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Chapter 9
Lecture Notes
Chapter theme: This chapter explores how budgets can be
adjusted so that meaningful comparisons to actual costs
can be made.
I. Flexible budgets
A. Characteristics of a flexible budget
i. A planning budget is prepared before the period
begins and is valid for only the planned level of
activity.
ii. A flexible budget is an estimate of what revenues
and costs should have been, given the actual level
of activity for the period. Flexible budgets:
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B. Larry’s Lawn Service: Illustrating the deficiencies
of the static planning budget
ii. Assume that Larry prepared the planning budget
for June as shown. Notice that the budget includes:
1. Two variable costs—gasoline and supplies
and equipment maintenance.
iii. Assume that Larry’s actual results for the month
of June are as shown. Notice:
1. Larry actually mowed 550 lawns.
iv. If Larry wanted to, he could compare his actual
results to the planning budget as shown on the
slide. Notice:
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(greater than) the planning budget.
5. The important question for us to consider is:
—do these expense variances indicate
whether Larry has done a good job
controlling his costs?
7. To intelligently evaluate Larry’s
performance, we need to determine how
much of the cost variances are due to higher
C. How a flexible budget works
i. Keys to understanding a flexible budget
1. Variable costs change in direct proportion to
changes in activity.
2. Total fixed costs remain unchanged within
the relevant range.
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ii. Larry’s Lawn Service: preparing a flexible
budget
1. Larry’s flexible budget for an activity level
of 550 lawns mowed is as shown on this
slide. Notice, the “Q” in all revenue and
Quick check – preparing a flexible budget
II. Flexible budget variances
Learning Objective 2: Prepare a report showing
activity variances.
A. Key terminology
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B. Larry’s Lawn Service: Computing activity
variances
i. The activity variances for Larry’s Lawn Service
would be computed as shown on this slide. Notice:
1. The level of activity in the flexible budget
(550 lawns) is 10% higher than the level of
3. The variable costs in the flexible budget
(gasoline and supplies and equipment
maintenance) are 10% higher than the
planning budget because variable costs vary
proportionally to changes in the activity
level.
change when the activity level changes.
5. The fixed costs in the flexible budget are the
same as the planning budget because they
do not change in response to changes in the
activity level within the relevant range.
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Learning Objective 3: Prepare a report showing
revenue and spending variances.
C. Key terminology
ii. A spending variance is the difference between
how much a cost should have been, given the actual
level of activity, and the actual amount of the cost.
D. Larry’s Lawn Service: Computing revenue and
spending variances
i. The revenue and spending variances for Larry’s
Lawn Service would be computed as shown on this
slide. Notice:
1. The apple icons on the slide indicate that the
an activity level of 550 lawns mowed.
3. The $1,950 unfavorable spending variance
indicates that total expenses were $1,950
greater than would be expected for an
activity level of 550 lawns mowed.
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E. Larry’s Lawn Service: combining activity and
revenue and spending variances
i. This slide contains the previously computed
activity, revenue, and spending variances. Notice:
1. The variances appear between the amounts
being compared rather than after them. More
specifically:
2. The activity variances can be computed by
taking the difference between the planning
and flexible budget columns or by taking the
difference in activity level between these
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3. The revenue and spending variances are
computed by comparing the flexible budget
amounts and the actual amounts. For
4. When interpreting a flexible budget
performance report it is important to
remember two things:
a. First, to generate a favorable activity
variance for net operating income,
managers must take actions to
increase the level of activity.
F. Performance reports: other issues
i. The performance reports in non-profit
organizations differ from our example in one
important respect—non-profit organizations
usually receive funding from sources other than
sales. For example:
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ii. 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.
III. Flexible budgets with multiple cost drivers
Learning Objective 5: Prepare a flexible budget with
more than one cost driver.
A. Key concepts
i. More than one cost driver may be needed to
I. Larry’s Lawn Service: Multiple cost drivers
i. Let’s assume that Larry determined that wages
and salaries were driven by the number of lawns
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ii. Larry’s flexible budget could easily be adjusted to
accommodate the second cost driver. Notice:
1. The number of hours (H) is designated as
the second cost driver.
2. Larry’s flexible budget is based on 100
hours of edging and trimming.
IV. Some common errors
Learning Objective 6: Understand common errors
made in preparing performance reports based on
budgets and actual results.
A. Key concepts
B. Assuming all costs are fixed
i. Comparing actual results to the planning budget is
equivalent to assuming that all costs are fixed (or
unaffected by changes in the activity level).
ii. This mode of analysis is flawed if variable costs
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be flexed to accommodate the actual level of
activity.
C. Assuming all costs are variable
i. Comparing actual results to the dollar amounts in
the planning budget multiplied by the percentage
increase in activity level is equivalent to assuming
that all costs are variable with respect to changes in
the activity level.