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Chapter 9

Chapter 9. Hmm! Comparing static budgets with actual costs is like comparing apples and oranges. Static Budgets and Performance Reports. Static budgets are prepared for a single, planned level of activity.

raphael-hardy
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Chapter 9

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  1. Chapter 9

  2. Hmm! Comparingstatic budgets withactual costs is likecomparing applesand oranges. Static Budgets and Performance Reports Static budgets are prepared for a single, planned levelof activity. Performance evaluation is difficult when actual activity differs from the planned level of activity.

  3. The relevant question is . . . “How much of the cost variances is due to higher or lower 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

  4. Show revenues and expensesthat should have occurred at theactual 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. Flexible Budgets

  5. Preparing a Flexible Budget To a budget we need to remember that: • Total variablecosts changein direct proportion to changes in activity. • Total fixedcosts remainunchanged within therelevant range. Variable Fixed

  6. The Planning (Static) Budget

  7. Actual Results

  8. How a Flexible Budget Works Let’s prepare a budgetfor Larry’s Lawn Service.

  9. Preparing a Flexible Budget

  10. Activity Variances Planning budget revenues and expenses Flexible budget revenuesand expenses The differences between the budget amounts are called activity variances.

  11. 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.

  12. Revenue and Spending Variances Flexible budget revenue Actual revenue The difference is a revenuevariance. Actual costs Flexible budget costs The difference is a spending variance.

  13. A Performance ReportCombining Activity and Revenue and Spending Variances

  14. Some Common Errors • The most common errors in preparing performancereports are to implicitly assume that:1. All costs are fixed, or that • All costs are variable.

  15. Common Error 1: Assuming All Costs Are Fixed

  16. Common Error 2: Assuming All Costs Are Variable

  17. Budgets with Multiple Cost Drivers More than one cost driver may be needed toadequately explain all ofthe costs in an organization. The cost formulas usedto prepare a flexiblebudget can be adjustedto recognize multiplecost drivers.

  18. Budgets with Multiple Cost Drivers Larry’s New Budget Because of the large unfavorable wages and salaries spendingvariance, Larry decided to add an additional cost driver for wages and salaries. The variance is due primarily to the number of hours required for the additional edging and trimming. So Larry estimates the additional hours and builds those hours into both his revenue and expense budget formulas.

  19. Budgets with Multiple Cost Drivers Larry’s Flexible Budget Based on More than One Cost Driver

  20. End of Chapter 9

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