What is the static budget variance of operating income

Health Care Finance

CHAPTER 17: VARIANCE ANALYSIS AND SENSITIVITY ANALYSIS

Budgets and Variance Analysis

• A variance is the difference between standard and actual prices and quantities.

• Flexible budgeting variance analysis provides a method to get more information about the composition of departmental expenses.

Variance Analysis

• This method subdivides variance into 3 types:

• Volume

• Use (or quantity)

• Spending (or price)

• Portion of the overall variance caused by a difference between the expected workload and the actual workload.

• Calculated as the difference between the total budgeted cost,* expected workload and the amount that would have been budgeted had the actual workload been known in advance.

* Defined as standard hours for actual production. Study text and illustration in the chapter.

Volume Variance Represents

• Use (or quantity) variance represents

• Portion of the overall variance caused by a difference between the budgeted and actual quantity of input needed per unit of output.

• 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.

Variance Analysis

Variance Analysis

• Spending (or price) variance represents

• Portion of the overall variance caused by a difference between the actual and expected price of an input.

• Calculated as the difference between the actual and budgeted unit price (or hourly rate) multiplied by the actual quantity of labor consumed (or supplies, etc.) per unit of output and by the actual output level.

Variance Analysis

• Can be performed as 2-variance or 3-variance analysis.

• 2-variance compares volume variance to budgeted costs*

• 3-variance compares volume variance, use variance, and spending variance.

* Defined as standard hours for actual production.

Variance Analysis: Example

• Our 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.

Variance Analysis: Example

• 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 shown in:

• Figure 17-1 (the elements) • Figure 17-2 (the composition) • Figures 17-3 and 17-4 (the calculation) • Study these examples before undertaking the

Practice Exercise.

Variance Analysis: Practice Exercise 17-I Solution

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

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

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

Variance Analysis: Practice Exercise 17-I Solution

Variance Analysis: Practice Exercise 17-I Solution

Variance Analysis: Assignment 17- 1 Solution

Worksheet 1

Applied Overhead Costs

Less: Budgeted Overhead Costs

Volume Variance (favorable)

Worksheet 2

Applied Overhead Costs

Less: Budgeted Overhead Costs at 24,000 hours

Budget Variance (unfavorable)

Worksheet 3

Volume Variance = favorable

Less: Budgeted Variance = unfavorable

Net Variance (favorable)

Routine Services

Nursing

$56,400

(48,000)

$8,400

Laboratory

$82,920

(71,000)

$11,920

$49,000

(48,000)

$1,000

$71,200

(71,000)

$200

$8,400

(1,000)

$7,400

$11,920

(200)

$11,720

Variance Analysis & Budgets

• Variance analysis can be applied to both flexible budgets and to static budgets.

• Definitions of both follow.

Flexible Budgets

• Are based on a level of operation that will change. In other words, the level of operations — or volume — is adjusted to show change during the budget period.

• The Hospital Rehab Services Example 1 and the Infusion Center Example 3 are both examples of flexible budget variance analysis.

Budget Types

• Are essentially based on a single level of operations. That level of operations — or volume — is never adjusted during the budget period.

• The Open Imaging Center Example 2 is an example of static budget variance analysis.

Sensitivity 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 no occur.

Sensitivity Analysis

• Forecasts should almost always be subjected to sensitivity analysis.

• Because a forecast views the future, and the future can never be absolutely predicted, forecasts will always contain a degree of uncertainty.

• So the “what-if” analyses become important to the manager’s decision-making.

Sensitivity Analysis

• A common example of sensitivity analysis is computing three levels of forecast revenue:

• Basic (planned & most likely)

• High (best case)

• Low (worst case)

• See the example in Figure 17-5.

Sensitivity Analysis: Assignment 17-2 Solution

50,000

100,000

150,000

200,000

250,000

1st Qtr 2nd Qtr 3rd Qtr 4th Qtr

Sensitivity Analysis Tools

• Manager’s tools involving sensitivity analysis include:

• Contribution margin & the contribution income statement

• Target operating income (using the contribution margin method)

• Finding the break-even point (using the contribution margin method)

Contribution Margin

• You will recall that the contribution margin is the difference between revenue and variable costs.

• The remaining difference is then available for fixed costs and operating income.

Contribution Margin Income Statement

The format appears as follows :

• Revenue $5,000

• Variable costs 3,000

• Contribution margin $2,000

• Fixed costs 1,200

• Operating income $ 800

Target Operating Income Using the Contribution Margin Method

• A target operating income computation allows the manager to determine how many units must be sold to yield a particular operating income

• Related discussion and illustration of the computation appears in the chapter.

Break-Even Point Using the Contribution Margin Method

• The break-even point is the point at which operating revenues and costs equal each other and operating income is zero.

• Related discussion and illustration of a break- even point computation using the contribution margin method appears in the chapter.

Target Operating Income: Practice Exercise 17-II Solution

• The required revenue to achieve a target operating income of $20,000 amounts to revenue of $75,000.

Target Operating Income: Assignment Exercise 17-3 Solution • The required revenue to achieve a target