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Flexible Budgets and Performance Analysis
Chapter 10

? 2010 The McGraw-Hill Companies, Inc.

Characteristics of Flexible Budgets
Hmm! Comparing static planning budgets with actual costs is like comparing apples and oranges.

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.
McGraw-Hill/Irwin

Slide 2

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.
McGraw-Hill/Irwin
Slide 3

Deficiencies of the Static Planning Budget
Larry’s Actual Results Compared with the Planning Budget

McGraw-Hill/Irwin

Slide 4

Deficiencies of the Static Planning Budget
Larry’s 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 5

Deficiencies of the Static Planning Budget
The relevant question is . . .
“How much of the cost variances is due to higher activity, and how much is due to cost control?”

To answer the question, we must the budget to the actual level of activity.

McGraw-Hill/Irwin

Slide 6

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.

Fixed

McGraw-Hill/Irwin

Slide 7

Preparing a Flexible Budget
Larry’s Flexible Budget

McGraw-Hill/Irwin

Slide 8

Activity Variances
Larry’s Flexible Budget Compared with the Planning Budget

McGraw-Hill/Irwin

Slide 9

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 10

Revenue and Spending Variances
Larry’s Flexible Budget Compared with the Actual Results

McGraw-Hill/Irwin

Slide 11

A Performance Report Combining Activity and Revenue and Spending Variances

McGraw-Hill/Irwin

Slide 12

Performance Reports in Non-Profit Organizations
Non-profit organizations may receive funding from sources other than the sale of goods and services, so revenues may consist of both fixed and variable elements.

State funding Tuition and fees Universities
McGraw-Hill/Irwin

Donations Endowments

Slide 13

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 14

Flexible Budgets with Multiple Cost Drivers
Because of the large unfavorable wages and salaries spending variance, Larry decided to add an additional cost driver for wages and salaries. The variance is due primarily to the number of hours required for the additional edging and trimming. So Larry estimates the additional hours and builds those hours into both his revenue and expense budget formulas.

Larry’s New Budget
McGraw-Hill/Irwin
Slide 15

Flexible Budgets with Multiple Cost Drivers
Larry’s Budget Based on More than One Cost Driver

McGraw-Hill/Irwin

Slide 16

Some Common Errors
The most common errors in preparing performance reports are to implicitly assume that: 1. All costs are fixed or that 2. All costs are variable.

Assume all costs are fixed.
McGraw-Hill/Irwin
Slide 17

End of Chapter 10

McGraw-Hill/Irwin

Slide 18


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