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I'm Larry Walther.
This is chapter 22, principlesofaccounting.com.
And in this module,
we will consider how flexible budgets can be used to adapt outcome assessments.
In the previous module,
we saw a performance report that was static in nature.
It was developed for a single presumed level of activity.
But when actual output varies from budgets variances are likely to arise and
they can be misleading.
Remember, higher variable costs are usually associated with higher volume but
higher volume is often times seen as a good thing.
So by having higher volume we have higher variable costs.
A static budget that only shows the budgeted cost
independent of the level of volume achieved
can produce some unfavorable signals when in fact things are going quite well.
So let's see how a flexible budget is going to work.
This is an example that corresponds to an example in your textbook.
Mooster's Dairy produces a premium brand of ice cream.
It's static budget is based on 100,000 gallons of productions each month.
Direct materials are anticipated at $1 per gallon.
Direct labor is anticipated at $0.50 per gallon.
Variable overhead is applied at a $1.50 per gallon and
fixed overhead is planned at $205,000 per month.
And so here is the static budget.
This assumes 100,000 units budgeted,
but the company actually produced 105,000 units.
So you can see the various costs and expenses.
But over on the far right, is the variance analysis.
All of our variable expense categories are red or unfavorable here.
We spent 5,000 more than we anticipated on materials.
We spent 3,000 more than we anticipated on labor.
We spent 5,000 more than we anticipated on variable factory overhead,
and it appears we spent 5,000 less than we anticipated on the fixed factory overhead.
But overall, we were $8,000 over budget and so the manager
may look poorly in the context of that simple statement, $8,000 over budget.
However, July 20X9 was hotter than usual and so
production was greater, sales were greater than anticipated
although the budget versus actual expense analysis revealed an unfavorable variance.
Were costs poorly controlled?
That's really the question we wish to assess.
And so here's a flexible budget.
Now I've prepared a budget assuming a 105,000 units about the and
compared that to the actual expenses.
Notice the Variable expenses have flexed.
Remember the application rate of $1 for materials and $0.50 for labor.
In any event, when I adjust my budget column and
then do a variance analysis based on the revised level of variable expenses.
I can see that I had the no variance in direct materials.
I had a $500 unfavorable direct labor variance.
I had a $2,500 variable overhead variance, that was favorable.
And then we kept our $5,000 of fixed overhead total variance.
And so we got total manufacturing costs that were actually 7,000 less than should
been incurred given the level of production achieved.
And so, the flexible budget as the name suggest is intended to flex or adjust
the budgeted expenditures based on the level of production that actually occurs
rather than having a set budget presuming a certain level of activity that may or
may not occur.
And so a flexible budget may provide a better tool for performance evaluation.
When performance evaluation is based on a static budget there is little incentive to
drive sales and production above anticipated levels.
And further with a static budget,
increases in volume tend to produce more costs and unfavorable variances.
Flexible budgets can be useful planning tools if prepared in advance.
So here's an example for Mooster's Dairy where our budget we prepared in advance.
We assumed different levels of activity.
We had a budget that should be incurred of 80,000 units were produced,
90,000 units, and so forth.
And so this gives management goals to control costs
within the volume that they are actually operating at.
Computers are helpful in preparing budget information that is flexed for
volume changes.
I used a spreadsheet on the screen,
you can imagine how a spreadsheet would simply index based on the variable weight
tied to the volume that's reported in a particular cell.
Selected information may also be shared with suppliers and
customers via electronic data interchange.
The supply chain could be immediately adjusted to match material orders and
actual production levels.
So, not only is the information system helpful in monitoring our progress
against our goals, but as we have higher, lower levels of volume,
we can share these files with our vendors and suppliers and they can
adjust their supply chain to match our particular needs far more efficiently.
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