Flexible Budgets and

Performance Analysis
Chapter 10

McGrawHill/Irwin

Copyright2010byTheMcGrawHillCompanies,Inc.Allrightsreserved.

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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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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Deficiencies of the Static Planning Budget

Larrys Planning Budget

10-4

Deficiencies of the Static Planning Budget

Larrys Actual Results

10-5

Deficiencies of the Static Planning Budget

Larrys Actual Results Compared with the Planning Budget

10-6

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?

10-7

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..

10-8

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.

le
b
ria
a
V
Fixed

10-9

Preparing a Flexible Budget

Larrys Flexible Budget

10-10

Activity Variances

Planning
budget revenues
and expenses

Flexible
budget revenues
and expenses

The differences between

the budget amounts are
called activity variances.
10-11

Activity Variances
Larrys Flexible Budget Compared with the Planning Budget

10-12

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.

10-13

Revenue and Spending Variances

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

10-14

Revenue and Spending Variances

Larrys Flexible Budget Compared with the Actual Results
Spending
variances

10-15

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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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

10-17

Flexible Budgets with Multiple Cost Drivers

Larrys Budget Based on More than One Cost Driver

10-18

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.

10-19

Common Error 1: Assuming All Costs Are

Fixed
Faulty Analysis Comparing Budgeted Amounts to Actual Amounts

10-20

Common Error 2: Assuming All Costs Are

Variable

Faulty Analysis that Assumes All budget Items Are Variable

10-21

End of Chapter 10

10-22