Budgets & Variances
Why budget
Budgets are among the most widely used tools for planning and controlling organisations. A budget is a quantitative expression, for a set time period, of a proposed future plan of action. It turns managers’ perspectives forward — to exploit opportunities and to anticipate problems. The budgeting cycle: (1) plan the performance of the organisation and its sub-units; (2) provide a frame of reference against which actual results are compared; (3) investigate variations from plan and take corrective action; (4) plan again with the feedback. The master budget coordinates all the individual budgets — operating decisions on acquiring and using resources, financing decisions on how to pay for them.
A variance is the difference between an actual result and a budgeted amount. A standard is a carefully predetermined amount, usually per unit. A static budget is based on one level of output and is not altered afterwards; a flexible budget is adjusted to the actual output, which lets managers compute a richer set of variances. A variance is favourable (F) if it increases operating income relative to budget and unfavourable (U) if it decreases it.
Webb Company — April 2007
Webb makes a jacket sold to clothing stores. Budgeted selling price 180; budgeted variable cost 99 per jacket (materials 60, direct manufacturing labour 16, variable manufacturing overhead 12, direct marketing labour 6, variable marketing overhead 5); budgeted fixed costs 710,000 (276,000 manufacturing, 434,000 marketing). The static budget assumed 12,000 jackets; 10,000 were actually made and sold.
| A | B | C | D | E | F | |
|---|---|---|---|---|---|---|
| 1 | Actual results | Flexible-budget variance | Flexible budget | Sales-volume variance | Static budget | |
| 2 | Units sold | 0 | 10,000 | (2,000) | ||
| 3 | Budgeted price / unit variable cost / fixed cost | |||||
| 4 | Revenues | 50,000 | 1,800,000 | (360,000) | 2,160,000 | |
| 5 | Variable costs | 130,000 | 990,000 | (198,000) | 1,188,000 | |
| 6 | Contribution margin | 730,000 | (80,000) | 810,000 | (162,000) | 972,000 |
| 7 | Fixed costs | (5,000) | 710,000 | 0 | 710,000 | |
| 8 | Operating income | 25,000 | (75,000) | 100,000 | (162,000) | 262,000 |
| 9 | Static-budget variance (Level 0) | (237,000) |
Reading the sheet: the static-budget variance of operating income is 237,000 U (Level 0). Level 1 splits it line by line against the static budget. Level 2 inserts the flexible budget at 10,000 units: the sales-volume variance (162,000 U) comes purely from selling 2,000 fewer jackets, while the flexible-budget variance (75,000 U) is what the operating managers can really be held to — revenue 50,000 F (price higher than budget), variable cost 130,000 U, fixed cost 5,000 F.
The five steps of a flexible budget
- Determine the budgeted selling price, unit variable cost and fixed costs.
- Determine the actual quantity of the revenue driver (10,000 jackets sold).
- Flexible-budget revenue = budgeted price × actual quantity = 180 × 10,000 = 1,800,000.
- Determine the actual quantity of the cost drivers (units produced and sold).
- Flexible-budget costs = budgeted unit variable cost × actual quantity + budgeted fixed cost = 990,000 + 710,000.