Chapter 9 — Flexible Budgets and Performance Analysis

Purpose of Budgets Definition:

A budget is a plan that uses estimated revenues and expenses for a specific period to guide and control operations.

Purpose of Budgets Main Idea:

Budgets are used for control — to compare planned results vs. actual results.

Purpose of Budgets Key Point:

If volume (sales) changes, variable costs are expected to change too.
→ Remember:

“If sales change, variable costs must change!”

Variance Analysis Cycle Definition:

The process of analyzing differences between actual results and budgeted results to identify areas needing attention.

Variance Analysis Cycle Steps

• Prepare performance reports (compare budget vs. actual).

• Analyze variances to identify causes.

• Take corrective action (improve operations or eliminate inefficiencies).

• Use results for future planning.

Variance Analysis Cycle Concept

Management by Exception → Focus on significant variances that need management attention.

Variance Analysis Cycle Goal

Replicate what works; eliminate what doesn’t.

Static (Planning) budget

Prepared for a single planned level of activity

Before the period starts

Can’t account for changes in actual activity

Flexible Budgets

Adjusted for actual activity levels

After actual results known

Requires understanding of variable & fixed costs

Static (Planning) vs. Flexible Budgets Why It Matters:

Performance evaluation becomes inaccurate if actual activity ≠ planned activity.
→ Need to adjust the budget (“flex” it) to make fair comparisons.

Price per unit = $10 Planned sales = 1,000 widgets

Actual sales = 900 widgets

If Variable Cost (VC) per unit = $6:

Static Budget Revenue: $10,000

Flexible Budget Revenue: 900 × $10 = $9,000

Static Budget VC: 1,000 × $6 = $6,000 Flexible Budget VC: 900 × $6 = $5,400

We don’t compare actual to static when activity differs — we use flexed budgets instead.

How to Flex a Budget, Rules to Flex a Budget:

1. Total Variable Costs change in direct proportion to activity.

2. Total Fixed Costs remain unchanged (within the relevant range).

How to “Flex” a Budget Equation:

Flexible Budget Cost=(Variable Cost per Unit×Actual Activity)+Fixed Costs

What should total wages & salaries be in a flexible budget for 600 lawns? If cost per lawn = $30 and fixed = $2,000

(600×30)+2,000=20,000(600 × 30) + 2,000 = 20,000(600×30)+2,000=20,000

Types of Variances

Activity, Revenue, Spending

Activity Variance

• Arises solely due to difference between actual activity and budgeted activity.

• Reflects expected differences, not performance problems.

• Example: Fewer customers = lower revenue, but not necessarily poor performance.

Revenue Variance

• Difference between actual revenue and flexible budget revenue.

Revenue Variance = Actual Revenue - Flexible Budget Revenue 

Spending Variance

• Difference between actual costs and flexible budget costs.

Spending Variance = Actual Cost - Flexible Budget Cost

Important:
Even fixed costs can have a spending variance (if overspent or underspent).

Flexible Budget Performance Report

Purpose:
Shows how much of the difference between budgeted and actual results is due to:

1. Changes in activity level

2. Changes in cost control

Flexible Budget Performance Report Layout Example:

	Planning Budget	Flexible Budget	Actual Results
Revenue	$10,000	$9,000	$9,300
Variable Costs	$6,000	$5,400	$5,500
Fixed Costs	$2,000	$2,000	$2,200
Net Operating Income	$2,000	$1,600	$1,600

Notes:

• Difference between Planning & Flexible = Activity Variance

• Difference between Flexible & Actual = Revenue/Spending Variances

Cost Center Performance Reports Definition:

Reports for managers responsible for cost control (not revenues).

Cost Center Performance Reports Characteristics:

• Focus on spending variances only.

• Evaluate how well a manager controls costs.

• Do not include revenue or net income variances.

Tip:
Always use a flexible budget for cost center evaluation — not a static one.

Multiple Cost Drivers Definition

A cost driver is a factor that causes or influences the cost of an activity.

Multiple Cost Drivers Key Concept

Some organizations have more than one cost driver — a single variable (like “number of lawns mowed”) may not fully explain cost behavior.

Multiple Cost Drivers Example

Larry’s Lawn Service

• Original driver: number of lawns.

• Added second driver: hours spent trimming/edging.
  → Leads to a more accurate flexible budget and variance analysis.

Benefit:
Using multiple cost drivers improves accuracy and performance insights.