8/10/2022

Session 2
Flexible Budgets and
Performance Analysis

Learning Objectives
1. Prepare a flexible budget
2. Use the flexible budget for performance
reporting

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Characteristics of Flexible Budgets

Hmm! Comparing
static planning budgets
Planning budgets
with actual costs
are prepared for is like comparing
a single, planned apples and oranges.
level of activity.
Performance
evaluation is difficult
when actual activity
differs from the
planned level of
activity.

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 on
mowing 500 lawns. Since all of the lawns are similar in size,
Larry felt that the number of lawns mowed in a month would
be the best way to measure overall activity for his business.

Larry’s Budget

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Deficiencies of the Static Planning Budget

Larry’s Planning Budget

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

Deficiencies of the Static Planning Budget

 The relevant question is . . .

“How much of the cost variances is due to higher
activity, and how much is due to cost control?”

 To answer the question,

we must
the budget to the
actual level of 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. Fixed

Preparing a Flexible Budget

Larry’s Flexible Budget

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Activity Variances

Planning Flexible
budget revenues budget revenues
and expenses and expenses

The differences between

the budget amounts are
called activity variances.

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.

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

Revenue and Spending Variances

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

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A Performance Report Combining Activity and

Revenue and Spending Variances