Flexible & Static Budgets and Variance Analysis

Flexible/Dynamic Budget

• A budget that is adjusted for changes in activity such as sales or production volume o Recognizes the fact that total variable costs and total revenue change based on the level of activity • Prepared at the end of an accounting period when the actual activity is known

Static/Master Budget

• A budget that projects a single level of expected activity o Created prior to the start of the budgeting period • A key planning tool, but difficult to compare actual costs at a different activity level to a static budget o Why? Total variable costs change at different levels of activity, while amounts on a static budget pertain to one level of activity

Flexible Budget Variance (FBV)

• The flexible budget variance is the difference between the actual results and the flexible budget. o FBV = Actual Results - Flexible Budget • It tells you the portion of the static budget variance that is attributable to either (second effect): 1. Price per unit is different than expected 2. Cost per unit is different than expected (for variable costs) 3. The total amount of a fixed cost being different than expected. • A company may analyze FBV more deeply by splitting the FBV into two specific variances, the price and efficiency variance. o Price variance is the difference between the actual price of input and the budgeted price of input. o Efficiency variance is the difference between the actual input quantity and the budgeted input quantity. • If a company uncovers specific problems in input prices and quantities from deeply analyzing the FBV, then the company may have to reexamine and obtain new budgeted input prices and quantities. There are 3 methods to obtain that information: 1. Obtain actual input data from past periods. Real data gives a better comparison than forecasted data. However, companies must be aware of what they are looking for and must take into account whether the old data is consistent with current technology. 2. Obtain data from other companies that have similar processes. The company can make a direct comparison or to evaluate performance with its competitors. However, this data is hard to obtain. 3. Using the standards developed by the firm itself. The companies know what they deem desirable, however, this is a subjective benchmark rather than realized one.

Sales Volume Variance (SVV)

• The sales volume variance is the difference between the flexible budget and the static budget. o SVV = Flexible Budget - Static Budget • It tells you the portion of the static budget variance that is attributable to there being a different level of activity than expected (effect 1).

Static Budget Variance (SBV)

• The static budget variance is the difference between the actual results and the amounts that were expected based on the static budget. o SBV = Actual Results - Static Budget • Looking at the static budget variance is not particularly helpful because there are two effects captured within it: 1. The effect of higher or lower volume than expected 2. The effect of differences between expected and actual amounts for price per unit, cost per unit (for variable costs), or the total amount of a fixed cost.

The Use of Variances

• Variances bring together the planning and control functions of management and facilitate management by exception. o Management by exception refers to managers paying close attention to the nonoperating area rather than operating areas for any underlying issues. • Variances allow managers to uncover problems/negatives or positives for the company. o Negatives such as more waste or scrap from production will cause managers to examine and improve the production process o Positives such as actual costs being less than budgeted costs will cause managers to examine and replicate the results in other processes. • Variances also acts as a way to evaluate the performance of the company and motivate managers for reaching specific variances thresholds. o Sometimes a very good variance may be the cause of problems for the company such as the number of product defects associated with the actual cost of production being less than budgeted costs. The company will increase the actual costs to improve upon that but will cause the good variance to decrease. *• F refers to favorable variances: denoting that actual costs is less than budgeted costs* o For SVV, Flexible budget is less than Static budget *• U refers to unfavorable variances: denoting that budgeted costs is less than actual costs* o For SVV, Flexible budget is more than Static budget