Chapter 8 Flexible Budgets Performance Reports Slides prepared

Chapter 8 Flexible Budgets & Performance Reports Slides prepared by Peter Miller ©National Core Accounting Publications 1

Flexible Budgets A flexible budget covers a range of activities within which the firm may operate. • As a planning tool, flexible budgets are prepared to enable a firm to quantify expected results at different activity levels. • As a control tool, flexible budgets are used to evaluate actual results by restating the original static budget figures to the actual level of activity achieved. Budgeted monetary amounts are related to the actual level of activity attained. Slides prepared by Peter Miller ©National Core Accounting Publications 2

Example Data Solution The flexible budget relates to both revenues as well as costs. In fact, it is in the area of costs where flexible budgeting is used extensively as both a planning and control tool. Slides prepared by Peter Miller ©National Core Accounting Publications 3

Classification of costs Fixed • Those costs which remain constant irrespective of the level of activity attained Variable • Those costs that vary according to changes in the level of activity The "flex" in a flexible budget concerns the variable costs (that is, those costs that vary with changes in activity levels) whereas the budget for fixed costs is static. Slides prepared by Peter Miller ©National Core Accounting Publications 4

Flexible Budget Formula Slides prepared by Peter Miller ©National Core Accounting Publications 5

Flexible Budgeting for Service Organisations Service organisations are dependent upon the quantity of services that can be provided for their income and are usually labour intensive. Example Slides prepared by Peter Miller ©National Core Accounting Publications 6

Solution Slides prepared by Peter Miller ©National Core Accounting Publications 7

Flexible Budgeting for Trading Operations Trading (retail or wholesale) organisations are in the business of purchasing and selling tangible items or products referred to as Inventory or Stock. When preparing budgets for trading organisations • Forecast revenue based on the development of pricing structures to be used for pricing the organisation’s products. • Forecast the cost of goods sold (also referred to as Cost of Sales). • Forecast other variable costs. • Forecast fixed costs associated with running the business. Slides prepared by Peter Miller ©National Core Accounting Publications 8

Flexible Budgeting Techniques applied to Trading Organisations Example Slides prepared by Peter Miller ©National Core Accounting Publications 9

Solution Slides prepared by Peter Miller ©National Core Accounting Publications 10

Flexible Budgeting for Manufacturing Operations The Manufacturing Firm incurs costs for: • Direct Materials classified as a variable cost. • Direct Labour classified as a variable cost. • Factory Overhead which has both a fixed and variable component. Factory overhead is comprised of all factory costs other than direct materials and direct labour. Variable manufacturing costs vary in proportion to units manufactured Slides prepared by Peter Miller ©National Core Accounting Publications 11

Flexible Budgeting for Manufacturing Operations Non Manufacturing costs • Selling Expenses which have both fixed and variable components. • Administration Expenses which are mainly fixed in nature. • Financial Expenses which relate to financing costs predominantly fixed in nature. Variable Expenses vary in proportion to units sold. Slides prepared by Peter Miller ©National Core Accounting Publications 12

Flexible Budgeting applied to Manufacturing Organisation Example Slides prepared by Peter Miller ©National Core Accounting Publications 13

Flexible Budgeting applied to Manufacturing Organisation Example (cont) Slides prepared by Peter Miller ©National Core Accounting Publications 14

Flexible Budgeting applied to Manufacturing Organisation Solution D. Wide Manufacturing Income Statement – Flexible Budget Forecasts Slides prepared by Peter Miller ©National Core Accounting Publications 15

Flexible Budgeting applied to Manufacturing Organisation Solution Slides prepared by Peter Miller ©National Core Accounting Publications 16

Performance Report Actual results achieved are compared with the Master (Static) Budget to enable the determination of variances. Revenue Variances Favourable Revenue Variance • If actual sales revenue is greater than budgeted sales revenue, this is a favourable variance. Unfavourable Revenue Variance • If actual sales revenue is less than budgeted sales revenue, this is an unfavourable variance. Slides prepared by Peter Miller ©National Core Accounting Publications 17

Performance Report Cost Variances Favourable Cost Variance • If actual costs and expenses are less than budgeted costs and expenses, this is classified as a favourable variance. Unfavourable Cost Variance • If actual costs and expenses are greater than budgeted costs and expenses, this is classified as an unfavourable variance. Slides prepared by Peter Miller ©National Core Accounting Publications 18

Favourable and Unfavourable Variances F (favourable) variance • The variance increases operating profits U (Unfavourable) Variance • Decreases operating profits Slides prepared by Peter Miller ©National Core Accounting Publications 19

Measurement and Disclosure of Variances may be measured and disclosed in two ways: • The absolute size of the variance • Percentage analysis Slides prepared by Peter Miller ©National Core Accounting Publications 20

Comparison of Actual Results with the Master (Static) Budget RESPONSIBILITY ACCOUNTING • At the end of an accounting period actual results should be compared to the budget. • Efficiencies or inefficiencies are measured by the resultant variances ( if any ). • Efficiency of operations are shown by favourable variances. • Inefficiencies are shown by unfavourable variances. Slides prepared by Peter Miller ©National Core Accounting Publications 21

Responsibility Centres Units or parts of the business that a manager has control over. • • Revenue Centre. Cost Centre. Profit Centre. Investment Centre. Slides prepared by Peter Miller ©National Core Accounting Publications 22

Management by Exception Management by exception is where the manager is notified only if there are variances that are significantly larger than expected. • Under this principal the manager is notified if all is well and things are going to plan. • Variance analysis is an important investigative tool to help guide the firm to take corrective action in those areas where there are problems as indicated by the size of the variance. Slides prepared by Peter Miller ©National Core Accounting Publications 23

Horizontal Trend Analysis involves comparing a base year with future years and measuring the percentage change. Example The base year is always considered 100 percent. Slides prepared by Peter Miller ©National Core Accounting Publications 24

Flexible Budgeting applied to a Manufacturing Organisation Example Slides prepared by Peter Miller ©National Core Accounting Publications 25

Flexible Budgeting applied to a Manufacturing Organisation Solution Slides prepared by Peter Miller ©National Core Accounting Publications 26

Current Month and Year to date Performance Analysis • When preparing budgets and performance reports most firms prepare annual operating budgets broken down into 12 monthly periods to more accurately predict revenues and costs to take into account monthly and seasonal variations. • It is also possible to analyse the operations for the business on a cumulative basis where the year to date budgets are compared to the year to date actual variance. Slides prepared by Peter Miller ©National Core Accounting Publications 27