1. Flexible Budgets and Performance Analysis
Chapter 9
Flexible Budgets and Performance Analysis
Chapter 9: Flexible Budgets and Performance Analysis
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

2. 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.
A planning budget is prepared before the period begins and is valid for only the planned level of activity. If the actual level of activity differs from what was planned, it would be misleading to evaluate performance by comparing actual costs to the static, unchanged planning budget.

3. 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.
Variable
Flexing a budget involves two key assumptions about cost behavior. First, total variable costs change in direct proportion to changes in activity; and second, total fixed costs remain unchanged within a specified activity range.
Fixed

4. Activity Variances Planning budget revenues and expenses Flexible
An activity variance arises solely due to the difference in the level of activity included in the planning budget and the actual level of activity .
The differences between the budget amounts are called activity variances.

5. Larry’s Flexible Budget Compared with the Planning Budget
Activity Variances
Larry’s Flexible Budget Compared with the Planning Budget
The activity variances for Larry’s Lawn Service would be computed as shown on this slide. Notice:
The level of activity in the flexible budget (550 lawns) is 10% higher than the level of activity in the planning budget (500 lawns). The planning budget shows revenue and cost amounts at the original planned level of activity while the flexible budget shows revenue and cost amounts at the actual level of activity. The differences (variances) between the planning budget for 500 lawns and the flexible budget for 550 lawns are due solely to the activity increase.
Revenue in the flexible budget is 10% higher than the planning budget because revenue varies proportionally to changes in the activity level. The higher activity level results in a favorable activity variance for revenue.
The variable costs in the flexible budget (gasoline and supplies and equipment maintenance) are 10% higher than the planning budget because variable costs vary proportionally to changes the activity level. The mixed cost (wages and salaries) in the flexible budget is less than 10% higher than the planning budget because the fixed cost component of the mixed cost does not change when the activity level changes. The higher activity level results in unfavorable activity variances for these costs.
The fixed costs in the flexible budget are the same as the planning budget because they do not change in response to changes in the activity level within the relevant range.

6. Larry’s Flexible Budget Compared with the Planning Budget
Activity Variances
Larry’s Flexible Budget Compared with the Planning Budget
Activity and revenue increase by 10 percent, but net operating income increases by more than 10 percent due to the presence of fixed costs.
Activity and revenue increase by 10 percent, but net operating income increases by more than 10 percent (33 percent) due to the presence of fixed costs.

7. Revenue and Spending Variances
Flexible budget revenue
Actual revenue
The difference is a revenue variance.
Flexible budget cost
Part I.
A revenue variance is the difference between what the total revenue should have been, given the actual level of activity for the period, and the actual total revenue.  
Part II.
A spending variance is the difference between how much a cost should have been, given the actual level of activity, and the actual amount of the cost.
Actual cost
The difference is a spending variance.

8. Now, let’s use budgeting
A Performance Report Combining Activity and Revenue and Spending Variances
Now, let’s use budgeting
concepts to combine the revenue and spending variances reports for Larry’s Lawn Service.
This report will bring together the information from the two earlier reports in a way that makes it easier to interpret what has happened during the period.

9. A Performance Report Combining Activity and Revenue and Spending Variances
Here we see a flexible budget performance report that shows both activity variances and revenue and spending variances. Note that the activity variances appear between the planning budget and the flexible budget and that the revenue and spending variances appear between the flexible budget and the actual results.

10. A Performance Report Combining Activity and Revenue and Spending Variances
50 lawns × $75 per lawn
50 lawns × $30 per lawn
The activity variances are based on the 50 lawns mowed in excess of the static planned level of 500. You can see that the activity revenue variance is $3,750 favorable (50 lawns times $75 per lawn), and the wages and salaries expense is $1,500 unfavorable (50 lawns times $30 per lawn). Make sure you can calculate the other activity variances for Larry.

11. A Performance Report Combining Activity and Revenue and Spending Variances
The revenue and spending variances are computed by comparing the flexible budget amounts and the actual amounts. For example:
The revenue variance of $1,750 favorable is computed by taking the difference between the actual amount ($43,000) and the flexible budget amount ($41,250).
When interpreting a flexible budget performance report it is important to remember two things: First, to generate a favorable activity variance for net operating income, managers must take actions to increase the level of activity.
Second, to generate a favorable overall revenue and spending variance, managers must take actions to protect selling prices, increase operating efficiency, and reduce the prices of inputs.
$43,000 actual - $41,250 budget

12. 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.
It is unlikely that all variable costs within a company are driven by a single factor such as the number of units produced, labor hours, or machine hours (or lawns mowed in Larry’s Lawn Service). 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.

13. End of Chapter 9
End of Chapter 9.