## Flexible Budget Variance

### Learning Outcomes

• Compute price and cost variances

A flexible budget allows volume differences to be removed from the analysis by using the same actual level of activity for both budget and actual, which would leave us with a portion of the budget variance resulting solely from price and cost differences.

Let’s assume actual results for the year were as follows:

GelSoft
Budget Performance Report
Actual Results Variance Static Budget
Units           180,000                         7,595         172,405
Sales Revenue $6,030,000 168,230$ 5,861,770
Variable Costs     3,420,000                   199,475     3,220,525
Contribution Margin     2,610,000                     (31,245)     2,641,245
Fixed Costs     2,650,000                   197,306     2,452,694
Operating Income $(40,000)Double line (228,551)$   188,551Double line

Management is unpleasantly surprised at this point. And remember that these results would probably not be available until February or even March of the following year if this analysis was only being done on an annual basis.

Sales volume was 7,595 more than planned, which is 4.4% more than the budgeted volume, but operating income came in at a loss.

Fixed costs were certainly higher than expected, but let’s break this down further by creating a flexible budget that would reflect our plan if we had known the exact volume—in other words, a new static budget based on 180,000 units:

GelSoft
Flexible Budget Performance Report
Actual Amounts per Unit Actual Results Flexible Budget Budgeted Amounts per Unit
Units           180,000           180,000
Sales Revenue $33.50$ 6,030,000 $6,120,000$ 34.00
Variable Costs $19.00 3,420,000 3,362,400$ 18.68
Contribution Margin 2,610,000 2,757,600
Fixed Costs 2,650,000 2,452,694
Operating Income $(40,000)Double line$    304,906Double line

If we had prepared the static budget based on all of our original assumptions except substituting 180,000 units for our original estimate of 172,405, we would have shown operating income of $304,906. No wonder management is upset. However, by re-calculating our static budget (now labeled as a flexible budget) we can see differences that arise solely due to cost and price differences: GelSoft Flexible Budget Performance Report Actual Amounts per Unit Actual Results Flexible Budget Variance Flexible Budget Budgeted Amounts per Unit Units 180,000 180,000 Sales Revenue$ 33.50 $6,030,000$    (90,000) $6,120,000$ 34.00
Variable Costs $19.00 3,420,000$      57,600 3,362,400 $18.68 Contribution Margin 2,610,000$   (147,600) 2,757,600
Fixed Costs 2,650,000   $197,306 2,452,694 Operating Income$  (40,000)Double line $(344,906)$    304,906Double line

Even though the company sold more units, the average price per unit came in at $33.50 instead of the planned$34.00, causing a decrease of $90,000 in total sales revenue simply due to an overall price decrease. It could be that additional sales promotions during the year increased sales volume but decreased average price. We call this an unfavorable variance and will identify it with the letter U. In addition, variable costs increased by$57,600 overall because of some slight increases in actual variable manufacturing costs. Even though that is a positive number in our calculation, it is an unfavorable variance because it hurt the bottom line. Same with fixed costs, which appear to be our main culprit here. It’s possible that during the year, since sales were robust, management chose to expand the selling, general, and administrative infrastructure (buying new equipment, doling out sales bonuses, etc.). The follow-up to this analysis would be to examine expense categories in more detail, using budget versus actual.

GelSoft
Flexible Budget Performance Report
Actual Amounts per Unit Actual Results Flexible Budget Variance F or U Flexible Budget Budgeted Amounts per Unit
Units           180,000           180,000
Sales Revenue $33.50$ 6,030,000 $(90,000) U$  6,120,000 $34.00 Variable Costs$ 19.00 3,420,000 $57,600 U 3,362,400$ 18.68
Contribution Margin 2,610,000 $(147,600) U 2,757,600 Fixed Costs 2,650,000$     197,306 U 2,452,694
Operating Income $(40,000)Double line$   (344,906) UDouble line $304,906Double line In summary, the combination of increased costs and a slight decrease in the sale price per unit combined to create an overall unfavorable budget variance of$344,906, even if we had known in advance that we would sell 180,000 units and had budgeted accordingly.

Before we look at the sales volume variance, check your understanding of the flexible (cost and price) budget variance.