AC 351 Chapter 9 Flexible Budgets and Performance Analysis

flexible budget

1.an estimate of what revenues and costs should have been, given the actual level of activity for the period 2.A flexible budget can be adjusted to reflect any level of activity—including the actual level of activity. 3.a budget that takes into account how costs are affected by changes in the level of activity

When actual results are directly compared to the static planning budget...

1.it is implicitly assumed that costs (and revenues) should not change with a change in the level of activity. 2.This assumption is valid only for fixed costs. 3.However, it is unlikely that all costs are fixed. 4.Some are likely to be variable or mixed.

a cost center performance report does not include

1.revenue 2.net operating income

the flexible budget performance report consists of...

1.spending and revenue variances 2.activity variance 3.planning budget 4.flexible budget 5.actual results

a university may receive funding from...

1.state funding 2.tuition and fees 3.donations 4.endowments

the cost formulas used to prepare a flexible budget...

can be adjusted to recognize multiple cost drivers

performance reports in nonprofit organizations may contain...

funding from sources other than the sale of goods and services, so revenues may consist of both fixed and variable elements

fixed costs are often...

more controllable than variable costs

when the activity level increases by 15%...

net operating income in the flexible budget will ordinarily increase by more than 15%

when flexing costs or sales that have a fixed and a variable component...

only flex the variable component and add it to the fixed for the total

if the actual level of activity is greater than the planned level of activity...

the actual variable costs are likely to be higher than planned variable costs regardless of managerial efficiency

if management plans the budget based off of 40 hours of operation and weather causes the business to be open for only 32...

the hourly wages need to be adjusted

companies use the...

variance analysis cycle to evaluate and improve performance

characteristics of flexible budgets

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 comparisons. 3.Help managers control costs. 4.Improve performance evaluation.

the relevant question in variance analysis is...

1.how much of the cost variances are due to higher activity and how much are due to cost control? 2.to answer the question we need to flex the planning budget to accommodate the actual level of activity

a favorable activity variance may not indicate good performance because...

a favorable activity variance for a variable cost will occur simply because the actual level of activity is less than the budgeted level of activity

Variance Analysis Cycle

1. Prepare performance report 2. Analyze variances 3. Raise questions 4. Identify root causes 5. Take actions 6. Conduct next period's operations Used to evaluate and improve performance

To flex a budget, we need to know that:

1. Total variable costs change in direct proportion to changes in activity 2. Total fixed costs remain unchanged within the relevant range

Which of the following may appear on a flexible budget performance report

1.An unfavorable activity variance. 2.A favorable revenue variance. 3.An unfavorable spending variance

non profit organizations...

1.may have revenue sources that are fixed 2.usually have significant funding sources other than sales

An unfavorable activity variance for revenue indicates that activity was less than expected when the static planning budget was developed.

true

more than one cost driver may be needed to...

adequately explain all of the costs in an organization

the percentage change in net income in the flexible budget is greater than the percentage change in activity...

due to fixed costs

Spending Variance

1.the difference between the actual amount of the cost and how much a cost should have been, given the actual level of activity 2.the difference between actual cost and the flexible budget cost 3.A spending variance is the difference between the actual amount of the cost and how much a cost should have been, given the actual level of activity. 4.Like the revenue variance, the interpretation of a spending variance is straightforward. 5.A favorable spending variance occurs because the cost is lower than expected for the actual level of activity. 6.An unfavorable spending variance occurs because the cost is higher than expected for the actual level of activity.

Revenue Variance

1.the difference between the actual total revenue and what the total revenue should have been, given the actual level of activity for the period 2.the difference between actual revenue and flexible budget revenue 3.A revenue variance is the difference between the actual revenue for the period and how much the revenue should have been, given the actual level of activity. 4.A revenue variance is easy to interpret. 5.A favorable revenue variance occurs because the revenue is greater than expected for the actual level of activity. 6.An unfavorable revenue variance occurs because the revenue is less than expected for the actual level of activity.

a flexible budget shows...

1.what revenue should have been at the actual level of activity 2.what variable costs should have been at the actual level of activity 3.what fixed costs should have been at the actual level of activity(please note these costs will remain the same from the static planned budget)

management by exception

A management system in which actual results are compared to a budget. Significant deviations from the budget are flagged as exceptions and investigated further. Enables managers to focus on the most important variances while bypassing trivial discrepancies between the budget and actual results.

Favorable Revenue Variance

A variance that occurs when actual revenue exceeds what the revenue should have been (budgeted revenue)

Unfavorable Revenue Variance

A variance that occurs when actual revenue falls below what the actual revenue should have been (budgeted revenue)

A flexible budget performance report contains activity variances but not revenue or spending variances.

false because it does contain revenue and spending variances

If the actual level of activity is 4% more than planned, then the costs in the static budget should be increased by 4% before comparing them to actual costs.

false because it should say variable costs

As noted above, a difference between the budget and actual results can be due to many factors..

1.Most importantly, the level of activity can have a very big impact on costs. 2.From a manager's perspective, a variance that is due to a change in activity is very different from a variance that is due to changes in prices and changes in how effectively resources are managed. 3.A variance of the first kind requires very different actions from a variance of the second kind. 4.Consequently, these two kinds of variances should be clearly separated from each other. 5.When the budget is directly compared to the actual results, these two kinds of variances are lumped together.

actual results can differ from the budget for many reasons:

1.Very broadly speaking, the differences are usually due to a change in the level of activity 2.changes in prices 3.changes in how effectively resources are managed.

Planning Budget

1.a budget created at the beginning of the budgeting period that is valid only for the planned level of activity 2.It is sometimes referred to as a static planning budget because it is not adjusted even if the level of activity subsequently changes.

comparing the static planning budget to actual results only makes sense when..

1.all costs are fixed 2.the actual activity level is the same as the budgeted activity level

the most common errors when preparing performance reports are to implicitly assume that either:

1.all expenses are fixed 2.all expenses are variable

activity variance

1.arises solely due to the difference in the actual level of activity and the level of activity included in the planning budget 2.An activity variance is the difference between a revenue or cost item in the flexible budget and the same item in the static planning budget. 3.An activity variance is due solely to the difference in the actual level of activity used in the flexible budget and the level of activity assumed in the planning budget. 4.Caution should be exercised in interpreting an activity variance. 5.The "favorable" and "unfavorable" labels are perhaps misleading for activity variances that involve costs. 6.A "favorable" activity variance for a cost occurs because the cost has some variable component and the actual level of activity is less than the planned level of activity. 7.An "unfavorable" activity variance for a cost occurs because the cost has some variable component and the actual level of activity is greater than the planned level of activity.

When the static planning budget is adjusted proportionately for a change in activity and then directly compared to actual results...

1.it is implicitly assumed that costs should change in proportion to a change in the level of activity. 2.This assumption is valid only for strictly variable costs. 3.However, it is unlikely that all costs are strictly variable. 4.Some are likely to be fixed or mixed.

static planning budget

1.only considers the planned level of activity 2.an unchanged planning budget

options to generate a favorable revenue and spending variance include...

1.protecting the selling price 2.reducing the price of inputs 3.increasing operating efficiency

in a flexible budget performance report...

1.the actual results are not directly compared to the static planning budget. 2.The flexible budget is interposed between the actual results and the static planning budget. 3.The differences between the flexible budget and the static planning budget are activity variances. 4.The differences between the actual results and the flexible budget are the revenue and spending variances. 5.The flexible budget performance report cleanly separates the differences between the actual results and the static planning budget that are due to changes in activity (the activity variances) from the differences that are due to changes in prices and the effectiveness with which resources are managed (the revenue and spending variances).

The only difference between a flexible budget based on a single cost driver and one based on two cost drivers is...

1.the cost formulas. 2.When there are two cost drivers, some costs may be a function of the first cost driver, some costs may be a function of the second cost driver, and some costs may be a function of both cost drivers.

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.

In a flexible budget, what will happen to fixed costs as the activity level increases

The fixed cost per unit will decrease.

when a 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

we should expect...

actual costs to vary with activity level

when preparing a flexible budget the level of activity

affects variable costs only

The activity variance for revenue is favorable if the actual revenue for the period exceeds the revenue in the static planning budget.

false because it should say the flexible budget versus the static planning budget

prepare a flexible budget with...

more than one cost driver

Variances are more accurate when using:

multiple cost drivers

to understand why actual net operating income differs from what it should have been at the actual level of activity...

the revenue and spending variances should be analyzed

Fixed costs should not be ignored when evaluating how well a manager has controlled costs.

true

performance evaluation is difficult...

when actual activity differs from the planned level of activity

the spending variance is labeled as favorable...

when the actual cost is less than what the cost should have been at the actual level of activity