Flexible Budgets And Performance Analysis 6g4p49

Flexible Budgets and Performance Analysis Chapter 9

PowerPoint Authors: Susan Coomer Galbreath, Ph.D., A Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., A, CIA Cynthia J. Rooney, Ph.D., A Copyright © 2015 by McGraw­Hill Education. All rights reserved.

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Variance Analysis Cycle

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Learning Objective 1 Prepare a flexible budget.

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Characteristics of Flexible Budgets 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.

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

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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.

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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

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Deficiencies of the Static Planning Budget Larry’s Planning Budget

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Deficiencies of the Static Planning Budget Larry’s Actual Results

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

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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.

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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?

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Deficiencies of the Static Planning Budget I don’t think I can answer the questions using a static budget.

Actual activity is above planned activity. So, shouldn’t the variable costs be higher if actual activity is higher?

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

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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

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How a Flexible Budget Works Let’s prepare a budget for Larry’s Lawn Service.

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Preparing a Flexible Budget Larry’s Flexible Budget

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Quick Check  What What should should the the total total wages wages and and salaries salaries cost cost be be in in aa flexible flexible budget budget for for 600 600 lawns? lawns? a. a. $18,000. $18,000. b. b. $20,000. $20,000. c. c. $23,000. $23,000. d. d. $25,000. $25,000.

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Quick Check  What be total total wages wages and salaries salaries cost What should should the be the the the total total wages wages andand and salaries salaries cost cost be in aaaflexible flexible budget budget for for 600 600 lawns? lawns? cost be inin in aflexible flexible budget budget for for 600 600 lawns? lawns? a. $18,000 a. $18,000. $18,000 $18,000. b. b. $20,000. $20,000. c. c. $23,000. $23,000. d. d. $25,000. $25,000. Total wages and salaries cost = $5,000 + ($30 per lawn  600 lawns) $5,000 + $18,000 = $23,000

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Learning Objective 2 Prepare a report showing activity variances.

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Activity Variances Flexible budget revenues and expenses

Planning budget revenues and expenses

The differences between the budget amounts are called activity variances.

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Activity Variances Let’s use

budgeting

concepts to compute activity variances for Larry’s Lawn Service.

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

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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.

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Learning Objective 3 Prepare a report showing revenue and spending variances.

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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.

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Revenue and Spending Variances Now, let’s use

budgeting

concepts to compute revenue and spending variances for Larry’s Lawn Service.

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Revenue and Spending Variances Larry’s Flexible Budget Compared with the Actual Results $1,750 favorable revenue variance

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

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Learning Objective 4 Prepare a performance report that combines activity variances and revenue and spending variances.

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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.

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A Performance Report Combining Activity and Revenue and Spending Variances

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A Performance Report Combining Activity and Revenue and Spending Variances

50 50 lawns lawns ×× $30 $30 per per lawn lawn

50 50 lawns lawns ×× $75 $75 per per lawn lawn

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A Performance Report Combining Activity and Revenue and Spending Variances

$43,000 $43,000 actual actual -- $41,250 $41,250 budget budget

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

Donations

Tuition and fees

Endowments Universities

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Performance Reports in Cost Centers Performance reports are often prepared for cost centers. These reports should be prepared using the same principles discussed so far, except for the fact that these reports will not contain revenue or net operating income variances.

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Learning Objective 5 Prepare a flexible budget with more than one cost driver.

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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 the the 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. So So Larry Larry estimated estimated the the additional additional hours hours and and developed developed aa new new 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

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

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Learning Objective 6 Understand common errors made in preparing performance reports based on budgets and actual results.

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

Assume all costs are fixed.

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Common Error 1: Assuming All Costs Are Fixed Faulty Analysis Comparing Budgeted Amounts to Actual Amounts

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Common Error 2: Assuming All Costs Are Variable Faulty Analysis that Assumes All Budget Items Are Variable

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End of Chapter 9