Static and Flexible Budget Example Assume that Max, Inc.

created its original income production cost budget assuming 1,000 units would be produced. At the end of the month, it was determined that actual production was only 900 units. If we compare the static budget which allows total costs of $6,550 with the actual amounts incurred of $6,320, it appears the manager is $230 under budget, creating a favorable variance. Static Budget 1,000 $2,000 1,500 250 $3,750 $2,000 800 $2,800 $6,550 Actual Amounts 900 $1,800 1,400 260 $3,460 $2,100 760 $2,860 $6,320

Units produced Variable costs: Direct labor Direct materials Factory supplies Total variable costs Fixed costs: Depreciation Occupancy costs Total fixed costs Total overhead costs

Unit costs $2.00 $1.50 $0.25

Variances 100 $200 100 10 $290 $100 40 $ 60 $230

U F F U F U F U F

These variances are not very meaningful because the manager produced fewer units. We should prepare a flexible budget that shows the amount of costs allowed at the 900 units that were actually produced. The format is the same. We replace the static budget column with the flexible budget amounts and calculate the new variances. Flexible Budget 900 $1,800 1,350 225 $3,375 $2,000 800 $2,800 $6,175 Actual Amounts 900 $1,800 1,400 260 $3,460 $2,100 760 $2,860 $6,320

Units produced Variable costs: Direct labor Direct materials Factory supplies Total variable costs Fixed costs: Depreciation Occupancy costs Total fixed costs Total overhead costs

Unit costs $2.00 $1.50 $0.25

Variances $ 0 50 35 $85 F U U F U F U U

$100 40 $ 60 $145

Now it appears the production manager spent more than he was allowed to spend at 900 units of activity. If any of the 5 cost amounts have variances that exceed the company's minimum threshold level for investigation of variances, we would need to

find remedies for any in need. and hopefully.determine the manager in charge. we might create comparative budgets for 920. MANAGEMENT ACCOUNTING: CONCEPTS AND TECHNIQUES By Dennis Caplan . This is done by selecting several activity levels and creating side-by-side budgets that show the costs allowed for each of these levels of activity. determine why the variances exist. 940. Planning With Flexible Budgets Some companies use flexible budgets as an aid in planning. 960 and 980 units so that a manager that produces units between those levels would have a better idea of how he compares to the benchmarks at those levels. This helps managers who don't want to wait until the end of the period to see how much they were allowed to spend for the level they achieved. For example.

budgets are planning tools. budgets are both planning tools and performance evaluation tools. this measure of output is the number of units of each product produced. Hence. In other words. Therefore. Often. For a factory. it might be the number of units of each product sold. prior to the start of the period. However. The static budget variance is the difference between any line-item in this original budget and the corresponding line-item from the statement of actual results. and they are usually prepared prior to the start of the period being budgeted. Usually. the comparison of the budget to actual results provides valuable information about performance. net income for profit centers.PART 2: MICROECONOMIC FOUNDATIONS OF MANAGEMENT ACCOUNTING CHAPTER 5: FLEXIBLE BUDGETING Chapter Contents: Introduction Pro Forma Analysis at Guess Who Jeans Static Budget Variance at Guess Who Jeans Flexible Budget Variance at Guess Who Jeans Introduction: A budget is a plan for the future. . the single most important input in the budget is some measure of anticipated output. The static budget is the budget that is based on this projected level of output. the line-item of most interest is the ³bottom line´: total cost of production for the factory and other cost centers. it is the number of patient days (the number of patient admissions multiplied by the average length of stay). For a hospital. For a retailer. the static budget is the ³original´ budget.

000 units to what the factory should have spent to make 10. The flexible budget asks the question: ³If I had known at the beginning of the period what my output volume (units produced or units sold) would be. patient days for a hospital). If these steps are applied to various anticipated levels of output. not to what the factory should have spent to make 9. The following steps are used to prepare a flexible budget: 1.000 units. 4.000 units. what would my budget have looked like?´ The motivation for the flexible budget is to compare apples to apples.. Flexible budgets are prepared at the end of the period.000 units or 11. where the projected level of output is incorporated at step 3..g. the analysis is called pro forma analysis. Also determine the budgeted sales price per unit of output. Pro forma analysis is useful for planning . the same steps described above for creating the flexible budget can be used prior to the start of the period to anticipate costs and revenues for any projected level of output. Build the flexible budget based on the budgeted cost information from steps 1 and 2. If the factory actually produced 10. and the actual volume of output from step 3.g.The flexible budget is a performance evaluation tool. A flexible budget adjusts the static budget for the actual level of output. Determine the actual volume of output achieved (e. The flexible budget variance is the difference between any line-item in the flexible budget and the corresponding line-item from the statement of actual results. then management should compare actual factory costs for 10. units produced for a factory. 3. units sold for a retailer. However. Determine the budgeted variable cost per unit of output. It cannot be prepared before the end of the period.000 units or any other production level. the retailer or the hospital). Determine the budgeted level of fixed costs. when actual output is known. 2. if the entity to which the budget applies generates revenue (e.

what will be the company¶s cash. a small. start-up fashion jeans manufacturer. if next year¶s sales are double this year¶s sales. and labor requirements in order to meet production needs? Pro Forma Analysis at Guess Who Jeans: Following are pro forma monthly income statements for Guess Who Jeans. For example. .purposes. The company has no variable marketing costs. The pro forma analysis was prepared at the beginning of the month and considered three alternative sales levels. materials.

000 150.000 150.000 200.000 150.000 600.000 Budgeted amount per unit Pro Forma Analysis for Alternative Output Levels Variable costs: Materials Labor Overhead Total 15 10 5 30 150.000 50.000 100.000 50.000 20.000 300.000 100.200.GUESS WHO JEANS PRO FORMA ANALYSIS FOR THE UPCOMING MONTH Income Statement line-item Revenue $40 10.000 30.000 Contribution margin $10 100.000 200.000 units $400.000 50.000 450.000 units $1.000 100.000 900.000 Fixed costs: Manufacturing Overhead Marketing costs Total fixed costs 100.000 100.000 .000 150.000 300.000 units $800.000 300.000 300.000 50.

and the static budget variance. Static Budget Variance at Guess Who Jeans: Guess Who management decides that 10. and sets the static budget based on this sales and production level. Hence.000) $50. Revenue and variable costs vary with output in a linear fashion.000 Since by definition. showing the static budget. revenue. each line-item for variable costs.000 units is the most likely output volume. . when output increases 100% from 10.000 units to 20. company personnel prepare the following table. fixed costs remain the same at all three projected levels of output. and contribution margin all increase 100%. After the end of the month. actual results.000 units.000 $150.Operating income ($50. fixed costs are not expected to change as volume of output changes within the relevant range.

000.GUESS WHO JEANS STATIC BUDGET VARIANCE FOR THE MONTH JUST ENDED Income Statement line-item Budgeted amount per unit Static Budget (A) 10.000 (80.000 189.000 50.000) (34.000 Fixed costs: Manufacturing Overhead Marketing costs Total fixed costs 100.000) Contribution margin $10 100.000 50.000 150.000) . (4.000 units $670.000 230.000 167.000 481.000) 1.000 105.000 Actual Results (B) 16.000 Revenue $40 Variable costs: Materials Labor Overhead Total 15 10 5 30 150.000 Static Budget Variance (A) ± (B) $270.000 300.000 100.000 89.000 49.000) (181.000 (5.000) (67.000 units $400.000 154.000 84.

The static budget variance shows a large favorable variance for revenue. The revenue variance might also be due to an average unit sales price that differed from budget.000) $35.000 In the variance column.g. The Flexible Budget Variance at Guess Who Jeans: In order to better understand the causes of the large revenue and variable cost variances in the static budget variance column. and negative numbers are unfavorable (bad news). the price of fabric).000 units. positive numbers are favorable variances (good news).g. and large unfavorable variances for variable costs. The variable cost variances might also be due to input prices that differed from budget (e. There are also small variances for fixed costs. many factors can cause actual fixed costs to differ from budgeted fixed costs that are unrelated to output volume.000 $85. These costs should not vary with the level of output (at least within the relevant range). or input quantities that differed from the per-unit budgeted amounts (e. Guess Who personnel prepare the following flexible budget.000 units. and depreciation expense can change if unexpected capital acquisitions or dispositions occur. However. property tax rates and the fixed salaries of front office personnel can change.Operating income ($50.. GUESS WHO JEANS FLEXIBLE BUDGET VARIANCE . while the company actually made and sold 16. yards of fabric per pair of pants).. These large variances are due primarily to the fact that the static budget was built on an output level of 10. For example.

000 481.000 160.000 $25.000 $35.000 29.000 units $670.000 230.000 50.000) (4.000 Flexible Budget Variance (A) ± (B) $30.000 (5.000 167.000 105.000.000) 1.000 80.000) Operating income $10.000 10.000) (1.000 Actual Results (B) 16.000 Revenue $40 Variable costs: Materials Labor Overhead Total 15 10 5 30 240.000 .000 154.000 480.FOR THE MONTH JUST ENDED Income Statement line-item Budgeted amount per unit Flexible Budget (A) 16.000 84.000 189.000 units $640. (4.000 Fixed costs: Manufacturing Overhead Marketing costs Total fixed costs 100.000 150.000) Contribution margin $10 160.000 49.000 (7.

For example. even after adjusting for the sales volume of 16. In other words.000 units. This unfavorable flexible budget variance implies that either wage rates were higher than planned. or to more efficient utilization of fabric (less waste than expected). Guess Who management sees that even after adjusting for sales volume. This favorable variance could be due to lower fabric prices. or labor was not as efficient as planned. and negative variances are unfavorable (bad news). The fixed cost variances are identical in this table to the previous table. Similarly. the components of variable overhead were either more expensive than budgeted. positive variances are favorable (good news). From this table. The favorable $30. Materials costs were lower than would have been expected for a sales volume of 16. electric rates might have been higher than planned.Once again. Labor and overhead were higher than expected. or both. or more electricity was used than planned per unit of output.000 units.000 variance must be due entirely to an average sales price that was higher than planned (almost $42 per pair compared to the original budget of $40 per pair). TABLE OF CONTENTS PREVIOUS CHAPTER NEXT CHAPTER GLOSSARY . or a combination of these two factors. revenue was higher than would have been expected. the flexible budget and flexible budget variance provide no additional information about fixed costs beyond what can be learned from the static budget variance. or were used more intensively than budgeted.