Planning Budget

EXHIBIT 9–1 Planning Budget


Note that the term revenue is used in the planning budget rather than sales. We use the term revenue throughout the chapter because some organizations have sources of revenue other than sales. For example, donations, as well as sales, are counted as revenue in nonprofit organizations.

Rick has identified eight major categories of costs—wages and salaries, hairstyling supplies, client gratuities, electricity, rent, liability insurance, employee health insurance, and miscellaneous. Client gratuities consist of flowers, candies, and glasses of champagne that Rick gives to his customers while they are in the salon.

Working with Victoria, Rick had already estimated a cost formula for each cost. For example, they determined that the cost formula for electricity should be $1,500 + $0.10 q, where q equals the number of client-visits. In other words, electricity is a mixed cost with a $1,500 fixed element and a $0.10 per client-visit variable element. Once the budgeted level of activity was set at 1,000 client-visits, it was easy to compute the budgeted amount for each line item in the budget. For example, using the cost formula, the budgeted cost for electricity was set at $1,600 (= $1,500 + $0.10 × 1,000).

At the end of March, Rick found that his actual profit was $21,230 as shown in the income statement in  Exhibit 9–2 . It is important to realize that the actual results are not determined by plugging the actual number of client-visits into the revenue and cost formulas. The formulas are simply estimates of what the revenues and costs should be for a given level of activity. What actually happens usually differs from what is supposed to happen.

EXHIBIT 9–2 Actual Results—Income Statement


Referring back to  Exhibit 9–1 , the budgeted net operating income was $16,800, so the actual profit was substantially higher than planned at the beginning of the month. This was, of course, good news, but Rick wanted to know more. Business was up by 10%—the salon had 1,100 client-visits instead of the budgeted 1,000 client-visits. Could this alone explain the higher net income? The answer is no. An increase in net operating income of 10% would have resulted in net operating income of only $18,480 (= 1.1 × $16,800), not the $21,230 actually earned during the month. What is responsible for this better outcome? Higher prices? Lower costs? Something else? Whatever the cause, Rick would like to know the answer and then hopefully repeat the same performance next month.

In an attempt to analyze what happened in March, Rick prepared the report comparing actual to budgeted costs that appears in  Exhibit 9–3 . Note that most of the variances in this report are labeled unfavorable (U) rather than favorable (F) even though net operating income was actually higher than expected. For example, wages and salaries show an unfavorable variance of $4,900because the budget called for wages and salaries of $102,000, whereas the actual wages and salaries expense was $106,900. The problem with the report, as Rick immediately realized, is that it compares revenues and costs at one level of activity (1,000 client-visits) to revenues and costs at a different level of activity (1,100 client-visits). This is like comparing apples to oranges. Because Rick had 100 more client-visits than expected, some of his costs should be higher than budgeted. From Rick’s standpoint, the increase in activity was good and should be counted as a favorable variance, but the increase in activity has an apparently negative impact on most of the costs in the report. Rick knew that something would have to be done to make the report more meaningful, but he was unsure of what to do. So he made an appointment to meet with Victoria Kho to discuss the next step.

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