Flexible Budgets and Performance Analysis

Learning Objectives Prepare a flexible budget Explain the advantages of the flexible budget over the planning (static) budget Use the flexible budget approach to prepare performance reports and analyze variances Understand common errors in preparing performance reports

Planning Budgets and Performance Evaluation The Budgets we studied previously are static in nature: based on a single, planned level of activity. Performance evaluation using planning budgets is useless. Hmm! Comparing actual revenue and costs with planning budgets is like comparing apples and oranges.

Planning Budgets and Performance Evaluation

Planning Budgets and Performance Evaluation

Planning Budgets and Performance Evaluation U = Unfavorable variance Actual revenue is less than budgeted revenue.

Planning Budgets and Performance Evaluation F = Favorable variance Actual costs are less than budgeted costs. U = Unfavorable variance Actual costs are more than budgeted costs.

Planning Budgets and Performance Evaluation Since most cost variances and income variance are favorable, have we done a good job?

Planning Budgets and Performance Evaluation Actual activity is below budgeted activity. So, shouldn’t revenue and costs be lower if actual activity is lower? I don’t think I can answer the question using a planning budget.

Planning Budgets and Performance Evaluation The relevant question is . . . “How much of the variance is due to lower activity, and how much is due to good (or poor) performance?” To answer the question, we must FLEX the budget to the actual level of activity.

Preparing a Flexible Budget To prepare a flexible budget, we must: choose the activity base(s) and determine the relevant range know how revenue and costs behave within the relevant range in response to changes in activity Recall that costs are classified as either variable or fixed variable costs change in total in direct proportion to changes in activity fixed costs remain unchanged in total within the relevant range Variable Fixed

Flexible Budgets and Performance Evaluation

ABC and Flexible Budget Companies that use ABC system also use flexible budgets. The difference between a company that uses ABC and one that does not lies in the number of flexible budgets that are prepared. In particular, with ABC a flexible budget is prepared for each activity center.

Flexible Budgets and Performance Evaluation Remember the question: “How much of the total variance (of $9,450 favorable income variance) is due to lower activity and how much is due to good or poor control?”

Flexible Budgets and Performance Evaluation Variance Analysis Let’s place the flexible budget for 8,000 Cards here. Difference between original planning budget operating income and actual results = $9,450 F.

Flexible Budgets and Performance Evaluation Variance Analysis Activity Control This $18,000 U income variance is due to lower activity. This $27,450 F income variance is due to good/poor control

Flexible Budgets and Performance Evaluation These differences are called revenue and spending variance. These differences are called activity variances.

Common Errors in Preparing Performance Reports Comparing planning budget amounts to actual amounts Assumes all revenue and costs are fixed Adjusting all amounts on planning budgets proportionately and comparing them to actual amounts Assumes all revenue and costs are variable