I Flexible Budgets II Budget Variances a Planning Budget prepared before the period begins and is valid for only the planned level of activity i Static planning budgets are suitable for planning but are inappropriate for evaluating how well costs are controlled 1 2 If activity is higher than expected variable costs should be higher than expected If activity is lower than expected variable costs should be lower than expected a The word Revenue is used rather than Sales b Flexible Budget estimate of what revenues and costs should have been given the actual level of activity for the period i When flexible budget is used in performance evaluation actual costs are compared to what the costs should have been for the actual level of activity during the period rather than to the static planning budget ii Adjustments must be made iii Recognizes that a budget can be adjusted to show what costs should be for the actual level of the activity iv The cost formula for each cost is used to estimate what the cost should have been for the actual level of activity a Must break down the variances into two types b Activity Variances the variances that are solely due to the difference in the level of activity between the planning budget from the beginning of the period and the actual level of activity i Planning Budget what should have happened at the budgeted level of activity of activity ii Flexible Budget what should have happened at the actual level iii Differences between the planning budget and the flexible budget show what should have happened because the actual level of activity differed from what had been expected iv Leverage effect The presence of fixed costs causes the flexible budget to show much higher net operating incomes Because of the existence of fixed costs net operating income does not change in proportion to changes in the level of activity The percentage changes in net operating income are ordinarily larger than the percentage increases in activity c Revenue and Spending Variances i Revenue Variance the difference between what the total revenue should have been given the actual level of activity for the period and the actual total revenue 1 If actual revenue exceeds what the revenue should have been the variance is labeled favorable if the average selling price is greater than expected a FLEXIBLE BUDGET EXPENSE PLANNING BUDGET EXPENSE FAVORABLE VARIANCE b Actual revenue is more than what it should have been c Actual revenues Budgeted Revenues d Actual Expenses Budgeted Expenses 2 If actual revenue is less than what the revenue should have been the variance is labeled unfavorable a FLEXIBLE BUDGET EXPENSE PLANNING BUDGET EXPENSE UNFAVORABLE VARIANCE b Actual revenue is less than what is should have been c Actual Revenues Budgeted Revenues d Actual Expenses Budgeted Expenses ii Spending Variance the difference between how much a cost should have been given the actual level of activity and the actual amount of the cost 1 2 If actual cost is greater than what the cost should have been the variance is labeled as unfavorable If actual cost is less than what cost should have been the variance is labeled as favorable iii A performance report combining activity and revenue and spending variances 1 Activity variances appear between the planning budget amounts and the flexible budget amounts 2 Planning budget 1 Activity Variances 2 1 Flexible Budget 2 Revenue and spending variances 3 2 actual results 3 a Fixed costs aren t affected by changes in the level of activity but can change for other reasons Doesn t mean they don t change at all just means that level of activity doesn t affect them i Cost is Variable if it is proportional to ii Cost is fixed if it doesn t depend on the activity level of activity iv Performance Reports in Nonprofit Organizations 1 The same as other performance reports EXCEPT that they usually receive a significant amount of funding from sources other than sales Grants and Donations v Performance Reports in Cost Centers 1 Cost Centers departments in organizations that don t have any source of outside revenue Large organizations that report for each department including ones that do not sell anything to outsiders 2 Exception that revenue and net operating income will not appear on the report because the managers in these departments are responsible for costs but not revenues III Flexible Budgets with Multiple Cost Drivers a Because the cost formulas based on one more than one cost driver are more accurate than the cost formulas based on just one cost driver the variances will be more accurate IV Common Errors V Powerpoint a Perfect budgets isolate activity variances and revenue and spending variances Unfortunately this approach is not always followed in practice b The most common errors in preparing performance reports are to assume that all costs are fixed or assume that all costs are variable i Error Assuming that all costs are fixed Error is made when static planning budget costs are compared to actual costs without any adjustment for the actual level of activity a To Flex a Budget we need to know that i Total variable costs change in direct proportion to changes in activity b Activity Variances ii Total fixed costs remain unchanged within the relevant range i The differences between the budgeted amounts ii The difference in the level of activity included in the planning budget and the actual level of activity Larry s Lawn Service Flexible Budget Performance Report For the Month Ended June 30 Revenue Expenses 75Q 37 500 3 750 F 41 250 1 750 F 43 000 Revenue Cost Formulas Planning Budget Activity Variances Number of lawns Q 500 5 000 30Q Wages and salaries Gasoline and supplies 9Q Equipment maintenance 3Q 1 000 Office and shop utilities Office and shop rent 2 000 Equipment Depreciation 2 500 1 000 Insurance Total expenses Net operating income 20 000 4 500 1 500 1 000 2 000 2 500 1 000 32 500 5 000 1 500 450 150 2 100 1 650 U U U U F Flexible Budget 550 21 500 4 950 1 650 1 000 2 000 2 500 1 000 34 600 6 650 Revenue and Spending Variances Actual Results 550 2 000 150 350 50 200 1 950 200 U U F F U U U 23 500 5 100 1 300 950 2 000 2 500 1 200 36 550 6 450
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