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Flexible Budgets and Performance Analysis Chapter 10
McGrawHill/Irwin
Copyright © 2010 by The McGrawHill Companies, Inc. All rights reserved.
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. 10-2
Deficiencies of the Static Planning Budget Larry’s Larry’s 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.
Larry’s Budget 10-3
Deficiencies of the Static Planning Budget Larry’s Planning Budget
10-4
Deficiencies of the Static Planning Budget Larry’s Actual Results
10-5
Deficiencies of the Static Planning Budget Larry’s Actual Results Compared with the Planning Budget
10-6
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?
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 Larry’s 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 Larry’s 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 Larry’s Flexible Budget Compared with the Actual Results $1,750 favorable revenue variance
10-14
Revenue and Spending Variances Larry’s 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. 10-16
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.
Larry’s New Budget 10-17
Flexible Budgets with Multiple Cost Drivers Larry’s 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
McGrawHill/Irwin
Copyright © 2010 by The McGrawHill Companies, Inc. All rights reserved.
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. 10-2
Deficiencies of the Static Planning Budget Larry’s Larry’s 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.
Larry’s Budget 10-3
Deficiencies of the Static Planning Budget Larry’s Planning Budget
10-4
Deficiencies of the Static Planning Budget Larry’s Actual Results
10-5
Deficiencies of the Static Planning Budget Larry’s Actual Results Compared with the Planning Budget
10-6
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?
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 Larry’s 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 Larry’s 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 Larry’s Flexible Budget Compared with the Actual Results $1,750 favorable revenue variance
10-14
Revenue and Spending Variances Larry’s 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. 10-16
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.
Larry’s New Budget 10-17
Flexible Budgets with Multiple Cost Drivers Larry’s 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
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