Exam

Theroleofthisappendixistoprovideasomewhatmoreformalized
methodologyforthecalculationofflexiblebudgetvariances.

FLEXIBLE BUDGET EXPENSE VARIANCES

Thefirststepinflexiblebudgetingistoestablishtheflexiblebudgetfor
theactualoutputlevel.Thatis,wemustdeterminewhatwewouldhave
expectedtospendifwehadknowninadvancetheoutputlevelthat
wouldactuallyoccur.Becauseofvariablecosts,wewouldhave
budgetedmoreresourcesifweknewservicelevelswouldbehigherand
lessresourcesifweknewtheyweregoingtobelower.Forexample,
consideranexcerptfromthevariancereportfortheMillbridgeHigh
SchoolforAugust.23
TownofMillbridgeHighSchoolAugustVarianceReport

Actual
Budget
Variance
Books
$120,000
$100,000
$20,000U
Theactualspendingwas$120,000.Thebudgetedcostwas$100,000.
Supposethatthebudgetassumedthattherewouldbe2,000students,
but2,100studentsenrolled.Assumingthatthepurchaseoftextbooks
wouldbeexpectedtovaryindirectproportionwithenrolledstudents,

thebudgetcalledforplannedspendingof$50perstudent(i.e.,$50
2,000students=$100,000).
For2,100studentsat$50perstudent,$105,000wouldhavebeen
budgetedforsupplies.Thisistheflexiblebudget.Itistheamountthe
schoolwouldhaveexpectedtospendhadtheactualnumberofstudents
beenknown.Theoriginalbudgetwas$100,000.Theflexiblebudget,
whichadjustsfortheactualvolume,is$105,000.Theactualamount
spentwas$120,000:

Thedifferencebetweentheoriginalbudgetandtheactualamountspent
isthetotalvariance.Thisisstill$20,000unfavorable.The$5,000

differencebetweentheoriginalbudgetandtheflexiblebudgetisthe
volumevariance.Thisvolumevarianceisunfavorablebecausethe
flexiblebudgetrequiresmorespendingthanwasexpectedinthe
originalbudget.Theincreasednumberofstudentsmaybeconsideredto
begoodorbad,dependingontheattitudesofthepeopleinthetown.
Regardless,fromavariancereportingstandpoint,theconventionisto
considerincreasedspendingtobeunfavorable.Managersshouldguard
themselvesfromassumingthatunfavorablevariancesarealwaysbad
events.
Thedifferencebetweentheflexiblebudgetandtheactualamountspent
isreferredtoastheflexiblebudgetvariance.Itsimplyrepresentsall
othercauses,asidefromthevolumevariance.Inthiscasetheflexible
budgetvarianceis$15,000.Itisunfavorable,sinceactualspendingwas
$15,000morethantheflexiblebudget,whichistheexpectedspending
fortheactualnumberofstudentsenrolled.Iftheflexiblebudget
varianceandvolumevariancearecombined,wegetthetotalvariance
forthelineitem.Notethatifoneofthesevarianceswasfavorableand
theotherwasunfavorable,theywouldoffseteachother,likepositive
andnegativenumbers.
Notethatinpreparationforthenewschoolyear,Millbridgeordersmostofits
booksduringAugustofeachyear.Therearemanyotherlinesinthevariance
report,butwewillfocusonjustthelineitemfortextbooks.
23

FLEXIBLE BUDGET NOTATION

Atthispointintheanalysis,wedonotknowmuchabouttheflexible
budgetvariance.Itisacombinationofthepriceandquantityvariance.
Weneedtobeabletocalculateeachofthesetwovariances.Todothis
wewillintroducesomenotation.TheletterAisusedtorefertoan
actualamount.TheletterBisusedtorefertoabudgetedamount.The
letterPstandsforapriceorrate,andtheletterQstandsforaquantity.
Theletteriisusedtostandforaninputandtheletterotostandforan
outputorworkload.Inputsareresourcesconsumed.Thesecanbelabor
hours,orunitsofsupplies,oranyotherresourcetheorganizationpays
for.Outputsareameasureofthevolumeofgoodsorservicebeing
produced.Thesecanbethenumberofstudentsorthenumberofmeals

orthenumberofpatients.
Thenotationiscombinedtoformsixkeyvariables.Pistandsforthe
priceoftheinput,suchas$20pertextbook.Qostandsforthetotal
quantityofoutput,suchasthenumberofstudents.Qistandsforthe
quantityofinputneededtoproduceoneunitofoutput.Forexample,we
mightexpectthateachyeartheschoolwillbuy,onaverage,2.5
textbooksperpupil.TheletterBinfrontofotherlettersindicatesa
budgetedamount.TheletterAinfrontofotherlettersindicatesan
actualresult.Thedefinitionsofthenotationcanbeformalizedas
follows:
BPi:
budgetedpriceperunitofinput
BQi:
budgetedquantityofinputforeachunitofoutput
BQo:
budgetedquantityofoutput
APi:
actualpricepaidperunitofinput
AQi:
actualquantityofinputforeachunitofoutputproduced
AQo:
actualquantityofoutput
SupposethatfortheTownofMillbridgeHighSchool,thesesixitems
hadthefollowingvalues:
BPi:

$20pertextbook
BQi:
2.5textbooksperstudent
BQo:
2,000students
APi:
$22pertextbook
AQi:
2.5974textbooksperstudent
AQo:
2,100students
Tocalculatetheprice,quantity,andvolumevariances,itisnecessaryto
getthesesixpiecesofinformation.Thethreebudgeteditemsare
generallyavailablefromthedatathatwereusedinmakingtheoriginal
budget.Thethreeactualpiecesofinformationshouldbeavailablein
mostorganizations.Schoolsystemswillknowtheactualnumberof
students,theAQo.Also,ifyoubuybooks,youshouldhavearecordof
howmanybookswerepurchasedandhowmuchwaspaidforthem.
Theactualpricepaidforeachbookisnotneeded.Ifweknowhow
manybookswepurchasedandhowmuchwepaidintotalforbooks,we
candividethetotalcostforbooksbythenumberofbookstofindthe
averagepricepaidperbook,theAPi.Similarly,wedonotneedto
knowhowmanybooksweacquiredforeachstudent.Ifweknowhow
manybooksweactuallypurchasedandhowmanystudentsweactually
had,wecandividetofindtheactualnumberofbookspurchasedper
student,onaverage,theAQi.
Thefirststepinthesedataistocalculatetheoriginalbudgetintermsof

thenotation.Theoriginalbudgetissimplytheexpectednumberofnew
booksperstudent,multipliedbytheexpectedcostperbook,multiplied
bytheexpectednumberofstudents.Usingournotation,thiscanbe
shownasfollows:
OriginalBudget
BQiBPiBQo
2.5$202,000
$100,000
Thatis,BQi,thebudgetedquantityofinputperunitofoutput,is2.5
newbooksperstudent;BPi,thebudgetedpriceperbookis$20;and
BQo,thebudgetedquantityofstudents,is2,000.Thetotalbudgeted
amountfortextbooksis$100,000.
Thenextstepistofindtheflexiblebudget.Recallthattheflexible
budgetistheamountthatonewouldhaveexpectedtospendifthe
actualnumberofenrolledstudentshadbeenknowninadvance.
Therefore,leavetheBQiatthebudgeted2.5booksperstudent,and
leavetheBPiatthebudgeted$20perbook.Theonlychangeisfroma
BQoof2,000studentstoanewAQoof2,100students.Theflexible
budgetcanbecalculatedasfollows:
FlexibleBudget
BQiBPiAQo
2.5$202,100
$105,000
Thedifferencebetweentheoriginalbudgetandtheflexiblebudgetis
causedbyadifferenceinthenumberofstudents.Otherthanthat,the
calculationsarethesame.Theoriginallybudgetedamountof$100,000
canbecomparedwiththeflexiblebudgetamountof$105,000to
determinethevolumevarianceof$5,000U.Sincethenumberof
studentsishigherthanexpected,costwillbehigherthanexpected.This

willgiverisetoanunfavorablevariance.Thecomparisonbetweenthe
originalbudgetandtheflexiblebudgetcanbeshownasfollows:

Wecanalsocalculatetheflexiblebudgetvariancethatwefoundearlier,
bycomparingtheflexiblebudgettotheactualspending.Theactual
amountspentissimplytheproductofthenumberofbookspurchased
perstudent,thecostperbook,andthenumberofstudents,asfollows:
Actual
AQiAPiAQo
2.5974$222,100
$120,000
Notethattocalculatetheactualcost,theactualnumberofbooksper
student,theactualpriceperbook,andtheactualnumberofstudentsis
used.Alsonotethattheactualnumberofbooksperstudentisbasedon
theactualnumberofbooksacquiredintotal,dividedbytheactual
numberofstudents.Thedifferencebetweentheflexiblebudgetandthe
actualamountspentwasearlierdescribedastheflexiblebudget
variance:

Thevolumevarianceandtheflexiblebudgetvarianceadduptothe
totalvarianceforthelineitem,asshownearlier.Usingournotation,
thatwouldappearasfollows:

Tothispoint,wehavethesameinformationaswehadbeforewe
startedusingnotation.Now,however,wecangofurtherbydetermining
thepriceandquantityvariances.Inordertodeterminethesevariances,

itisnecessarytoderiveasubcategory.Thissubcategoryissimplya
devicetoallowforseparationoftheflexiblebudgetvarianceintotwo
pieces:thepricevarianceandthequantityvariance.Thesubcategoryis
definedastheactualquantityofinputperunitofoutput,multipliedby
thebudgetedpriceoftheinput,timestheactualoutputlevel.Intermsof
thenotation,thesubcategorycanbecalculatedasfollows:
Subcategory
AQiBPiAQo
2.5974$202,100
$109,091
Ifthesubcategorycalculationiscomparedwiththeactualcosts,the
pricevariancecanbedeterminedasfollows:

NotethattheactualandsubcategorycalculationsbothusetheAQiand
theAQo.Theonlydifferencebetweenthetwocalculationsisthatthe
actualusestheAPiwhereasthesubcategoryusestheBPi.Sincethe
priceistheonlyelementthatdiffers,itmustberesponsibleforthe
$10,909differencebetweenthetwocalculations.This$10,909variance
isbecausebookscost$22onaverage,insteadof$20asexpected.
Todeterminethequantityvariance,itisonlynecessarytocomparethe

subcategorywiththeflexiblebudget:

Incomparingthesubcategoryandtheflexiblebudgetcalculations,we
notethatbothusetheBPiandtheAQo.However,thesubcategoryuses
AQi,whereastheflexiblebudgetusesBQi.So,the$4,091difference
thatisobservedistheresultofthefactthatthenumberofbooks
purchasedperpupil,onaverage,differedfromtheexpectednumber.
Thus,wehaveaquantitydifference.Notethatthisquantitydifference
hasnothingtodowiththenumberofstudentsbutratherwiththe
numberofbooksperstudent.24
Reviewingthepriceandquantityvariances,wecanlookathowthey
togethercomprisetheflexiblebudgetvariance:

Noticethataddingthepricevarianceof$10,909Uandthequantity
varianceof$4,091Uresultsintheflexiblebudgetvariance.Recallthat
theflexiblebudgetvarianceandthevolumevarianceadduptothetotal
variance.Figure8A1showsthatthethreeindividualvariances
price,quantity,andvolumeadduptothetotalvariancefortheline
item.

FIGURE 8-A-1
Analysis Model

Flexible Budget Variance

Inthisexamplewehaveconstructedasubcategorythatusestheactualquantityof
inputsperunitofoutputandthebudgetedpriceofinputs.Thisisanarbitrary
convention.Wecouldhaveinsteadusedthebudgetedquantityofinputsperunitof
outputandtheactualpriceofinputs.Wewouldstillgenerateapriceandquantity
varianceifthisswitchwasmade.However,thereisaninteractioneffectofprice
andquantity,andtheanswersmayvaryslightlyifthealternativeapproachisused.
24

Recallthatwithoutflexiblebudgetvarianceanalysis,thetotalvariance
forthelineitemwouldbetheonlypieceofinformationavailablefor
analysis.Therewasanunfavorablevarianceof$20,000.Without
additionalinformation,thisvariancemightbeattributedtotheincrease
inthenumberofstudents.UsingFigure8A1,itispossibleto
determinethatofthistotalvariance,$5,000wascausedbytheincrease
inthenumberofstudents.However,$4,091wascausedbyanincrease
inthenumberofbooksperstudent,and$10,909wascausedbyeither
anincreaseinbookpricesorperhapsamovementtoacquiring
different,moreexpensivebooksthanhadbeenplanned.Wewould
certainlywanttoinvestigateboththequantityandpricevariancesto
determinemorespecificallywhytheyoccurredandwhetherany
remedialactionisnecessarytoavoidcostoverrunsinthefuture.
InconsideringFigure8A1,notethatthiscalculationwouldneedtobe
doneforeachlineitemforeachdepartment.Althoughthatmightseem
tobealargetaskinlargeorganizations,itisreadilyconvertedtoa
simplecomputerspreadsheetprogram.Thus,themajoreffortrequired
tocalculateprice,quantity,andvolumevariancesistoinputintothe

computerthesixbasicpiecesofinformationneededforeachlineitem
(i.e.,BQi,BPi,BQo,AQi,APi,andAQo).
Itisalsoimportanttorealizethattheprice,quantity,andvolume
variancesaremerelycomponentsofthetotalvarianceforanylineitem.
InFigure8A1,thetotalvarianceis$20,000.Notethatifwecompare
theactualamountspent,$120,000,withtheoriginalbudgetof$100,000
inthatfigure,thedifferenceisthe$20,000totalvariance.Aswetryto
understandwhythattotalamountwasincurred,thevariancehasbeen
dividedintocomponents.Notethatthepricevarianceof$10,909,plus
thequantityvarianceof$4,091plusthevolumevarianceof$5,000add
uptothetotalvariance.
Itsometimesisnotobviouswhetheravarianceisfavorableor
unfavorable.LookingatFigure8A1,aneasyruleofthumbisthatas
onemovesfromtherightsidetowardtheleft.largernumbersontheleft
indicateunfavorablevariances.Iftheflexiblebudgetamountislarger
thantheoriginallybudgetedamount,thevolumevarianceis
unfavorable.Ifthesubcategoryisgreaterthantheflexiblebudget,the
quantityvarianceisunfavorable.Thisistruebecauseasonemoves
fromtheoriginalbudgettowardtheleft,movementistowardtheactual
result.Iftheactualresultislargerthantheoriginalbudget,thenmore
wasspentthanbudgeted.Suchhigherspendingindicatesan
unfavorablevariance.
(FinancialManagementforPublic,Health,andNotforProfit
Organizations,3rdEdition.PearsonLearningSolutions14).
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