Flexible Budgets and

Performance Analysis
 Learning Objectives
• Prepare a flexible budget
• Explain the advantages of the flexible budget over
the planning (static) budget
• Use the flexible budget approach to prepare
performance reports and analyze variances
• Understand common errors in preparing
performance reports
Planning Budgets and Performance Evaluation

• The Budgets we studied previously are static in

nature: based on a single, planned level of activity.
• Performance evaluation using planning budgets is
useless.
Hmm! Comparing
actual revenue and costs
with planning budgets is
like comparing
apples and oranges.
Planning Budgets and Performance Evaluation
Planning Budgets and Performance Evaluation
 Planning Budgets and Performance Evaluation
U = Unfavorable variance
Actual revenue is less than budgeted revenue.
 Planning Budgets and Performance Evaluation

F = Favorable variance
Actual costs are less than budgeted costs.

U = Unfavorable variance
Actual costs are more than budgeted costs.
Planning Budgets and Performance Evaluation

Since most cost variances and income variance are

favorable, have we done a good job?
Planning Budgets and Performance Evaluation

I don’t think I Actual activity is below

can answer the budgeted activity.
question using
a planning budget. So, shouldn’t revenue and costs
be lower if actual activity
is lower?
 Planning Budgets and Performance Evaluation

• The relevant question is . . .

– “How much of the variance is due to lower activity, and
how much is due to good (or poor) performance?”
• To answer the question,
we must FLEX
the budget to the
actual level of activity.
 Preparing a Flexible Budget
• To prepare a flexible budget, we must:
– choose the activity base(s) and determine the relevant
range
– know how revenue and costs behave within the relevant
range in response to changes in activity
– Recall that costs are classified as either variable or fixed
• variable costs change in
total in direct proportion
to changes in activity b le
ria
• fixed costs remain V a
unchanged in total within Fixed
the relevant range
Flexible Budgets and Performance Evaluation
 ABC and Flexible Budget
• Companies that use ABC system also use flexible
budgets.
• The difference between a company that uses ABC
and one that does not lies in the number of flexible
budgets that are prepared.
• In particular, with ABC a flexible budget is prepared
for each activity center.
 Flexible Budgets and Performance Evaluation

• Remember the question: “How much of the

total variance (of $9,450 favorable income
variance) is due to lower activity and how
much is due to good or poor control?”
Flexible Budgets and Performance Evaluation

Variance Analysis

Let’s place the

flexible budget
for 8,000 Cards
here.

Difference between original planning budget

operating income and actual results = $9,450 F.
Flexible Budgets and Performance Evaluation

Variance Analysis

Activity Control

This $18,000 U income variance is This $27,450 F income variance

due to lower activity. is due to good/poor control
Flexible Budgets and Performance Evaluation
These differences are
called revenue and
These differences are spending variance.
called activity variances.
 Common Errors in Preparing Performance
Reports
1. Comparing planning budget amounts to actual
amounts
– Assumes all revenue and costs are fixed
2. Adjusting all amounts on planning budgets
proportionately and comparing them to actual
amounts
– Assumes all revenue and costs are variable