Flexible Budgets and

Performance Analysis
Chapter 9

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
 9-2

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.
 9-3

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.

Let’s look at Larry’s Lawn Service.
 9-4

Deficiencies of the Static Planning

Budget
Larry’s
Larry’s Lawn
Lawn Service
Service provides
provides lawn
lawn care
care inin aa planned
planned
community
community where
where 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 onon
mowing
mowing 500500 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.

Larry’s Budget
 9-5

Deficiencies of the Static Planning

Budget
Larry’s Planning Budget
 9-6

Deficiencies of the Static Planning

Budget
Larry’s Actual Results Compared with the Planning Budget
 9-7

Deficiencies of the Static Planning

Budget
Larry’s 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?
 9-8

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 are
are due
due to
to
higher
higher activity
activity and
and how
how much
much are
are due
due to
to cost
cost
control?”
control?”

 To
To answer
answer thethe question,
question,
we
we must
must
the
the budget
budget toto the
the
actual
actual level
level of
of activity.
activity.
 9-9

How a Flexible Budget Works

To a budget, we need to know that:

▫ Total variable costs change
in direct proportion to
changes in activity.
ble
▫ Total fixed costs remain ar ia
V
unchanged within the Fixed
relevant range.
 9-10

Preparing a Flexible Budget

Larry’s Flexible Budget
 9-11

Activity Variances

Flexible Planning
budget revenues budget revenues
and expenses and expenses

The differences between

the budget amounts are
called activity variances.
 9-12

Activity Variances
Larry’s Flexible Budget Compared with the Planning Budget
 9-13

Revenue and Spending Variances

Actual revenue Flexible budget revenue

The difference is a revenue variance.

Actual cost Flexible budget cost

The difference is a spending variance.

 9-14

Revenue and Spending Variances

Larry’s Flexible Budget Compared with the Actual Results
$1,750 favorable
revenue variance
 9-15

Revenue and Spending Variances

Larry’s Flexible Budget Compared with the Actual Results
Spending
variances
 9-16

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.
 9-17

Flexible Budgets with Multiple Cost

Drivers
Because
Because thethe time
time required
required for
for edging
edging and
and trimming
trimming is is different
different for
for
different
different lawns,
lawns, Larry
Larry decided
decided to
to add
add an
an additional
additional cost
cost driver
driver
(hours)
(hours) for
for the
the time
time required
required for
for edging
edging and
and trimming.
trimming. SoSo Larry
Larry
estimated
estimated thethe additional
additional hours
hours and
and developed
developed aa newnew flexible
flexible
budget
budget that
that includes
includes the
the second
second cost
cost driver
driver in
in both
both his
his revenue
revenue
and
and expense
expense budget
budget formulas.
formulas.

Larry’s New Budget

 9-18

Flexible Budgets with Multiple Cost

Drivers
Larry’s Budget Based on More than One Cost Driver
 9-19

Some Common Errors

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

Assume all costs are fixed.

 9-20

Common Error 1: Assuming All Costs

Are Fixed
Faulty Analysis Comparing Budgeted Amounts to Actual Amounts
 9-21

Common Error 2: Assuming All Costs

Are Variable
Faulty Analysis that Assumes All Budget Items Are Variable
 9-22

End of Chapter 9