Flexible Budgets and Performance Analysis

1. Flexible Budgets andPerformance Analysis Chapter 9 October 30, 2013

2. Why is a flexible budget needed • The planning budget is basically valid for the level of activity in the original plan/budget • The actual level of activity is always different than the plan • Activity variances are normal/expected, i.e. higher sales result in higher COGS • Actual results also include spending variances which are often obscured by activity variances

3. What is a Flexible Budget • A flexible budget is prepared based on the actual level of activity for the period. • It identifies what sales and expenses should be at the actual level of activity • By comparing actual activity to the flexible budget, you eliminate activity variances and isolate the spending variances • Spending variances are the real performance variances and must be analyzed

4. Learning Objective 1 Prepare a flexible budget.

5. Planning budgetsare prepared fora single, plannedlevelof activity. Hmm! Comparingstatic planning budgets with actual costsis like comparingapples and oranges. Characteristics of Flexible Budgets Performance evaluation is difficult when actual activity differs from the planned level of activity.

6. May be prepared for any activity level in the relevant range. Show costs that should have beenincurred at the actual level ofactivity, enabling “apples to apples”cost comparisons. Help managers control costs. Improve performance evaluation. Let’s look at Larry’s Lawn Service. Characteristics of Flexible Budgets

7. Larry’s Budget Deficiencies of the Static Planning Budget Larry’s Lawn Service provides lawn care in a planned community where all lawns are approximately the same size.At the end of May, Larry prepared his June budget based onmowing 500 lawns. Since all of the lawns are similar in size,Larry felt that the number of lawns mowed in a month wouldbe the best way to measure overall activity for his business.

8. Deficiencies of the Static Planning Budget Larry’s Planning Budget

9. Deficiencies of the Static Planning Budget Larry’s Actual Results

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

11. 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.

12. 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 arefavorable, has Larry done a good job controlling costs?

13. I don’t think Ican answer thequestions usinga static budget. Actual activity is above planned activity. So, shouldn’t the variablecosts be higher if actualactivity is higher? Deficiencies of the Static Planning Budget

14. The relevant question is . . . “How much of the cost variances are due to higher activity and how much are due to cost control?” To answer the question,we mustthe budget to theactual level of activity. Deficiencies of the Static Planning Budget

15. How a Flexible Budget Works To a budget, we need to know that: • Total variable costschangein direct proportion to changes in activity. • Total fixedcosts remainunchangedwithin therelevant range. Variable Fixed

16. How a Flexible Budget Works Let’s prepare a budgetfor Larry’s Lawn Service.

17. Preparing a Flexible Budget Larry’s Flexible Budget

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

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

20. Learning Objective 2 Prepare a report showing activity variances.

21. Activity Variances Planning budget revenues and expenses Flexible budget revenuesand expenses The differences between the budget amounts are called activity variances.

22. Activity Variances Let’s use budgeting concepts to compute activity variances for Larry’s Lawn Service.

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

24. 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.

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

26. 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.

27. Revenue and Spending Variances Now, let’s use budgeting concepts to compute revenue and spending variances for Larry’s Lawn Service.

28. Revenue and Spending Variances Larry’s Flexible Budget Compared with the Actual Results $1,750 favorablerevenue variance

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

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

31. 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.

32. A Performance Report Combining Activity and Revenue and Spending Variances

33. A Performance Report Combining Activity and Revenue and Spending Variances 50 lawns × $75 per lawn 50 lawns × $30 per lawn

34. A Performance Report Combining Activity and Revenue and Spending Variances $43,000 actual - $41,250 budget

35. End of Chapter 9