SlideShare a Scribd company logo
Flexible Budgets and
Performance Analysis
            Chapter 10



               © 2010 The McGraw-Hill Companies, Inc.
Learning Objective 1

                    Prepare a flexible budget.




McGraw-Hill/Irwin                                Slide 2
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/Irwin                                     Slide 3
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/Irwin                                        Slide 4
Deficiencies of the Static Planning Budget

      Larry’s Lawn Service provides lawn care in a planned
      Larry’s Lawn Service provides lawn care in a planned
  community where all lawns are approximately the same size.
  community where all lawns are approximately the same size.
  At the end of May, Larry prepared his June budget based on
  At the end of May, Larry prepared his June budget based on
  mowing 500 lawns. Since all of the lawns are similar in size,
  mowing 500 lawns. Since all of the lawns are similar in size,
  Larry felt that the number of lawns mowed in a month would
   Larry felt that the number of lawns mowed in a month would
   be the best way to measure overall activity for his business.
   be the best way to measure overall activity for his business.




                                             Larry’s Budget
McGraw-Hill/Irwin                                            Slide 5
Deficiencies of the Static Planning Budget
                                   Larry’s Planning Budget
                                           Larry's Lawn Service
                                       For the Month Ended June 30

                                                      Revenue/Cost     Planning
                                                        Formulas        Budget
                    Number of lawns (Q)                                      500
                    Revenue                          ($75Q)            $   37,500
                    Expenses:
                       Wages and salaries            ($5,000 + $30Q)   $   20,000
                       Gasoline and supplies         ($9Q)                  4,500
                       Equipment maintenance         ($3Q)                  1,500
                       Office and shop utilities     ($1,000)               1,000
                       Office and shop rent          ($2,000)               2,000
                       Equipment Depreciation        ($2,500)               2,500
                       Insurance                     ($1,000)               1,000
                    Total expenses                                         32,500
                    Net operating income                               $    5,000


McGraw-Hill/Irwin                                                                   Slide 6
Deficiencies of the Static Planning Budget
                             Larry’s Actual Results
                                    Larry's Lawn Service
                                For the Month Ended June 30

                                                                  Actual
                                                                  Results
                    Number of lawns                                    550
                    Revenue                                   $     43,000
                    Expenses:
                       Wages and salaries                     $     23,500
                       Gasoline and supplies                         5,100
                       Equipment maintenance                         1,300
                       Office and shop utilities                       950
                       Office and shop rent                          2,000
                       Equipment Depreciation                        2,500
                       Insurance                                     1,200
                    Total expenses                                  36,550
                    Net operating income                      $      6,450


McGraw-Hill/Irwin                                                            Slide 7
Deficiencies of the Static Planning Budget
Larry’s Actual Results Compared with the Planning Budget
                                     Larry's Lawn Service
                                 For the Month Ended June 30

                                Revenue/Cost     Planning          Actual
                                  Formulas        Budget           Results        Variances
Number of lawns (Q)                                    500              550
Revenue                        ($75Q)            $   37,500    $     43,000   $        5,500 F
Expenses:
   Wages and salaries          ($5,000 + $30Q)   $   20,000    $     23,500   $        3,500   U
   Gasoline and supplies       ($9Q)                  4,500           5,100              600   U
   Equipment maintenance       ($3Q)                  1,500           1,300              200   F
   Office and shop utilities   ($1,000)               1,000             950               50   F
   Office and shop rent        ($2,000)               2,000           2,000              -
   Equipment Depreciation      ($2,500)               2,500           2,500              -
   Insurance                   ($1,000)               1,000           1,200              200   U
Total expenses                                       32,500          36,550            4,050   U
Net operating income                             $    5,000    $      6,450   $        1,450   F


McGraw-Hill/Irwin                                                                        Slide 8
Deficiencies of the Static Planning Budget
Larry’s Actual Results Compared with the Planning Budget
  F = Favorable variance that occurs when actual
                         Larry's Lawn Service
                     For the Month Ended June 30
    revenue is greater than budgeted revenue.
                          Revenue/Cost   Planning    Actual
                            Formulas      Budget     Results          Variances
Number of lawns (Q)                           500         550
Revenue                      ($75Q)          $ 37,500 $ 43,000    $        5,500 F
Expenses:
   Wages and salaries        ($5,000 + $30Q) $ 20,000 $ 23,500    $        3,500   U
      U = Unfavorable variance that 4,500
   Gasoline and supplies     ($9Q)
                                                 occurs when
                                                          5,100              600   U
   Equipment costs are ($3Q)
    actual maintenance greater than budgeted costs.
                                                1,500     1,300              200   F
   Office and shop utilities ($1,000)           1,000       950               50   F
   Office and shop rent      ($2,000)           2,000     2,000              -
   Equipment Favorable($2,500)
         F = Depreciation variance that occurs when
                                                2,500     2,500              -
   Insurance                 ($1,000)           1,000     1,200              200   U
       actual costs are less than budgeted costs.
Total expenses                                 32,500    36,550            4,050   U
Net operating income                         $  5,000 $   6,450   $        1,450   F


McGraw-Hill/Irwin                                                            Slide 9
Deficiencies of the Static Planning Budget
Larry’s Actual Results Compared with the Planning Budget
                               Larry's Lawn Service
                           For the Month Ended June 30

                          Revenue/Cost   Planning        Actual
                            Formulas      Budget         Results        Variances
Number of lawns (Q)                            500            550
Revenue                      ($75Q)          $ 37,500 $ 43,000      $        5,500 F
Expenses:
   Wages and salaries
       Since these variances are $ 20,000
   Gasoline and supplies
                             ($5,000 + $30Q)
                             ($9Q)
                                                      $ 23,500
                                             unfavorable, 5,100
                                                4,500
                                                           has      $        3,500
                                                                               600
                                                                                      U
                                                                                      U
   Equipment maintenance poor job controlling costs?
        Larry done a ($3Q)                      1,500     1,300                200    F
   Office and shop utilities ($1,000)           1,000       950                 50    F
   Office and shop rent      ($2,000)           2,000     2,000                -
   Equipment Depreciation variances are favorable, has
         Since these ($2,500)                   2,500     2,500                -
   Insurance                 ($1,000)           1,000     1,200                200    U
        Larry done a good job controlling costs?
Total expenses                                 32,500   36,550               4,050    U
Net operating income                         $  5,000 $   6,450     $        1,450    F


McGraw-Hill/Irwin                                                              Slide 10
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/Irwin                                       Slide 11
Deficiencies of the Static Planning Budget

     The relevant question is .. .. ..
     The relevant question is
              “How much of the cost variances is due to higher
              “How much of the cost variances is due to higher
              activity, and how much is due to cost control?”
              activity, and how much is due to cost control?”


     To answer the question,
     To answer the question,
      we must
       we must
      the budget to the
       the budget to the
      actual level of activity..
       actual level of activity



McGraw-Hill/Irwin                                            Slide 12
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
                                                 able
       unchanged within the                 Vari
       relevant range.                         Fixed




McGraw-Hill/Irwin                                       Slide 13
How a Flexible Budget Works



                     Let’s prepare a
                             budget
                    for Larry’s Lawn
                         Service.




McGraw-Hill/Irwin                      Slide 14
Preparing a Flexible Budget
                                 Larry’s Flexible Budget
                                         Larry's Lawn Service
                                     For the Month Ended June 30

                                                    Revenue/Cost     Flexible
                                                      Formulas        Budget
                    Number of lawns (Q)                                    550
                    Revenue                        ($75Q)            $   41,250
                    Expenses:
                       Wages and salaries          ($5,000 + $30Q)   $   21,500
                       Gasoline and supplies       ($9Q)                  4,950
                       Equipment maintenance       ($3Q)                  1,650
                       Office and shop utilities   ($1,000)               1,000
                       Office and shop rent        ($2,000)               2,000
                       Equipment Depreciation      ($2,500)               2,500
                       Insurance                   ($1,000)               1,000
                    Total expenses                                       34,600
                    Net operating income                             $    6,650


McGraw-Hill/Irwin                                                                 Slide 15
Quick Check 
         What should the total wages and salaries cost
         What should the total wages and salaries cost
         be in a flexible budget for 600 lawns?
         be in a flexible budget for 600 lawns?
         a. $18,000
         a. $18,000
         b. $20,000.
         b. $20,000.
         c. $23,000.
         c. $23,000.
         d. $25,000.
         d. $25,000.




McGraw-Hill/Irwin                                        Slide 16
Quick Check 
         What should be the total wages and salaries
         What should the the total wages and salaries
                         be total wages and salaries cost
                         the total wages and salaries cost
         be in in flexible budget for 600 lawns?
         cost in a flexible budget for 600 lawns?
         cost a a flexible budget for 600 lawns?
         be in a flexible budget for 600 lawns?
         a. $18,000
         a. $18,000
         b. $20,000.
         b. $20,000.
         c. $23,000.
         c. $23,000.
         d. $25,000.
         d. $25,000.

        Total wages and salaries cost
                    = $5,000 + ($30 per lawn × 600 lawns)
                    = $5,000 + $18,000 = $23,000

McGraw-Hill/Irwin                                            Slide 17

More Related Content

What's hot

Flexible budget (Management Accounting)
Flexible budget (Management Accounting)Flexible budget (Management Accounting)
Flexible budget (Management Accounting)
Abdul Basit
 
Consolidated Financial Statements
Consolidated Financial StatementsConsolidated Financial Statements
Consolidated Financial Statements
Avinash Chavan
 
Absorption costing vs variable costing
Absorption costing  vs variable costingAbsorption costing  vs variable costing
Absorption costing vs variable costing
Shankar Jyoti Doley
 
Acc mgt noreen07 profit planning
Acc mgt noreen07 profit planningAcc mgt noreen07 profit planning
Acc mgt noreen07 profit planning
Judianto Nugroho
 
CVP Analysis
CVP AnalysisCVP Analysis
CVP Analysis
Chandrakant Phad
 
Balance sheet
Balance sheetBalance sheet
Balance sheet
Shair Ali
 
Accounting for Income Tax
Accounting for Income TaxAccounting for Income Tax
Accounting for Income Tax
Elyka Marisse Agan
 
Process costing explained
Process costing explainedProcess costing explained
Process costing explained
Sam zain
 
Managerial accounting
Managerial accountingManagerial accounting
Managerial accounting
Khalid Aziz
 
Flexible Budgets and Standard Costs
Flexible Budgets and Standard CostsFlexible Budgets and Standard Costs
Flexible Budgets and Standard Costs
Patrina Hibbert
 
Financial forecasting-planning
Financial forecasting-planningFinancial forecasting-planning
Financial forecasting-planning
Dr. Abzal Basha
 
IFRS 3 - Business Combinations
IFRS 3 - Business CombinationsIFRS 3 - Business Combinations
IFRS 3 - Business Combinations
PIRON
 
Cash Flow Statement PPT
Cash Flow Statement PPTCash Flow Statement PPT
Variable costing a tool for management
Variable costing a tool for managementVariable costing a tool for management
Variable costing a tool for management
Muhammad Sario
 
Non current assets held for sale and discontinued
Non current assets held for sale and discontinuedNon current assets held for sale and discontinued
Non current assets held for sale and discontinued
Hyderabad Chapter of ICWAI
 
Variable and absorption costing
Variable and absorption costingVariable and absorption costing
Variable and absorption costing
rikdas1989
 
Management Accounting and its Roles and Principles
Management Accounting and its Roles and PrinciplesManagement Accounting and its Roles and Principles
Management Accounting and its Roles and Principles
Imran Butt
 
Difference between management and Financial accounting.
Difference between management and Financial accounting.Difference between management and Financial accounting.
Difference between management and Financial accounting.
VadivelM9
 
Cost Volume Profit Analysis
Cost Volume Profit AnalysisCost Volume Profit Analysis
Cost Volume Profit Analysis
Mohammed Alashi
 
Inventories and the Cost of Goods Sold
Inventories and the Cost of Goods SoldInventories and the Cost of Goods Sold
Inventories and the Cost of Goods Sold
Muhammad Unaib Aslam
 

What's hot (20)

Flexible budget (Management Accounting)
Flexible budget (Management Accounting)Flexible budget (Management Accounting)
Flexible budget (Management Accounting)
 
Consolidated Financial Statements
Consolidated Financial StatementsConsolidated Financial Statements
Consolidated Financial Statements
 
Absorption costing vs variable costing
Absorption costing  vs variable costingAbsorption costing  vs variable costing
Absorption costing vs variable costing
 
Acc mgt noreen07 profit planning
Acc mgt noreen07 profit planningAcc mgt noreen07 profit planning
Acc mgt noreen07 profit planning
 
CVP Analysis
CVP AnalysisCVP Analysis
CVP Analysis
 
Balance sheet
Balance sheetBalance sheet
Balance sheet
 
Accounting for Income Tax
Accounting for Income TaxAccounting for Income Tax
Accounting for Income Tax
 
Process costing explained
Process costing explainedProcess costing explained
Process costing explained
 
Managerial accounting
Managerial accountingManagerial accounting
Managerial accounting
 
Flexible Budgets and Standard Costs
Flexible Budgets and Standard CostsFlexible Budgets and Standard Costs
Flexible Budgets and Standard Costs
 
Financial forecasting-planning
Financial forecasting-planningFinancial forecasting-planning
Financial forecasting-planning
 
IFRS 3 - Business Combinations
IFRS 3 - Business CombinationsIFRS 3 - Business Combinations
IFRS 3 - Business Combinations
 
Cash Flow Statement PPT
Cash Flow Statement PPTCash Flow Statement PPT
Cash Flow Statement PPT
 
Variable costing a tool for management
Variable costing a tool for managementVariable costing a tool for management
Variable costing a tool for management
 
Non current assets held for sale and discontinued
Non current assets held for sale and discontinuedNon current assets held for sale and discontinued
Non current assets held for sale and discontinued
 
Variable and absorption costing
Variable and absorption costingVariable and absorption costing
Variable and absorption costing
 
Management Accounting and its Roles and Principles
Management Accounting and its Roles and PrinciplesManagement Accounting and its Roles and Principles
Management Accounting and its Roles and Principles
 
Difference between management and Financial accounting.
Difference between management and Financial accounting.Difference between management and Financial accounting.
Difference between management and Financial accounting.
 
Cost Volume Profit Analysis
Cost Volume Profit AnalysisCost Volume Profit Analysis
Cost Volume Profit Analysis
 
Inventories and the Cost of Goods Sold
Inventories and the Cost of Goods SoldInventories and the Cost of Goods Sold
Inventories and the Cost of Goods Sold
 

Similar to Flexible budget

Manufacturing cost accounting ppt @ mba finance
Manufacturing cost accounting ppt @ mba financeManufacturing cost accounting ppt @ mba finance
Manufacturing cost accounting ppt @ mba finance
Babasab Patil
 
Operational budgeting
Operational budgetingOperational budgeting
Operational budgeting
Khiemmy dela Torre
 
Accountability 101
Accountability 101Accountability 101
Accountability 101
4Good.org
 
Managerial Accounting Garrison Noreen Brewer Chapter 10
Managerial Accounting Garrison Noreen Brewer Chapter 10Managerial Accounting Garrison Noreen Brewer Chapter 10
Managerial Accounting Garrison Noreen Brewer Chapter 10
Asif Hasan
 
rmk_111303margin
rmk_111303marginrmk_111303margin
rmk_111303margin
finance22
 
rmk_111303margin
rmk_111303marginrmk_111303margin
rmk_111303margin
finance22
 
B7 flexi budget
B7 flexi budgetB7 flexi budget
B7 flexi budget
Sejahtera Affif
 
chap11notes.pdf
chap11notes.pdfchap11notes.pdf
chap11notes.pdf
Ellamae79
 
Chap009 ACT 505
Chap009 ACT 505Chap009 ACT 505
Chap009 ACT 505
Weshi Wesh
 
Actual Cost Vs Plan Projection Powerpoint Presentation Slides
Actual Cost Vs Plan Projection Powerpoint Presentation SlidesActual Cost Vs Plan Projection Powerpoint Presentation Slides
Actual Cost Vs Plan Projection Powerpoint Presentation Slides
SlideTeam
 
Budgets
BudgetsBudgets
Budgets
gemdeane1
 
ConAgra Q4Jul04
ConAgra Q4Jul04ConAgra Q4Jul04
ConAgra Q4Jul04
finance21
 
Chap009 7e edited
Chap009 7e editedChap009 7e edited
Chap009 7e edited
OpieUtopis
 
Business growth model 2 for import to keynote
Business growth model  2 for import to keynoteBusiness growth model  2 for import to keynote
Business growth model 2 for import to keynote
MacKenzie, George & Company
 
Solution Manual For Accounting 28th Edition by Carl S. Warren, Christine Joni...
Solution Manual For Accounting 28th Edition by Carl S. Warren, Christine Joni...Solution Manual For Accounting 28th Edition by Carl S. Warren, Christine Joni...
Solution Manual For Accounting 28th Edition by Carl S. Warren, Christine Joni...
mwangimwangi222
 
8013 lecture depreciation
8013 lecture depreciation8013 lecture depreciation
8013 lecture depreciation
Boran Eshtawi
 
Q305_netcapital
Q305_netcapitalQ305_netcapital
Q305_netcapital
finance50
 
yuty
yutyyuty
Actual Cost Vs Plan Projection PowerPoint Presentation Slides
Actual Cost Vs Plan Projection PowerPoint Presentation Slides Actual Cost Vs Plan Projection PowerPoint Presentation Slides
Actual Cost Vs Plan Projection PowerPoint Presentation Slides
SlideTeam
 
Gnb 11 12e
Gnb 11 12eGnb 11 12e
Gnb 11 12e
Saif Mahmud
 

Similar to Flexible budget (20)

Manufacturing cost accounting ppt @ mba finance
Manufacturing cost accounting ppt @ mba financeManufacturing cost accounting ppt @ mba finance
Manufacturing cost accounting ppt @ mba finance
 
Operational budgeting
Operational budgetingOperational budgeting
Operational budgeting
 
Accountability 101
Accountability 101Accountability 101
Accountability 101
 
Managerial Accounting Garrison Noreen Brewer Chapter 10
Managerial Accounting Garrison Noreen Brewer Chapter 10Managerial Accounting Garrison Noreen Brewer Chapter 10
Managerial Accounting Garrison Noreen Brewer Chapter 10
 
rmk_111303margin
rmk_111303marginrmk_111303margin
rmk_111303margin
 
rmk_111303margin
rmk_111303marginrmk_111303margin
rmk_111303margin
 
B7 flexi budget
B7 flexi budgetB7 flexi budget
B7 flexi budget
 
chap11notes.pdf
chap11notes.pdfchap11notes.pdf
chap11notes.pdf
 
Chap009 ACT 505
Chap009 ACT 505Chap009 ACT 505
Chap009 ACT 505
 
Actual Cost Vs Plan Projection Powerpoint Presentation Slides
Actual Cost Vs Plan Projection Powerpoint Presentation SlidesActual Cost Vs Plan Projection Powerpoint Presentation Slides
Actual Cost Vs Plan Projection Powerpoint Presentation Slides
 
Budgets
BudgetsBudgets
Budgets
 
ConAgra Q4Jul04
ConAgra Q4Jul04ConAgra Q4Jul04
ConAgra Q4Jul04
 
Chap009 7e edited
Chap009 7e editedChap009 7e edited
Chap009 7e edited
 
Business growth model 2 for import to keynote
Business growth model  2 for import to keynoteBusiness growth model  2 for import to keynote
Business growth model 2 for import to keynote
 
Solution Manual For Accounting 28th Edition by Carl S. Warren, Christine Joni...
Solution Manual For Accounting 28th Edition by Carl S. Warren, Christine Joni...Solution Manual For Accounting 28th Edition by Carl S. Warren, Christine Joni...
Solution Manual For Accounting 28th Edition by Carl S. Warren, Christine Joni...
 
8013 lecture depreciation
8013 lecture depreciation8013 lecture depreciation
8013 lecture depreciation
 
Q305_netcapital
Q305_netcapitalQ305_netcapital
Q305_netcapital
 
yuty
yutyyuty
yuty
 
Actual Cost Vs Plan Projection PowerPoint Presentation Slides
Actual Cost Vs Plan Projection PowerPoint Presentation Slides Actual Cost Vs Plan Projection PowerPoint Presentation Slides
Actual Cost Vs Plan Projection PowerPoint Presentation Slides
 
Gnb 11 12e
Gnb 11 12eGnb 11 12e
Gnb 11 12e
 

Flexible budget

  • 1. Flexible Budgets and Performance Analysis Chapter 10 © 2010 The McGraw-Hill Companies, Inc.
  • 2. Learning Objective 1 Prepare a flexible budget. McGraw-Hill/Irwin Slide 2
  • 3. 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/Irwin Slide 3
  • 4. 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/Irwin Slide 4
  • 5. Deficiencies of the Static Planning Budget Larry’s Lawn Service provides lawn care in a planned Larry’s Lawn Service provides lawn care in a planned community where all lawns are approximately the same size. community where all lawns are approximately the same size. At the end of May, Larry prepared his June budget based on At the end of May, Larry prepared his June budget based on mowing 500 lawns. Since all of the lawns are similar in size, mowing 500 lawns. Since all of the lawns are similar in size, Larry felt that the number of lawns mowed in a month would Larry felt that the number of lawns mowed in a month would be the best way to measure overall activity for his business. be the best way to measure overall activity for his business. Larry’s Budget McGraw-Hill/Irwin Slide 5
  • 6. Deficiencies of the Static Planning Budget Larry’s Planning Budget Larry's Lawn Service For the Month Ended June 30 Revenue/Cost Planning Formulas Budget Number of lawns (Q) 500 Revenue ($75Q) $ 37,500 Expenses: Wages and salaries ($5,000 + $30Q) $ 20,000 Gasoline and supplies ($9Q) 4,500 Equipment maintenance ($3Q) 1,500 Office and shop utilities ($1,000) 1,000 Office and shop rent ($2,000) 2,000 Equipment Depreciation ($2,500) 2,500 Insurance ($1,000) 1,000 Total expenses 32,500 Net operating income $ 5,000 McGraw-Hill/Irwin Slide 6
  • 7. Deficiencies of the Static Planning Budget Larry’s Actual Results Larry's Lawn Service For the Month Ended June 30 Actual Results Number of lawns 550 Revenue $ 43,000 Expenses: Wages and salaries $ 23,500 Gasoline and supplies 5,100 Equipment maintenance 1,300 Office and shop utilities 950 Office and shop rent 2,000 Equipment Depreciation 2,500 Insurance 1,200 Total expenses 36,550 Net operating income $ 6,450 McGraw-Hill/Irwin Slide 7
  • 8. Deficiencies of the Static Planning Budget Larry’s Actual Results Compared with the Planning Budget Larry's Lawn Service For the Month Ended June 30 Revenue/Cost Planning Actual Formulas Budget Results Variances Number of lawns (Q) 500 550 Revenue ($75Q) $ 37,500 $ 43,000 $ 5,500 F Expenses: Wages and salaries ($5,000 + $30Q) $ 20,000 $ 23,500 $ 3,500 U Gasoline and supplies ($9Q) 4,500 5,100 600 U Equipment maintenance ($3Q) 1,500 1,300 200 F Office and shop utilities ($1,000) 1,000 950 50 F Office and shop rent ($2,000) 2,000 2,000 - Equipment Depreciation ($2,500) 2,500 2,500 - Insurance ($1,000) 1,000 1,200 200 U Total expenses 32,500 36,550 4,050 U Net operating income $ 5,000 $ 6,450 $ 1,450 F McGraw-Hill/Irwin Slide 8
  • 9. Deficiencies of the Static Planning Budget Larry’s Actual Results Compared with the Planning Budget F = Favorable variance that occurs when actual Larry's Lawn Service For the Month Ended June 30 revenue is greater than budgeted revenue. Revenue/Cost Planning Actual Formulas Budget Results Variances Number of lawns (Q) 500 550 Revenue ($75Q) $ 37,500 $ 43,000 $ 5,500 F Expenses: Wages and salaries ($5,000 + $30Q) $ 20,000 $ 23,500 $ 3,500 U U = Unfavorable variance that 4,500 Gasoline and supplies ($9Q) occurs when 5,100 600 U Equipment costs are ($3Q) actual maintenance greater than budgeted costs. 1,500 1,300 200 F Office and shop utilities ($1,000) 1,000 950 50 F Office and shop rent ($2,000) 2,000 2,000 - Equipment Favorable($2,500) F = Depreciation variance that occurs when 2,500 2,500 - Insurance ($1,000) 1,000 1,200 200 U actual costs are less than budgeted costs. Total expenses 32,500 36,550 4,050 U Net operating income $ 5,000 $ 6,450 $ 1,450 F McGraw-Hill/Irwin Slide 9
  • 10. Deficiencies of the Static Planning Budget Larry’s Actual Results Compared with the Planning Budget Larry's Lawn Service For the Month Ended June 30 Revenue/Cost Planning Actual Formulas Budget Results Variances Number of lawns (Q) 500 550 Revenue ($75Q) $ 37,500 $ 43,000 $ 5,500 F Expenses: Wages and salaries Since these variances are $ 20,000 Gasoline and supplies ($5,000 + $30Q) ($9Q) $ 23,500 unfavorable, 5,100 4,500 has $ 3,500 600 U U Equipment maintenance poor job controlling costs? Larry done a ($3Q) 1,500 1,300 200 F Office and shop utilities ($1,000) 1,000 950 50 F Office and shop rent ($2,000) 2,000 2,000 - Equipment Depreciation variances are favorable, has Since these ($2,500) 2,500 2,500 - Insurance ($1,000) 1,000 1,200 200 U Larry done a good job controlling costs? Total expenses 32,500 36,550 4,050 U Net operating income $ 5,000 $ 6,450 $ 1,450 F McGraw-Hill/Irwin Slide 10
  • 11. 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/Irwin Slide 11
  • 12. Deficiencies of the Static Planning Budget  The relevant question is .. .. ..  The relevant question is “How much of the cost variances is due to higher “How much of the cost variances is due to higher activity, and how much is due to cost control?” activity, and how much is due to cost control?”  To answer the question,  To answer the question, we must we must the budget to the the budget to the actual level of activity.. actual level of activity McGraw-Hill/Irwin Slide 12
  • 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 able unchanged within the Vari relevant range. Fixed McGraw-Hill/Irwin Slide 13
  • 14. How a Flexible Budget Works Let’s prepare a budget for Larry’s Lawn Service. McGraw-Hill/Irwin Slide 14
  • 15. Preparing a Flexible Budget Larry’s Flexible Budget Larry's Lawn Service For the Month Ended June 30 Revenue/Cost Flexible Formulas Budget Number of lawns (Q) 550 Revenue ($75Q) $ 41,250 Expenses: Wages and salaries ($5,000 + $30Q) $ 21,500 Gasoline and supplies ($9Q) 4,950 Equipment maintenance ($3Q) 1,650 Office and shop utilities ($1,000) 1,000 Office and shop rent ($2,000) 2,000 Equipment Depreciation ($2,500) 2,500 Insurance ($1,000) 1,000 Total expenses 34,600 Net operating income $ 6,650 McGraw-Hill/Irwin Slide 15
  • 16. Quick Check  What should the total wages and salaries cost What should the total wages and salaries cost be in a flexible budget for 600 lawns? be in a flexible budget for 600 lawns? a. $18,000 a. $18,000 b. $20,000. b. $20,000. c. $23,000. c. $23,000. d. $25,000. d. $25,000. McGraw-Hill/Irwin Slide 16
  • 17. Quick Check  What should be the total wages and salaries What should the the total wages and salaries be total wages and salaries cost the total wages and salaries cost be in in flexible budget for 600 lawns? cost in a flexible budget for 600 lawns? cost a a flexible budget for 600 lawns? be in a flexible budget for 600 lawns? a. $18,000 a. $18,000 b. $20,000. b. $20,000. c. $23,000. c. $23,000. d. $25,000. d. $25,000. Total wages and salaries cost = $5,000 + ($30 per lawn × 600 lawns) = $5,000 + $18,000 = $23,000 McGraw-Hill/Irwin Slide 17

Editor's Notes

  1. Chapter 10: Flexible Budgets and Performance Analysis This chapter explores how budgets can be adjusted so that meaningful comparisons to actual costs can be made.
  2. Learning objective number 1 is to p repare a flexible budget.
  3. A planning budget is prepared before the period begins and is valid for only the planned level of activity. If the actual level of activity differs from what was planned, it would be misleading to evaluate performance by comparing actual costs to the static, unchanged planning budget.
  4. A flexible budget provides estimates of what revenues and costs should be for any level of activity, within a specified range. When used for performance evaluation purposes, actual costs are compared to what the costs should have been for the actual level of activity during the period. This enables “apples-to-apples” cost comparisons.
  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.
  6. Larry identified 7 major expenses for his business. In addition, Larry estimated a cost formula for revenue and for each expense in terms of the number of lawns mowed. Revenue, along with each of the 7 major expense categories, and their relationship to the number of lawns (Q) is as follows: Revenue, $75 per lawn (Q) Wages and salaries, $5,000 + $30 per lawn (Q) Gasoline and supplies, $9Q Equipment maintenance, $3Q Some expenses are not directly related to the number of lawns mowed. They are the fixed costs: office and shop utilities, $1,000; office and shop rent, $2,000; equipment depreciation, $2,500; and insurance, $1,000. Larry’s static planning budget is based on an activity level of 500 lawns.
  7. Assume that Larry’s actual results for the month of June are as shown. Notice that Larry actually mowed 550 lawns.
  8. If Larry wanted to, he could compare his actual results to the planning budget as shown on the slide. Notice that a variance is computed for revenue and each expense item. The planning budget column and actual results column have apple and orange icons to emphasize that the amounts in both columns are based on different levels of activity ( 500 vs. 550 lawns ).
  9. Revenue variances are labeled favorable when actual revenues exceed budgeted revenues, and they are labeled unfavorable when actual revenues are less than budgeted revenues. Expense variances are labeled favorable when actual expenses are less than budgeted expenses, and they are labeled unfavorable when actual expenses exceed budgeted expenses.
  10. Has Larry done a poor job controlling those costs with unfavorable variances? Has he done a good job controlling the costs with favorable variances?
  11. The answer is unclear because the actual activity level (550 lawns) does not equal the planned activity level (500 lawns).
  12. This raises an additional question, namely – How much of the cost variances is due to higher activity, and how much is due to cost control? To answer this question, we must “flex” the budget.
  13. Flexing a budget involves two key assumptions about cost behavior. First, total variable costs change in direct proportion to changes in activity; and second, total fixed costs remain unchanged within a specified activity range.
  14. Let’s continue the Larry’s Lawn Service example by preparing a flexible budget at the actual level of activity.
  15. Larry’s flexible budget for an activity level of 550 lawns mowed is as shown on this slide. The key to preparing a flexible budget is to state each variable cost as a function of activity. For example, gasoline and supplies are equal to $9 per lawn, and the variable portion of wages and salaries is $30 per lawn. While variable costs are expressed per unit of activity, fixed costs are not. The fixed costs are not sensitive to changes in the activity level. Notice, the “Q” in all revenue and cost formulas is 550 lawns mowed. So, for example: Revenue of $41,250 is computed by multiplying $75 × 550. Wages and salaries of $21,500 is computed by multiplying $30 × 550 plus $5,000 in fixed salaries. Can you compute the flexible budget amount for wages and salaries at a different level of activity? The question on the following screen will ask you to do that.
  16. Here’s the question. What should be the total wages and salaries cost in a flexible budget for 600 lawns?
  17. Total wages and salaries is the sum of the $5,000 of fixed portion plus the $18,000 of variable portion. The variable portion is computed by multiplying $30 per lawn times 600 lawns.