The document discusses flexible budgets and performance analysis. It provides examples to illustrate how to prepare flexible budgets that account for multiple activity levels, as well as calculate variances between flexible budgets and actual results. The key benefits of flexible budgets are that they allow for "apples-to-apples" comparisons of costs when actual activity differs from planned levels. Flexible budgets more accurately reveal whether variances are due to external factors like activity changes or controllable factors like poor cost management. The document outlines how to prepare flexible budgets, calculate variances, and analyze performance using these variance reports.

1. © 2012 McGraw-Hill Education (Asia)Garrison, Noreen, Brewer, Cheng & Yuen
Flexible Budgets and
Performance Analysis
Chapter 11

2. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 2
Learning Objective 1
Prepare a flexible budget.

3. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 3
Characteristics of Flexible Budgets
Planning budgets
are prepared for
a single, planned
level of activity.
Performance
evaluation is difficult
when actual activity
differs from the
planned level of
activity.
Hmm! Comparing
static planning budgets
with actual costs
is like comparing
apples and oranges.

4. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 4
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

5. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 5
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

6. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 6
Deficiencies of the Static Planning Budget
Larry’s Planning Budget

7. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 7
Deficiencies of the Static Planning Budget
Larry’s Actual Results

8. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 8
Deficiencies of the Static Planning Budget
Larry’s Actual Results Compared with the Planning Budget

9. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 9
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.

10. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 10
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?

11. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 11
I don’t think I
can answer the
questions using
a static budget.
Actual activity is above
planned activity.
So, shouldn’t the variable
costs be higher if actual
activity is higher?
Deficiencies of the Static Planning Budget

12. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 12
 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

13. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 13
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

14. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 14
Let’s prepare a
budget
for Larry’s Lawn
Service.
How a Flexible Budget Works

15. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 15
Preparing a Flexible Budget
Larry’s Flexible Budget

16. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 16
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.

17. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 17
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.
Total wages and salaries cost
= $5,000 + ($30 per lawn  600 lawns)
= $5,000 + $18,000 = $23,000
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.

18. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 18
Learning Objective 2
Prepare a report showing
activity variances.

19. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 19
Activity Variances
Planning
budget revenues
and expenses
Flexible
budget revenues
and expenses
The differences between
the budget amounts are
called activity variances.

20. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 20
Let’s use budgeting
concepts to compute activity
variances for Larry’s Lawn Service.
Activity Variances

21. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 21
Activity Variances
Larry’s Flexible Budget Compared with the Planning Budget

22. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 22
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.

23. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 23
Learning Objective 3
Prepare a report showing
revenue and spending
variances.

24. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 24
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.

25. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 25
Now, let’s use budgeting
concepts to compute revenue and
spending variances for Larry’s Lawn
Service.
Revenue and Spending Variances

26. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 26
Revenue and Spending Variances
Larry’s Flexible Budget Compared with the Actual Results
$1,750 favorable
revenue variance

27. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 27
Larry’s Flexible Budget Compared with the Actual Results
Revenue and Spending Variances
Spending
variances

28. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 28
Learning Objective 4
Prepare a performance
report that combines
activity variances and
revenue and spending
variances.

29. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 29
Now, let’s use budgeting
concepts to combine the revenue and
spending variances reports for Larry’s
Lawn Service.
A Performance Report Combining Activity
and Revenue and Spending Variances

30. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 30
A Performance Report Combining Activity
and Revenue and Spending Variances

31. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 31
A Performance Report Combining Activity
and Revenue and Spending Variances
50 lawns × $75 per lawn 50 lawns × $30 per lawn

32. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 32
A Performance Report Combining Activity
and Revenue and Spending Variances
$43,000 actual - $41,250 budget

33. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 33
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.
Universities
Tuition and fees
DonationsState funding
Endowments

34. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 34
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.

35. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 35
Learning Objective 5
Prepare a flexible budget
with more than one cost
driver.

36. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 36
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.
Flexible Budgets with Multiple Cost Drivers

37. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 37
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
Flexible Budgets with Multiple Cost Drivers

38. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 38
Flexible Budgets with Multiple Cost Drivers
Larry’s Budget Based on More than One Cost Driver

39. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 39
Learning Objective 6
Understand common
errors made in preparing
performance reports
based on budgets and
actual results.

40. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 40
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.

41. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 41
Common Error 1: Assuming All Costs Are
Fixed
Faulty Analysis Comparing Budgeted Amounts to Actual Amounts

42. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 42
Common Error 2: Assuming All Costs Are
Variable
Faulty Analysis that Assumes All budget Items Are Variable

43. McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 43
End of Chapter 11