The Flexible Budget

Chapter 9
Roadmap
 In Chapter 8 (i.e., last class), we examined
budgetary planning.
 Based on a sales forecast, we planned our production,
purchasing, human resource, selling and administrative,
and cash management activities for the upcoming period.
 In Chapter 9, we examine budgetary control.
 As we will see, our static planning budget is generally
inadequate for budgetary control
 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.
Budgetary Control
 A major function of management is to control
operations
 Managers analyze differences between actual and
planned results and determine causes.
 Provides management with feedback on operations
 Allows managers to update the assumptions used in their
planning models
 Reports can be prepared as frequently as needed.
Today, we’ll compare actual profit (i.e., the amount
realized at the end of the budget period) to the
budgeted profit from the profit plan.

Master budget Actual

profit profit

Total profit variance

We’ll discover that this comparison isn’t very

informative. So, we’ll introduce an extra step that
provides more information…
 The flexible budget is constructed using the CVP tools from
Chapter 5. Essentially, this chapter shows how CVP provides
useful information for control.

Master budget Profit in flexible Actual

profit budget profit

“Planning” or Flexible budget variance

“activity” variance

Total profit variance

Example: Larry’s Lawn Service
 Larry’s Lawn Service provides lawn care in a
planned community where all lawns are
approximately the same size.
 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.

 At the end of May, Larry prepared his June

budget based on mowing 500 lawns.
 At the end of June, Larry realized that he mowed
50 more lawns than expected.
 Deficiency of the Static Budget for
Budgetary Control
Larry’s Planning Budget - Built Using the Tools In Ch. 8
Larry's Lawn Service
For the Month Ended June 30

Revenue/Cost Planning
Formulas Budget
Number of lawns (Q) 500
Revenue ($75Q) $ 37,500
Expenses:
Wages and salaries ($5,000 + $30Q) $ 20,000
Gasoline and supplies ($9Q) 4,500
Equipment maintenance ($3Q) 1,500
Office and shop utilities ($1,000) 1,000
Office and shop rent ($2,000) 2,000
Equipment Depreciation ($2,500) 2,500
Insurance ($1,000) 1,000
Total expenses 32,500
Net operating income $ 5,000
 Deficiency of the Static Budget for
Budgetary Control Note: the actual results will NOT typically
obey the revenue/cost formulas that were
Larry’s Actual Results Compared with
usedthe Planning
for planning Budget
purposes.

Larry's Lawn Service

For example: $75 x 550 = $41, 250
For the Month Ended June 30

Revenue/Cost Planning Actual

Formulas Budget Results
Number of lawns (Q) 500 550
Revenue ($75Q) $ 37,500 $ 43,000
Expenses:
Wages and salaries ($5,000 + $30Q) $ 20,000 $ 23,500
Gasoline and supplies ($9Q) 4,500 5,100
Equipment maintenance ($3Q) 1,500 1,300
Office and shop utilities ($1,000) 1,000 950
Office and shop rent ($2,000) 2,000 2,000
Equipment Depreciation ($2,500) 2,500 2,500
Insurance ($1,000) 1,000 1,200
Total expenses 32,500 36,550
Net operating income $ 5,000 $ 6,450
 Deficiency of the Static Budget for
Budgetary Control

F = Favorable variance that occurs when actual

Larry's Lawn Service
For the Month Ended June 30
revenue is greater than budgeted revenue.
Revenue/Cost Planning Actual
Formulas Budget Results Variances
Number of lawns (Q) 500 550
Revenue ($75Q) $ 37,500 $ 43,000 $ 5,500 F
Expenses:
U = Unfavorable
Wages and salaries variance
($5,000 + $30Q)that occurs $when
$ 20,000 23,500 $ 3,500 U
actual
Gasoline costs are greater
and supplies ($9Q) than budgeted
4,500 costs.
5,100 600 U
Equipment maintenance ($3Q) 1,500 1,300 200 F
Office and shop utilities ($1,000) 1,000 950 50 F
Office and shop rent ($2,000) 2,000 2,000 -
F = Favorable
Equipment variance that occurs
Depreciation ($2,500) 2,500 when
2,500 -
Insurance ($1,000) 1,000 1,200 200 U
actual
Total expenses
costs are less than budgeted
32,500
costs.
36,550 4,050 U
Net operating income $ 5,000 $ 6,450 $ 1,450 F
 Deficiency of the Static Budget for
Budgetary Control

Larry's Lawn Service

For the Month Ended June 30

Revenue/Cost Planning Actual

Formulas Budget Results Variances
Number of lawns (Q) 500 550
Revenue ($75Q) $ 37,500 $ 43,000 $ 5,500 F
Since these variances are unfavorable, has
Expenses:
Wages and salaries ($5,000 + $30Q) $ 20,000 $ 23,500 $ 3,500 U
Larry done a good or a bad job controlling
Gasoline and supplies ($9Q) 4,500 5,100 600 U
Equipment maintenance ($3Q) costs? 1,500 1,300 200 F
Office and shop utilities ($1,000) 1,000 950 50 F
OfficeYou cannot
and shop rent answer
($2,000) this question
2,000 using a
2,000 -
Equipment Depreciation ($2,500) 2,500 2,500 -
Insurance
static
($1,000)
budget!! 1,000 1,200 200 U
Total expenses 32,500 36,550 4,050 U
Larryincome
Net operating mowed 50 more lawns $ than
5,000 expected
$ 6,450 $ 1,450 F
and some of his costs are variable!
 Learning Objective 3:

Introduce flexible budgets as a tool for

budgetary control
Characteristics of Flexible Budgets
 Flexible budgets use the same cost assumptions
and equations as the static budget
 Only difference: Flexible budget is adjusted for
different volume levels
 May be prepared for any activity level in the relevant range
 Shows costs that should have been incurred at the actual
level of activity, enabling “apples to apples” cost/revenue
comparisons

 Best analyzed using contribution margin format

 Variable costs change, fixed costs do not
 Basically, apply the CVP model from Chapter 5
Characteristics of Flexible Budgets
 Flexible budgets can be prepared for each type
of budget in the master budget
 However, we will focus on the budgeted income statement
(i.e., “profit plan”)

 Helps managers control costs

 Facilitates performance evaluation
 For example, the manager of a cost center should
not be penalized for an increase in total variable
costs if the increase in total variable costs is
attributable to an increase in sales.
Practice: Flexible budget preparation
EXERCISE 9-1 Prepare a Flexible Budget [LO1]

Gator Divers is a company that provides diving services such as underwater ship
repairs to clients in the Tampa Bay area. The company's planning budget for
March appears below:

Required:

During March, the company's activity was actually 190 diving-hours. Prepare a flexible budget
for that level of activity.
 During March, the company’s activity was actually 190 diving-hours. Complete the flexible
budget for that level of activity. (Input all amounts as positive values. Omit the "$" sign in
Solution your response.)

Gator Divers
Flexible Budget
For the Month Ended March 31
Revenue 72,200
$
Expenses:
Wages and salaries 36,700

Supplies 950

Equipment rental 7,440

Insurance 4,200

Miscellaneous 825

Total expense 50,115

Net operating income 22,085

$

Explanation:
Revenue ($380.00 × 190) = $72,200
Wages and salaries ($12,000 + ($130.00 × 190)) = $36,700
Supplies ($5.00 × 190) = $950
Equipment rental ($2,500 + ($26.00 × 190)) = $7,440
Miscellaneous ($540 + ($1.50 × 190)) = $825
Decomposing Total Variance:
Activity Variances & Flexible Budget Variances
 The difference between the planning (static)
budget and the flexible budget is called an
“activity variance” or a “planning variance.”
 The difference between the flexible budget and
actual results is called a flexible budget variance.
 For the profit plan (i.e., the budgeted income statement),
there are two types of flexible budget variances:
 Revenue variances
 Spending variances
Budgeted and Actual Results
Profit Line (per
CVP model)
Profit or Loss ($)

Budgeted Profit
Profit Variance

Actual Profit
0
Volume of Activity

Budgeted Actual
volume volume

(Fixed Cost)
 Activity Variance
Profit ($)
Flexibl Master
Activity Actual Profit Line (per
e Budget
Variance Profit
+
Budget Profit CVP relation)
Flexible B
Profit
Budget
Variance A
=
Total
Profit ($)

Profit C
Variance
0
Volume of
Activity
Budgeted Actual
volume volume

(Fixed Costs)

Volume of Activity
 A Performance Report Combining Activity
and Revenue/Spending Variances
Larry's Lawn Service
Flexible Budget Performance Report
For the Month Ended June 30

Revenue and
Revenue/Cost Planning Activity Flexible Spending Actual
Formulas Budget Variances Budget Variances Results
Number of lawns (Q) 500 50 550 550
Revenue ($75Q) $ 37,500 $ 3,750 F $ 41,250 $ 1,750 F $ 43,000
Expenses:
Wages and salaries ($5,000 + $30Q) $ 20,000 $ 1,500 U $ 21,500 $ 2,000 U $ 23,500
Gasoline and supplies ($9Q) 4,500 450 U 4,950 150 U 5,100
Equipment maintenance ($3Q) 1,500 150 U 1,650 350 F 1,300
Office and shop utilities ($1,000) 1,000 - 1,000 50 F 950
Office and shop rent ($2,000) 2,000 - 2,000 - 2,000
Equipment Depreciation ($2,500) 2,500 - 2,500 - 2,500
Insurance ($1,000) 1,000 - 1,000 200 U 1,200
Total expenses 32,500 2,100 U 34,600 1,950 U 36,550
Net operating income $ 5,000 $ 1,650 F $ 6,650 $ 200 U $ 6,450
Practice: Activity variance vs. Revenue/Spending variance
EXERCISE 9–4 Prepare a Flexible Budget Performance Report [LO4]

Mt. Hood Air offers scenic overflights of Mt. Hood and the Columbia River
gorge. Data concerning the company's operations in August appear below:

The company measures its activity in terms of flights. Customers can buy individual tickets for
overflights or hire an entire plane for an overflight at a discount.

Required:

1. Prepare a flexible budget performance report for August.

2. Which of the variances should be of concern to management? Explain.
 Solution

Mt. Hood Air

Flexible Budget Performance Report
For the Month Ended August 31
Revenue
and
Planning Activity Flexible Spending
Budget Variances Budget Variances Actual Results
Flights (q) 50 52 52
Revenue ($360.00q) $ 18,000 $ 720 F $ 18,720 $ 1,740 U $ 16,980

Expenses:
Wages and salaries ($3,800 + $92.00q) 8,400 184 U 8,584 44 F 8,540
Fuel ($34.00q) 1,700 68 U 1,768 162 U 1,930
Airport fees ($870 + $35.00q) 2,620 70 U 2,690 0 None 2,690
Aircraft depreciation ($11.00q) 550 22 U 572 0 None 572
Office expenses ($230 + $1.00q) 280 2 U 282 168 U 450

Total expense 13,550 346 U 13,896 286 U 14,182

Net operating income $ 4,450 $ 374 F $ 4,824 $ 2,026 U $ 2,798

 Learning Objective 4:

Prepare a flexible budget with more than

one cost driver.
Flexible Budgets with Multiple Cost Drivers
 Thus far, we’ve relied on very simple cost-equations
when constructing our flexible budget.
 We’ve assumed that only one activity - the number of
lawns mowed in a month – drives costs
 However, we can build budgets using more
complicated (and accurate) cost-equations.
 Some companies use Activity-Based-Budgeting (ABB),
which allows non-volume drivers to be incorporated into
the budgetary process
 ABB is beyond the scope of this course. However, we will
construct flexible budgets with > 1 volume-based activity
measure.
 Flexible Budgets with Multiple Cost Drivers

Imagine
Imagine that
that not
not all
all of
of Larry’s
Larry’s jobs
jobs take
take the
the same
same amount
amount of
of time
time
to
to complete.
complete. Some
Some jobsjobs require
require time
time for
for 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.
Flexible Budgets with Multiple Cost Drivers
Larry’s Budget Based on More than One Cost Driver
Larry's Lawn Service
For the Month Ended June 30

Revenue/Cost Flexible
Formulas Budget
Number of lawns (Q) 550
Number of hours (H) 100
Revenues ($75Q + $30H) $ 44,250
Expenses:
Wages and salaries ($5,000 + $30Q + $25H) $ 24,000
Gasoline and supplies ($9Q) 4,950
Equipment maintenance ($3Q) 1,650
Office and shop utilities ($1,000) 1,000
Office and shop rent ($2,000) 2,000
Equipment Depreciation ($2,500) 2,500
Insurance ($1,000) 1,000
Total expenses 37,100
Net operating income $ 7,150
Practice: Activity variance vs. Revenue/Spending variance
PROBLEM 9–20 Activity and Spending Variances [LO1, LO2, LO3]

You have just been hired by SecuriDoor Corporation, the manufacturer of a revolutionary new
garage door opening device. The president has asked that you review the company's costing
system and “do what you can to help us get better control of our manufacturing overhead
costs.” You find that the company has never used a flexible budget, and you suggest that
preparing such a budget would be an excellent first step in overhead planning and control.

After much effort and analysis, you determined the following cost formulas and gathered the following
actual cost data for April:

p. 411

During April, the company worked 18,000 machine-hours and produced 12,000 units. The company had
originally planned to work 20,000 machine-hours during April.

Required:

1. Prepare a report showing the activity variances for April. Explain what these variances mean.
2. Prepare a report showing the spending variances for April. Explain what these variances mean.
 Solution: Problem 9-20
SecuriDoor Corporation
Activity & Revenue/Spending Variances
For the Month Ended April 30
Activity Revenue and
Planning Budget Flexible Budget Actual Results
Variances Spending Variances
Machine-hours (q ) 20,000 18,000 18,000

Utilities ($16,500 + $0.15q ) $ 19,500 $ 300 F $ 19,200 $ 2,100 U $ 21,300

Maintenance ($38,600 + $1.80q ) 74,600 3,600 F 71,000 2,600 F 68,400
Supplies ($0.50q ) 10,000 1,000 F 9,000 800 U 9,800
Indirect labor ($94,300 + $1.20q ) 118,300 2,400 F 115,900 3,300 U 119,200
Depreciation ($68,000) 68,000 0 None 68,000 1,700 U 69,700

Total $ 290,400 $ 7,300 F $ 283,100 $ 5,300 U $ 288,400