Akmen Flexible Budget

Flexible Budgets and
Performance Analysis
Chapter 11
Garrison, Noreen, Brewer, Cheng & Yuen
2012 McGraw-Hill Education (Asia)
Learning Objective 1
Prepare a flexible budget.
McGraw-Hill Education (Asia)

McGraw-Hill/Irwin
Slide 2
Characteristics of Flexible Budgets

Hmm! Comparing
static planning budgets
with actual costs
is like comparing
apples and oranges.
Planning budgets
are prepared for
a single, planned
level of activity.
Performance
evaluation is difficult
when actual activity
differs from the
planned level of
activity.
McGraw-Hill/Irwin
Slide 3
Characteristics of Flexible Budgets

May be prepared for any activity
level in the relevant range.
Show costs that should have been
incurred at the actual level of
activity, enabling apples to apples
cost comparisons.
Help managers control costs.

Improve performance evaluation.
Lets look at Larrys Lawn Service.

McGraw-Hill/Irwin
Slide 4
Deficiencies of the Static Planning Budget

Larrys Lawn Service provides lawn care in a planned
community where all lawns are approximately the same size.
At the end of May, Larry prepared his June budget based on
mowing 500 lawns. Since all of the lawns are similar in size,
Larry felt that the number of lawns mowed in a month would
be the best way to measure overall activity for his business.
Larrys Budget
McGraw-Hill/Irwin
Slide 5

Larrys Planning Budget

McGraw-Hill/Irwin
Slide 6

Larrys Actual Results

McGraw-Hill/Irwin
Slide 7

Larrys Actual Results Compared with the Planning Budget

McGraw-Hill/Irwin
Slide 8

F = Favorable variance that occurs when actual
revenue is greater than budgeted revenue.
U = Unfavorable variance that occurs when

actual costs are greater than budgeted costs.
F = Favorable variance that occurs when
actual costs are less than budgeted costs.

McGraw-Hill/Irwin
Slide 9

Since these variances are unfavorable, has

Larry done a poor job controlling costs?
Since these variances are favorable, has
Larry done a good job controlling costs?

McGraw-Hill/Irwin
Slide 10

I dont think I
can answer the
questions using
a static budget.

McGraw-Hill/Irwin
Actual activity is above

planned activity.
So, shouldnt the variable
costs be higher if actual
activity is higher?
Slide 11

The relevant question is . . .
How much of the cost variances is due to higher
activity, and how much is due to cost control?
To answer the question,

we must
the budget to the
actual level of activity.

McGraw-Hill/Irwin
Slide 12
How a Flexible Budget Works
To
a budget we need to know that:
Total variable costs change

in direct proportion to
changes in activity.
Total fixed costs remain

unchanged within the
relevant range.

McGraw-Hill/Irwin
Fixed
Slide 13
How a Flexible Budget Works
Lets prepare a
budget
for Larrys Lawn
Service.

McGraw-Hill/Irwin
Slide 14
Preparing a Flexible Budget

Larrys Flexible Budget

McGraw-Hill/Irwin
Slide 15
Quick Check
What should the total wages and salaries cost
be in a flexible budget for 600 lawns?
a. $18,000
b. $20,000.
c. $23,000.
d. $25,000.

McGraw-Hill/Irwin
Slide 16
Quick Check
What should the
be the
totaltotal
wages
wages
andand
salaries
salaries
cost
costinina aflexible
be
flexiblebudget
budgetforfor600
600lawns?
lawns?
a. $18,000
b. $20,000.
c. $23,000.
d. $25,000.
Total wages and salaries cost
= $5,000 + ($30 per lawn 600 lawns)
= $5,000 + $18,000 = $23,000
McGraw-Hill/Irwin
Slide 17
Prepare a report showing

activity variances.

McGraw-Hill/Irwin
Slide 18
Activity Variances
Planning
budget revenues
and expenses
Flexible
budget revenues
and expenses
The differences between

the budget amounts are
called activity variances.
McGraw-Hill/Irwin
Slide 19
Activity Variances
Lets use
budgeting
concepts to compute activity

variances for Larrys Lawn Service.

McGraw-Hill/Irwin
Slide 20
Activity Variances
Larrys Flexible Budget Compared with the Planning Budget

McGraw-Hill/Irwin
Slide 21
Activity Variances
Larrys Flexible Budget Compared with the Planning Budget
Activity and revenue increase by 10 percent, but net operating income
increases by more than 10 percent due to the presence of fixed costs.

McGraw-Hill/Irwin
Slide 22
Prepare a report showing

revenue and spending
variances.

McGraw-Hill/Irwin
Slide 23
Revenue and Spending Variances

Flexible budget revenue
Actual revenue
The difference is a revenue variance.
Flexible budget cost
Actual cost
The difference is a spending variance.

McGraw-Hill/Irwin
Slide 24
Now, lets use
budgeting
concepts to compute revenue and

spending variances for Larrys Lawn
Service.

McGraw-Hill/Irwin
Slide 25

Larrys Flexible Budget Compared with the Actual Results
$1,750 favorable
revenue variance

McGraw-Hill/Irwin
Slide 26

Larrys Flexible Budget Compared with the Actual Results
Spending
variances

McGraw-Hill/Irwin
Slide 27
Prepare a performance
report that combines
activity variances and
revenue and spending
variances.

McGraw-Hill/Irwin
Slide 28
A Performance Report Combining Activity

and Revenue and Spending Variances
Now, lets use
budgeting
concepts to combine the revenue and

spending variances reports for Larrys
Lawn Service.

McGraw-Hill/Irwin
Slide 29


McGraw-Hill/Irwin
Slide 30

50 lawns $75 per lawn

McGraw-Hill/Irwin
50 lawns $30 per lawn
Slide 31

$43,000 actual - $41,250 budget

McGraw-Hill/Irwin
Slide 32
Performance Reports in Non-Profit

Organizations
Non-profit organizations may receive funding from
sources other than the sale of goods and services,
so revenues may consist of both fixed and
variable elements.
State funding
Donations
Tuition and fees
Endowments
Universities
McGraw-Hill/Irwin
Slide 33
Performance Reports in Cost Centers

Performance reports are often prepared
for cost centers. These reports should be
prepared using the same principles
discussed so far, except for the fact that
these reports will not contain revenue or
net operating income variances.

McGraw-Hill/Irwin
Slide 34
Prepare a flexible budget

with more than one cost
driver.

McGraw-Hill/Irwin
Slide 35
Flexible Budgets with Multiple Cost Drivers

More than one cost
driver may be needed to
adequately explain all of
the costs in an organization.
The cost formulas used
to prepare a flexible
budget can be adjusted
to recognize multiple
cost drivers.
McGraw-Hill/Irwin
Slide 36

Because of the large unfavorable wages and salaries spending
variance, Larry decided to add an additional cost driver for
wages and salaries. The variance is due primarily to the number
of hours required for the additional edging and trimming. So
Larry estimates the additional hours and builds those hours into
both his revenue and expense budget formulas.
Larrys New Budget

McGraw-Hill/Irwin
Slide 37

Larrys Budget Based on More than One Cost Driver

McGraw-Hill/Irwin
Slide 38
Understand common
errors made in preparing
performance reports
based on budgets and
actual results.

McGraw-Hill/Irwin
Slide 39
Some Common Errors

The most common errors in preparing performance
reports are to implicitly assume that:
1. All costs are fixed or that
2. All costs are variable.
Assume all costs are fixed.

McGraw-Hill/Irwin
Slide 40
Common Error 1: Assuming All Costs Are

Fixed
Faulty Analysis Comparing Budgeted Amounts to Actual Amounts

McGraw-Hill/Irwin
Slide 41
Common Error 2: Assuming All Costs Are

Variable
Faulty Analysis that Assumes All budget Items Are Variable

McGraw-Hill/Irwin
Slide 42
End of Chapter 11

McGraw-Hill/Irwin
Slide 43

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Flexible Budgets and

Garrison, Noreen, Brewer, Cheng & Yuen

2012 McGraw-Hill Education (Asia)

Prepare a flexible budget.

McGraw-Hill Education (Asia)

Garrison, Noreen, Brewer, Cheng & Yuen

Characteristics of Flexible Budgets

Garrison, Noreen, Brewer, Cheng & Yuen

Characteristics of Flexible Budgets

Help managers control costs.

Lets look at Larrys Lawn Service.

Garrison, Noreen, Brewer, Cheng & Yuen

Deficiencies of the Static Planning Budget

Garrison, Noreen, Brewer, Cheng & Yuen

Deficiencies of the Static Planning Budget

McGraw-Hill Education (Asia)

Garrison, Noreen, Brewer, Cheng & Yuen

Deficiencies of the Static Planning Budget

McGraw-Hill Education (Asia)

Garrison, Noreen, Brewer, Cheng & Yuen

Deficiencies of the Static Planning Budget

McGraw-Hill Education (Asia)

Garrison, Noreen, Brewer, Cheng & Yuen

Deficiencies of the Static Planning Budget

U = Unfavorable variance that occurs when

McGraw-Hill Education (Asia)

Garrison, Noreen, Brewer, Cheng & Yuen

Deficiencies of the Static Planning Budget

Since these variances are unfavorable, has

McGraw-Hill Education (Asia)

Garrison, Noreen, Brewer, Cheng & Yuen

Deficiencies of the Static Planning Budget

McGraw-Hill Education (Asia)

Actual activity is above

Garrison, Noreen, Brewer, Cheng & Yuen

Deficiencies of the Static Planning Budget

To answer the question,

McGraw-Hill Education (Asia)

Garrison, Noreen, Brewer, Cheng & Yuen

How a Flexible Budget Works

a budget we need to know that:

Total variable costs change

Total fixed costs remain

McGraw-Hill Education (Asia)

Garrison, Noreen, Brewer, Cheng & Yuen

How a Flexible Budget Works

McGraw-Hill Education (Asia)

Garrison, Noreen, Brewer, Cheng & Yuen

Preparing a Flexible Budget

McGraw-Hill Education (Asia)

Garrison, Noreen, Brewer, Cheng & Yuen

McGraw-Hill Education (Asia)

Garrison, Noreen, Brewer, Cheng & Yuen

Garrison, Noreen, Brewer, Cheng & Yuen

Prepare a report showing

McGraw-Hill Education (Asia)

Garrison, Noreen, Brewer, Cheng & Yuen

The differences between

Garrison, Noreen, Brewer, Cheng & Yuen

concepts to compute activity

McGraw-Hill Education (Asia)

Garrison, Noreen, Brewer, Cheng & Yuen

McGraw-Hill Education (Asia)

Garrison, Noreen, Brewer, Cheng & Yuen