Faulty Analysis Comparing Budgeted Amounts to Actual Amounts (Implicitly Assumes All Income Statement Items Are Fixed)
The other common error when comparing budgets to actual results is to assume that all costs are variable. A report that makes this error appears in Exhibit 9–10 . The variances in this report are computed by comparing actual results to the amounts in the second numerical column where all of the budget items have been inflated by 10%—the percentage by which activity increased. This is a perfectly valid adjustment to make if an item is strictly variable—like sales and hairstyling supplies. It is not a valid adjustment if the item contains any fixed element. Take, for example, rent. If the salon serves 10% more customers in a given month, would you expect the rent to increase by 10%? The answer is no. Ordinarily, the rent is fixed in advance and does not depend on the volume of business. Therefore, the amount shown in the second numerical column of $31,350 is incorrect, which leads to the erroneous favorable variance of $2,850. In fact, the actual rent paid was exactly equal to the budgeted rent, so there should be no variance at all on a valid report.