1. Operational Budgeting
Lecture 25
Operational Budgeting 2

2. Flexible Budgeting
Let’s change topics.

3. Consider the following condensed example from the Cheese Company . . .
Flexible Budgeting
Hmm! Comparing costs at different levels of activity is like comparing apples with oranges.
Consider the following condensed example from the Cheese Company . . .
Performance evaluation is difficult when actual activity differs from the activity originally budgeted.

4. Flexible Budgeting

5. Flexible Budgeting
U = Unfavorable variance – Cheese Company was unable to achieve the budgeted level of activity.

6. F = Favorable variance: actual costs are less than budgeted costs.
Flexible Budgeting
F = Favorable variance: actual costs are less than budgeted costs.

7. Flexible Budgeting
Since cost variances are favorable, have we done a good job controlling costs?

8. I don’t think I can answer the question using the original budget.
Flexible Budgeting
How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?
I don’t think I can answer the question using the original budget.

9. I don’t think I can answer the question using the original budget.
Flexible Budgeting
How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?
I don’t think I can answer the question using the original budget.
To answer the question, we must
the budget to the actual level of activity.

10. Flexible Budgeting Central Concept
If you can tell me what your activity was for the period, I will tell you what your costs and revenue should have been.

11. Flexible Budgeting
Show expenses that should have occurred at the actual level of activity.
May be prepared for any activity level in the relevant range.
Reveal variances due to good cost
control or lack of cost control.
Improve performance evaluation.

12. Flexible Budgeting
To a budget for different activity levels, we must know how costs behave with changes in activity levels.
Total variable costs change in direct proportion to changes in activity.
Total fixed costs remain unchanged within the relevant range.
Variable
Fixed

13. Flexible Budgeting
Let’s prepare budgets for the Cheese Company.

14. Variable costs are expressed as a constant amount per hour.
Flexible Budgeting
Variable costs are expressed as a constant amount per hour.
In the original budget, indirect labor was $40,000 for 10,000 hours resulting in a rate of $4.00 per hour.

15. Flexible Budgeting

16. Flexible Budgeting
Total variable cost = $7.50 per unit × budget level in units

17. Flexible Budgeting
Fixed costs are expressed as a total amount that does not change within the relevant range of activity.

18. Flexible Budgeting Performance Report
Now let’s prepare a budget performance report at 8,000 actual machine hours for the Cheese Co.

19. Flexible Budgeting Performance Report

20. Flexible Budgeting Performance Report
Indirect labor and indirect material have unfavorable variances because actual costs are more than the flexible budget costs.

21. Flexible Budgeting Performance Report
Power has a favorable variance because the actual cost is less than the flexible budget cost.

22. Source: Adopted from McGraw-Hill/Irvin
I would be happy to assist you with your cash budget!