budget).
Examples of how the variance analysis works are contained in Figure 17–1 (the elements), in Figure 17-2 (the composition), and in Figures 17–3 and 17–4 (the calculations). Study these examples before undertaking the Practice Exercise.
We have restated Exhibit 17–2 in a worksheet format for purposes of this example. The new format appears as follows. (The numbers have not changed.)
| Actual Cost | $920,000 |
| Less: Flexible Budget | 990,000 |
| Price Variance (favorable) | $ 70,000 |
| Budgeted Cost | $937,500 |
| Less: Flexible Budget | 990,000 |
| Quantity Variance (unfavorable) | − $52,500 |
| Net Variance (favorable) | $ 17,500 |
Assumptions (refer to Exhibit 17-2)
| Overhead Cost | divided by | # Therapy Minutes (Activity Level) | equals | Cost per Therapy Minute | |
|---|---|---|---|---|---|
| Actual | (1) $920,000 | (3) 330,000 | (5) $2.79 | ||
| Budgeted | (2) $937,500 | (4) 312,500 | (6) $3.00 |
Practice Exercise 17–1
Exhibit 17–2 presents the Variance Analysis for hospital rehab services for the third quarter. For our practice exercise we will duplicate this report for the fourth quarter. We are able to reformat the information in Exhibit 17–2 into a worksheet as follows. The fourth quarter assumptions appear below the worksheet.
| Actual Cost | |
| Less: Flexible Budget | |
| Price Variance (favorable) | |
| Budgeted Cost | |
| Less: Flexible Budget | |
| Quantity Variance (unfavorable) | |
| Net Variance (unfavorable) | |
Assumptions
| Overhead Cost | divided by | # Therapy Minutes (Activity Level) | equals | Cost per Therapy Minute | |
|---|---|---|---|---|---|
| Actual | (1) $950,000 | (3) 350,000 | (5) $2.71 | ||
| Budgeted | (2) $930,000 | (4) 310,000 | (6) $3.00 |
Required
- 1. Set up a worksheet for the fourth quarter like that shown in Exhibit 17–2 for the third quarter.
- 2. Insert the Fourth Quarter Input Data (per assumptions given above) on the worksheet.
- 3. Complete the “Actual Cost,” “Flexible Budget,” and “Budgeted Cost” sections at the top of the worksheet.
- 4. Compute the Price Variance and the Quantity Variance in the middle of the worksheet.
- 5. Indicate whether the Price and the Quantity Variances are favorable or unfavorable for the fourth quarter.
Optional
Can you compute how the $950,000 actual overhead costs and the $930,000 budgeted overhead costs were calculated?
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