Flexible Budgets and

Performance Analysis
Chapter 10

McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill 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.
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Deficiencies of the Static Planning Budget

Larry’s
Larry’s Lawn
Lawn Service
Service provides
provides lawn
lawn care
care inin aa planned
planned
community
community where
where allall lawns
lawns are
are approximately
approximately the the same
same size.
size.
At
At the
the end
end ofof May,
May, Larry
Larry prepared
prepared his his June
June budget
budget based
based onon
mowing
mowing 500500 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 toto 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

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 ofof 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 toto 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 ble
unchanged within the ar ia
V
relevant range. Fixed

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Preparing a Flexible Budget
Larry’s Flexible Budget

10-10
Activity Variances

Planning Flexible
budget revenues budget revenues
and expenses 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.

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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

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.

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 Flexible Budgets with Multiple Cost Drivers

Because
Because ofof the
the large
large unfavorable
unfavorable wages
wages and
and salaries
salaries spending
spending
variance,
variance, Larry
Larry decided
decided toto 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 toto 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

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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
or that
2.
2. All costs
costs are
are variable.
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

10-21
End of Chapter 10

10-22