PowerPoint Authors:
Susan Coomer Galbreath, ., CPA
Charles W. Caldwell, ., CMA
Jon A. Booker, ., CPA, CIA
Cynthia J. Rooney, ., CPA
Copyright © 2015 by McGraw-Hill Education. All rights reserved.
Flexible Budgets and
Performance Analysis
Chapter 9
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Variance Analysis Cycle
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Learning Objective 1
Prepare a flexible budget.
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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.
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Characteristics of Flexible Budgets
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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.
Deficiencies of the Static Planning Budget
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Deficiencies of the Static Planning Budget
Larry’s Planning Budget
Sheet1
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
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Deficiencies of the Static Planning Budget
Larry’s Actual Results
Sheet1
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
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Deficiencies of the Static Planning Budget
Larry’s Actual Results Compared with the Planning Budget
Sheet1
Larry's Lawn Service
For the Month Ended June 30
Revenue/Cost Actual Planning
Formulas Results Budget Variances
Number of lawns (Q) 550 500
Revenue ($75Q) $43,000 $37,500 $5,500 F
Expenses:
Wages and salaries ($5,000 + $30Q) $23,500 $20,000 $3,500 U
Gasoline and supplies ($9Q) 5,100 4,500 600 U
Equipment maintenance ($3Q) 1,300 1,500 200 F
Office and shop utilities ($1,000) 950 1,000 50 F
Office and shop rent ($2,000) 2,000 2,000
Equipment Depreciation ($2,500) 2,500 2,500
Insurance ($1,000) 1,200 1,000 200 U
Total expenses 36,550 32,500 4,050 U
Net operating income $6,450 $5,000 $1,450 F
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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.
Sheet1
Larry's Lawn Service
For the Month Ended June 30
Revenue/Cost Actual Planning
Formulas Results Budget Variances
Number of lawns (Q) 550 500
Revenue ($75Q) $43,000 $37,500 $5,500 F
Expenses:
Wages and salaries ($5,000 + $30Q) $23,500 $20,000 $3,500 U
Gasoline and supplies ($9Q) 5,100 4,500 600 U
Equipment maintenance ($3Q) 1,300 1,500 200 F
Office and shop utilities ($1,000) 950 1,000 50 F
Office and shop rent ($2,000) 2,000 2,000
Equipment Depreciation ($2,500) 2,500 2,500
Insurance ($1,000) 1,200 1,000 200 U
Total expenses 36,550 32,500 4,050 U
Net operating income $6,450 $5,000 $1,450 F
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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?
Sheet1
Larry's Lawn Service
For the Month Ended June 30
Revenue/Cost Actual Planning
Formulas Results Budget Variances
Number of lawns (Q) 550 500
Revenue ($75Q) $43,000 $37,500 $5,500 F
Expenses:
Wages and salaries ($5,000 + $30Q) $23,500 $20,000 $3,500 U
Gasoline and supplies ($9Q) 5,100 4,500 600 U
Equipment maintenance ($3Q) 1,300 1,500 200 F
Office and shop utilities ($1,000) 950 1,000 50 F
Office and shop rent ($2,000) 2,000 2,000
Equipment Depreciation ($2,500) 2,500 2,500
Insurance ($1,000) 1,200 1,000 200 U
Total expenses 36,550 32,500 4,050 U
Net operating income $6,450 $5,000 $1,450 F
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Deficiencies of the Static Planning Budget
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The relevant question is . . .
“How much of the cost variances are due to higher activity and how much are due to cost control?”
To answer the question,
we must
the budget to the
actual level of activity.
Deficiencies of the Static Planning Budget
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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
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Let’s prepare a
budget
for Larry’s Lawn Service.
How a Flexible Budget Works
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Preparing a Flexible Budget
Larry’s Flexible Budget
Sheet1
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
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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.
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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.
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Learning Objective 2
Prepare a report showing activity variances.
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Activity Variances
Flexible
budget revenues
and expenses
Planning
budget revenues
and expenses
The differences between the budget amounts are called activity variances.
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Let’s use budgeting
concepts to compute activity variances for Larry’s Lawn Service.
Activity Variances
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Activity Variances
Larry’s Flexible Budget Compared with the Planning Budget
Sheet1
Larry's Lawn Service
For the Month Ended June 30
Revenue/Cost Flexible Planning Activity
Formulas Budget Budget Variances
Number of lawns (Q) 550 500
Revenue ($75Q) $41,250 $37,500 $3,750 F
Expenses:
Wages and salaries ($5,000 + $30Q) $21,500 $20,000 $1,500 U
Gasoline and supplies ($9Q) 4,950 4,500 450 U
Equipment maintenance ($3Q) 1,650 1,500 150 U
Office and shop utilities ($1,000) 1,000 1,000
Office and shop rent ($2,000) 2,000 2,000
Equipment Depreciation ($2,500) 2,500 2,500
Insurance ($1,000) 1,000 1,000
Total expenses 34,600 32,500 2,100 U
Net operating income $6,650 $5,000 $1,650 F
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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.
Sheet1
Larry's Lawn Service
For the Month Ended June 30
Revenue/Cost Flexible Planning Activity
Formulas Budget Budget Variances
Number of lawns (Q) 550 500
Revenue ($75Q) $41,250 $37,500 $3,750 F
Expenses:
Wages and salaries ($5,000 + $30Q) $21,500 $20,000 $1,500 U
Gasoline and supplies ($9Q) 4,950 4,500 450 U
Equipment maintenance ($3Q) 1,650 1,500 150 U
Office and shop utilities ($1,000) 1,000 1,000
Office and shop rent ($2,000) 2,000 2,000
Equipment Depreciation ($2,500) 2,500 2,500
Insurance ($1,000) 1,000 1,000
Total expenses 34,600 32,500 2,100 U
Net operating income $6,650 $5,000 $1,650 F
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Learning Objective 3
Prepare a report showing revenue and spending variances.
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Revenue and Spending Variances
Actual revenue
Flexible budget revenue
The difference is a revenue variance.
Actual cost
Flexible budget cost
The difference is a spending variance.
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Now, let’s use budgeting
concepts to compute revenue and spending variances for Larry’s Lawn Service.
Revenue and Spending Variances
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Revenue and Spending Variances
Larry’s Flexible Budget Compared with the Actual Results
Sheet1
Larry's Lawn Service
For the Month Ended June 30
Revenue and
Revenue/Cost Actual Flexible Spending
Formulas Results Budget Variances
Number of lawns (Q) 550 550
Revenue ($75Q) $43,000 $41,250 $1,750 F
Expenses:
Wages and salaries ($5,000 + $30Q) $23,500 $21,500 $2,000 U
Gasoline and supplies ($9Q) 5,100 4,950 150 U
Equipment maintenance ($3Q) 1,300 1,650 350 F
Office and shop utilities ($1,000) 950 1,000 50 F
Office and shop rent ($2,000) 2,000 2,000
Equipment Depreciation ($2,500) 2,500 2,500
Insurance ($1,000) 1,200 1,000 200 U
Total expenses 36,550 34,600 1,950 U
Net operating income $6,450 $6,650 $200 U
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Larry’s Flexible Budget Compared with the Actual Results
Revenue and Spending Variances
Spending
variances
Sheet1
Larry's Lawn Service
For the Month Ended June 30
Revenue and
Revenue/Cost Actual Flexible Spending
Formulas Results Budget Variances
Number of lawns (Q) 550 550
Revenue ($75Q) $43,000 $41,250 $1,750 F
Expenses:
Wages and salaries ($5,000 + $30Q) $23,500 $21,500 $2,000 U
Gasoline and supplies ($9Q) 5,100 4,950 150 U
Equipment maintenance ($3Q) 1,300 1,650 350 F
Office and shop utilities ($1,000) 950 1,000 50 F
Office and shop rent ($2,000) 2,000 2,000
Equipment Depreciation ($2,500) 2,500 2,500
Insurance ($1,000) 1,200 1,000 200 U
Total expenses 36,550 34,600 1,950 U
Net operating income $6,450 $6,650 $200 U
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Learning Objective 4
Prepare a performance report that combines activity variances and revenue and spending variances.
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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
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A Performance Report Combining Activity and Revenue and Spending Variances
Sheet1
Larry's Lawn Service
Flexible Budget Performance Report
For the Month Ended June 30
Revenue and
Revenue/Cost Actual Spending Flexible Activity Planning
Formulas Results Variances Budget Variances Budget
Number of lawns (Q) 550 550 500
Revenue ($75Q) $43,000 $1,750 F $41,250 $3,750 F $37,500
Expenses:
Wages and salaries ($5,000 + $30Q) $23,500 $2,000 U $21,500 $1,500 U $20,000
Gasoline and supplies ($9Q) 5,100 150 U 4,950 450 U 4,500
Equipment maintenance ($3Q) 1,300 350 F 1,650 150 U 1,500
Office and shop utilities ($1,000) 950 50 F 1,000 1,000
Office and shop rent ($2,000) 2,000 2,000 2,000
Equipment Depreciation ($2,500) 2,500 2,500 2,500
Insurance ($1,000) 1,200 200 U 1,000 1,000
Total expenses 36,550 1,950 U 34,600 2,100 U 32,500
Net operating income $6,450 $200 U $6,650 $1,650 F $5,000
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Here we see a flexible budget performance report that shows both activity variances and revenue and spending variances. Note that the activity variances appear between the planning budget and the flexible budget and that the revenue and spending variances appear between the flexible budget and the actual results.
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A Performance Report Combining Activity and Revenue and Spending Variances
Sheet1
Larry's Lawn Service
Flexible Budget Performance Report
For the Month Ended June 30
Revenue and
Revenue/Cost Actual Spending Flexible Activity Planning
Formulas Results Variances Budget Variances Budget
Number of lawns (Q) 550 550 500
Revenue ($75Q) $43,000 $1,750 F $41,250 $3,750 F $37,500
Expenses:
Wages and salaries ($5,000 + $30Q) $23,500 $2,000 U $21,500 $1,500 U $20,000
Gasoline and supplies ($9Q) 5,100 150 U 4,950 450 U 4,500
Equipment maintenance ($3Q) 1,300 350 F 1,650 150 U 1,500
Office and shop utilities ($1,000) 950 50 F 1,000 1,000
Office and shop rent ($2,000) 2,000 2,000 2,000
Equipment Depreciation ($2,500) 2,500 2,500 2,500
Insurance ($1,000) 1,200 200 U 1,000 1,000
Total expenses 36,550 1,950 U 34,600 2,100 U 32,500
Net operating income $6,450 $200 U $6,650 $1,650 F $5,000
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$43,000 actual - $41,250 budget
A Performance Report Combining Activity and Revenue and Spending Variances
Sheet1
Larry's Lawn Service
Flexible Budget Performance Report
For the Month Ended June 30
Revenue and
Revenue/Cost Actual Spending Flexible Activity Planning
Formulas Results Variances Budget Variances Budget
Number of lawns (Q) 550 550 500
Revenue ($75Q) $43,000 $1,750 F $41,250 $3,750 F $37,500
Expenses:
Wages and salaries ($5,000 + $30Q) $23,500 $2,000 U $21,500 $1,500 U $20,000
Gasoline and supplies ($9Q) 5,100 150 U 4,950 450 U 4,500
Equipment maintenance ($3Q) 1,300 350 F 1,650 150 U 1,500
Office and shop utilities ($1,000) 950 50 F 1,000 1,000
Office and shop rent ($2,000) 2,000 2,000 2,000
Equipment Depreciation ($2,500) 2,500 2,500 2,500
Insurance ($1,000) 1,200 200 U 1,000 1,000
Total expenses 36,550 1,950 U 34,600 2,100 U 32,500
Net operating income $6,450 $200 U $6,650 $1,650 F $5,000
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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
Donations
State funding
Endowments
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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.
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Learning Objective 5
Prepare a flexible budget with more than one cost driver.
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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
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Because the time required for edging and trimming is different for different lawns, Larry decided to add an additional cost driver (hours) for the time required for edging and trimming. So Larry estimated the additional hours and developed a new flexible budget that includes the second cost driver in both his revenue and expense budget formulas.
Flexible Budgets with Multiple Cost Drivers
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Flexible Budgets with Multiple Cost Drivers
Larry’s Budget Based on More than One Cost Driver
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Larry's Lawn Service
For the Month Ended June 30
Revenue/Cost Flexible
Formulas Budget
Number of lawns (Q) 550
Numer of hours (H) 100
Revenues ($75Q + $25H) $43,750
Expenses:
Wages and salaries ($5,000 + $29Q + $25H) $23,450
Gasoline and supplies ($8Q + $6H) 5,000
Equipment maintenance ($2Q + $2H) 1,300
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 36,250
Net operating income $7,500
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Learning Objective 6
Understand common errors made in preparing performance reports based on budgets and actual results.
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Some Common Errors
The most common errors when preparing performance
reports are to implicitly assume that:
1. All costs are fixed, or that;
All costs are variable.
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Common Error 1: Assuming All Costs Are Fixed
Faulty Analysis Comparing Budgeted Amounts to Actual Amounts
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Larry's Lawn Service
For the Month Ended June 30
Actual Planning
Results Budget Variances
Number of lawns (Q) 550 500
Revenue $43,000 $37,500 $5,500 F
Expenses:
Wages and salaries $23,500 $20,000 $3,500 U
Gasoline and supplies 5,100 4,500 600 U
Equipment maintenance 1,300 1,500 200 F
Office and shop utilities 950 1,000 50 F
Office and shop rent 2,000 2,000
Equipment Depreciation 2,500 2,500
Insurance 1,200 1,000 200 U
Total expenses 36,550 32,500 4,050 U
Net operating income $6,450 $5,000 $1,450 F
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Common Error 2: Assuming All Costs Are Variable
Faulty Analysis that Assumes All Budget Items Are Variable
Sheet1
Larry's Lawn Service
For the Month Ended June 30
Planning
Actual Planning Budget
Results Budget × 110% Variances
Number of lawns 550 500 550
Revenue $43,000 $37,500 $41,250 $1,750 F
Expenses:
Wages and salaries $23,500 $20,000 $22,000 $1,500 U
Gasoline and supplies 5,100 4,500 4,950 150 U
Equipment maintenance 1,300 1,500 1,650 350 F
Office and shop utilities 950 1,000 1,100 150 F
Office and shop rent 2,000 2,000 2,200 200 F
Equipment Depreciation 2,500 2,500 2,750 250 F
Insurance 1,200 1,000 1,100 100 U
Total expenses 36,550 32,500 35,750 800 U
Net operating income $6,450 $5,000 $5,500 $950 F
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End of Chapter 9
Here we see a flexible budget performance report that shows both activity variances and revenue and spending variances. Note that the activity variances appear between the planning budget and the flexible budget and that the revenue and spending variances appear between the flexible budget and the actual results.
