Children’s Hospital of the King’s Daughters Health system in Norfolk, Virginia, introduced a new budgeting method that allowed the hospital’s annual plan to be updated for changes in operating plans. For example, if the budget was based on 400 patient-days (number of patients × number of days in hospital) and the actual count rose to 450 patient-days, the variable costs of staffing, lab work, and medication costs could be adjusted to reflect this changes. The budget manager stated, “I work with hospital directors to turn data into meaningful information and effect change before the month ends.”
(a) What budgeting methods are being used under the new approach?
(b) Why are these methods superior to the former approaches?

(a)   The hospital’s new budget method is clearly an example of a flexible budget. The budget changes with changes in underlying activity, such as patient-days. Patient-days are the number of patients multiplied by the number of days in the hospital. As the number of patient-days changes, it would be reasonable to expect that the hospital’s variable costs should also change. In addition, the last quote suggests that the new budget approach is a monthly continuous budget. The budget helps the managers plan month-by-month expenditures.

(b)   The advantage of a flexible budget is to accurately plan variable costs of the hospital with changes in the underlying activity base. Using a static budget would create actual deviations from budget that would be difficult to interpret. Managers would not be able to determine if the deviations were the result of cost (in)efficiencies or whether they were due to changes in activity level. A flexible budget causes the budget to “flex” with changes in underlying activity level so that any remaining actual deviations from budget can more clearly be identified with (in)efficiency or other special causes. The continuous budget also provides timely information to managers so that they can adjust actual spending patterns to the budgeted amounts.