204 Understanding the Numbers
estimated unit cost, the standard cost. Fixed costs remain the same, of course,
and are just inserted into the budget. The last column shows the actual rev-
enues and actual costs: To get them you multiply the actual selling or the actual
unit cost by the actual volume. The middle column shows the estimated selling
price and the estimated unit costs multiplied by the actual volume.
“Note that the only difference between the f lexible budget in column 2
and the static budget in column 1 lies in the volume being used. The static bud-
get uses the expected volume while the f lexible budget uses the actual volume.
In other words, the difference between f lexible and static may be attributed
entirely to changing activity levels. The difference is, therefore, dubbed an ac-
tivity variance.
“The unit price and cost terms for the actual revenues and costs in col-
umn 3 differ from the corresponding price and cost terms for the f lexible bud-
get in column 2; however, the activity level is the same: Both use the actual
level of sales. In other words, the difference between actual and f lexible may
be attributed to changing selling and cost prices. These differences are dubbed
the price variances.Let’s summarize the definitions of these terms.
“Now look what happens if all you have is the budget from the beginning of the
year. The variable costs, for which you are responsible, are $1,400 above bud-
get. You could reasonably expect to have your boss down here chewing you out
for not controlling your costs. But, if you know your standard costs, you can ad-
just the budget for volume and give him the number in the second column.
That comparison shows that you actually got your costs down by $900. Let me
show you what I mean in more depth.”
Price Variance Actual Results Flexible Budget
Activity Variance Flexible Budget Static BudgetPrice IndexActual Results
Flexible BudgetActivity Index =Flexible Budget
Static Budget=−
=−=EXHIBIT 7.1 Static versus f lexible budgets.
Budget (Static) Budget (Flexible) Actual
Volume in reams 1,000 1,200 1,200
Revenues $12,000 $14,400 $13,800
at $12/ream at $12/ream at $11.50/ream
Variable costs $7,000 $8,400 $7,500
at $7.00/ream at $7.00/ream at $6.25/ream
Fixed costs $4,000 $4,000 $4,680
Net income $1,000 $2,000 $1,620