Chapter 17 Notes
- Understand the three types of flexible budget variance
- Perform budget variance
- Compute a contribution margin
- Perform Sensitivity analysis
Variance Analysis and Sensitivity Analysis
Variance Analysis Overview
A variance is, basically, the difference between standard and actual expenses and revenue. Variance analysis analyzes these differences. The following discussion assumes a flexible budget. Flexible budgeting provides a method to get more information about the composition of departmental expenses.
Three Types of Flexible Budget Variance
The volume variance is the portion of the overall variance caused by a difference between the expected workload and the actual workload and is calculated as the difference between the total budgeted cost based on a predetermined, expected workload level and the amount that would have been budgeted had the actual workload been know in advance.
The quantity or use variance is the portion of the overall variance that is caused by a difference between the budgeted and actual quantity of input needed per unit of output, and is calculated as the difference between the actual quantity of inputs used per unit of output multiplied by the actual output level and the budgeted unit price.
Also known as the spending variance. This variance is the portion of the overall variance caused by a difference between the actual and expected price of an input and is calculated as the difference between the actual and budgeted unit price or hourly rate, multiplied by the actual quantity of goods, or labor, consumed per unit of output and by the actual output level.
Review Table 17 – 1 for Static Budget Variance Analysis
Review Table 17 – 2 for Flexible Budget Variance Analysis
Is a “what if” proposition. It answers questions about what may happen if major assumptions change or if certain predicted events do not occur. The “what if” feature allows the manager to plan for a variety of possibilities in different scenarios. It looks at different scenarios within the budgeting process.
Forecasts should always be subjected to sensitivity analysis. Because forecasts always contain a degree of uncertainty, they should be subjected to what if scenarios. What will Radiology operating income be If the department’s revenue is ten percent higher than expected?
Sensitivity Analysis Tools
Two Sensitivity tools are Contribution Margin and Contribution Income Statement. The Contribution Income statement specifically identifies the contribution margin within the income statement format. The Contribution Margin is the difference between revenue and variable costs. The remaining difference is available for fixed costs and operating income. See example on Page 200.
100 procedures completed at $50 per procedure = $5,000 revenue
Variable costs amount to $30 per procedure = $3,000
Contribution Margin equals $2,000 ($5,000-$3,000)
Fixed costs = $1,200
Operating Income would then equal $800.
Target Operating Income Using the Contribution Margin Method
This allows the manager to determine how many procedures must be completed in order to yield a particular operating income.
N = Fixed Costs + Target Operating Income
Contribution Margin per Procedure
Desired operating income is $1,600
Procedure Price for Revenue is $100
Variable cost per unit is $60
Total fixed cost is $2,000, then
N = $2,000 + $1,600 = 90 Units
Therefore, it would take a target of 90 procedures to produce operating income of $1,600. This can be proven as follows:
Revenue at $100 per unit x 90 units = $9,000
Variable Costs $60 per unit x 90 units = $5,400
Contribution Margin $3,600
Fixed Costs 2,000
Target Operating Income $1,600
Breakeven Point Using the Contribution Margin Method
If we remember that the breakeven point is when operating revenues equal costs and operating income is zero. This can be easily arrived at by using sensitivity analysis as follows:
Calculate Breakeven point by number of units
Break-Even Number of Units = Fixed Costs/Contribution Margin per Unit
Break-Even Number of Units = $2,000/$40 = 50 Units
Contribution Income Statement will be as follows:
Revenue at $100 per unit x 50 units = $5,000
Variable Costs $60 per unit x 50 units = $3,000
Contribution Margin $2,000
Fixed Costs 2,000
Operating Income at Breakeven $ -0-