© 2010 The McGraw-Hill Companies, Inc.

Flexible Budgets andPerformance Analysis

Chapter 10

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Learning Objective 1

Prepare a flexible Prepare a flexible budget.budget.

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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.

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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

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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 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

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Deficiencies of the Static Planning BudgetLarry’s Planning Budget

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Deficiencies of the Static Planning BudgetLarry’s Actual Results

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Deficiencies of the Static Planning BudgetLarry’s Actual Results Compared with the Planning Budget

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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.

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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?

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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

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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

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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 remainunchanged within therelevant range. Fixed

Variable

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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

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Preparing a Flexible BudgetLarry’s Flexible Budget

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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.

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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.