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© 2010 The McGraw-Hill Companies, Inc.
Flexible Budgets andPerformance Analysis
Chapter 10
McGraw-Hill/Irwin Slide 2
Learning Objective 1
Prepare a flexible Prepare a flexible budget.budget.
McGraw-Hill/Irwin Slide 3
Characteristics of Flexible Budgets
Planning budgetsare prepared fora single, plannedlevel of activity.
Performance evaluation is difficult when actual activity
differs from the planned level of
activity.
Hmm! Comparingstatic planning budgets
with actual costsis like comparing
apples and oranges.
McGraw-Hill/Irwin Slide 4
Improve performance evaluation.
May be prepared for any activity level in the relevant range.
Show costs that should have beenincurred at the actual level ofactivity, enabling “apples to apples”cost comparisons.
Help managers control costs.
Let’s look at Larry’s Lawn Service.
Characteristics of Flexible Budgets
McGraw-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 onmowing 500 lawns. Since all of the lawns are similar in size,Larry felt that the number of lawns mowed in a month wouldbe 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 onmowing 500 lawns. Since all of the lawns are similar in size,Larry felt that the number of lawns mowed in a month wouldbe the best way to measure overall activity for his business.
Larry’s Budget
Deficiencies of the Static Planning Budget
McGraw-Hill/Irwin Slide 6
Deficiencies of the Static Planning BudgetLarry’s Planning Budget
McGraw-Hill/Irwin Slide 7
Deficiencies of the Static Planning BudgetLarry’s Actual Results
McGraw-Hill/Irwin Slide 8
Deficiencies of the Static Planning BudgetLarry’s Actual Results Compared with the Planning Budget
McGraw-Hill/Irwin Slide 9
Deficiencies of the Static Planning BudgetLarry’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.
McGraw-Hill/Irwin Slide 10
Deficiencies of the Static Planning BudgetLarry’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?
McGraw-Hill/Irwin Slide 11
I don’t think Ican answer thequestions usinga static budget.
Actual activity is above planned activity.
So, shouldn’t the variablecosts be higher if actual
activity is higher?
Deficiencies of the Static Planning Budget
McGraw-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 mustthe budget to theactual 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 mustthe budget to theactual level of activity.
Deficiencies of the Static Planning Budget
McGraw-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 remainunchanged within therelevant range. Fixed
Variable
McGraw-Hill/Irwin Slide 14
Let’s prepare a budget
for Larry’s Lawn Service.
Let’s prepare a budget
for Larry’s Lawn Service.
How a Flexible Budget Works
McGraw-Hill/Irwin Slide 15
Preparing a Flexible BudgetLarry’s Flexible Budget
McGraw-Hill/Irwin Slide 16
Quick Check
What should the total wages and salaries cost be in a flexible budget for 600 lawns?a. $18,000b. $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. $18,000b. $20,000.c. $23,000.d. $25,000.
McGraw-Hill/Irwin Slide 17
Quick Check
What should be the total wages and salaries cost in a flexible budget for 600 lawns?a. $18,000b. $20,000.c. $23,000.d. $25,000.
What should be the total wages and salaries cost in a flexible budget for 600 lawns?a. $18,000b. $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. $18,000b. $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. $18,000b. $20,000.c. $23,000.d. $25,000.
McGraw-Hill/Irwin Slide 18
Learning Objective 2
Prepare a report Prepare a report showing activity showing activity
variances.variances.
McGraw-Hill/Irwin Slide 19
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.
McGraw-Hill/Irwin Slide 20
Let’s use budgeting
concepts to compute activity variances for Larry’s Lawn Service.
Let’s use budgeting
concepts to compute activity variances for Larry’s Lawn Service.
Activity Variances
McGraw-Hill/Irwin Slide 21
Activity VariancesLarry’s Flexible Budget Compared with the Planning Budget
McGraw-Hill/Irwin Slide 22
Activity VariancesLarry’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/Irwin Slide 23
Learning Objective 3
Prepare a report Prepare a report showing revenue and showing revenue and spending variances.spending variances.
McGraw-Hill/Irwin Slide 24
Revenue and Spending Variances
Flexible budget revenue Actual revenue
The difference is a revenue variance.The difference is a revenue variance.
Flexible budget cost Actual cost
The difference is a spending variance.The difference is a spending variance.
McGraw-Hill/Irwin Slide 25
Now, let’s use budgeting
concepts to compute revenue and spending variances for Larry’s Lawn
Service.
Now, let’s use budgeting
concepts to compute revenue and spending variances for Larry’s Lawn
Service.
Revenue and Spending Variances
McGraw-Hill/Irwin Slide 26
Revenue and Spending VariancesLarry’s Flexible Budget Compared with the Actual Results
$1,750 favorable$1,750 favorablerevenue variancerevenue variance
McGraw-Hill/Irwin Slide 27
Larry’s Flexible Budget Compared with the Actual Results
Revenue and Spending Variances
Spending variances
McGraw-Hill/Irwin Slide 28
Learning Objective 4
Prepare a performance Prepare a performance report that combines report that combines activity variances and activity variances and revenue and spending revenue and spending
variances.variances.
McGraw-Hill/Irwin Slide 29
Now, let’s use budgeting
concepts to combine the revenue and spending variances reports for Larry’s
Lawn Service.
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
McGraw-Hill/Irwin Slide 30
A Performance Report Combining Activity and Revenue and Spending Variances
McGraw-Hill/Irwin Slide 31
A Performance Report Combining Activity and Revenue and Spending Variances
50 lawns × $75 per lawn50 lawns × $75 per lawn 50 lawns × $30 per lawn50 lawns × $30 per lawn
McGraw-Hill/Irwin Slide 32
A Performance Report Combining Activity and Revenue and Spending Variances
$43,000 actual - $41,250 budget$43,000 actual - $41,250 budget
McGraw-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.
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
McGraw-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.
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/Irwin Slide 35
Learning Objective 5
Prepare a flexible Prepare a flexible budget with more than budget with more than
one cost driver.one cost driver.
McGraw-Hill/Irwin Slide 36
More than one cost driver may be needed toadequately explain all of
the costs in an organization.
More than one cost driver may be needed toadequately explain all of
the costs in an organization.
The cost formulas usedto prepare a flexible
budget can be adjustedto recognize multiple
cost drivers.
The cost formulas usedto prepare a flexible
budget can be adjustedto recognize multiple
cost drivers.
Flexible Budgets with Multiple Cost Drivers
McGraw-Hill/Irwin Slide 37
Because of the large unfavorable wages and salaries spendingvariance, 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.
Because of the large unfavorable wages and salaries spendingvariance, 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
McGraw-Hill/Irwin Slide 38
Flexible Budgets with Multiple Cost DriversLarry’s Budget Based on More than One Cost Driver
McGraw-Hill/Irwin Slide 39
Learning Objective 6
Understand common Understand common errors made in errors made in
preparing performance preparing performance reports based on reports based on
budgets and actual budgets and actual results.results.
McGraw-Hill/Irwin Slide 40
Some Common Errors
The most common errors in preparing performancereports are to implicitly assume that:1. All costs are fixed or that 2. All costs are variable.
The most common errors in preparing performancereports are to implicitly assume that:1. All costs are fixed or that 2. All costs are variable.
Assume all costs are fixed.
McGraw-Hill/Irwin Slide 41
Common Error 1: Assuming All Costs Are Fixed
Faulty Analysis Comparing Budgeted Amounts to Actual Amounts
McGraw-Hill/Irwin Slide 42
Common Error 2: Assuming All Costs Are VariableFaulty Analysis that Assumes All budget Items Are Variable
McGraw-Hill/Irwin Slide 43
End of Chapter 10