Question

University Inn's most recent monthly expense analysis report revealed significant cost overruns. The manager was asked to explain the deviations. Below is the "budget v. actual" expense report for the month in question.

University Inn Budget v. Actual Expense Report For the Month Ending October 31, 2007
	Actual (at 96% capacity)	Budget (established at 80% capacity)	Variance
Utilities	$ 52,000	$ 45,000	$ (7,000)
Laundry	20,000	18,000	(2,000)
Food service	41,000	35,000	(6,000)
Rent/taxes	60,000	60,000	-
Staff wages	57,000	55,000	(2,000)
Management salaries	43,500	45,000	1,500
Water	13,000	10,000	(3,000)
Maintenance	15,200	15,000	(200)
	$ 301,700	$ 283,000	$ (18,700)

The Inn has observed that utilities, water, food service, staff wages, and laundry costs all vary with activity. The other costs are fixed. The budget reflected above was based upon an assumed 80% occupancy rate. The university's football team was on a winning streak and numerous alumni were returning to campus in October, resulting in a 96% occupancy rate during the month.

Prepare a "flexible budget" based upon a 96% occupancy rate, and identify whether the Inn is being efficiently or inefficiently run. Comment on specific costs, and note why a flexible budget can improve performance evaluations.

An example of the first line of the budget is provided below:

	Actual	Budget	Variance
Utilities	$52,000	$54,000	$2,000 under budget
	Actual is already at 96% capacity	The budget was 45,000 assuming 80% capacity. To convert to 96% capacity: 54,000 divide by 0.8 = 56,2560 (representing 100% capacity) X > 0.96 = 54,000

Answer 1

Based on the information available in the question we can prepare a "Flexible budget" as follows:-

Step 1:- Classify costs into variable and fixed costs

Variable costs

Utilities

Laundry

Food service

Staff wages

Water

Fixed costs

Management salaries

Rent/taxes

Maintenance

Step 2:- Compute costs at 100% of capacity for variable costs

Variable costs	Costs(at 80% rate)	/	80%	Costs (100% occupancy rate)
Utilities	45,000	/	80%	56,250
Laundry	18,000	/	80%	22,500
Food service	35,000	/	80%	43,750
Staff wages	55,000	/	80%	68,750
Water	10,000	/	80%	12,500

Step 3:- Compute costs at 96% of capacity for variable costs

Variable costs	Costs (100% occupancy rate)	*	96%	Costs(96% occupancy rate)
Utilities	56,250	*	96%	54,000
Laundry	22,500	*	96%	21,600
Food service	43,750	*	96%	42,000
Staff wages	68,750	*	96%	66,000
Water	12,500	*	96%	12,000

Step 4:- Prepare the Actual vs Budget expense report:-

Particulars	Actual cost(96%)	Flexible budget(96%)	Variance
Variable costs
Utilities	52,000	54,000	$2,000 under budget
Laundry	20,000	21,600	$1,600 under budget
Food service	41,000	42,000	$1,000 under budget
Staff wages	57,000	66,000	$9,000 under budget
Water	13,000	12,000	$1,000 over budget
Fixed Costs
Management salaries	43,500	45,000	$1,500 under budget
Rent/taxes	60,000	60,000	No variance
Maintenance	15,200	15,000	$200 over budget

Total

3,01,700

3,15,600

$13,900 under budget

Based on the above information, we can observe that the total expenses for University Inn is below the budget. As such, we presume that University Inn is effeciently run as the actual costs incurred are lesser than the budgeted costs.

While utilities, laundry, food service, staff wages and Management salaries are all under the budgeted expenses, the management has done a reasonably good job to ensure that these expenses are kept under control. These are variable expenses and they are generally bound to change with the level of volume(occupancy in the case of University Inn).

However, Maintenance and water charges - the amounts incurred as part of these expenses are higher than the budgeted expenses. Management should focus to ensure that these expenses are also controlled so that it can reduce the inefficiencies with respect to these expenses.

Flexible budgets can help a company to improve performance evaluation because the variable costs are adjusted to the approximate level of activity. A company would be able to project/forecast the varying levels of profit or income based on the forecasts. This way, a business will be able to understand the level of activity that is required to achieve a targeted profit of the business. Since the fixed costs remain the same over the varying level of activities, flexible budget adjusts the budget based on the varying levels of input for the variable costs. The cost comparison at various level of activity is more appropriate in the case of Flexible budgets.

Please let me know if you have any questions via comments and all the best :)