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Flexible Budgets and

Performance Analysis
Chapter 9

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright2015byMcGrawHillEducation.Allrightsreserved.

9-2

Variance Analysis Cycle

9-3

Learning Objective 1
Prepare a flexible
budget.

9-4

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.

9-5

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.

Lets look at Larrys Lawn Service.

9-6

Deficiencies of the Static Planning Budget


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

Larrys Budget

9-7

Deficiencies of the Static Planning Budget


Larrys Planning Budget

9-8

Deficiencies of the Static Planning Budget


Larrys Actual Results

9-9

Deficiencies of the Static Planning Budget


Larrys Actual Results Compared with the Planning Budget

9-10

Deficiencies of the Static Planning Budget


Larrys Actual Results Compared with the Planning Budget
F = Favorable variance that occurs when actual
revenue is greater than budgeted revenue.

U = Unfavorable variance that occurs when


actual costs are greater than budgeted costs.
F = Favorable variance that occurs when
actual costs are less than budgeted costs.

9-11

Deficiencies of the Static Planning Budget


Larrys 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?

9-12

Deficiencies of the Static Planning Budget


I dont think I
can answer the
questions using
a static budget.

Actual activity is above


planned activity.
So, shouldnt the variable
costs be higher if actual
activity is higher?

9-13

Deficiencies of the Static Planning Budget


The
The relevant
relevant question
question is
is .. .. ..
How
How much
much of
of the
the cost
cost variances
variances are
are due
due to
to
higher
higher activity
activity and
and how
how much
much are
are due
due to
to cost
cost
control?
control?

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

9-14

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.

le
b
ria
a
V
Fixed

9-15

How a Flexible Budget Works


Lets prepare a
budget
for Larrys Lawn
Service.

9-16

Preparing a Flexible Budget


Larrys Flexible Budget

9-17

Quick Check
What
What should
should the
the total
total wages
wages and
and salaries
salaries cost
cost
be
be in
in aa flexible
flexible budget
budget for
for 600
600 lawns?
lawns?
a.
a. $18,000.
$18,000.
b.
b. $20,000.
$20,000.
c.
c. $23,000.
$23,000.
d.
d. $25,000.
$25,000.

9-18

Quick Check
What
be
total
total
wages
wages
and
salaries
salaries
cost
What should
should the
be the
the
the
total
total
wages
wages
andand
and
salaries
salaries
cost
cost
be
in
aaaflexible
flexible
budget
budget
for
for
600
600
lawns?
lawns?
cost
be
inin
in
aflexible
flexible
budget
budget
for
for
600
600
lawns?
lawns?
a.
$18,000
a. $18,000.
$18,000
$18,000.
b.
b. $20,000.
$20,000.
c.
c. $23,000.
$23,000.
d.
d. $25,000.
$25,000.
Total wages and salaries cost
= $5,000 + ($30 per lawn 600 lawns)
$5,000 + $18,000 = $23,000

9-19

Learning Objective 2
Prepare a report
showing activity
variances.

9-20

Activity Variances
Flexible
budget revenues
and expenses

Planning
budget revenues
and expenses

The differences between


the budget amounts are
called activity variances.

9-21

Activity Variances
Lets use

budgeting

concepts to compute activity


variances for Larrys Lawn Service.

9-22

Activity Variances
Larrys Flexible Budget Compared with the Planning Budget

9-23

Activity Variances
Larrys 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.

9-24

Learning Objective 3
Prepare a report
showing revenue and
spending variances.

9-25

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.

9-26

Revenue and Spending Variances


Now, lets use

budgeting

concepts to compute revenue and


spending variances for Larrys Lawn
Service.

9-27

Revenue and Spending Variances


Larrys Flexible Budget Compared with the Actual Results
$1,750 favorable
revenue variance

9-28

Revenue and Spending Variances


Larrys Flexible Budget Compared with the Actual Results
Spending
variances

9-29

Learning Objective 4
Prepare a performance
report that combines
activity variances and
revenue and spending
variances.

9-30

A Performance Report Combining Activity


and Revenue and Spending Variances
Now, lets use

budgeting

concepts to combine the revenue and


spending variances reports for Larrys
Lawn Service.

9-31

A Performance Report Combining Activity


and Revenue and Spending Variances

9-32

A Performance Report Combining Activity


and Revenue and Spending Variances

50
50 lawns
lawns $30
$30 per
per lawn
lawn

50
50 lawns
lawns $75
$75 per
per lawn
lawn

9-33

A Performance Report Combining Activity


and Revenue and Spending Variances

$43,000
$43,000 actual
actual -- $41,250
$41,250 budget
budget

9-34

Performance Reports in Non-Profit


Organizations
Non-profit
Non-profit organizations
organizations may
may receive
receive funding
funding from
from
sources
sources other than
than the sale of goods
goods and
and services,
services,
so revenues may
may consist
consist of
of both
both fixed
fixed and
and
variable
variable elements.
State funding

Donations

Tuition and fees

Endowments
Universities

9-35

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.

9-36

Learning Objective 5
Prepare a flexible budget
with more than one cost
driver.

9-37

Flexible Budgets with Multiple Cost Drivers


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.

9-38

Flexible Budgets with Multiple Cost Drivers


Because
Because the
the time
time required
required for
for edging
edging and
and trimming
trimming is
is different
different for
for
different
different lawns,
lawns, Larry
Larry decided
decided to
to add
add an
an additional
additional cost
cost driver
driver
(hours)
(hours) for
for the
the time
time required
required for
for edging
edging and
and trimming.
trimming. So
So Larry
Larry
estimated
estimated the
the additional
additional hours
hours and
and developed
developed aa new
new flexible
flexible
budget
budget that
that includes
includes the
the second
second cost
cost driver
driver in
in both
both his
his revenue
revenue
and
and expense
expense budget
budget formulas.
formulas.

Larrys New Budget

9-39

Flexible Budgets with Multiple Cost Drivers


Larrys Budget Based on More than One Cost Driver

9-40

Learning Objective 6
Understand common
errors made in preparing
performance reports
based on budgets and
actual results.

9-41

Some Common Errors


The
The most common
common errors
errors when preparing performance
reports
reports are
are to
to implicitly
implicitly assume that:
1.
1. All
All costs
costs are
are fixed,
fixed, or
or that;
that;
2.
2. All
All costs
costs are
are variable.

Assume all costs are fixed.

9-42

Common Error 1: Assuming All Costs Are


Fixed
Faulty Analysis Comparing Budgeted Amounts to Actual Amounts

9-43

Common Error 2: Assuming All Costs Are


Variable
Faulty Analysis that Assumes All Budget Items Are Variable

9-44

End of Chapter 9

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