Chapter 9

flexible budget

A report showing estimates of what revenues and costs should have been, given the actual level of activity for the period.

what is a flexible budget and how does it differ from a static planning budget?

A flexible budget can be adjusted to reflect any level of activity—including the actual level of activity. By contrast, a static planning budget is prepared for a single level of activity and is not subsequently adjusted.

what is revenue variance and what does it mean?

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. A revenue variance is easy to interpret. A favorable revenue variance occurs because the revenue is greater than expected for the actual level of activity. An unfavorable revenue variance occurs because the revenue is less than expected for the actual level of activity.

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.

What is a static planning budget?

A planning budget is prepared before the period begins and is valid for only the planned level of activity. It is sometimes referred to as a static planning budget because it is not adjusted even if the level of activity subsequently changes.

if the actual level of activity is greater than the planned level of activity, would you expect the activity variances for variable expenses to be favorable, unfavorable, or a combination of the two?

If the actual level of activity is greater than the planned level of activity, the activity variances for variables expenses will be unfavorable.

how does a flexible budget based on two cost drivers differ from a flexible budget based on one cost driver?

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

Planning Budget

a budget created at the beginning of the budgeting period that is valid only for the planned level of activity

Spending Variance

the difference between the actual amount of the cost and how much the cost should have been given the actual level of activity. A favorable (unfavorable) spending variance occurs because the cost is lower (higher) than expected, given the actual level of activity for the period.

what is spending variance and what does it mean

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. Like the revenue variance, the interpretation of a spending variance is straight-forward. A favorable spending variance occurs because the cost is lower than expected for the actual level of activity. An unfavorable spending variance occurs because the cost is higher than expected for the actual level of activity.

What are some of the possible reasons that actual results may differ from what had been budgeted at the beginning of a period?

Actual results can differ from the budget for many reasons. Very broadly speaking, the differences are usually due to a change in the level of activity, changes in prices, and changes in how effectively resources are managed.

what is an activity variance and what does it mean?

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. 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. Caution should be exercised in interpreting an activity variance. The "favorable" and "unfavorable" labels are perhaps misleading for activity variances that involve costs. 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. 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.

why is it difficult to interpret a difference between how much expense was budgeted and how much was actually spent?

As noted above, a difference between the budget and actual results can be due to many factors. Most importantly, the level of activity can have a very big impact on costs. 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. A variance of the first kind requires very different actions from a variance of the second kind. Consequently, these two kinds of variances should be clearly separated from each other. When the budget is directly compared to the actual results, these two kinds of variances are lumped together.

what does a flexible budget performance report do that a simple comparison of budget performance report do that a simple comparison of budgeted to actual results does not do

In a flexible budget performance report, the actual results are not directly compared to the static planning budget. The flexible budget is interposed between the actual results and the static planning budget. The differences between the flexible budget and the static planning budget are activity variances. The differences between the actual results and the flexible budget are the revenue and spending variances. 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).

Activity Variance

The difference between a revenue or cost item in the flexible budget and the same item in the static planning budget. An activity variance is due solely to the difference between the actual level of activity used in the flexible budget and the level of activity assumed in the planning budget.

Revenue Variance

The difference between the actual revenue for the period and how much the revenue should have been, given the actual level of activity. A favorable (unfavorable) revenue variance occurs because the revenue is higher (lower) than expected, given the actual level of activity for the period.