Part V: Plan, Monitor and Control Financial Operations CHAPTER 13: BUDGETING AND VARIANCE ANALYSIS

an organization’s performance standards set out performance levels. Budget Types An organization’s objectives define specific activities; how they are assembled; and levels of operation while an organization’s performance standards set out performance levels. A budget quantifies these activities into financial terms.

Budget Types Static Budgets Are essentially based on a single level of operations. That level of operations — or volume — is never adjusted during the budget period. It doesn’t move - therefore it is “static”.

Budget Types 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. It is adjusted, or flexed - therefore it is “flexible”.

To review a budget, the manager needs to know Budget Review To review a budget, the manager needs to know How the budget report format is constructed More details are in the chapter.

To review a budget, the manager needs to know Budget Review To review a budget, the manager needs to know How to annualize partial year expenses More details are in the chapter.

Remember, building a budget means making a series of assumptions. Building Budgets The budget process should begin with a review of the strategy and objectives. Remember, building a budget means making a series of assumptions.

To build a budget, a manager must consider Building Budgets To build a budget, a manager must consider The workload forecast (it must tie into the forecasted volume) Whether budget projects will use resources during the budget period. Whether budget operations will be placed under unusual or inconvenient circumstances during the budget period (remodeling, for example). More details are in the chapter.

Budget: Example $21,600,000 22,000,000 $ (400,000) Revenue Expenses $ (400,000) Revenue Expenses Excess of Expenses over Revenue Step 1. Actual Step 2. Budgeted $24,000,000 22,400,000 $ 1,600,000 Revenue Expenses Excess of Revenue over Expenses $(2,400,000) (400,000) $(2,000,000) $24,000,000 22,400,000 $ 1,600,000 $21,600,000 22,000,000 $ (400,000) Revenue Expenses Excess of Expenses over Revenue Step 3. Actual Budgeted Static Budget Variance

Static Budget Variance Budget Exercise $17,550,000 4,400,000 $21,950,000 $16,100,000 4,000,000 $20,000,000 $ 1,850,000 Revenue – Inpatient Revenue – Outpatient Subtotal Expenses – Inpatient Expenses – Outpatient Excess of Expenses over Revenue Actual Step 1. $19,500,000 4,000,000 $23,500,000 $18,000,000 3,800,000 $21,800,000 $ 1,700,000 Revenue – Inpatient Revenue – Outpatient Subtotal Expenses – Inpatient Expenses – Outpatient Excess of Expenses over Revenue Budgeted Step 2. $(1,950,000) 400,000 $(1,550,000) $(1,900,000) 200,000 $(1,700,000) $ 150,000 $19,500,000 4,000,000 $23,500,000 $18,000,000 3,800,000 $21,800,000 $ 1,700,000 $17,550,000 4,400,000 $21,950,000 $16,100,000 $20,000,000 $ 1,850,000 Revenue – Inpatient Revenue – Outpatient Subtotal Expenses – Inpatient Expenses – Outpatient Excess of Expenses over Revenue Static Budget Variance Budgeted Actual Step 3.

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.

This method subdivides variance into Variance Analysis This method subdivides variance into 3 types: Volume Use (or quantity) Spending (or price)

Volume variance represents Variance Analysis Volume variance represents 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.

Use (or quantity) variance represents Variance Analysis 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. Study the text and illustrations in the chapter.

Spending (or price) variance represents Variance Analysis Spending (or price) variance represents Portion of the overall variance caused by a difference between the 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. Examine the text and illustrations in the chapter.

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. Study text and illustrations shown in the chapter.

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. 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 13-1 (the elements) Page 130 Figure 13-2 (the composition) Page 131 Figures 13-3 and 13-4 (the calculation) Page 131 Study these examples before undertaking the Practice Exercise.

Variance Analysis: Practice Solution #1 Actual Costs Flexible Budget Budgeted Costs (based on actual quantity) 687,000RVUs x $4.70 per RVU 687,000RVUs x $5.00per RVU 650,000 RVUs x $5.00per RVU =$3,228,900 = 3,435,000 = 3,250,000 Price Variance Quantity Variance 206,100 185,000 (favorable) (unfavorable)

Variance Analysis: Practice Solution #2 Worksheet 1 Applied Overhead Costs Less: Budgeted Overhead Costs Volume Variance (favorable) Worksheet 2 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 $1,000 $71,200 $200 (1,000) $7,400 (200) $11,720 Routine Services Nursing ________________________________________________ Laboratory ____________________________________