Flexible Budgets and Performance Analysis PDF

Flexible Budgets and Performance Analysis CHAPTER 9 Managerial Accounting Eighteenth edition  9-2 Variance Analysis Cycle ©McGraw-Hill Education. All rights reserved. A...

Flexible Budgets and Performance Analysis CHAPTER 9 Managerial Accounting Eighteenth edition  9-2 Variance Analysis Cycle ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-3 Learning Objective 1 Prepare a planning budget and a flexible budget with one cost driver. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-4 Characteristics of Flexible Budgets – Part 1 Planning budgets are prepared for a single, planned level of activity. Performance evaluation is difficult when actual activity differs from the planned level of activity. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-5 Characteristics of Flexible Budgets – Part 2 1. May be prepared for any activity level in the relevant range. 2. Show costs that should have been incurred at the actual level of activity, enabling “apples to apples” cost comparison. 3. Help managers control costs. 4. Improve performance evaluation. Let’s look at Larry’s Lawn Service. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-6 Larry’s Lawn Service – Static Planning Budget Assumptions 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 on mowing 500 lawns. Since all of the lawns are similar in size, Larry felt that the number of lawns mowed in a month would be the best way to measure overall activity for his business. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-7 Larry’s Lawn Service Planning Budget Larry’s Planning Budget Larry's Lawn Service For the Month Ended June 30 Revenue/Cost Planning Formulas Budget Number of lawns (Q) 500 Revenue ($75Q) $ 37,500 Expenses: Wages and salaries ($5,000 + $30Q) $ 20,000 Gasoline and supplies ($9Q) 4,500 Equipment maintenance ($3Q) 1,500 Office and shop utilities ($1,000) 1,000 Office and shop rent ($2,000) 2,000 Equipment Depreciation ($2,500) 2,500 Insurance ($1,000) 1,000 Total expenses 32,500 Net operating income $ 5,000 ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-8 Larry’s Lawn Service Actual Results Larry’s Actual Results Larry's Lawn Service For the Month Ended June 30 Actual Results Number of lawns 550 Revenue $ 43,000 Expenses: Wages and salaries $ 23,500 Gasoline and supplies 5,100 Equipment maintenance 1,300 Office and shop utilities 950 Office and shop rent 2,000 Equipment Depreciation 2,500 Insurance 1,200 Total expenses 36,550 Net operating income $ 6,450 ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-9 Larry’s Lawn Service – Comparing Actual Results with the Planning Budget Larry’s Actual Results Compared with the Planning Budget Larry's Lawn Service For the Month Ended June 30 Revenue/Cost Actual Planning Formulas Results Budget Variances Number of lawns (Q) 550 500 Revenue ($75Q) $ 43,000 $ 37,500 $ 5,500 F Expenses: Wages and salaries ($5,000 + $30Q) $ 23,500 $ 20,000 $ 3,500 U Gasoline and supplies ($9Q) 5,100 4,500 600 U Equipment maintenance ($3Q) 1,300 1,500 200 F Office and shop utilities ($1,000) 950 1,000 50 F Office and shop rent ($2,000) 2,000 2,000 - Equipment Depreciation ($2,500) 2,500 2,500 - Insurance ($1,000) 1,200 1,000 200 U Total expenses 36,550 32,500 4,050 U Net operating income $ 6,450 $ 5,000 $ 1,450 F ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-10 Larry’s Lawn Service – Favorable and Unfavorable Variances Larry’s Actual Results Compared with the Planning Budget F = Favorable variance that Larry's occurs Lawn Servicewhen actual For the Month Ended June 30 revenue is greater than budgeted revenue. Revenue/Cost Actual Planning Formulas Results Budget Variances Number of lawns (Q) 550 500 Revenue ($75Q) $ 43,000 $ 37,500 $ 5,500 F Expenses: U = Unfavorable Wages and salariesvariance($5,000that + $30Q)occurs when$ actual $ 23,500 20,000 $ 3,500 U Gasoline and supplies ($9Q) 5,100 4,500 600 U costs are greater Equipment maintenance ($3Q) than budgeted costs. 1,300 1,500 200 F Office and shop utilities ($1,000) 950 1,000 50 F Office and shop rent ($2,000) 2,000 2,000 - F = Favorable variance that occurs when Equipment Depreciation ($2,500) 2,500 2,500 - actual costs are less than budgeted costs. Insurance ($1,000) 1,200 1,000 200 U Total expenses 36,550 32,500 4,050 U Net operating income $ 6,450 $ 5,000 $ 1,450 F ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-11 Larry’s Lawn Service – Can Cost Control be Evaluated by These Variances? Larry’s Actual Results Compared with the Planning Budget Since these variances are Larry's unfavorable, Lawn Service has Larry For the Month Ended June 30 done a poor job controlling costs? Revenue/Cost Actual Planning Formulas Results Budget Variances Number of lawns (Q) 550 500 Revenue ($75Q) $ 43,000 $ 37,500 $ 5,500 F Expenses: Since these variances ($5,000 are Wages and salaries + $30Q)unfavorable, $ 23,500 $ has 20,000 $ 3,500 U Gasoline and supplies ($9Q) 5,100 4,500 600 U Larry done a poor($3Q) job controlling1,300 Equipment maintenance costs?1,500 200 F Office and shop utilities ($1,000) 950 1,000 50 F Office and shop rent ($2,000) 2,000 2,000 - Since these variances are favorable, has Larry Equipment Depreciation ($2,500) 2,500 2,500 - done a good job controlling costs? Insurance ($1,000) 1,200 1,000 200 U Total expenses 36,550 32,500 4,050 U Net operating income $ 6,450 $ 5,000 $ 1,450 F ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-12 Variance Analysis – The Relevant Question At this point, we cannot answer this question because the actual level of activity is greater than the planned level of activity. Therefore, actual variable costs are likely to be higher than planned variable costs regardless of Larry’s managerial efficiency. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-13 Actual Costs are Expected to Vary with Activity Level The relevant question is... “How much of the cost variances are due to higher activity and how much are due to cost control?” To answer the question, we need to flex the planning budget to accommodate the actual level of activity. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-14 How a Flexible Budget Works – Part 1 To flex a budget, we need to know that: ◦Total variable costs change in direct proportion to changes in activity. ◦Total fixed costs remain unchanged within the relevant range. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-15 How a Flexible Budget Works – Part 2 Let’s prepare a flexible budget for Larry’s Lawn Service. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-16 Preparing a Flexible Budget Larry’s Flexible Budget Larry's Lawn Service For the Month Ended June 30 $75 × 550 lawns Revenue/Cost Flexible Formulas Budget Number of lawns (Q) 550 Revenue ($75Q) $ 41,250 Expenses: Wages and salaries ($5,000 + $30Q) $ 21,500 Gasoline and supplies ($9Q) 4,950 Equipment maintenance ($3Q) 1,650 Office and shop utilities ($1,000) 1,000 Office and shop rent ($2,000) 2,000 Equipment Depreciation ($2,500) 2,500 Insurance ($1,000) 1,000 Total expenses 34,600 Net operating income $ 6,650 ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-17 Quick Check 1 What should the total wages and salaries cost be in a flexible budget for 600 lawns? a. $18,000. b. $20,000. c. $23,000. d. $25,000. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-18 Quick Check 1a What should the total wages and salaries cost be in a flexible budget for 600 lawns? a. $18,000. b. $20,000. Total wages and salaries cost = $5,000 + ($30 per lawn  600 lawns) c. $23,000. = $5,000 + $18,000 = $23,000 d. $25,000. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-19 Learning Objective 2 Calculate and interpret activity variances. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-20 Activity Variances – Part 1 An activity variance arises solely due to the difference in the actual level of activity and the level of activity included in the planning budget. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-21 Activity Variances – Part 2 Let’s use flexible budgeting concepts to compute activity variances for Larry’s Lawn Service. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-22 Activity Variances – Part 3 Larry’s Flexible Budget Compared with the Planning Budget Larry's Lawn Service For the Month Ended June 30 Revenue/Cost Flexible Planning Activity Formulas Budget Budget Variances Number of lawns (Q) 550 500 Revenue ($75Q) $ 41,250 $ 37,500 $ 3,750 F Expenses: Wages and salaries ($5,000 + $30Q) $ 21,500 $ 20,000 $ 1,500 U Gasoline and supplies ($9Q) 4,950 4,500 450 U Equipment maintenance ($3Q) 1,650 1,500 150 U Office and shop utilities ($1,000) 1,000 1,000 - Office and shop rent ($2,000) 2,000 2,000 - Equipment Depreciation ($2,500) 2,500 2,500 - Insurance ($1,000) 1,000 1,000 - Total expenses 34,600 32,500 2,100 U Net operating income $ 6,650 $ 5,000 $ 1,650 F ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-23 Activity Variances – Part 4 Larry’s Flexible Budget Compared with the Planning Budget Activity and revenue increase by Lawn Larry's 10 percent, Service but net operating income increases by more than For 10 the Month Ended June 30 percent due to the presence of fixed costs. Revenue/Cost Flexible Planning Activity Formulas Budget Budget Variances Number of lawns (Q) 550 500 Revenue ($75Q) $ 41,250 $ 37,500 $ 3,750 F Expenses: Wages and salaries ($5,000 + $30Q) $ 21,500 $ 20,000 $ 1,500 U Gasoline and supplies ($9Q) 4,950 4,500 450 U Equipment maintenance ($3Q) 1,650 1,500 150 U Office and shop utilities ($1,000) 1,000 1,000 - Office and shop rent ($2,000) 2,000 2,000 - Equipment Depreciation ($2,500) 2,500 2,500 - Insurance ($1,000) 1,000 1,000 - Total expenses 34,600 32,500 2,100 U Net operating income $ 6,650 $ 5,000 $ 1,650 F ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-24 Learning Objective 3 Calculate and interpret revenue and spending variances. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-25 Key Terminology Flexible budget Actual revenue revenue The difference is a revenue variance. Actual cost Flexible budget cost The difference is a spending variance. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-26 Revenue and Spending Variances – Part 1 Now, let’s use flexible budgeting concepts to compute revenue and spending variances for Larry’s Lawn Service. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-27 Revenue and Spending Variances – Part 2 Larry’s Flexible Budget Compared with the Actual Results Larry's Lawn Service $1,750 favorable For the Month Ended June 30 revenue variance Revenue and Revenue/Cost Actual Flexible Spending Formulas Results Budget Variances Number of lawns (Q) 550 550 Revenue ($75Q) $ 43,000 $ 41,250 $ 1,750 F Expenses: Wages and salaries ($5,000 + $30Q) $ 23,500 $ 21,500 $ 2,000 U Gasoline and supplies ($9Q) 5,100 4,950 150 U Equipment maintenance ($3Q) 1,300 1,650 350 F Office and shop utilities ($1,000) 950 1,000 50 F Office and shop rent ($2,000) 2,000 2,000 - Equipment Depreciation ($2,500) 2,500 2,500 - Insurance ($1,000) 1,200 1,000 200 U Total expenses 36,550 34,600 1,950 U Net operating income $ 6,450 $ 6,650 $ 200 U ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-28 Revenue and Spending Variances – Part 3 Larry’s Flexible Budget Compared with the Actual Results Larry's Lawn Service Spending For the Month Ended June 30 variances Revenue and Revenue/Cost Actual Flexible Spending Formulas Results Budget Variances Number of lawns (Q) 550 550 Revenue ($75Q) $ 43,000 $ 41,250 $ 1,750 F Expenses: Wages and salaries ($5,000 + $30Q) $ 23,500 $ 21,500 $ 2,000 U Gasoline and supplies ($9Q) 5,100 4,950 150 U Equipment maintenance ($3Q) 1,300 1,650 350 F Office and shop utilities ($1,000) 950 1,000 50 F Office and shop rent ($2,000) 2,000 2,000 - Equipment Depreciation ($2,500) 2,500 2,500 - Insurance ($1,000) 1,200 1,000 200 U Total expenses 36,550 34,600 1,950 U Net operating income $ 6,450 $ 6,650 $ 200 U ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-29 Learning Objective 4 Prepare a performance report with one cost driver that combines activity variances and revenue and spending variances. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-30 A Performance Report Combining Activity and Revenue and Spending Variances – Part 1 Now, let’s use flexible budgeting concepts to combine the revenue and spending variances reports for Larry’s Lawn Service. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-31 A Performance Report Combining Activity and Revenue and Spending Variances – Part 2 ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-32 A Performance Report Combining Activity and Revenue and Spending Variances – Part 3 50 lawns × $30 per lawn 50 lawns × $75 per lawn ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-33 A Performance Report Combining Activity and Revenue and Spending Variances – Part 4 $43,000 actual - $41,250 budget ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-34 Performance Reports in Nonprofit Organizations Nonprofit organizations may receive funding from sources other than the sale of goods and services, so revenues may consist of both fixed and variable elements. State funding Donations Universiti Tuition and fees es Endowments ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-35 Performance Reports in Cost Centers Performance reports are often prepared for cost centers. These reports should be prepared using the same principles discussed so far, except for the fact that these reports will not contain revenue or net operating income variances. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-36 Learning Objective 5 Prepare a planning budget and a flexible budget with more than one cost driver. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-37 Planning and Flexible Budgets with Multiple Cost Drivers – Part 1 More than one cost driver may be needed to adequately explain all of the costs in an organization. The cost formulas used to prepare a flexible budget can be adjusted to recognize multiple cost drivers. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-38 Planning and Flexible Budgets with Multiple Cost Drivers – Part 2 Because the time required for edging and trimming is different for different lawns, Larry decided to add an additional cost driver (hours) for the time required for edging and trimming. So Larry estimated the additional hours and developed a new planning and flexible budget that includes the second cost driver in both his revenue and expense budget formulas. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-39 Planning and Flexible Budgets with Multiple Cost Drivers – Part 3 Planning Budget with multiple cost drivers Larry's Lawn Service For the Month Ended June 30 Revenue/Cost Planning Formulas Budget Number of lawns (Q) 500 Numer of hours (H) 100 Revenues ($75Q + $25H) $ 40,000 Expenses: Wages and salaries ($5,000 + $29Q + $25H) $ 22,000 Gasoline and supplies ($8Q + $6H) 4,600 Equipment maintenance ($2Q + $2H) 1,200 Office and shop utilities ($1,000) 1,000 Office and shop rent ($2,000) 2,000 Equipment Depreciation ($2,500) 2,500 Insurance ($1,000) 1,000 Total expenses 34,300 Net operating income $ 5,700 ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-40 Planning and Flexible Budgets with Multiple Cost Drivers – Part 4 Flexible Budget with multiple cost drivers Larry's Lawn Service For the Month Ended June 30 Revenue/Cost Flexible Formulas Budget Number of lawns (Q) 550 Numer of hours (H) 100 Revenues ($75Q + $25H) $ 43,750 Expenses: Wages and salaries ($5,000 + $29Q + $25H) $ 23,450 Gasoline and supplies ($8Q + $6H) 5,000 Equipment maintenance ($2Q + $2H) 1,300 Office and shop utilities ($1,000) 1,000 Office and shop rent ($2,000) 2,000 Equipment Depreciation ($2,500) 2,500 Insurance ($1,000) 1,000 Total expenses 36,250 Net operating income $ 7,500 ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-41 Learning Objective 6 Prepare a performance report with more than one cost driver that combines activity variances and revenue and spending variances. ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-42 A Performance Report with Multiple Cost Drivers ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.  9-43 End of Chapter 9 ©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or fur distribution permitted without the prior written consent of McGraw-Hill Education.