Week 11: Flexible Budgets and

Performance Analysis
Chapter 10
FB2101 (2010/211 Sem B)

2010 The McGraw-Hill Companies, Inc.

 Learning Objective 1

Prepare a flexible
budget.

McGraw-Hill/Irwin Slide 2
 Characteristics of Flexible Budgets

Hmm! Comparing
static planning budgets
Planning budgets with actual costs
are prepared for is like comparing
a single, planned apples and oranges.
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
Larrys Lawn
Lawn Service
Service provides
provides lawn
lawn care
care inin aa planned
planned
community
community wherewhere allall lawns
lawns are
are approximately
approximately the the same
same size.
size.
At
At the
the end
end ofof 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 toto measure
measure overall
overall activity
activity for
for his
his business.
business.

Larrys Budget
McGraw-Hill/Irwin Slide 5
 Deficiencies of the Static Planning Budget
Larrys Planning Budget

McGraw-Hill/Irwin Slide 6
 Deficiencies of the Static Planning Budget
Larrys Actual Results

McGraw-Hill/Irwin Slide 7
 Deficiencies of the Static Planning Budget
Larrys Actual Results Compared with the Planning Budget

McGraw-Hill/Irwin 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.

McGraw-Hill/Irwin 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?

McGraw-Hill/Irwin Slide 10
 Deficiencies of the Static Planning Budget

I dont think I Actual activity is above

can answer the planned activity.
questions using
a static budget. So, shouldnt the variable
costs be higher if actual
activity is higher?

McGraw-Hill/Irwin Slide 11
 Deficiencies of the Static Planning Budget

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

To
To answer
answer the
the question,
question,
we
we must
must
the
the budget
budget toto the
the
actual
actual level
level of
of activity
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 b le
unchanged within the aria
V
relevant range. Fixed

McGraw-Hill/Irwin 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
What should
should thethe total
total wages
wages and
and salaries
salaries cost
cost
be
be in
in aa flexible
flexible budget
budget forfor 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.

McGraw-Hill/Irwin Slide 16
 Learning Objective 2

Prepare a report
showing activity
variances.

McGraw-Hill/Irwin Slide 17
 Activity Variances

Planning Flexible
budget revenues budget revenues
and expenses and expenses

The differences between

the budget amounts are
called activity variances.
McGraw-Hill/Irwin Slide 18
 Activity Variances

Lets use budgeting

concepts to compute activity
variances for Larrys Lawn Service.

McGraw-Hill/Irwin Slide 19
 Activity Variances
Larrys Flexible Budget Compared with the Planning Budget

McGraw-Hill/Irwin Slide 20
 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 21
 Learning Objective 3

Prepare a report
showing revenue and
spending variances.

McGraw-Hill/Irwin Slide 22
 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 23
 Revenue and Spending Variances

Now, lets use budgeting

concepts to compute revenue and
spending variances for Larrys Lawn
Service.

McGraw-Hill/Irwin Slide 24
 Revenue and Spending Variances
Larrys Flexible Budget Compared with the Actual Results
$1,750 favorable
revenue variance

McGraw-Hill/Irwin Slide 25
 Revenue and Spending Variances
Larrys Flexible Budget Compared with the Actual Results
Spending
variances

McGraw-Hill/Irwin Slide 26
 Learning Objective 4

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

McGraw-Hill/Irwin Slide 27
 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 28
 A Performance Report Combining Activity
and Revenue and Spending Variances

McGraw-Hill/Irwin Slide 29
 A Performance Report Combining Activity
and Revenue and Spending Variances

50
50 lawns
lawns $75
$75 per
per lawn
lawn 50
50 lawns
lawns $30
$30 per
per lawn
lawn

McGraw-Hill/Irwin Slide 30
 A Performance Report Combining Activity
and Revenue and Spending Variances

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

McGraw-Hill/Irwin Slide 31
 Learning Objective 5

Prepare a flexible
budget with more than
one cost driver.

McGraw-Hill/Irwin Slide 32
 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 33
 Flexible Budgets with Multiple Cost Drivers

Because
Because ofof the
the large
large unfavorable
unfavorable wages
wages and
and salaries
salaries spending
spending
variance,
variance, Larry
Larry decided
decided toto 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 toto 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

McGraw-Hill/Irwin Slide 34
 Flexible Budgets with Multiple Cost Drivers
Larrys Budget Based on More than One Cost Driver

McGraw-Hill/Irwin Slide 35
 Learning Objective 6

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

McGraw-Hill/Irwin Slide 36
 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.

McGraw-Hill/Irwin Slide 37
 Common Error 1: Assuming All Costs Are
Fixed
Faulty Analysis Comparing Budgeted Amounts to Actual Amounts

McGraw-Hill/Irwin Slide 38
 Common Error 2: Assuming All Costs Are
Variable
Faulty Analysis that Assumes All budget Items Are Variable

McGraw-Hill/Irwin Slide 39
 End of Chapter 10

McGraw-Hill/Irwin Slide 40