Flexible Budgets and

Performance Analysis
Chapter 11

Garrison, Noreen, Brewer, Cheng & Yuen

2012 McGraw-Hill Education (Asia)

Learning Objective 1

Prepare a flexible
budget.

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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.
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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.

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Slide 4

Deficiencies of the Static Planning Budget

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

Larrys Budget
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Slide 5

Deficiencies of the Static Planning Budget

Larrys Planning Budget

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Slide 6

Deficiencies of the Static Planning Budget

Larrys Actual Results

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Slide 7

Deficiencies of the Static Planning Budget

Larrys Actual Results Compared with the Planning Budget

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Slide 8

Deficiencies of the Static Planning Budget

Larrys Actual Results Compared with the Planning Budget
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.

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Slide 9

Deficiencies of the Static Planning Budget

Larrys Actual Results Compared with the Planning Budget

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?

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Slide 10

Deficiencies of the Static Planning Budget

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

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Actual activity is above

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

Garrison, Noreen, Brewer, Cheng & Yuen

Slide 11

Deficiencies of the Static Planning Budget

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

To
To answer
answer the
the question,
question,
we
we must
must
the
the budget
budget to
to the
the
actual
actual level
level of
of activity
activity..

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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.

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le
b
ria
a
V

Garrison, Noreen, Brewer, Cheng & Yuen

Fixed

Slide 13

How a Flexible Budget Works

Lets prepare a
budget
for Larrys Lawn
Service.

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Slide 14

Preparing a Flexible Budget

Larrys Flexible Budget

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Slide 15

Quick Check
What
What should
should the
the total
total wages
wages and
and salaries
salaries cost
cost
be
be in
in aa flexible
flexible budget
budget for
for 600
600 lawns?
lawns?
a.
a. $18,000
$18,000
b.
b. $20,000.
$20,000.
c.
c. $23,000.
$23,000.
d.
d. $25,000.
$25,000.

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Slide 16

Quick Check
What
be
total
total
wages
wages
and
salaries
salaries
cost
What should
should the
be the
the
the
total
total
wages
wages
andand
and
salaries
salaries
cost
cost
be
in
aaaflexible
flexible
budget
budget
for
for
600
600
lawns?
lawns?
cost
be
inin
in
aflexible
flexible
budget
budget
for
for
600
600
lawns?
lawns?
a.
a. $18,000
$18,000
b.
b. $20,000.
$20,000.
c.
c. $23,000.
$23,000.
d.
d. $25,000.
$25,000.
Total wages and salaries cost
= $5,000 + ($30 per lawn 600 lawns)
= $5,000 + $18,000 = $23,000
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Slide 17

Learning Objective 2

Prepare a report
showing activity
variances.

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Slide 18

Activity Variances

Planning
budget revenues
and expenses

Flexible
budget revenues
and expenses

The differences between

the budget amounts are
called activity variances.
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Slide 19

Activity Variances

Lets use

budgeting

concepts to compute activity

variances for Larrys Lawn Service.

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Slide 20

Activity Variances
Larrys Flexible Budget Compared with the Planning Budget

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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.

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Slide 22

Learning Objective 3

Prepare a report
showing revenue and
spending variances.

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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.

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Slide 24

Revenue and Spending Variances

Now, lets use

budgeting

concepts to compute revenue and

spending variances for Larrys Lawn
Service.

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Slide 25

Revenue and Spending Variances

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

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Slide 26

Revenue and Spending Variances

Larrys Flexible Budget Compared with the Actual Results
Spending
variances

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Slide 27

Learning Objective 4

Prepare a performance
report that combines
activity variances and
revenue and spending
variances.

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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.

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Slide 29

A Performance Report Combining Activity

and Revenue and Spending Variances

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Slide 30

A Performance Report Combining Activity

and Revenue and Spending Variances

50
50 lawns
lawns $75
$75 per
per lawn
lawn

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50
50 lawns
lawns $30
$30 per
per lawn
lawn

Garrison, Noreen, Brewer, Cheng & Yuen

Slide 31

A Performance Report Combining Activity

and Revenue and Spending Variances

$43,000
$43,000 actual
actual -- $41,250
$41,250 budget
budget

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Slide 32

Performance Reports in Non-Profit

Organizations
Non-profit organizations may
may receive
receive funding
funding from
from
sources other
other than the sale of goods and
and services,
services,
so
so revenues
revenues may
may consist
consist of
of both
both fixed
fixed and
and
variable
variable elements.
elements.

State funding

Donations

Tuition and fees

Endowments
Universities

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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.

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Slide 34

Learning Objective 5

Prepare a flexible
budget with more than
one cost driver.

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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.
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Slide 36

Flexible Budgets with Multiple Cost Drivers

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

Larrys New Budget

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Slide 37

Flexible Budgets with Multiple Cost Drivers

Larrys Budget Based on More than One Cost Driver

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Slide 38

Learning Objective 6

Understand common
errors made in
preparing performance
reports based on
budgets and actual
results.

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Slide 39

Some Common Errors

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

Assume all costs are fixed.

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Slide 40

Common Error 1: Assuming All Costs Are

Fixed
Faulty Analysis Comparing Budgeted Amounts to Actual Amounts

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Slide 41

Common Error 2: Assuming All Costs Are

Variable
Faulty Analysis that Assumes All budget Items Are Variable

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Slide 42

End of Chapter 11

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