Flexible Budgets andPerformance Analysis

Chapter 10

Slide 2

Characteristics of Flexible Budgets

Planning budgetsare prepared fora single, plannedlevel of activity.

Performance evaluation is difficult when actual activity

differs from the planned level of

activity.

Hmm! Comparingstatic planning budgets

with actual costsis like comparing

apples and oranges.

Slide 3

Improve performance evaluation.

May be prepared for any activity level in the relevant range.

Show costs that should have beenincurred at the actual level ofactivity, enabling “apples to apples”cost comparisons.

Help managers control costs.

Let’s look at Larry’s Lawn Service.

Characteristics of Flexible Budgets

Slide 4

Larry’s 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 onmowing 500 lawns. Since all of the lawns are similar in size,Larry felt that the number of lawns mowed in a month wouldbe the best way to measure overall activity for his business.

Larry’s 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 onmowing 500 lawns. Since all of the lawns are similar in size,Larry felt that the number of lawns mowed in a month wouldbe the best way to measure overall activity for his business.

Larry’s Budget

Deficiencies of the Static Planning Budget

Slide 5

Deficiencies of the Static Planning BudgetLarry’s Planning Budget

Slide 6

Deficiencies of the Static Planning BudgetLarry’s Actual Results

Slide 7

Deficiencies of the Static Planning BudgetLarry’s Actual Results Compared with the Planning Budget

Slide 8

Deficiencies of the Static Planning BudgetLarry’s Actual Results Compared with the Planning Budget

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

U = Unfavorable variance that occurs when actual costs are greater than budgeted costs.

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

Slide 9

Deficiencies of the Static Planning BudgetLarry’s Actual Results Compared with the Planning Budget

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

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

Slide 10

I don’t think Ican answer thequestions usinga static budget.

Actual activity is above planned activity.

So, shouldn’t the variablecosts be higher if actual

activity is higher?

Deficiencies of the Static Planning Budget

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 mustthe budget to theactual level of activity.

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 mustthe budget to theactual level of activity.

Deficiencies of the Static Planning Budget

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 remainunchanged within therelevant range. Fixed

Variable

Slide 13

Let’s prepare a budget

for Larry’s Lawn Service.

Let’s prepare a budget

for Larry’s Lawn Service.

How a Flexible Budget Works

Slide 14

Preparing a Flexible BudgetLarry’s Flexible Budget

Slide 15

Activity Variances

Planning budget revenues

and expenses

Flexible budget revenues

and expenses

The differences between The differences between the budget amounts are the budget amounts are called activity variances.called activity variances.

Slide 16

Let’s use budgeting

concepts to compute activity variances for Larry’s Lawn Service.

Let’s use budgeting

concepts to compute activity variances for Larry’s Lawn Service.

Activity Variances

Slide 17

Activity VariancesLarry’s Flexible Budget Compared with the Planning Budget

Slide 18

Activity VariancesLarry’s 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.

Slide 19

Learning Objective 3

Prepare a report Prepare a report showing revenue and showing revenue and spending variances.spending variances.

Slide 20

Revenue and Spending Variances

Flexible budget revenue Actual revenue

The difference is a revenue variance.The difference is a revenue variance.

Flexible budget cost Actual cost

The difference is a spending variance.The difference is a spending variance.

Slide 21

Now, let’s use budgeting

concepts to compute revenue and spending variances for Larry’s Lawn

Service.

Now, let’s use budgeting

concepts to compute revenue and spending variances for Larry’s Lawn

Service.

Revenue and Spending Variances

Slide 22

Revenue and Spending VariancesLarry’s Flexible Budget Compared with the Actual Results

$1,750 favorable$1,750 favorablerevenue variancerevenue variance

Slide 23

Larry’s Flexible Budget Compared with the Actual Results

Revenue and Spending Variances

Spending variances