Flexible Budgets and
Performance Analysis
Topic 7/Chapter 9
Garrison, Noreen, Brewer, Cheng & Yuen © 2012 McGraw-Hill Education (Asia)
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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 2
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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 3
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
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 4
Deficiencies of the Static Planning Budget
Larry’s Planning Budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 5
Deficiencies of the Static Planning Budget
Larry’s Actual Results
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 6
Deficiencies of the Static Planning Budget
Larry’s Actual Results Compared with the Planning Budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 7
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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 8
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?
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 9
Deficiencies of the Static Planning Budget
I don’t think I Actual activity is above
can answer the planned activity.
questions using
a static budget. So, shouldn’t the variable
costs be higher if actual
activity is higher?
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 10
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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 11
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 b le
unchanged within the a r ia
V
relevant range. Fixed
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 12
How a Flexible Budget Works
Let’s prepare a
budget
for Larry’s Lawn
Service.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 13
Preparing a Flexible Budget
Larry’s Flexible Budget
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McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 14
Quick Check ü
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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 15
Quick Check ü
What should the be the
totaltotal
wages
wages
andandsalaries
salaries
cost
costinina aflexible
be flexiblebudget
budgetforfor600
600lawns?
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
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 16
Learning Objective 2
Prepare a report showing
activity variances.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 17
Activity Variances
Planning Flexible
budget revenues budget revenues
and expenses and expenses
The differences between
the budget amounts are
called activity variances.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 18
Activity Variances
Let’s use budgeting
concepts to compute activity
variances for Larry’s Lawn Service.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 19
Activity Variances
Larry’s Flexible Budget Compared with the Planning Budget
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McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 20
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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 21
Learning Objective 3
Prepare a report showing
revenue and spending
variances.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 22
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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 23
Revenue and Spending Variances
Now, let’s use budgeting
concepts to compute revenue and
spending variances for Larry’s Lawn
Service.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 24
Revenue and Spending Variances
Larry’s Flexible Budget Compared with the Actual Results
$1,750 favorable
revenue variance
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 25
Revenue and Spending Variances
Larry’s Flexible Budget Compared with the Actual Results
Spending
variances
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McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 26
Learning Objective 4
Prepare a performance
report that combines activity
variances and revenue and
spending variances.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 27
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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 28
A Performance Report Combining Activity
and Revenue and Spending Variances
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 29
A Performance Report Combining Activity
and Revenue and Spending Variances
50 lawns × $75 per lawn 50 lawns × $30 per lawn
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 30
A Performance Report Combining Activity
and Revenue and Spending Variances
$43,000 actual - $41,250 budget
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 31
Performance Reports in Non-Profit
Organizations
Non-profit organizations may receive funding from
sources other than the sale of goods and services,
so revenues may consist of both fixed and
variable elements.
State funding Donations
Tuition and fees Endowments
Universities
McGraw-Hill Education (Asia)
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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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 33
Learning Objective 5
Prepare a flexible budget
with more than one cost
driver.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 34
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.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 35
Flexible Budgets with Multiple Cost Drivers
Because of the large unfavorable wages and salaries spending
variance, Larry decided to add an additional cost driver for
wages and salaries. The variance is due primarily to the number
of hours required for the additional edging and trimming. So
Larry estimates the additional hours and builds those hours into
both his revenue and expense budget formulas.
Larry’s New Budget
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McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 36
Flexible Budgets with Multiple Cost Drivers
Larry’s Budget Based on More than One Cost Driver
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McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 37
Learning Objective 6
Understand common errors
made in preparing
performance reports based
on budgets and actual
results.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 38
Some Common Errors
The most common errors in preparing performance
reports are to implicitly assume that:
1. All costs are fixed or that
2. All costs are variable.
Assume all costs are fixed.
McGraw-Hill Education (Asia)
McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 39
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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