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Flexible Budgets and

Performance Analysis

Chapter 10

Learning Objective 1

Prepare a flexible Prepare a flexible

budget. budget.

Improve performance evaluation. 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.

Let’s look at Larry’s Lawn Service.

Characteristics of Flexible Budgets

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 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

Deficiencies of the Static Planning Budget

Deficiencies of the Static Planning Budget

Larry’s Actual Results Compared with the Planning Budget F = Favorable variance that occurs when actual costs are less than budgeted costs. U = Unfavorable variance that occurs when actual costs are greater than budgeted costs. F = Favorable variance that occurs when actual revenue is greater than budgeted revenue.

Deficiencies of the Static Planning Budget

Larry’s Actual Results Compared with the Planning Budget Since these variances are favorable, has Larry done a good job controlling costs? Since these variances are unfavorable, has Larry done a poor job controlling costs?

 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.

 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.

Deficiencies of the Static Planning Budget

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 Variable

Preparing a Flexible Budget

Larry’s Flexible Budget

Quick Check 

What should the total wages and salaries cost

be in a flexible budget for 600 lawns?

a. $18,

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,

b. $20,000.

c. $23,000.

d. $25,000.

Learning Objective 2

Prepare a report Prepare a report

showing activity showing activity

variances. variances.

Activity Variances

Planning

budget revenues

and expenses

Flexible

budget revenues

and expenses

The differences between The differences between

the budget amounts are the budget amounts are

called activity variances. called activity variances.

Activity Variances

Larry’s Flexible Budget Compared with the Planning Budget

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.