This variance analysis example and practice exercise use the flexible budget approach. A flexible budget is one that is created using budgeted revenue and/or budgeted cost amounts. A flexible budget is adjusted, or flexed, to the actual level of output achieved (or perhaps expected to be achieved) during the budget period. A flexible budget thus looks toward a range of activity or volume (versus only one level in the static budget).

Examples of how the variance analysis works are contained in Figure 18-1 (the elements), in Figure 18-2 (the composition), and in Figures 18-3 and 18-4 (the calculation). Study these examples before undertaking the Practice Exercise. We have restated Exhibit 18-2 in a worksheet format for purposes of this example. The new format appears as follows. (The numbers have not changed.)

Exhibit 18-2
Actual Cost	$920,000
Less: Flexible Budget	990,000
Price Variance (favorable)	$70,000
Budgeted Cost	$937,500
Less: Flexible Budget	990,000
Quantity Variance (unfavorable)	- $52,500
Net Variance (favorable)	$17,500

Assumptions (refer to Exhibit 18-2)

Practice Exercise 18-1: Variance Analysis

	Overhead Cost		# Therapy Minutes (Activity Level)	=	Cost per Therapy Minute
Actual	$920,000		330,000	=	(5) $2.79
Budgeted	$937,500		312,500	=	$3.00

Exhibit 18-2 presents the Variance Analysis for Hospital Systems Rehab Services for the third quarter. For our practice exercise we will duplicate this report for the fourth quarter. We are able to reformat the information in Exhibit 18-2 into a worksheet as follows. The fourth quarter assumptions appear below the worksheet.

Actual Cost
Less: Flexible Budget
Price Variance (favorable)
Budgeted Cost
Less: Flexible Budget
Quantity Variance (unfavorable)
Net Variance (unfavorable)

Assumptions

	Overhead Cost		# Therapy Minutes (Activity Level)	=	Cost per Therapy Minute
Actual	(1) $950,000		(3) 350,000	=	(5) $2.71
Budgeted	(2) $930,000		(4) 310,000	=	(6) $3.00

Required

Set up a worksheet for the fourth quarter like that shown in Exhibit 18-2 for the third quarter.

Insert the Fourth Quarter Input Data (per assumptions given above) on the worksheet. Complete the "Actual Cost," "Flexible Budget," and "Budgeted Cost" sections at the top of the worksheet. Compute the Price Variance and the Quantity Variance in the middle of the worksheet. Indicate whether the Price and the Quantity Variances are favorable or unfavorable for the fourth quarter.

Optional

Can you compute how the $950,000 actual overhead costs and the $930,000 budgeted overhead costs were calculated?

Solution to Practice Exercise 18-1

The required solution to Practice Exercise 18-1 is as follows:

The Price Variance is $100,000 (favorable).

The Quantity Variance is $120,000 (unfavorable).

The Net Variance is $20,000 (unfavorable).

Actual Cost	$950,000
Less: Flexible Budget	1,050,000
Price Variance (favorable)	$100,000
Budgeted Cost	$930,000
Less: Flexible Budget	1,050,000
Quantity Variance (unfavorable)	- $120,000
Net Variance (unfavorable)	- $20,000

Assumptions

	Overhead Cost		# Therapy Minutes (Activity Level)	=	Cost per Therapy Minute
Actual	$950,000		(3) 350,000	=	(5) $2.71
Budgeted	$930,000		(4) 310,000	=	$3.00

Optional Solution to Practice Exercise 18-1

The $950,000 actual overhead cost represents 350,000 therapy minutes times $2.71 per therapy minute.

The $930,000 budgeted overhead cost represents 310,000 therapy minutes times $3.00 per therapy minute.

Now it's Your Turn: Assignment Exercise 18-1: Variance Analysis

Greenview Hospital operated at 120 percent of normal capacity in two of its departments during the year. It operated 120 percent times 20,000 normal capacity direct labor nursing hours in routine services and it operated 120 percent times 20,000 normal capacity equipment hours in the laboratory. The lab allocates overhead by measuring minutes and hours the equipment is used; thus equipment hours.

Assumptions

For Routine Services Nursing:

20,000 hours 120% = 24,000 direct labor nursing hours.

Budgeted Overhead at 24,000 hours = $42,000 fixed plus $6,000 variable = $48,000 total.

Actual Overhead at 24,000 hours = $42,000 fixed plus $7,000 variable = $49,000 total.

Applied Overhead for 24,000 hours at $2.35 @ = $56,400.

For Laboratory:

20,000 hours 120% = 24,000 equipment hours.

Budgeted Overhead at 24,000 hours = $59,600 fixed plus $11,400 variable = $71,000 total.

Actual Overhead at 24,000 hours = $59,600 fixed plus $11,600 variable = $71,200 total.

Applied Overhead for 24,000 hours at $3.455 @ = $82,920.

Required

1. Set up a worksheet for Applied Overhead Costs and Volume Variance with a column for Routine Services Nursing and a second column for Laboratory.

2. Set up a worksheet for Actual Overhead Costs and Budget Variance with a column for Routine Services Nursing and a second column for Laboratory.

3. Set up a worksheet for Volume Variance and Budget Variance totaling Net Variance with a column for Routine Services Nursing and a second column for Laboratory.

4. Insert input data from Assumptions.

5. Complete computations for all three worksheets.