Static and flexible budgets: what changed with the work?

An overrun can include the cost of doing more work as well as spending above the allowance for that work. A flexible budget separates them by applying the original budget rules to the activity actually completed.

Keep the original plan

Consider an invented service operation planning 1,000 standard jobs for one month. Its budget allows $6 of variable operating cost per job and $4,000 of fixed operating costs. The original total is $10,000: $6,000 plus $4,000.

One job means the same completed service throughout this comparison. The planned and actual work have the same mix, scope and service standard. The existing operation can handle 900–1,300 jobs within its available staffing and equipment; the budget model holds its $6 rate and $4,000 fixed allowance across that range.

These are the operating cost categories included in the illustration, including management pay. Financing, income tax and equipment purchases are outside it. All actual costs shown are incurred and paid in the month, with no inventory or unpaid-balance changes.

The operation actually completes 1,200 jobs. Its variable spending is $7,500 and fixed spending is $4,100, totaling $11,600. That is $1,600 above the original $10,000 plan.

The original plan still shows what was expected. Add another comparison to examine spending at the output achieved.

Apply the budget rules to actual work

Using the original $6 rate, 1,200 jobs carry a variable-cost allowance of $7,200. Add the same $4,000 fixed allowance. The flexible budget at actual output is $11,200.

The OpenStax flexible-budget explanation distinguishes this activity-adjusted comparison from a static budget set for one output level. Here, only the job count changes. The budgeted rate and fixed allowance stay where they were.

Original monthly plan, allowance at actual output and actual spending

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The $1,600 difference now has two parts. An additional $1,200 is allowed for the 200 extra jobs at $6 each. Another $400 is actual spending above the allowance for 1,200 jobs. Together, $1,200 plus $400 reconciles to the original $1,600 overrun.

Within the $400, variable spending is $300 above its $7,200 allowance and fixed spending is $100 above its $4,000 allowance. Calling the entire $1,600 a spending variance would mix the extra activity with spending above the original cost rules.

The difference does not explain itself

The report has located the $400. It has not established its cause. Higher input prices, extra resources used on the same work or an unsuitable original allowance could produce differences requiring different responses. The total alone cannot distinguish them.

OpenStax's discussion of standard costs separates expected prices from expected quantities used and calls for investigating differences from actual results. In this example, the next record to examine is the breakdown behind the $300 variable difference and the item behind the extra $100 fixed spending.

The flexible allowance is not a record of approval for the additional work or spending. Keep the approved plan, the calculation at actual activity and any later approval distinct. Replacing the old $10,000 with $11,200 and presenting it as the original plan would erase the forecast difference.

The same overrun, two input records

The $300 variable-cost difference could come from a higher price, greater input use or both. Suppose the invented operation has this input allowance: its entire $6 variable allowance is for two liters of one consumable per standard job at $3 per liter. For 1,200 completed jobs, the allowance is therefore 2,400 liters costing $7,200.

All material is purchased, used and paid for in the month, with no opening or closing material stock. The service standard and all other model conditions remain unchanged. These are additional hypothetical records for understanding the report, not findings about why its actual costs rose.

One possible record shows 2,500 liters used at $3 each, costing $7,500. The price matches the budget. Use is 100 liters above the allowance for the completed work; at $3 each, that accounts for the entire $300.

Another possible record shows 2,400 liters used at $3.125 each, also costing $7,500. Use matches the allowance. The extra $0.125 paid on each of 2,400 liters accounts for the same $300. The total cost report cannot tell these records apart.

The Scottish Qualifications Authority's variance formula sheet distinguishes material price and material usage variances. For this comparison, express amounts above the allowance as positive dollars:

• Price difference: actual quantity multiplied by the difference between actual and budgeted price.
• Usage difference: actual quantity minus the allowance for completed output, multiplied by the budgeted price.

Now supply a third record: 2,500 liters at $3.125. Actual cost is $7,812.50, or $612.50 above the $7,200 allowance. This replaces the earlier $7,500 variable-spending assumption; it is not another explanation of a $300 total.

The price part is 2,500 × $0.125 = $312.50. The usage part is 100 × $3 = $300. Together they reconcile to $612.50. Applying the price increase only to the budgeted 2,400 liters would miss $12.50 paid on the extra 100 liters.

Those calculations locate differences in the supplied records. They do not establish waste, poor purchasing or a sensible allowance. Check the quantities, unit prices, work completed and service requirements before assigning a cause. A lower input price could also change the quantity needed; a separate price and usage calculation does not establish that purchasing and operations could control them separately.

Try a different actual total

Keep the 1,200 completed jobs and all the original budget assumptions. Change actual spending to $10,800. Is that above the original plan? Is it above the allowance for the work completed?

It is $800 above the original $10,000 but $400 below the flexible $11,200. The bridge is an extra $1,200 allowed for activity, less $400 of spending against that allowance. Spending less than the allowance does not, by itself, establish that the operation improved.

In an actual report, verify the service standard and cost scope before interpreting the lower total. An omitted cost or unfinished job would change the comparison. If a volume crosses into another staffing or equipment requirement, the fixed-cost rule needs examination too; the next-customer example follows that step.

A readable budget report keeps three figures: what was planned, what the original cost model allows at actual activity and what was actually spent. Then investigate the remaining difference. For the book's wider operating decisions, read the opening of Infinite Upside: Building Wealth With Room to Live.