Chapter 17 Notes

Overview

- 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

Volume 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.

Quantity Variance

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.

Price Variance

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

Sensitivity 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?

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.

Assume:

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.

Formula is:

N = Fixed Costs + Target Operating Income

Contribution Margin per Procedure

If the:

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

$40

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-