CH 9 Flexible Budgets Compressed

CHAPTER 9

FPO

Flexible Budgets and

Performance Analysis
Why Do Companies Need Flexible Budgets?
LEARNING OBJECTIVES
BUSINESS FOCUS
After studying Chapter 9, you should be able to:
LO9–1 Prepare a planning budget and a

flexible budget and understand
how they differ from one another.
LO9–2 Calculate and interpret activity

variances.
LO9–3 Calculate and interpret revenue

and spending variances.
© Michael Sears/MCT/Newscom LO9–4 Prepare a performance report

that combines activity variances
The difficulty of accurately predicting future financial performance can be and revenue and spending
readily understood by reading the annual report of any publicly traded com- variances.
pany. For example, Nucor Corporation, a steel manufacturer headquar-
tered in Charlotte, North Carolina, cites numerous reasons why its actual LO9–5 Prepare a flexible budget with
results may differ from expectations, including the following: (1) changes more than one cost driver.
in the supply and cost of raw materials; (2) changes in the availability and LO9–6 Understand common errors made
cost of electricity and natural gas; (3) changes in the market demand for in preparing performance reports
steel products; (4) fluctuations in currency conversion rates; (5) significant based on budgets and actual
changes in laws or government regulations; and (6) the cyclical nature of results.
the steel industry. ■
Source: Nucor Corporation 2014 Annual Report.
413
414 Chapter 9
n the last chapter we explored how budgets are developed before
I a period begins. In this chapter, we explain how budgets can be adjusted to help
guide actual operations and influence the performance evaluation process. For
example, an organization’s actual expenses will rarely equal its budgeted expenses
as estimated at the beginning of the period. The reason is that the actual level of activ-
ity (such as unit sales) will rarely be the same as the budgeted activity; therefore, many
actual expenses and revenues will naturally differ from what was budgeted. Should a
manager be penalized for spending 10% more than budgeted for a variable expense like
direct materials if unit sales are 10% higher than budgeted? Of course not. After study-
ing this chapter, you’ll know how to adjust a budget to enable meaningful comparisons
to actual results.
The Variance Analysis Cycle

Companies use the variance analysis cycle, as illustrated in Exhibit 9–1, to evaluate and
improve performance. The cycle begins with the preparation of performance reports in
the accounting department. These reports highlight variances, which are the differences
between the actual results and what should have occurred according to the budget. The
variances raise questions. Why did this variance occur? Why is this variance larger than
it was last period? The significant variances are investigated so that their root causes can
be either replicated or eliminated. Then, next period’s operations are carried out and the
cycle begins again with the preparation of a new performance report for the latest period.
The emphasis should be on highlighting superior and unsatisfactory results, finding the
root causes of these outcomes, and then replicating the sources of superior achievement
and eliminating the sources of unsatisfactory performance. The variance analysis cycle
should not be used to assign blame for poor performance.
Managers frequently use the concept of management by exception in conjunction
with the variance analysis cycle. Management by exception is a management system
that compares actual results to a budget so that significant deviations can be flagged as
exceptions and investigated further. This approach enables managers to focus on the most
important variances while bypassing trivial discrepancies between the budget and actual
results. For example, a variance of $5 is probably not big enough to warrant attention,
whereas a variance of $5,000 might be worth tracking down. Another clue is the size of
the variance relative to the amount of spending. A variance that is only 0.1% of spending
on an item is probably caused by random factors. On the other hand, a variance of 10%
of spending is much more likely to be a signal that something is wrong. In addition to
EXHIBIT 9–1 Variance Analysis Cycle

The Variance Analysis Cycle
Raise Identify Take
questions root causes actions
Conduct next
Analyze
period’s
variances
operations
Prepare Begin
performance
report
Flexible Budgets and Performance Analysis 415
watching for unusually large variances, the pattern of the variances should be monitored.
For example, a run of steadily mounting variances should trigger an investigation even
though none of the variances is large enough by itself to warrant investigation.
Next, we explain how organizations use flexible budgets to compare actual results to
what should have occurred according to the budget.
Flexible Budgets
Characteristics of a Flexible Budget
The budgets that we explored in the last chapter were planning budgets. A planning LO9–1
budget is prepared before the period begins and is valid for only the planned level of Prepare a planning budget
activity. A static planning budget is suitable for planning but is inappropriate for evalu- and a flexible budget and
ating how well costs are controlled. If the actual level of activity differs from what was understand how they differ
planned, it would be misleading to compare actual costs to the static, unchanged planning from one another.
budget. If activity is higher than expected, variable costs should be higher than expected;
and if activity is lower than expected, variable costs should be lower than expected.
Flexible budgets take into account how changes in activity affect costs. A flexible
budget is an estimate of what revenues and costs should have been, given the actual level
of activity for the period. When a flexible budget is used in performance evaluation,
actual costs are compared to what the costs should have been for the actual level of activ-
ity during the period rather than to the static planning budget. This is a very important
distinction. If adjustments for the level of activity are not made, it is very difficult to
interpret discrepancies between budgeted and actual costs.
IN BUSINESS
WINNERS AND LOSERS FROM THE NBA LOCKOUT
A company’s actual net operating income can deviate from the budget for numerous and often
uncontrollable reasons. For example, when the National Basketball Association (NBA) decided
to suspend play because of a dispute between its team owners and players, many small busi-
nesses suffered—caterers, sports bars, apparel retailers, and parking lot owners all experienced
a drop in revenues. BestSportsApparel.com experienced a substantial drop in NBA apparel
sales due to the work stoppage. Rather than hiring 12 extra employees for the NBA season, the
company reduced the size of its workforce.
While some companies lost revenues when the NBA shut down, others benefited from the © Jason O. Watson/Getty Images
situation. Andrew Zimbalist, professor of economics at Smith College, notes that “local econo-
mies are not impacted by sports work stoppages” because people choose to spend their enter-
tainment dollars at other venues such as the theater, the zoo, or the museum.
Source: Emily Maltby and Sarah E. Needleman, “NBA Lockout: Local Firms Lose Big,” The Wall Street Journal, October 13, 2011, p. B5.
Deficiencies of the Static Planning Budget

To illustrate the difference between a static planning budget and a flexible budget, con-
sider Rick’s Hairstyling, an upscale hairstyling salon located in Beverly Hills that is
owned and managed by Rick Manzi. Recently Rick has been attempting to get better con-
trol of his revenues and costs, and at the urging of his accounting and business adviser,
Victoria Kho, he has begun to prepare monthly budgets.
At the end of February, Rick prepared the March budget that appears in Exhibit 9–2.
Rick believes that the number of customers served in a month (also known as the number of
client-visits) is the best way to measure the overall level of activity in his salon. A customer
who comes into the salon and has his or her hair styled is counted as one client-visit.
416 Chapter 9
EXHIBIT 9–2
Planning Budget Rick’s Hairstyling
Planning Budget
For the Month Ended March 31
Budgeted client-visits (q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000
Revenue ($180.00q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $180,000
Expenses:
Wages and salaries ($65,000 + $37.00q) . . . . . . . . . . . . . . . . . . . . . 102,000
Hairstyling supplies ($1.50q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,500
Client gratuities ($4.10q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,100
Electricity ($1,500 + $0.10q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,600
Rent ($28,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,500
Liability insurance ($2,800) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,800
Employee health insurance ($21,300) . . . . . . . . . . . . . . . . . . . . . . . . 21,300
Miscellaneous ($1,200 + $0.20q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,400
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163,200
Net operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 16,800
Note that the term revenue is used in the planning budget rather than sales. We use
the term revenue throughout the chapter because some organizations have sources of rev-
enue other than sales. For example, donations, as well as sales, are counted as revenue in
nonprofit organizations.
Rick has identified eight major categories of costs—wages and salaries, hairstyling
supplies, client gratuities, electricity, rent, liability insurance, employee health insurance,
and miscellaneous. Client gratuities consist of flowers, candies, and glasses of cham-
pagne that Rick gives to his customers while they are in the salon.
Working with Victoria, Rick estimated a cost formula for each cost. For example,
the cost formula for electricity is $1,500 + $0.10q, where q equals the number of cli-
ent-visits. In other words, electricity is a mixed cost with a $1,500 fixed element and
a $0.10 per client-visit variable element. Once the budgeted level of activity was set at
1,000 client-visits, Rick computed the budgeted amount for each line item in the budget.
For example, using the cost formula, he set the budgeted cost for electricity at $1,600
(= $1,500 + $0.10 × 1,000). To finalize his budget, Rick computed his expected net oper-
ating income for March of $16,800.
At the end of March, Rick prepared the income statement in Exhibit 9–3, which shows
that 1,100 clients actually visited his salon in March and that his actual net operating income
for the month was $21,230. It is important to realize that the actual results are not determined
by plugging the actual number of client-visits into the revenue and cost formulas. The
formulas are simply estimates of what the revenues and costs should be for a given level of
activity. What actually happens usually differs from what is supposed to happen.
The first thing Rick noticed when comparing Exhibits 9–2 and 9–3 is that the actual
profit of $21,230 (from Exhibit 9–3) was substantially higher than the budgeted profit of
$16,800 (from Exhibit 9–2). This was, of course, good news, but Rick wanted to know
more. Business was up by 10%—the salon had 1,100 client-visits instead of the budgeted
1,000 client-visits. Could this alone explain the higher net operating income? The answer
is no. An increase in net operating income of 10% would have resulted in net operating
income of only $18,480 (= 1.1 × $16,800), not the $21,230 actually earned during the
month. What is responsible for this better outcome? Higher prices? Lower costs? Some-
thing else? Whatever the cause, Rick would like to know the answer and then hopefully
repeat the same performance next month.
In an attempt to analyze what happened in March, Rick prepared the report com-
paring actual to budgeted costs that appears in Exhibit 9–4. Note that most of the vari-
ances in this report are labeled unfavorable (U) rather than favorable (F) even though net
EXHIBIT 9–3
Rick’s Hairstyling Actual Results—Income Statement
Income Statement
Actual client-visits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $194,200
Expenses:
Wages and salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106,900
Hairstyling supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,620
Client gratuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,870
Electricity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,550
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,500
Liability insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,800
Employee health insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22,600
Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,130
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172,970
EXHIBIT 9–4
Rick’s Hairstyling Comparison of Actual Results to the
Comparison of Actual Results to the Planning Budget Static Planning Budget
Actual Planning
Results Budget Variances*
Client-visits . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100 1,000
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $194,200 $180,000 $14,200 F
Expenses:
Wages and salaries . . . . . . . . . . . . . . . . . . 106,900 102,000 4,900 U
Hairstyling supplies . . . . . . . . . . . . . . . . . . 1,620 1,500 120 U
Client gratuities . . . . . . . . . . . . . . . . . . . . . . 6,870 4,100 2,770 U
Electricity . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,550 1,600 50 F
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,500 28,500 0
Liability insurance . . . . . . . . . . . . . . . . . . . . 2,800 2,800 0
Employee health insurance . . . . . . . . . . . 22,600 21,300 1,300 U
Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . 2,130 1,400 730 U
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . 172,970 163,200 9,770 U
Net operating income . . . . . . . . . . . . . . . . . . $ 21,230 $ 16,800 $ 4,430 F
*The revenue variance is labeled favorable (unfavorable) when the actual revenue
is greater than (less than) the planning budget. The expense variances are labeled
favorable (unfavorable) when the actual expense is less than (greater than) the
planning budget.
operating income was actually higher than expected. For example, wages and salaries
show an unfavorable variance of $4,900 because the actual wages and salaries expense
was $106,900, whereas the budget called for wages and salaries of $102,000. The prob-
lem with the report, as Rick immediately realized, is that it compares revenues and costs
at one level of activity (1,000 client-visits) to revenues and costs at a different level of
activity (1,100 client-visits). This is like comparing apples to oranges. Because Rick had
100 more client-visits than expected, some of his costs should be higher than budgeted.
From Rick’s standpoint, the increase in activity was good; however, it appears to be
having a negative impact on most of the costs in the report. Rick knew that something
418 Chapter 9
would have to be done to make the report more meaningful, but he was unsure of what to
do. So he made an appointment to meet with Victoria Kho to discuss the next step.
MANAGERIAL Victoria: How is the budgeting going?

ACCOUNTING IN ACTION Rick: Pretty well. I didn’t have any trouble putting together the budget for March. I
THE ISSUE also prepared a report comparing the actual results for March to the budget, but that
report isn’t giving me what I really want to know.
Victoria: Because your actual level of activity didn’t match your budgeted activity?
Rick: Right. I know the level of activity shouldn’t affect my fixed costs, but we had
more client-visits than I had expected and that had to affect my other costs.
Victoria: So you want to know whether the higher actual costs are justified by the
higher level of activity?
Rick: Precisely.
Victoria: If you leave your reports and data with me, I can work on it later today, and by
tomorrow I’ll have a report to show you.
How a Flexible Budget Works

A flexible budget adjusts to show what costs should be for the actual level of activity.
To illustrate how flexible budgets work, Victoria prepared the report in Exhibit 9–5 that
shows what the revenues and costs should have been given the actual level of activity in
March. Preparing the report is straightforward. The cost formula for each cost is used to
estimate what the cost should have been for 1,100 client-visits—the actual level of activ-
ity for March. For example, using the cost formula $1,500 + $0.10q, the cost of electric-
ity in March should have been $1,610 (= $1,500 + $0.10 × 1,100). Also, notice that the
amounts of rent ($28,500), liability insurance ($2,800), and employee health insurance
($21,300) in the flexible budget equal the corresponding amounts in the planning budget
(see Exhibit 9–2). This occurs because fixed costs are not affected by the activity level.
We can see from the flexible budget that the net operating income in March should
have been $30,510, but recall from Exhibit 9–3 that the net operating income was actu-
ally only $21,230. The results are not as good as we thought. Why? We will answer that
question shortly.
To summarize to this point, Rick had budgeted for a profit of $16,800. The actual
profit was quite a bit higher—$21,230. However, Victoria’s analysis shows that given the
EXHIBIT 9–5
Flexible Budget Based on Actual
Rick’s Hairstyling
Activity
Flexible Budget
Actual client-visits (q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100
Revenue ($180.000)q . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 198,000
Expenses:
Wages and salaries ($65,000 + $37.00q) . . . . . . . . . . . . . . . . . . . . . . . . 105,700
Hairstyling supplies ($1.50q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,650
Client gratuities ($4.10q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,510
Electricity ($1,500 + $0.10q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,610
Rent ($28,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,500
Liability insurance ($2,800) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,800
Employee health insurance ($21,300) . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,300
Miscellaneous ($1,200 + $0.20q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,420
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167,490
Net operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 30,510
actual number of client-visits in March, the profit should have been even higher—$30,510.
What are the causes of these discrepancies? Rick would certainly like to build on the
positive factors, while working to reduce the negative factors. But what are they?
Flexible Budget Variances

To answer Rick’s questions concerning the discrepancies between budgeted and actual
costs, Victoria broke down the variances shown in Exhibit 9–4 into two types of
variances—activity variances and revenue and spending variances. We explain how she
did it in the next two sections.
Activity Variances
Part of the discrepancy between the budgeted profit and the actual profit is due to the fact
that the actual level of activity in March was higher than expected. How much of this dis- LO9–2
Calculate and interpret activity
crepancy was due to this single factor? Victoria prepared the report in Exhibit 9–6 to answer
variances.
this question. In that report, the flexible budget based on the actual level of activity for the
period is compared to the planning budget from the beginning of the period. The flexible
budget shows what should have happened at the actual level of activity, whereas the plan-
ning budget shows what should have happened at the budgeted level of activity. Therefore,
the differences between the flexible budget and the planning budget show what should have
happened solely because the actual level of activity differed from what had been expected.
For example, the flexible budget based on 1,100 client-visits shows revenue of
$198,000 (= $180 per client-visit × 1,100 client-visits). The planning budget based
on 1,000 client-visits shows revenue of $180,000 (= $180 per client-visit × 1,000
client-visits). Because the salon had 100 more client-visits than anticipated in the
EXHIBIT 9–6
Rick’s Hairstyling Activity Variances from Comparing
Activity Variances the Flexible Budget Based on
For the Month Ended March 31 Actual Activity to the Planning
Flexible Planning Activity Budget
Budget Budget Variances*
Client-visits . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100 1,000
Revenue ($180.00q) . . . . . . . . . . . . . . . . . . . $198,000 $180,000 $18,000 F
Expenses:
Wages and salaries
($65,000 + $37.00q) . . . . . . . . . . . . . . 105,700 102,000 3,700 U
Hairstyling supplies ($1.50q) . . . . . . . . . . 1,650 1,500 150 U
Client gratuities ($4.10q) . . . . . . . . . . . . . 4,510 4,100 410 U
Electricity ($1,500 + $0.10q) . . . . . . . . . . 1,610 1,600 10 U
Rent ($28,500) . . . . . . . . . . . . . . . . . . . . . . 28,500 28,500 0
Liability insurance ($2,800) . . . . . . . . . . . 2,800 2,800 0
Employee health insurance ($21,300) . . 21,300 21,300 0
Miscellaneous ($1,200 + $0.20q) . . . . . . 1,420 1,400 20 U
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . 167,490 163,200 4,290 U
Net operating income . . . . . . . . . . . . . . . . . . $ 30,510 $ 16,800 $13,710 F
*The revenue variance is labeled favorable (unfavorable) when the revenue in

the flexible budget is greater than (less than) the planning budget. The expense
variances are labeled favorable (unfavorable) when the expense in the flexible
budget is less than (greater than) the planning budget.
420 Chapter 9
planning budget, actual revenue should have been higher than planned revenue by
$18,000 (= $198,000 − $180,000). This activity variance is shown on the report as
$18,000 F (favorable). Similarly, the flexible budget based on 1,100 client-visits shows
electricity cost of $1,610 (= $1,500 + $0.10 per client-visit × 1,100 client-visits).
The planning budget based on 1,000 client-visits shows electricity cost of $1,600
(= $1,500 + $0.10 per client-visit × 1,000 client-visits). Because the salon had 100
more client-visits than anticipated in the planning budget, the actual electricity cost
should have been higher than the planned cost by $10 (= $1,610 − $1,600). The activ-
ity variance for electricity is shown on the report as $10 U (unfavorable). Note that in
this case, the label “unfavorable” may be a little misleading. The electricity cost should
be $10 higher because business was up by 100 client-visits; therefore, it would be mis-
leading to describe this variance in negative terms given that it was a necessary cost of
serving more customers. For reasons such as this, we would like to caution you against
assuming that unfavorable variances always indicate bad performance and favorable
variances always indicate good performance.
Because all of the variances on this report are solely due to the difference between
the actual level of activity and the level of activity in the planning budget from the begin-
ning of the period, they are called activity variances. For example, the activity variance
for revenue is $18,000 F, the activity variance for electricity is $10 U, and so on. The
most important activity variance appears at the very bottom of the report; namely, the
$13,710 F (favorable) variance for net operating income. This variance says that because
activity was higher than expected in the planning budget, the net operating income should
have been $13,710 higher. We caution against placing too much emphasis on any other
single variance in this report. As we have said above, one would expect some costs to be
higher as a consequence of more business. It is misleading to think of these unfavorable
variances as indicative of poor performance.
On the other hand, the favorable activity variance for net operating income is impor-
tant. Let’s explore this variance a bit more thoroughly. First, as we have already noted,
activity was up by 10%, but the flexible budget indicates that net operating income
should have increased much more than 10%. A 10% increase in net operating income
from the $16,800 in the planning budget would result in net operating income of $18,480
(= 1.1 × $16,800); however, the flexible budget shows much higher net operating income
of $30,510. Why? The short answer is: Because of the presence of fixed costs. When
we apply the 10% increase to the budgeted net operating income to estimate the profit
at the higher level of activity, we implicitly assume that the revenues and all of the costs
increase by 10%. But they do not. Note that when the activity level increases by 10%,
three of the costs—rent, liability insurance, and employee health insurance—do not
increase at all. These are all entirely fixed costs. So while sales do increase by 10%, these
costs do not increase. This results in net operating income increasing by more than 10%.
A similar effect occurs with the mixed costs, which contain fixed cost elements—wages
and salaries, electricity, and miscellaneous. While sales increase by 10%, these mixed
costs increase by less than 10%, resulting in an overall increase in net operating income
of more than 10%. Because of the existence of fixed costs, net operating income does
not change in proportion to changes in the level of activity. There is a leverage effect.
The percentage changes in net operating income are ordinarily larger than the percentage
increases in activity.
Revenue and Spending Variances

LO9–3 In the last section we answered the question “What impact did the change in activity have
Calculate and interpret on our revenues, costs, and profit?” In this section we will answer the question “How well
revenue and spending did we control our revenues, our costs, and our profit?”
variances. Recall that the flexible budget based on the actual level of activity in Exhibit 9–5
shows what should have happened given the actual level of activity. Therefore, Victoria’s
next step was to compare actual results to the flexible budget—in essence comparing
what actually happened to what should have happened. Her work is shown in Exhibit 9–7.
EXHIBIT 9–7
Rick’s Hairstyling Revenue and Spending Variances
Revenue and Spending Variances from Comparing Actual Results to
For the Month Ended March 31 the Flexible Budget
Revenue
and
Actual Flexible Spending
Results Budget Variances*
Client-visits . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100 1,100
Revenue($180.00q) . . . . . . . . . . . . . . . . . . . . $194,200 $198,000 $3,800 U
Expenses:
Wages and salaries
($65,000 + $37.00q) . . . . . . . . . . . . . . 106,900 105,700 1,200 U
Hairstyling supplies ($1.50q) . . . . . . . . . . 1,620 1,650 30 F
Client gratuities ($4.10q) . . . . . . . . . . . . . 6,870 4,510 2,360 U
Electricity ($1,500 + $0.10q) . . . . . . . . . . 1,550 1,610 60 F
Rent ($28,500) . . . . . . . . . . . . . . . . . . . . . . 28,500 28,500 0
Liability insurance ($2,800) . . . . . . . . . . . 2,800 2,800 0
Employee health insurance ($21,300) . . . . 22,600 21,300 1,300 U
Miscellaneous ($1,200 + $0.20q) . . . . . . 2,130 1,420 710 U
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . 172,970 167,490 5,480 U
Net operating income . . . . . . . . . . . . . . . . . . $ 21,230 $ 30,510 $9,280 U
*
The revenue variance is labeled favorable (unfavorable) when the actual revenue
is greater than (less than) the flexible budget. The expense variances are labeled
favorable (unfavorable) when the actual expense is less than (greater than) the
flexible budget.
Focusing first on revenue, the actual revenue totaled $194,200. However, the
flexible budget indicates that, given the actual level of activity, revenue should have
been $198,000. Consequently, revenue was $3,800 less than it should have been,
given the actual number of client-visits for the month. This discrepancy is labeled as a
$3,800 U (unfavorable) variance and is called a revenue variance. A revenue variance
is the difference between the actual total revenue and what the total revenue should have
been, given the actual level of activity for the period. If actual revenue exceeds what
the revenue should have been, the variance is labeled favorable. If actual revenue is less
than what the revenue should have been, the variance is labeled unfavorable. Why would
actual revenue be less than or more than it should have been, given the actual level of
IN BUSINESS
THE SALES IMPLICATIONS OF THE WORLD CUP
Actual sales volumes can differ from planned sales volumes for many reasons. For example,
some companies may fail to consider how sporting events such as the World Cup will affect their
planned sales. Corning said TV sales were up 13% in Europe and 64% in Latin America during
the World Cup and Carrefour reported a bump in sales of its beer, soft drinks, and meats dur-
ing the same period. Conversely, Whirlpool reported lower demand for its washing machines
(because the company claimed that customers were spending their disposable income on TVs)
and Denny’s reported a drop in full-service dining during the World Cup.
© andresr/Getty Images RF
Source: Vipal Monga and Emily Chasan, “When in Doubt, Blame It on the World Cup,” The Wall Street Journal, July 31, 2014,
pp. B1 and B4.
422 Chapter 9
activity? Basically, the revenue variance is favorable if the average selling price is greater
than expected; it is unfavorable if the average selling price is less than expected. This
could happen for a variety of reasons including a change in selling price, a different mix
of products sold, a change in the amount of discounts given, poor accounting controls,
and so on.
Focusing next on costs, the actual electricity cost was $1,550; however, the flexible
budget indicates that electricity costs should have been $1,610 for the 1,100 client-visits
in March. Because the cost was $60 less than we would have expected for the actual
level of activity during the period, it is labeled as a favorable variance, $60 F. This is
an example of a spending variance. 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. If the actual cost is greater than what the cost should have been, the vari-
ance is labeled as unfavorable. If the actual cost is less than what the cost should have
been, the variance is labeled as favorable. Why would a cost have a favorable or unfavor-
able variance? There are many possible explanations including paying a higher price for
inputs than should have been paid, using too many inputs for the actual level of activity, a
change in technology, and so on. In the next chapter we will explore these types of expla-
nations in greater detail.
Note from Exhibit 9–7 that the overall net operating income variance is $9,280 U
(unfavorable). This means that given the actual level of activity for the period, the net
operating income was $9,280 lower than it should have been. There are a number of
reasons for this. The most prominent is the unfavorable revenue variance of $3,800. Next
in line is the $2,360 unfavorable variance for client gratuities. Looking at this in another
way, client gratuities were more than 50% larger than they should have been according
to the flexible budget. This is a variance that Rick would almost certainly want to inves-
tigate further. He may find that this unfavorable variance is not necessarily a bad thing.
It is possible, for example, that more lavish use of gratuities led to the 10% increase in
client-visits.
Exhibit 9–7 also includes a $1,300 unfavorable variance related to employee health
insurance, thereby highlighting how a fixed cost can have a spending variance. While
fixed costs do not depend on the level of activity, the actual amount of a fixed cost can
differ from the estimated amount included in a flexible budget. For example, perhaps
Rick’s employee health insurance premiums unexpectedly increased by $1,300 during
March.
In conclusion, the revenue and spending variances in Exhibit 9–7 will help Rick bet-
ter understand why his actual net operating income differs from what should have hap-
pened given the actual level of activity.
A Performance Report Combining Activity and Revenue

and Spending Variances
LO9–4 Exhibit 9–8 displays Victoria’s performance report that combines the activity vari-
Prepare a performance ances (from Exhibit 9–6) with the revenue and spending variances (from Exhibit 9–7).
report that combines activity The report brings together information from those two earlier exhibits in a way that
variances and revenue and makes it easier to interpret what happened during the period. The format of this report
spending variances. is a bit different from the format of the previous reports in that the variances appear
between the amounts being compared rather than after them. For example, the activ-
ity variances appear between the flexible budget amounts and the planning budget
amounts. In Exhibit 9–6, the activity variances appeared after the flexible budget and
the planning budget.
Note two numbers in particular in the performance report—the activity variance
for net operating income of $13,710 F (favorable) and the overall revenue and spending
variance for net operating income of $9,280 U (unfavorable). It is worth repeating what
those two numbers mean. The $13,710 favorable activity variance occurred because
actual activity (1,100 client-visits) was greater than the budgeted level of activity
EXHIBIT 9–8
Performance Report Combining Activity Variances with Revenue and Spending Variances
Flexible Budget Performance Report
Revenue and
(1) Spending (2) Activity (3)
Actual Variances Flexible Variances Planning
Results (1) – (2) Budget (2) – (3) Budget
Client-visits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100 1,100 1,000
Revenue ($180.00q) . . . . . . . . . . . . . . . . . . . . . . . . . $194,200 $3,800 U $198,000 $18,000 F $180,000
Expenses:
Wages and salaries ($65,000 + $37.00q) . . . . . 106,900 1,200 U 105,700 3,700 U 102,000
Hairstyling supplies ($1.50q) . . . . . . . . . . . . . . . . . 1,620 30 F 1,650 150 U 1,500
Client gratuities ($4.10q) . . . . . . . . . . . . . . . . . . . . 6,870 2,360 U 4,510 410 U 4,100
Electricity ($1,500 + $0.10q) . . . . . . . . . . . . . . . . . 1,550 60 F 1,610 10 U 1,600
Rent ($28,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,500 0 28,500 0 28,500
Liability insurance ($2,800) . . . . . . . . . . . . . . . . . . 2,800 0 2,800 0 2,800
Employee health insurance ($21,300) . . . . . . . . 22,600 1,300 U 21,300 0 21,300
Miscellaneous ($1,200 + $0.20q) . . . . . . . . . . . . 2,130 710 U 1,420 20 U 1,400
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172,970 5,480 U 167,490 4,290 U 163,200
Net operating income . . . . . . . . . . . . . . . . . . . . . . . . . $ 21,230 $9,280 U $ 30,510 $13,710 F $ 16,800
(1,000 client-visits). The $9,280 unfavorable overall revenue and spending variance
occurred because the profit was not as large as it should have been for the actual level
of activity for the period. These two different variances mean very different things
and call for different types of actions. To generate a favorable activity variance for net
operating income, managers must take actions to increase client-visits. To generate a
favorable overall revenue and spending variance, managers must take actions to protect
selling prices, increase operating efficiency, and reduce the prices of inputs.
The performance report in Exhibit 9–8 provides much more useful information to
managers than a simple comparison of the planning budget with actual results as shown
in Exhibit 9–4. In Exhibit 9–4, the effects of changes in activity were jumbled together
with the effects of how well prices were controlled and operations were managed. The
performance report in Exhibit 9–8 clearly separates these effects, allowing managers to
take a much more focused approach in evaluating operations.
To get a better idea of how the performance report accomplishes this task, look at
hairstyling supplies in the performance report. The actual cost of hairstyling supplies
was $1,620 for the period, whereas in the planning budget, this cost was $1,500. In the
comparison of the actual results to the planning budget in Exhibit 9–4, this difference
is shown as an unfavorable variance of $120. Exhibit 9–4 uses a static planning budget
approach that compares actual costs at one level of activity to budgeted costs at a differ-
ent level of activity. As we said before, this is like comparing apples to oranges. This vari-
ance is actually a mixture of two different effects. This becomes clear in the performance
report in Exhibit 9–8. The $120 difference between the actual results and the budgeted
amount is composed of two different variances—a favorable spending variance of $30
and an unfavorable activity variance of $150. The favorable spending variance occurred
424 Chapter 9
because less was spent on hairstyling supplies than one would have expected, given the
actual level of activity for the month. The activity variance occurs because activity was
greater than anticipated in the planning budget, which naturally resulted in a higher total
cost for this variable cost.
The flexible budget performance report in Exhibit 9–8 provides a more valid assess-
ment of performance than simply comparing actual costs to static planning budget costs
because actual costs are compared to what costs should have been at the actual level of
activity. In other words, apples are compared to apples. When this is done, we see that
the spending variance for hairstyling supplies is $30 F (favorable) rather than $120 U
(unfavorable) as it was in the original static planning budget performance report (see
Exhibit 9–4). In some cases, as with hairstyling supplies in Rick’s report, an unfavorable
static planning budget variance may be transformed into a favorable revenue or spending
variance when an increase in activity is properly taken into account. The following dis-
cussion took place the next day at Rick’s salon.
Victoria: Let me show you what I’ve got. [Victoria shows Rick the flexible budget
MANAGERIAL
ACCOUNTING IN ACTION
performance report in Exhibit 9–8.] I simply used the cost formulas to update
the budget to reflect the increase in client-visits you experienced in March.
THE WRAP-UP
That allowed me to come up with a better benchmark for what the costs should
have been.
Rick: That’s what you labeled the “flexible budget based on 1,100 client-visits”?
Victoria: That’s right. Your original budget was based on 1,000 client-visits, so it
understated what some of the costs should have been when you actually served 1,100
customers.
Rick: That’s clear enough. These spending variances aren’t quite as shocking as the
variances on my first report.
Victoria: Yes, but you still have an unfavorable variance of $2,360 for client gratuities.
Rick: I know how that happened. In March there was a big political fundraising din-
ner that I forgot about when I prepared the March budget. To fit all of our regular
clients in, we had to push them through here pretty fast. Everyone still got top-rate
service, but I felt bad about not being able to spend as much time with each cus-
tomer. I wanted to give my customers a little extra something to compensate them
for the less personal service, so I ordered a lot of flowers, which I gave away by
the bunch.
Victoria: With the prices you charge, Rick, I am sure the gesture was appreciated.
Rick: One thing bothers me about the report. When we discussed my costs before,
you called rent, liability insurance, and employee health insurance fixed costs.
How can I have a variance for a fixed cost? Doesn’t fixed mean that it doesn’t
change?
Victoria: We call these costs fixed because they shouldn’t be affected by changes in the
level of activity. However, that doesn’t mean that they can’t change for other reasons.
Also, the use of the term fixed suggests to people that the cost can’t be controlled,
but that isn’t true. It is often easier to control fixed costs than variable costs. For
example, it would be fairly easy for you to change your insurance bill by adjusting
the amount of insurance you carry. It would be much more difficult for you to signifi-
cantly reduce your spending on hairstyling supplies—a variable cost that is a neces-
sary part of serving customers.
Rick: I think I understand, but it is confusing.
Victoria: Just remember that a cost is called variable if it is proportional to activity; it
is called fixed if it does not depend on the level of activity. However, fixed costs can
change for reasons unrelated to changes in the level of activity. And controllability
has little to do with whether a cost is variable or fixed. Fixed costs are often more
controllable than variable costs.
IN BUSINESS
CHILLY SPRING WEATHER BRINGS BIG DISCOUNTS
AND LOWER MARGINS
Cold temperatures can keep shoppers away from malls. When April temperatures dropped
below expectations so did sales at Victoria’s Secret, Bath & Body Works, and Aeropostale.
Fewer shoppers also can lead to big discounts as Aeropostale offered 50% off shorts to those
who did choose to shop in its stores.
When these types of retailers establish their budgets for the spring, it is impossible for
them to foresee months in advance how the weather may influence their sales, which in turn
can have an impact on their revenue activity variances.
© Austin Bush/Getty Images
Source: Anna Prior and Karen Talley, “Weather Holds Back Retailers,” The Wall Street Journal, May 10, 2013, p. B2.
Performance Reports in Nonprofit Organizations

The performance reports in nonprofit organizations are basically the same as the
performance reports we have considered so far—with one prominent difference.
Nonprofit organizations usually receive a significant amount of funding from sources
other than sales. For example, universities receive their funding from sales (i.e., tuition
charged to students), from endowment income and donations, and—in the case of
public universities—from state appropriations. This means that, like costs, the revenue
in governmental and nonprofit organizations may consist of both fixed and variable
elements. For example, the Seattle Opera Company’s revenue in a recent year consisted
of grants and donations of $12,719,000 and ticket sales of $8,125,000 (or about $75.35
per ticket sold). Consequently, the revenue formula for the opera can be written as:
Revenue = $12,719,000 + $75.35q
where q is the number of tickets sold. In other respects, the performance report for the
Seattle Opera and other nonprofit organizations would be similar to the performance
report in Exhibit 9–8.
Performance Reports in Cost Centers

Performance reports are often prepared for organizations that do not have any source of
outside revenue. In particular, in a large organization a performance report may be pre-
pared for each department—including departments that do not sell anything to outsiders.
For example, a performance report is very commonly prepared for production depart-
ments in manufacturing companies. Such reports should be prepared using the same
principles we have discussed and should look very much like the performance report in
Exhibit 9–8—with the exception that revenue, and consequently net operating income,
will not appear on the report. Because the managers in these departments are responsible
for costs, but not revenues, they are often called cost centers.
Flexible Budgets with Multiple Cost Drivers

At Rick’s Hairstyling, we have thus far assumed that there is only one cost driver—the
number of client-visits. However, in the activity-based costing chapter, we found that more LO9–5
Prepare a flexible budget with
than one cost driver might be needed to adequately explain all of the costs in an organization. more than one cost driver.
For example, some of the costs at Rick’s Hairstyling probably depend more on the number of
hours that the salon is open for business than the number of client-visits. Specifically, most
of Rick’s employees are paid salaries, but some are paid on an hourly basis. None of the
426 Chapter 9
EXHIBIT 9–9
Flexible Budget Based on More than
One Cost Driver
Flexible Budget
Actual client-visits (q1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100
Actual hours of operation (q2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 190
Revenue ($180.00q1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $198,000
Expenses:
Wages and salaries ($65,000 + $220q2) . . . . . . . . . . . . . . . . . . . . . . 106,800
Hairstyling supplies ($1.50q1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,650
Client gratuities ($4.10q1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,510
Electricity ($390 + $0.10q1 + $6.00q2) . . . . . . . . . . . . . . . . . . . . . . . 1,640
Rent ($28,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,500
Liability insurance ($2,800) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,800
Employee health insurance ($21,300) . . . . . . . . . . . . . . . . . . . . . . . . 21,300
Miscellaneous ($1,200 + $0.20q1) . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,420
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168,620
employees is paid on the basis of the number of customers actually served. Consequently,
the cost formula for wages and salaries would be more accurate if it were stated in terms of
the hours of operation rather than the number of client-visits. The cost of electricity is even
more complex. Some of the cost is fixed—the heat must be kept at some minimum level
even at night when the salon is closed. Some of the cost depends on the number of client-
visits—the power consumed by hair dryers depends on the number of customers served.
Some of the cost depends on the number of hours the salon is open—the costs of lighting
the salon and heating it to a comfortable temperature. Consequently, the cost formula for
electricity would be more accurate if it were stated in terms of both the number of client-
visits and the hours of operation rather than just in terms of the number of client-visits.
Exhibit 9–9 shows a flexible budget in which these changes have been made. In
that flexible budget, two cost drivers are listed—client-visits and hours of operation—
where q1 refers to client-visits and q2 refers to hours of operation. For example, wages
and salaries depend on the hours of operation and its cost formula is $65,000 + $220q2.
Because the salon actually operated 190 hours, the flexible budget amount for wages
and salaries is $106,800 (= $65,000 + $220 × 190). The electricity cost depends on
IN BUSINESS
ON-CALL SCHEDULING DRAWS THE ATTENTION OF THE
NEW YORK ATTORNEY GENERAL
The New York Attorney General has warned Target, Gap, and 11 other companies that their on-
call employee scheduling practices may violate the law. These companies are using software
programs to forecast immediate-term staffing needs based on real-time sales and customer
traffic information. If a store is busy it requires its on-call employees to come to work, whereas if
the store is not busy the employees do not come to work and they are not paid. In other words,
the employees need to plan to be available even though they may or may not be called into
work or get paid.
From a flexible budgeting standpoint, the companies are trying to make their labor costs
variable with respect to sales and customer traffic. From a legal standpoint, the Attorney General
noted that this compensation scheme leaves employees “too little time to make arrangements
for family needs, let alone to find an alternative source of income to compensate for the lost pay.”
Source: Lauren Weber, “Retailers Under Fire for Work Schedules,” The Wall Street Journal, April 13, 2015, pp. B1–B2.
both client-visits and the hours of operation and its cost formula is $390 + $0.10q1 + $6.00q2.
Because the actual number of client-visits was 1,100 and the salon actually operated
for 190 hours, the flexible budget amount for electricity is $1,640 (= $390 + $0.10
× 1,100 + $6.00 × 190). Notice that the net operating income in the flexible budget
based on two cost drivers is $29,380, whereas the net operating income in the flexible
budget based on one cost driver (see Exhibit 9–5) is $30,510. These two amounts differ
because the flexible budget based on two cost drivers is more accurate than the flexible
budget based on one driver.
The revised flexible budget based on both client-visits and hours of operation can be
used exactly like we used the earlier flexible budget based on just client-visits to compute
activity variances as in Exhibit 9–6, revenue and spending variances as in Exhibit 9–7,
and a performance report as in Exhibit 9–8. The difference is that because the cost formu-
las based on more than one cost driver are more accurate than the cost formulas based on
just one cost driver, the variances will also be more accurate.
Some Common Errors

We started this chapter by discussing the need for managers to understand the difference
between what actually happened and what was expected to happen—formalized by the LO9–6
Understand common
planning budget. To meet this need, we developed a flexible budget that allowed us to iso- errors made in preparing
late activity variances and revenue and spending variances. Unfortunately, this approach performance reports based on
is not always followed in practice—resulting in misleading and difficult-to-interpret budgets and actual results.
reports. The most common errors in preparing performance reports are to implicitly
assume that all costs are fixed or to implicitly assume that all costs are variable. These
erroneous assumptions lead to inaccurate benchmarks and incorrect variances.
We have already discussed one of these errors—assuming that all costs are fixed. This
is the error that is made when static planning budget costs are compared to actual costs with-
out any adjustment for the actual level of activity. Such a comparison appeared in Exhibit
9–4. For convenience, the comparison of actual to planned revenues and costs is repeated
in Exhibit 9–10. Looking at that exhibit, note that the actual cost of hairstyling supplies of
$1,620 is directly compared to the planned cost of $1,500, resulting in an unfavorable vari-
ance of $120. But this comparison only makes sense if the cost of hairstyling supplies is
fixed. If the cost of hairstyling supplies isn’t fixed (and indeed it is not), one would expect
EXHIBIT 9–10
Rick’s Hairstyling Faulty Analysis Comparing Actual
For the Month Ended March 31 Amounts to Planned Amounts
Actual Planning (Implicitly Assumes All Income
Results Budget Variances Statement Items Are Fixed)
Client-visits . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100 1,000
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $194,200 $180,000 $14,200 F
Expenses:
Wages and salaries . . . . . . . . . . . . . . . . . 106,900 102,000 4,900 U
Hairstyling supplies . . . . . . . . . . . . . . . . . 1,620 1,500 120 U
Client gratuities . . . . . . . . . . . . . . . . . . . . . 6,870 4,100 2,770 U
Electricity . . . . . . . . . . . . . . . . . . . . . . . . . . 1,550 1,600 50 F
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,500 28,500 0
Liability insurance . . . . . . . . . . . . . . . . . . . 2,800 2,800 0
Employee health insurance . . . . . . . . . . 22,600 21,300 1,300 U
Miscellaneous . . . . . . . . . . . . . . . . . . . . . . 2,130 1,400 730 U
Total expense . . . . . . . . . . . . . . . . . . . . . . . . 172,970 163,200 9,770 U
Net operating income . . . . . . . . . . . . . . . . . $ 21,230 $ 16,800 $ 4,430 F
428 Chapter 9
IN BUSINESS
SNOW REMOVAL BUDGETS GET PLOWED UNDER
The District of Columbia budgeted $6.2 million for its annual snow removal needs based on
an expectation of 15 inches of snow per year. So, when it received 28 inches of snow in one
weekend, its snow removal budget got plowed under. During this same weekend, the Virginia
Department of Transportation estimated that 500,000 tons of snow dropped on its northern
Virginia roadways, leading to historic cost overruns in its $79 million snow removal budget.
In these types of situations, a flexible budget can help managers assess operational efficiency.
For example, a manager could create a cost formula such as “the snow removal cost per inch of
snow” to estimate what the total variable snow removal costs should be for the actual inches of
© Getty Images RF
snowfall. This “flexed” snow removal cost could be compared to the actual snow removal cost in
an effort to identify sources of exceptional performance or opportunities for process improvement.
Source: Sudeep Reddy and Clare Ansberry, “States Face Big Costs to Dig Out From Blizzard,”The Wall Street Journal, February 9,
2010, p. A6.
the cost to go up because of the increase in activity over the planning budget. Comparing
actual costs to static planning budget costs only makes sense if the cost is fixed. If the cost
isn’t fixed, it needs to be adjusted for any change in activity that occurs during the period.
The other common error when comparing a planning budget to actual results is to
assume that all costs are variable. A report that makes this error appears in Exhibit 9–11.
The variances in this report are computed by comparing actual results to the amounts in the
second numerical column where all of the items in the planning budget have been inflated
by 10%—the percentage by which activity increased. This is a perfectly valid adjustment
to make if an item is strictly variable—like sales and hairstyling supplies. It is not a valid
adjustment if the item contains any fixed element. Take, for example, rent. If the salon serves
10% more customers in a given month, would you expect the rent to increase by 10%? The
answer is no. Ordinarily, the rent is fixed in advance and does not depend on the volume of
business. Therefore, the amount shown in the second numerical column of $31,350 is incor-
rect, which leads to the erroneous favorable variance of $2,850. In fact, the actual rent paid
was exactly equal to the budgeted rent, so there should be no variance at all on a valid report.
EXHIBIT 9–11
Faulty Analysis That Assumes All Rick’s Hairstyling
Items in the Planning Budget Are For the Month Ended March 31
Variable (2)
(1) Planning
Actual Budget × Variances
Results (1,100/1,000) (1) – (2)
Client-visits . . . . . . . . . . . . . . . . . . . . . . . . 1,100
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . $194,200 $198,000 $3,800 U
Expenses:
Wages and salaries . . . . . . . . . . . . . . . 106,900 112,200 5,300 F
Hairstyling supplies . . . . . . . . . . . . . . . 1,620 1,650 30 F
Client gratuities . . . . . . . . . . . . . . . . . . . 6,870 4,510 2,360 U
Electricity . . . . . . . . . . . . . . . . . . . . . . . . 1,550 1,760 210 F
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,500 31,350 2,850 F
Liability insurance . . . . . . . . . . . . . . . . . 2,800 3,080 280 F
Employee health insurance . . . . . . . . 22,600 23,430 830 F
Miscellaneous . . . . . . . . . . . . . . . . . . . . 2,130 1,540 590 U
Total expense . . . . . . . . . . . . . . . . . . . . . . 172,970 179,520 6,550 F
Net operating income . . . . . . . . . . . . . . . $ 21,230 $ 18,480 $2,750 F
Summary
Directly comparing actual revenues and costs to static planning budget revenues and costs can
easily lead to erroneous conclusions. Actual revenues and costs differ from budgeted revenues and
costs for a variety of reasons, but one of the biggest is a change in the level of activity. One would
expect actual revenues and costs to increase or decrease as the activity level increases or decreases.
Flexible budgets enable managers to isolate the various causes of the differences between budgeted
and actual costs.
A flexible budget is a budget that is adjusted to the actual level of activity. It is the best esti-
mate of what revenues and costs should have been, given the actual level of activity during the
period. The flexible budget can be compared to the budget from the beginning of the period or to
the actual results.
When the flexible budget is compared to the planning budget, activity variances are the result.
An activity variance shows how a revenue or cost should have changed in response to the differ-
ence between actual and planned activity.
When actual results are compared to the flexible budget, revenue and spending variances are the
result. A favorable revenue variance indicates that revenue was larger than should have been expected,
given the actual level of activity. An unfavorable revenue variance indicates that revenue was less than
it should have been, given the actual level of activity. A favorable spending variance indicates that
the cost was less than expected, given the actual level of activity. An unfavorable spending variance
indicates that the cost was greater than it should have been, given the actual level of activity.
A flexible budget performance report combines activity variances and revenue and spending
variances on one report.
Common errors in comparing actual costs to budgeted costs are to assume all costs are fixed or to
assume all costs are variable. If all costs are assumed to be fixed, the variances for variable and mixed
costs will be incorrect. If all costs are assumed to be variable, the variances for fixed and mixed costs
will be incorrect. The variance for a cost will only be correct if the actual behavior of the cost is used to
develop the flexible budget benchmark.
Review Problem: Variance Analysis Using a Flexible Budget

Harrald’s Fish House is a family-owned restaurant that specializes in Scandinavian-style seafood.
Data concerning the restaurant’s monthly revenues and costs appear below (q refers to the number
of meals served):
Formula
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $16.50q
Cost of ingredients . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $6.25q
Wages and salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,400
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $800 + $0.20q
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,200
Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $600 + $0.80q
Required:
1. Prepare the restaurant’s planning budget for April assuming that 1,800 meals are served.
2. Assume that 1,700 meals were actually served in April. Prepare a flexible budget for this level
of activity.
3. The actual results for April appear below. Prepare a flexible budget performance report for the
restaurant for April.
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $27,920
Cost of ingredients . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,110
Wages and salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,130
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,080
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,200
Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,240
430 Chapter 9
Solution to Review Problem

1. The planning budget for April appears below:
Harrald’s Fish House

Planning Budget
For the Month Ended April 30
Budgeted meals served (q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800
Revenue ($16.50q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $29,700
Expenses:
Cost of ingredients ($6.25q) . . . . . . . . . . . . . . . . . . . . . . . . . 11,250
Wages and salaries ($10,400) . . . . . . . . . . . . . . . . . . . . . . . . 10,400
Utilities ($800 + $0.20q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,160
Rent ($2,200) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,200
Miscellaneous ($600 + $0.80q) . . . . . . . . . . . . . . . . . . . . . . 2,040
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,050
Net operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,650
2. The flexible budget for April appears below:

Flexible Budget
Actual meals served (q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,700
Revenue ($16.50q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $28,050
Expenses:
Cost of ingredients ($6.25q) . . . . . . . . . . . . . . . . . . . . . . . . . 10,625
Wages and salaries ($10,400) . . . . . . . . . . . . . . . . . . . . . . . . 10,400
Utilities ($800 + $0.20q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,140
Rent ($2,200) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,200
Miscellaneous ($600 + $0.80q) . . . . . . . . . . . . . . . . . . . . . . 1,960
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,325
3. The flexible budget performance report for April appears below:

Flexible Budget Performance Report
Revenue
and
(1) Spending (2) Activity (3)
Actual Variances Flexible Variances Planning
Results (1) – (2) Budget (2) – (3) Budget
Meals served . . . . . . . . . . . . . . . . . . . . . 1,700 1,700 1,800
Revenue ($16.50q) . . . . . . . . . . . . . . . $27,920 $130 U $28,050 $1,650 U $29,700
Expenses:
Cost of ingredients ($6.25q) . . . . . 11,110 485 U 10,625 625 F 11,250
Wages and salaries ($10,400) . . . . 10,130 270 F 10,400 0 10,400
Utilities ($800 + $0.20q) . . . . . . . . . 1,080 60 F 1,140 20 F 1,160
Rent ($2,200) . . . . . . . . . . . . . . . . . . 2,200 0 2,200 0 2,200
Miscellaneous ($600 + $0.80q) . . . . 2,240 280 U 1,960 80 F 2,040
Total expense . . . . . . . . . . . . . . . . . . . . 26,760 435 U 26,325 725 F 27,050
Net operating income . . . . . . . . . . . . . $ 1,160 $565 U $ 1,725 $ 925 U $ 2,650
Glossary
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 differ-
ence between the actual level of activity used in the flexible budget and the level of activity
assumed in the planning budget. (p. 420)
Flexible budget A report showing estimates of what revenues and costs should have been, given
the actual level of activity for the period. (p. 415)
Management by exception A management system in which actual results are compared to a bud-
get. Significant deviations from the budget are flagged as exceptions and investigated further.
(p. 414)
Planning budget A budget created at the beginning of the budgeting period that is valid only for
the planned level of activity. (p. 415)
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. (p. 421)
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 vari-
ance occurs because the cost is lower (higher) than expected, given the actual level of activity
for the period. (p. 422)
Questions
9–1 What is a static planning budget?
9–2 What is a flexible budget and how does it differ from a static planning budget?
9–3 What are some of the possible reasons that actual results may differ from what had been
budgeted at the beginning of a period?
9–4 Why is it difficult to interpret a difference between how much expense was budgeted and
how much was actually spent?
9–5 What is an activity variance and what does it mean?
9–6 What is a revenue variance and what does it mean?
9–7 What is a spending variance and what does it mean?
9–8 What does a flexible budget performance report do that a simple comparison of budgeted
to actual results does not do?
9–9 How does a flexible budget based on two cost drivers differ from a flexible budget based
on one cost driver?
9–10 What assumption is implicitly made about cost behavior when actual results are directly
compared to a static planning budget? Why is this assumption questionable?
9–11 What assumption is implicitly made about cost behavior when all of the items in a static
planning budget are adjusted in proportion to a change in activity? Why is this assump-
tion questionable?
Applying Excel
The Excel worksheet form that appears below is to be used to recreate the Review Problem relating LO9–1, LO9–2, LO9–3,
to Harrald’s Fish House. Download the workbook containing this form from Connect, where you LO9–4
will also receive instructions about how to use this worksheet form.
You should proceed to the requirements below only after completing your worksheet.
Required:
1. Check your worksheet by changing the revenue in cell D4 to $16.00; the cost of ingredients
in cell D5 to $6.50; and the wages and salaries in cell B6 to $10,000. The activity variance
for net operating income should now be $850 U and the spending variance for total expenses
should be $410 U. If you do not get these answers, find the errors in your worksheet and cor-
rect them.
a. What is the activity variance for revenue? Explain this variance.
b. What is the spending variance for the cost of ingredients? Explain this variance.
432 Chapter 9
2. Revise the data in your worksheet to reflect the results for the following year:
Data
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $16.50q
Cost of ingredients . . . . . . . . . . . . . . . . . . . . . . . $6.25q
Wages and salaries . . . . . . . . . . . . . . . . . . . . . . $10,400
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $800 + $0.20q
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,200
Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . . . . . $600 + $0.80q
Actual results:
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $28,900
Cost of ingredients . . . . . . . . . . . . . . . . . . . . . . . $11,300
Wages and salaries . . . . . . . . . . . . . . . . . . . . . . $10,300
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,120
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,300
Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,020
Planning budget activity . . . . . . . . . . . . . . . . . . 1,700 meals served
Actual activity . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800 meals served
Using the flexible budget performance report, briefly evaluate the company’s performance for the
year and indicate where attention should be focused.
The Foundational 15
Adger Corporation is a service company that measures its output based on the number of customers LO9–1, LO9–2, LO9–3
served. The company provided the following fixed and variable cost estimates that it uses for
budgeting purposes and the actual results for May as shown below:
Variable Element
Fixed Element per Customer Actual Total
per Month Served for May
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,000 $160,000
Employee salaries and wages . . . . . . . . . . . . . . $50,000 $1,100 $88,000
Travel expenses . . . . . . . . . . . . . . . . . . . . . . . . . . $600 $19,000
Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . $36,000 $34,500
When preparing its planning budget the company estimated that it would serve 30 customers per
month; however, during May the company actually served 35 customers.
Required (all computations pertain to the month of May):
1. What amount of revenue would be included in Adger’s flexible budget?
2. What amount of employee salaries and wages would be included in Adger’s flexible budget?
3. What amount of travel expenses would be included in Adger’s flexible budget?
4. What amount of other expenses would be included in Adger’s flexible budget?
5. What net operating income would appear in Adger’s flexible budget?
6. What is Adger’s revenue variance?
7. What is Adger’s employee salaries and wages spending variance?
8. What is Adger’s travel expenses spending variance?
9. What is Adger’s other expenses spending variance?
10. What amount of revenue would be included in Adger’s planning budget?
11. What amount of employee salaries and wages would be included in Adger’s planning budget?
12. What amount of travel expenses would be included in Adger’s planning budget?
13. What amount of other expenses would be included in Adger’s planning budget?
14. What activity variance would Adger report with respect to its revenue?
15. What activity variances would Adger report with respect to each of its expenses?
Exercises
EXERCISE 9–1 Prepare a Flexible Budget LO9–1
Puget Sound Divers is a company that provides diving services such as underwater ship repairs to
clients in the Puget Sound area. The company’s planning budget for May appears below:
Puget Sound Divers

Planning Budget
For the Month Ended May 31
Budgeted diving-hours (q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
Revenue ($365.00q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 36,500
Expenses:
Wages and salaries ($8,000 + $125.00q) . . . . . . . . . . . . . . 20,500
Supplies ($3.00q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300
Equipment rental ($1,800 + $32.00q) . . . . . . . . . . . . . . . . . 5,000
Insurance ($3,400) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,400
Miscellaneous ($630 + $1.80q) . . . . . . . . . . . . . . . . . . . . . . 810
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,010
During May, the company’s actual activity was 105 diving-hours.

Required:
Using Exhibit 9–5 as your guide, prepare a flexible budget for May.
434 Chapter 9
EXERCISE 9–2 Activity Variances LO9–2

Flight Café prepares in-flight meals for airlines in its kitchen located next to a local airport. The
company’s planning budget for July appears below:
Flight Café
Planning Budget
For the Month Ended July 31
Budgeted meals (q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,000
Revenue ($4.50q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 81,000
Expenses:
Raw materials ($2.40q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43,200
Wages and salaries ($5,200 + $0.30q) . . . . . . . . . . . . . . . . 10,600
Utilities ($2,400 + $0.05q) . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,300
Facility rent ($4,300) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,300
Insurance ($2,300) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,300
Miscellaneous ($680 + $0.10q) . . . . . . . . . . . . . . . . . . . . . . 2,480
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66,180
In July, 17,800 meals were actually served. The company’s flexible budget for this level of activity
appears below:
Flight Café
Flexible Budget
Budgeted meals (q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,800
Revenue ($4.50q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 80,100
Expenses:
Raw materials ($2.40q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42,720
Utilities ($2,400 + $0.05q) . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,290
Facility rent ($4,300) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,300
Insurance ($2,300) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,300
Miscellaneous ($680 + $0.10q) . . . . . . . . . . . . . . . . . . . . . . 2,460
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65,610
Required:
1. Calculate the company’s activity variances for July. (Hint: Refer to Exhibit 9–6.)
2. Which of the activity variances should be of concern to management? Explain.
EXERCISE 9–3 Revenue and Spending Variances LO9–3

Quilcene Oysteria farms and sells oysters in the Pacific Northwest. The company harvested and
sold 8,000 pounds of oysters in August. The company’s flexible budget for August appears below:
Quilcene Oysteria
Flexible Budget
For the Month Ended August 31
Actual pounds (q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000
Revenue ($4.00q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 32,000
Expenses:
Packing supplies ($0.50q) . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,000
Oyster bed maintenance ($3,200) . . . . . . . . . . . . . . . . . . . . 3,200
Shipping ($0.80q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,400
Utilities ($830) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 830
Other ($450 + $0.05q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 850
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,580
The actual results for August appear below:

Quilcene Oysteria
Income Statement
Actual pounds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $35,200
Expenses:
Packing supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,200
Oyster bed maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,100
Wages and salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,640
Shipping . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,950
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 810
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 980
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,680
Net operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $13,520
Required:
Calculate the company’s revenue and spending variances for August. (Hint: Refer to Exhibit 9–7.)
EXERCISE 9–4 Prepare a Flexible Budget Performance Report LO9–4

Vulcan Flyovers offers scenic overflights of Mount St. Helens, the volcano in Washington State
that explosively erupted in 1982. Data concerning the company’s operations in July appear below:
Vulcan Flyovers
Operating Data
Actual Flexible Planning
Results Budget Budget
Flights (q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 48 50
Revenue ($320.00q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $13,650 $15,360 $16,000
Expenses:
Wages and salaries ($4,000 + $82.00q) . . . . . . . . . . . . 8,430 7,936 8,100
Fuel ($23.00q) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,260 1,104 1,150
Airport fees ($650 + $38.00q) . . . . . . . . . . . . . . . . . . . . 2,350 2,474 2,550
Aircraft depreciation ($7.00q) . . . . . . . . . . . . . . . . . . . . . 336 336 350
Office expenses ($190 + $2.00q) . . . . . . . . . . . . . . . . . . 460 286 290
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,836 12,136 12,440
Net operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 814 $ 3,224 $ 3,560
The company measures its activity in terms of flights. Customers can buy individual tickets for
overflights or hire an entire plane for an overflight at a discount.
Required:
1. Using Exhibit 9–8 as your guide, prepare a flexible budget performance report for July that
includes revenue and spending variances and activity variances.
2. Which of the variances should be of concern to management? Explain.
EXERCISE 9–5 Prepare a Flexible Budget with More Than One Cost Driver LO9–5
Alyeski Tours operates day tours of coastal glaciers in Alaska on its tour boat the Blue Glacier.
Management has identified two cost drivers—the number of cruises and the number of passengers—
that it uses in its budgeting and performance reports. The company publishes a schedule of day
cruises that it may supplement with special sailings if there is sufficient demand. Up to 80 passengers
can be accommodated on the tour boat. Data concerning the company’s cost formulas appear below:
Fixed Cost per Month Cost per Cruise Cost per Passenger
Vessel operating costs . . . . . . $5,200 $480.00 $2.00
Advertising . . . . . . . . . . . . . . . . $1,700
Administrative costs . . . . . . . . . $4,300 $24.00 $1.00
Insurance . . . . . . . . . . . . . . . . . . $2,900
436 Chapter 9
For example, vessel operating costs should be $5,200 per month plus $480 per cruise plus $2 per
passenger. The company’s sales should average $25 per passenger. In July, the company provided
24 cruises for a total of 1,400 passengers.
Required:
Using Exhibit 9–9 as your guide, prepare the company’s flexible budget for July.
EXERCISE 9–6 Critique a Variance Report LO9–6
The Terminator Inc. provides on-site residential pest extermination services. The company has
several mobile teams who are dispatched from a central location in company-owned trucks. The
company uses the number of jobs to measure activity. At the beginning of April, the company
budgeted for 100 jobs, but the actual number of jobs turned out to be 105. A report comparing the
budgeted revenues and costs to the actual revenues and costs appears below:
The Terminator Inc.

Variance Report
Actual Planning
Results Budget Variances
Jobs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 100
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $20,520 $19,500 $ 1,020 F
Expenses:
Mobile team operating costs . . . . . . . . . . . . . . . 10,320 10,000 320 U
Exterminating supplies . . . . . . . . . . . . . . . . . . . . 960 1,800 840 F
Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800 800 0
Dispatching costs . . . . . . . . . . . . . . . . . . . . . . . . . 2,340 2,200 140 U
Office rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800 1,800 0
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,100 2,100 0
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,320 18,700 380 F
Net operating income . . . . . . . . . . . . . . . . . . . . . . . $ 2,200 $ 800 $ 1,400 F
Required:
Is the above variance report useful for evaluating how well revenues and costs were controlled
during April? Why, or why not?
EXERCISE 9–7 Critique a Variance Report LO9–6
Refer to the data for The Terminator Inc. in Exercise 9–6. A management intern has suggested that
the budgeted revenues and costs should be adjusted for the actual level of activity in April before
they are compared to the actual revenues and costs. Because the actual level of activity was 5%
higher than budgeted, the intern suggested that all budgeted revenues and costs should be adjusted
upward by 5%. A report comparing the budgeted revenues and costs, with this adjustment, to the
actual revenues and costs appears below.
The Terminator Inc.

Variance Report
Adjusted
Actual Planning
Jobs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 105
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $20,520 $ 20,475 $ 45 F
Expenses:
Mobile team operating costs . . . . . . . . . . . . . . . . 10,320 10,500 180 F
Exterminating supplies . . . . . . . . . . . . . . . . . . . . . 960 1,890 930 F
Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 800 840 40 F
Dispatching costs . . . . . . . . . . . . . . . . . . . . . . . . . . 2,340 2,310 30 U
Office rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800 1,890 90 F
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,100 2,205 105 F
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,320 19,635 1,315 F
Net operating income . . . . . . . . . . . . . . . . . . . . . . . . $ 2,200 $ 840 $1,360 F
Required:
Is the above variance report useful for evaluating how well revenues and costs were controlled dur-
ing April? Why, or why not?
EXERCISE 9–8 Flexible Budgets and Activity Variances LO9–1, LO9–2

Jake’s Roof Repair has provided the following data concerning its costs:
Fixed Cost Cost per

per Month Repair-Hour
Wages and salaries . . . . . . . . . . . . . . . . . . . $23,200 $16.30
Parts and supplies . . . . . . . . . . . . . . . . . . . . $8.60
Equipment depreciation . . . . . . . . . . . . . . . $1,600 $0.40
Truck operating expenses . . . . . . . . . . . . . $6,400 $1.70
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,480
Administrative expenses . . . . . . . . . . . . . . . $4,500 $0.80
For example, wages and salaries should be $23,200 plus $16.30 per repair hour. The company
expected to work 2,800 repair-hours in May, but actually worked 2,900 repair-hours. The company
expects its sales to be $44.50 per repair-hour.
Required:
Compute the company’s activity variances for May. (Hint: Refer to Exhibit 9–6.)
EXERCISE 9–9 Planning Budget LO9–1

Wyckam Manufacturing Inc. has provided the following information concerning its manufacturing
costs:
Fixed Cost Cost per

per Month Machine-Hour
Direct materials . . . . . . . . . . . . . . . . . . . . . . . . . . . $4.25
Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $36,800
Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $0.30
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,400 $0.05
Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $16,700
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $12,700
For example, utilities should be $1,400 per month plus $0.05 per machine-hour. The company
expects to work 5,000 machine-hours in June. Note that the company’s direct labor is a fixed cost.
Required:
Using Exhibit 9–2 as your guide, prepare the company’s planning budget for June.
EXERCISE 9–10 Planning Budget LO9–1

Lavage Rapide is a Canadian company that owns and operates a large automatic car wash facility
near Montreal. The following table provides data concerning the company’s costs:
Fixed Cost Cost per

per Month Car Washed
Cleaning supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . $0.80
Electricity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,200 $0.15
Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $0.20
Wages and salaries . . . . . . . . . . . . . . . . . . . . . . . . . $5,000 $0.30
Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $6,000
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,000
Administrative expenses . . . . . . . . . . . . . . . . . . . . . $4,000 $0.10
For example, electricity costs are $1,200 per month plus $0.15 per car washed. The company
expects to wash 9,000 cars in August and to collect an average of $4.90 per car washed.
Required:
Using Exhibit 9–2 as your guide, prepare the company’s planning budget for August.
438 Chapter 9
EXERCISE 9–11 Flexible Budget LO9–1

Refer to the data for Lavage Rapide in Exercise 9–10. The company actually washed 8,800 cars in
August.
Required:
Using Exhibit 9–5 as your guide, prepare the company’s flexible budget for August.
EXERCISE 9–12 Activity Variances LO9–2

Refer to the data for Lavage Rapide in Exercise 9–10. The company actually washed 8,800 cars in
August.
Required:
Calculate the company’s activity variances for August. (Hint: Refer to Exhibit 9–6.)
EXERCISE 9–13 Revenue and Spending Variances LO9–3

Refer to the data for Lavage Rapide in Exercise 9–10. Also assume that the company’s actual oper-
ating results for August are as follows:
Lavage Rapide
Income Statement
Actual cars washed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,800
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 43,080
Expenses:
Cleaning supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,560
Electricity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,670
Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,260
Wages and salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,500
Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,000
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000
Administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,950
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39,940
Net operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,140
Required:
Calculate the company’s revenue and spending variances for August. (Hint: Refer to Exhibit 9–7.)
EXERCISE 9–14 Prepare a Flexible Budget Performance Report LO9–4

Refer to the data for Lavage Rapide in Exercises 9–10 and 9–13.
Required:
Using Exhibit 9–8 as your guide, prepare a flexible budget performance report that shows the com-
pany’s revenue and spending variances and activity variances for August.
EXERCISE 9–15 Flexible Budget Performance Report in a Cost Center LO9–1, LO9–2, LO9–3, LO9–4
Packaging Solutions Corporation manufactures and sells a wide variety of packaging products.
Performance reports are prepared monthly for each department. The planning budget and flexible
budget for the Production Department are based on the following formulas, where q is the number
of labor-hours worked in a month:
Cost Formulas
Direct labor . . . . . . . . . . . . . . . . . . . . . . . . $15.80q
Indirect labor . . . . . . . . . . . . . . . . . . . . . . . $8,200 + $1.60q
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . $6,400 + $0.80q
Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,100 + $0.40q
Equipment depreciation . . . . . . . . . . . . . $23,000 + $3.70q
Factory rent . . . . . . . . . . . . . . . . . . . . . . . . $8,400
Property taxes . . . . . . . . . . . . . . . . . . . . . . $2,100
Factory administration . . . . . . . . . . . . . . . $11,700 + $1.90q
The Production Department planned to work 8,000 labor-hours in March; however, it actually
worked 8,400 labor-hours during the month. Its actual costs incurred in March are listed below:
Actual Cost Incurred in March

Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . $134,730
Indirect labor . . . . . . . . . . . . . . . . . . . . . . . . . . . $19,860
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $14,570
Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $4,980
Equipment depreciation . . . . . . . . . . . . . . . . . $54,080
Factory rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,700
Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . $2,100
Factory administration . . . . . . . . . . . . . . . . . . . $26,470
Required:
1. Using Exhibit 9–2 as your guide, prepare the Production Department’s planning budget for
the month.
2. Using Exhibit 9–5 as your guide, prepare the Production Department’s flexible budget for the month.
3. Using Exhibit 9–8 as your guide, prepare the Production Department’s flexible budget perfor-
mance report for March, including both the spending and activity variances.
4. What aspects of the flexible budget performance report should be brought to management’s
attention? Explain.
EXERCISE 9–16 Flexible Budgets and Revenue and Spending Variances LO9–1, LO9–3
Via Gelato is a popular neighborhood gelato shop. The company has provided the following cost
formulas and actual results for the month of June:
Fixed Element Variable Element Actual Total

per Month per Liter for June
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . $12.00 $71,540
Raw materials . . . . . . . . . . . . . . . . . . . . $4.65 $29,230
Wages . . . . . . . . . . . . . . . . . . . . . . . . . . $5,600 $1.40 $13,860
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . $1,630 $0.20 $3,270
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,600 $2,600
Insurance . . . . . . . . . . . . . . . . . . . . . . . . $1,350 $1,350
Miscellaneous . . . . . . . . . . . . . . . . . . . . $650 $0.35 $2,590
While gelato is sold by the cone or cup, the shop measures its activity in terms of the total number
of liters of gelato sold. For example, wages should be $5,600 plus $1.40 per liter of gelato sold and
the actual wages for June were $13,860. Via Gelato expected to sell 6,000 liters in June, but actu-
ally sold 6,200 liters.
Required:
Calculate Via Gelato revenue and spending variances for June. (Hint: Refer to Exhibit 9–7.)
EXERCISE 9–17 Flexible Budget Performance Report LO9–1, LO9–2, LO9–3, LO9–4

AirQual Test Corporation provides on-site air quality testing services. The company has provided
the following cost formulas and actual results for the month of February:
Fixed Component Variable Actual Total

per Month Component per Job for February
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . $360 $18,950
Technician wages . . . . . . . . . . . . . . . . . $6,400 $6,450
Mobile lab operating expenses . . . . . $2,900 $35 $4,530
Office expenses . . . . . . . . . . . . . . . . . . $2,600 $2 $3,050
Advertising expenses . . . . . . . . . . . . . $970 $995
Insurance . . . . . . . . . . . . . . . . . . . . . . . . $1,680 $1,680
Miscellaneous expenses . . . . . . . . . . . $500 $3 $465
The company uses the number of jobs as its measure of activity. For example, mobile lab operat-
ing expenses should be $2,900 plus $35 per job, and the actual mobile lab operating expenses for
February were $4,530. The company expected to work 50 jobs in February, but actually worked
52 jobs.
440 Chapter 9
Required:
Using Exhibit 9–8 as your guide, prepare a flexible budget performance report showing AirQual
Test Corporation’s revenue and spending variances and activity variances for February.
EXERCISE 9–18 Working with More Than One Cost Driver LO9–2, LO9–3, LO9–4, LO9–5
The Gourmand Cooking School runs short cooking courses at its small campus. Management has iden-
tified two cost drivers it uses in its budgeting and performance reports—the number of courses and the
total number of students. For example, the school might run two courses in a month and have a total of
50 students enrolled in those two courses. Data concerning the company’s cost formulas appear below:
Fixed Cost Cost per Cost per

per Month Course Student
Instructor wages . . . . . . . . . . . . . . . . . . . . $3,080
Classroom supplies . . . . . . . . . . . . . . . . . $260
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . $870 $130
Campus rent . . . . . . . . . . . . . . . . . . . . . . . $4,200
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . $1,890
Administrative expenses . . . . . . . . . . . . . $3,270 $15 $4
For example, administrative expenses should be $3,270 per month plus $15 per course plus $4 per
student. The company’s sales should average $800 per student.
The company planned to run three courses with a total of 45 students; however, it actually
ran three courses with a total of only 42 students. The actual operating results for September appear below:
Actual
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $32,400
Instructor wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . $9,080
Classroom supplies . . . . . . . . . . . . . . . . . . . . . . . . . $8,540
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,530
Campus rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $4,200
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,890
Administrative expenses . . . . . . . . . . . . . . . . . . . . . $3,790
Required:
Using Exhibits 9–8 and 9–9 as your guide, prepare a flexible budget performance report that shows
both revenue and spending variances and activity variances for September.
Problems
PROBLEM 9–19: Flexible Budget Performance Reports; Working Backwards LO 9–1, LO 9–2, 9–3, 9–4
Ray Company provided the following excerpts from its Production Department’s flexible budget
performance report:
Ray Company
Production Department Flexible Budget Performance Report
Actual Spending Flexible Activity Planning
Results Variances Budget Variances Budget
Labor-hours (q) . . . . . . . . . . . . . . . . . . . 9,480 ? 9,000
Direct labor ($?q) . . . . . . . . . . . . . . . . . $134,730 $ ? $132,720 $ ? $ ?
Indirect labor ($? + $1.50q) . . . . . . . . ? 1,780 F 21,640 ? ?
Utilities ($6,500 + $?q) . . . . . . . . . . . . ? 1,450 U ? 336 U 12,800
Supplies ($? + $?q) . . . . . . . . . . . . . . . 4,940 ? 4,444 ? 4,300
Equipment depreciation
($78,400) . . . . . . . . . . . . . . . . . . . . . . ? 0 ? ? ?
Factory administration
($18,700 + $1.90q) . . . . . . . . . . . . . ? ? ? ? ?
Total expense . . . . . . . . . . . . . . . . . . . . $288,088 $ ? $ ? $ ? $ ?
Required:
Complete the Production Department’s Flexible Budget Performance Report by filling in all the
question marks.
PROBLEM 9–20 Activity and Spending Variances LO9–1, LO9–2, LO9–3

You have just been hired by FAB Corporation, the manufacturer of a revolutionary new garage
door opening device. The president has asked that you review the company’s costing system and
“do what you can to help us get better control of our manufacturing overhead costs.” You find that
the company has never used a flexible budget, and you suggest that preparing such a budget would
be an excellent first step in overhead planning and control.
After much effort and analysis, you determined the following cost formulas and gathered the
following actual cost data for March:
Actual Cost
Cost Formula in March
Utilities . . . . . . . . . . . . . . . $20,600 + $0.10 per machine-hour $24,200
Maintenance . . . . . . . . . . $40,000 + $1.60 per machine-hour $78,100
Supplies . . . . . . . . . . . . . . $0.30 per machine-hour $8,400
Indirect labor . . . . . . . . . . $130,000 + $0.70 per machine-hour $149,600
Depreciation . . . . . . . . . . $70,000 $71,500
During March, the company worked 26,000 machine-hours and produced 15,000 units. The com-
pany had originally planned to work 30,000 machine-hours during March.
Required:
1. Calculate the activity variances for March. (Hint: Refer to Exhibit 9–6.) Explain what these
variances mean.
2. Calculate the spending variances for March. (Hint: Refer to Exhibit 9–7.) Explain what these
variances mean.
PROBLEM 9–21 More than One Cost Driver LO9–2, LO9–3, LO9–4, LO9–5
Milano Pizza is a small neighborhood pizzeria that has a small area for in-store dining as well as
offering take-out and free home delivery services. The pizzeria’s owner has determined that the
shop has two major cost drivers—the number of pizzas sold and the number of deliveries made.
The pizzeria’s cost formulas appear below:
Fixed Cost Cost per Cost per

per Month Pizza Delivery
Pizza ingredients . . . . . . . . . . . . . . . . . . $3.80
Kitchen staff . . . . . . . . . . . . . . . . . . . . . . . $5,220
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . $630 $0.05
Delivery person . . . . . . . . . . . . . . . . . . . $3.50
Delivery vehicle . . . . . . . . . . . . . . . . . . . $540 $1.50
Equipment depreciation . . . . . . . . . . . . $275
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,830
Miscellaneous . . . . . . . . . . . . . . . . . . . . . $820 $0.15
In November, the pizzeria budgeted for 1,200 pizzas at an average selling price of $13.50 per
pizza and for 180 deliveries.
Data concerning the pizzeria’s actual results in November appear below:
Actual Results
Pizzas . . . . . . . . . . . . . . . . . . . . . . . . . . 1,240
Deliveries . . . . . . . . . . . . . . . . . . . . . . . 174
Revenue . . . . . . . . . . . . . . . . . . . . . . . . $17,420
Pizza ingredients . . . . . . . . . . . . . . . . $4,985
Kitchen staff . . . . . . . . . . . . . . . . . . . . . $5,281
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . $984
Delivery person . . . . . . . . . . . . . . . . . $609
Delivery vehicle . . . . . . . . . . . . . . . . . $655
Equipment depreciation . . . . . . . . . . $275
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,830
Miscellaneous . . . . . . . . . . . . . . . . . . . $954
442 Chapter 9
Required:
1. Using Exhibits 9–8 and 9–9 as your guide, prepare a flexible budget performance report
that shows both revenue and spending variances and activity variances for the pizzeria for
November.
2. Explain the activity variances.
PROBLEM 9–22 Critique a Report; Prepare a Performance Report LO9–1, LO9–2, LO9–3, LO9–4, LO9–6
TipTop Flight School offers flying lessons at a small municipal airport. The school’s owner and
manager has been attempting to evaluate performance and control costs using a variance report
that compares the planning budget to actual results. A recent variance report appears below:
TipTop Flight School

Variance Report
Actual Planning
Lessons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155 150
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $33,900 $33,000 $ 900 F
Expenses:
Instructor wages . . . . . . . . . . . . . . . . . . . . . . 9,870 9,750 120 U
Aircraft depreciation . . . . . . . . . . . . . . . . . . 5,890 5,700 190 U
Fuel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,750 2,250 500 U
Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . 2,450 2,330 120 U
Ground facility expenses . . . . . . . . . . . . . . 1,540 1,550 10 F
Administration . . . . . . . . . . . . . . . . . . . . . . . . 3,320 3,390 70 F
Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . 25,820 24,970 850 U
Net operating income . . . . . . . . . . . . . . . . . . . $ 8,080 $ 8,030 $ 50 F
After several months of using such variance reports, the owner has become frustrated. For
example, she is quite confident that instructor wages were very tightly controlled in July, but the
report shows an unfavorable variance.
The planning budget was developed using the following formulas, where q is the number of
lessons sold:
Cost Formulas
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . $220q
Instructor wages . . . . . . . . . . . . . . . . . . . $65q
Aircraft depreciation . . . . . . . . . . . . . . . $38q
Fuel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $15q
Maintenance . . . . . . . . . . . . . . . . . . . . . . $530 + $12q
Ground facility expenses . . . . . . . . . . . $1,250 + $2q
Administration . . . . . . . . . . . . . . . . . . . . . $3,240 + $1q
Required:
1. Should the owner feel frustrated with the variance reports? Explain.
2. Using Exhibit 9–8 as your guide, prepare a flexible budget performance report for the school
for July.
3. Evaluate the school’s performance for July.
PROBLEM 9–23 Performance Report for a Nonprofit Organization LO9–1, LO9–2, LO9–3, LO9–4, LO9–6
The St. Lucia Blood Bank, a private charity partly supported by government grants, is located
on the Caribbean island of St. Lucia. The blood bank has just finished its operations for Sep-
tember, which was a very busy month due to a powerful hurricane that hit neighboring islands
causing many injuries. The hurricane largely bypassed St. Lucia, but residents of St. Lucia
willingly donated their blood to help people on other islands. As a consequence, the blood
bank collected and processed over 20% more blood than had been originally planned for the
month.
A report prepared by a government official comparing actual costs to budgeted costs for the
blood bank appears below. Continued support from the government depends on the blood bank’s
ability to demonstrate control over its costs.
St. Lucia Blood Bank
Cost Control Report
For the Month Ended September 30
Actual Planning
Liters of blood collected . . . . . . . . . . . . . . . 620 500
Medical supplies . . . . . . . . . . . . . . . . . . . . . . $ 9,250 $ 7,500 $1,750 U
Lab tests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,180 6,000 180 U
Equipment depreciation . . . . . . . . . . . . . . . 2,800 2,500 300 U
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 1,000 0
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 570 500 70 U
Administration . . . . . . . . . . . . . . . . . . . . . . . . 11,740 11,250 490 U
Total expense . . . . . . . . . . . . . . . . . . . . . . . . $31,540 $28,750 $2,790 U
The managing director of the blood bank was very unhappy with this report, claiming that his
costs were higher than expected due to the emergency on the neighboring islands. He also pointed
out that the additional costs had been fully covered by payments from grateful recipients on the
other islands. The government official who prepared the report countered that all of the figures
had been submitted by the blood bank to the government; he was just pointing out that actual costs
were a lot higher than promised in the budget.
The following cost formulas were used to construct the planning budget:
Cost Formulas
Medical supplies . . . . . . . . . . . . . . . $15.00q
Lab tests . . . . . . . . . . . . . . . . . . . . . . $12.00q
Equipment depreciation . . . . . . . . $2,500
Rent . . . . . . . . . . . . . . . . . . . . . . . . . $1,000
Utilities . . . . . . . . . . . . . . . . . . . . . . . $500
Administration . . . . . . . . . . . . . . . . . $10,000 + $2.50q
Required:
1. Using Exhibit 9–8 as your guide, prepare a flexible budget performance report for September.
2. Do you think any of the variances in the report you prepared should be investigated? Why?
PROBLEM 9–24 Critiquing a Report; Preparing a Performance Budget LO9–1, LO9–2, LO9–3, LO9–4, LO9–6
Exchange Corp. is a company that acts as a facilitator in tax-favored real estate swaps. Such swaps,
know as 1031 exchanges, permit participants to avoid some or all of the capital gains taxes that
would otherwise be due. The bookkeeper for the company has been asked to prepare a report for
the company to help its owner/manager analyze performance. The first such report appears below:
Exchange Corp.
Analysis of Revenues and Costs
For the Month Ended May 31
Actual Planning Budget
Unit Revenues Unit Revenues
and Costs and Costs Variances
Exchanges completed . . . . . . . . . . . . . . . . 50 40
Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . $385 $395 $10 U
Expenses:
Legal and search fees . . . . . . . . . . . . . . 184 165 19 U
Office expenses . . . . . . . . . . . . . . . . . . . 112 135 23 F
Equipment depreciation . . . . . . . . . . . . 8 10 2F
Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 45 9F
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . 4 5 1F
Total expense . . . . . . . . . . . . . . . . . . . . . . . 344 360 16 F
Net operating income . . . . . . . . . . . . . . . . $ 41 $ 35 $ 6F
444 Chapter 9
Note that the revenues and costs in the above report are unit revenues and costs. For example,
the average office expense is $135 per exchange completed on the planning budget; whereas, the
average actual office expense is $112 per exchange completed.
Legal and search fees is a variable cost; office expenses is a mixed cost; and equipment depre-
ciation, rent, and insurance are fixed costs. In the planning budget, the fixed component of office
expenses was $5,200.
All of the company’s revenues come from fees collected when an exchange is completed.
Required:
1. Evaluate the report prepared by the bookkeeper.
2. Using Exhibit 9–8 as your guide, prepare a performance report that would help the owner/
manager assess the performance of the company in May.
3. Using the report you created, evaluate the performance of the company in May.
PROBLEM 9–25 Critiquing a Variance Report; Preparing a Performance Report LO9–1, LO9–2, LO9–3,
LO9–4, LO9–6
Several years ago, Westmont Corporation developed a comprehensive budgeting system for plan-
ning and control purposes. While departmental supervisors have been happy with the system, the
factory manager has expressed considerable dissatisfaction with the information being generated
by the system.
A report for the company’s Assembly Department for the month of March follows:
Assembly Department
Cost Report
Actual Planning
Machine-hours . . . . . . . . . . . . . . . . . . . . . 35,000 40,000
Variable costs:
Supplies . . . . . . . . . . . . . . . . . . . . . . . . . $ 29,700 $ 32,000 $2,300 F
Scrap . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,500 20,000 500 F
Indirect materials . . . . . . . . . . . . . . . . . 51,800 56,000 4,200 F
Fixed costs:
Wages and salaries . . . . . . . . . . . . . . . 79,200 80,000 800 F
Equipment depreciation . . . . . . . . . . . 60,000 60,000 —
Total cost . . . . . . . . . . . . . . . . . . . . . . . . . . $240,200 $248,000 $7,800 F
After receiving a copy of this cost report, the supervisor of the Assembly Department
stated, “These reports are super. It makes me feel really good to see how well things are going
in my department. I can’t understand why those people upstairs complain so much about the
reports.”
For the last several years, the company’s marketing department has chronically failed to meet
the sales goals expressed in the company’s monthly budgets.
Required:
1. The company’s president is uneasy about the cost reports and would like you to evaluate their
usefulness to the company.
2. What changes, if any, should be made in the reports to give better insight into how well depart-
mental supervisors are controlling costs?
3. Using Exhibit 9–8 as your guide, prepare a new performance report for the quarter, incorpo-
rating any changes you suggested in question (2) above.
4. How well were costs controlled in the Assembly Department in March?
PROBLEM 9–26 Critiquing a Cost Report; Preparing a Performance Report LO9–1, LO9–2, LO9–3,
LO9–4, LO9–6
Frank Weston, supervisor of the Freemont Corporation’s Machining Department, was visibly upset
after being reprimanded for his department’s poor performance over the prior month. The depart-
ment’s cost control report is given below:
Freemont Corporation–Machining Department

Cost Control Report
For the Month Ended June 30
Actual Planning
Machine-hours . . . . . . . . . . . . . . . . . . . . . 38,000 35,000
Direct labor wages . . . . . . . . . . . . . . . . . . $ 86,100 $ 80,500 $ 5,600 U
Supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . 23,100 21,000 2,100 U
Maintenance . . . . . . . . . . . . . . . . . . . . . . . 137,300 134,000 3,300 U
Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,700 15,200 500 U
Supervision . . . . . . . . . . . . . . . . . . . . . . . . 38,000 38,000 0
Depreciation . . . . . . . . . . . . . . . . . . . . . . . 80,000 80,000 0
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $380,200 $368,700 $11,500 U
“I just can’t understand all of these unfavorable variances,” Weston complained to the supervi-
sor of another department. “When the boss called me in, I thought he was going to give me a pat
on the back because I know for a fact that my department worked more efficiently last month than
it has ever worked before. Instead, he tore me apart. I thought for a minute that it might be over the
supplies that were stolen out of our warehouse last month. But they only amounted to a couple of
hundred dollars, and just look at this report. Everything is unfavorable.”
Direct labor wages and supplies are variable costs; supervision and depreciation are fixed
costs; and maintenance and utilities are mixed costs. The fixed component of the budgeted mainte-
nance cost is $92,000; the fixed component of the budgeted utilities cost is $11,700.
Required:
1. Evaluate the company’s cost control report and explain why the variances were all unfavorable.
2. Using Exhibit 9–8 as your guide, prepare a performance report that will help Mr. Weston’s
superiors assess how well costs were controlled in the Machining Department.
Cases
CASE 9–27 Ethics and the Manager LO9–3
Tom Kemper is the controller of the Wichita manufacturing facility of Prudhom Enterprises, Inc.
The annual cost control report is one of the many reports that must be filed with corporate
headquarters and is due at corporate headquarters shortly after the beginning of the New Year.
Kemper does not like putting work off to the last minute, so just before Christmas he prepared a
preliminary draft of the cost control report. Some adjustments would later be required for transac-
tions that occur between Christmas and New Year’s Day. A copy of the preliminary draft report,
which Kemper completed on December 21, follows:
Wichita Manufacturing Facility

Cost Control Report
December 21 Preliminary Draft
Actual Flexible Spending
Labor-hours . . . . . . . . . . . . . . . . . . . 18,000 18,000
Direct labor . . . . . . . . . . . . . . . . . . . $ 326,000 $ 324,000 $ 2,000 U
Power . . . . . . . . . . . . . . . . . . . . . . . . 19,750 18,000 1,750 U
Supplies . . . . . . . . . . . . . . . . . . . . . . 105,000 99,000 6,000 U
Equipment depreciation . . . . . . . . 343,000 332,000 11,000 U
Supervisory salaries . . . . . . . . . . . . 273,000 275,000 2,000 F
Insurance . . . . . . . . . . . . . . . . . . . . . 37,000 37,000 0
Industrial engineering . . . . . . . . . . 189,000 210,000 21,000 F
Factory building lease . . . . . . . . . . 60,000 60,000 0
Total expense . . . . . . . . . . . . . . . . . $1,352,750 $1,355,000 $ 2,250 F
446 Chapter 9
Melissa Ilianovitch, the general manager at the Wichita facility, asked to see a copy of the
preliminary draft report. Kemper carried a copy of the report to her office where the following
discussion took place:
Ilianovitch: Wow! Almost all of the variances on the report are unfavorable. The only favorable vari-
ances are for supervisory salaries and industrial engineering. How did we have an unfavorable
variance for depreciation?
Kemper: Do you remember that milling machine that broke down because the wrong lubricant was
used by the machine operator?
Ilianovitch: Yes.
Kemper: We couldn’t fix it. We had to scrap the machine and buy a new one.
Ilianovitch: This report doesn’t look good. I was raked over the coals last year when we had just a few
unfavorable variances.
Kemper: I’m afraid the final report is going to look even worse.
Ilianovitch: Oh?
Kemper: The line item for industrial engineering on the report is for work we hired Ferguson Engineer-
ing to do for us. The original contract was for $210,000, but we asked them to do some additional
work that was not in the contract. We have to reimburse Ferguson Engineering for the costs of that
additional work. The $189,000 in actual costs that appears on the preliminary draft report reflects
only their billings up through December 21. The last bill they had sent us was on November 28, and
they completed the project just last week. Yesterday I got a call from Laura Sunder over at Ferguson
and she said they would be sending us a final bill for the project before the end of the year. The total
bill, including the reimbursements for the additional work, is going to be . . .
Ilianovitch: I am not sure I want to hear this.
Kemper: $225,000
Ilianovitch: Ouch!
Kemper: The additional work added $15,000 to the cost of the project.
Ilianovitch: I can’t turn in a report with an overall unfavorable variance! They’ll kill me at corporate
headquarters. Call up Laura at Ferguson and ask her not to send the bill until after the first of the
year. We have to have that $21,000 favorable variance for industrial engineering on the report.
Required:
What should Tom Kemper do? Explain.
CASE 9–28 Critiquing a Report; Calculating Spending Variances LO9–3, LO9–5, LO9–6

Boyne University offers an extensive continuing education program in many cities throughout
the state. For the convenience of its faculty and administrative staff and to save costs, the uni-
versity operates a motor pool. The motor pool’s monthly planning budget is based on operating
20 vehicles; however, for the month of March the university purchased one additional vehicle.
The motor pool furnishes gasoline, oil, and other supplies for its automobiles. A mechanic
does routine maintenance and minor repairs. Major repairs are performed at a nearby com-
mercial garage.
The following cost control report shows actual operating costs for March of the current year
compared to the planning budget for March.
Boyne University Motor Pool

Cost Control Report
March Planning (Over)

Actual Budget Under Budget
Miles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63,000 50,000
Autos . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 20
Gasoline . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 9,350 $ 7,500 $(1,850)
Oil, minor repairs, parts . . . . . . . . . . . . . . 2,360 2,000 (360)
Outside repairs . . . . . . . . . . . . . . . . . . . . . 1,420 1,500 80
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . 2,120 2,000 (120)
Salaries and benefits . . . . . . . . . . . . . . . . 7,540 7,540 0
Vehicle depreciation . . . . . . . . . . . . . . . . 5,250 5,000 (250)
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $28,040 $25,540 $(2,500)
The planning budget was based on the following assumptions:

a. $0.15 per mile for gasoline.
b. $0.04 per mile for oil, minor repairs, and parts.
c. $75 per automobile per month for outside repairs.
d. $100 per automobile per month for insurance.
e. $7,540 per month for salaries and benefits.
f. $250 per automobile per month for depreciation.
The supervisor of the motor pool is unhappy with the report, claiming it paints an unfair pic-
ture of the motor pool’s performance.
Required:
1. Calculate the spending variances for March. (Hint: Refer to Exhibit 9–7.)
2. What are the deficiencies in the original cost control report? How do your calculations in part
(1) above overcome these deficiencies?
(CMA, adapted)
CASE 9–29 Performance Report with More than One Cost Driver LO9–1, LO9–2, LO9–3,
LO9–4, LO9–5
The Little Theatre is a nonprofit organization devoted to staging plays for children. The theater
has a very small full-time professional administrative staff. Through a special arrangement
with the actors’ union, actors and directors rehearse without pay and are paid only for actual
performances.
The Little Theatre had tentatively planned to put on six different productions with a total of
108 performances. For example, one of the productions was Peter Rabbit, which had a six-week
run with three performances on each weekend. The costs from the current year’s planning budget
appear below.
The Little Theatre

Costs from the Planning Budget
For the Year Ended December 31
Budgeted number of productions . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Budgeted number of performances . . . . . . . . . . . . . . . . . . . . . . . . . 108
Actors and directors wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $216,000
Stagehands wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,400
Ticket booth personnel and ushers wages . . . . . . . . . . . . . . . . . . . 16,200
Scenery, costumes, and props . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108,000
Theater hall rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54,000
Printed programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,000
Publicity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000
Administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43,200
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $508,800
Some of the costs vary with the number of productions, some with the number of perfor-
mances, and some are fixed and depend on neither the number of productions nor the number
of performances. The costs of scenery, costumes, props, and publicity vary with the number
of productions. It doesn’t make any difference how many times Peter Rabbit is performed,
the cost of the scenery is the same. Likewise, the cost of publicizing a play with posters and
radio commercials is the same whether there are 10, 20, or 30 performances of the play. On
the other hand, the wages of the actors, directors, stagehands, ticket booth personnel, and ush-
ers vary with the number of performances. The greater the number of performances, the higher
the wage costs will be. Similarly, the costs of renting the hall and printing the programs will
vary with the number of performances. Administrative expenses are more difficult to ana-
lyze, but the best estimate is that approximately 75% of the budgeted costs are fixed, 15%
depend on the number of productions staged, and the remaining 10% depend on the number
of performances.
After the beginning of the year, the board of directors of the theater authorized expanding the
theater’s program to seven productions and a total of 168 performances. Not surprisingly, actual
costs were considerably higher than the costs from the planning budget. (Grants from donors and
448 Chapter 9
ticket sales were also correspondingly higher, but are not shown here.) Data concerning the actual
costs appear below:
The Little Theatre

Actual Costs
For the Year Ended December 31
Actual number of productions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Actual number of performances . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168
Actors and directors wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $341,800
Stagehands wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49,700
Ticket booth personnel and ushers wages . . . . . . . . . . . . . . . . . . . 25,900
Scenery, costumes, and props . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130,600
Theater hall rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78,000
Printed programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38,300
Publicity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,100
Administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,500
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $726,900
Required:
1. Use Exhibit 9–8 as your guide, prepare a flexible budget performance report for the year that
shows both spending variances and activity variances.
2. If you were on the board of directors of the theater, would you be pleased with how well costs
were controlled during the year? Why, or why not?
3. The cost formulas provide figures for the average cost per production and average cost per
performance. How accurate do you think these figures would be for predicting the cost of a
new production or of an additional performance of a particular production?

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CHAPTER 9

Flexible Budgets and

After studying Chapter 9, you should be able to:

LO9–1 Prepare a planning budget and a

LO9–2 Calculate and interpret activity

LO9–3 Calculate and interpret revenue

© Michael Sears/MCT/Newscom LO9–4 Prepare a performance report

n the last chapter we explored how budgets are developed before

The Variance Analysis Cycle

EXHIBIT 9–1 Variance Analysis Cycle

Deficiencies of the Static Planning Budget

MANAGERIAL Victoria: How is the budgeting going?

How a Flexible Budget Works

Flexible Budget Variances

*The revenue variance is labeled favorable (unfavorable) when the revenue in

Revenue and Spending Variances

A Performance Report Combining Activity and Revenue

Performance Reports in Nonprofit Organizations

Revenue = $12,719,000 + $75.35q

Performance Reports in Cost Centers

Flexible Budgets with Multiple Cost Drivers

Some Common Errors

Review Problem: Variance Analysis Using a Flexible Budget

Solution to Review Problem

Harrald’s Fish House

2. The flexible budget for April appears below:

Harrald’s Fish House

3. The flexible budget performance report for April appears below:

Harrald’s Fish House

Puget Sound Divers

During May, the company’s actual activity was 105 diving-hours.

EXERCISE 9–2 Activity Variances LO9–2

EXERCISE 9–3 Revenue and Spending Variances LO9–3

The actual results for August appear below:

EXERCISE 9–4 Prepare a Flexible Budget Performance Report LO9–4

The Terminator Inc.

The Terminator Inc.

EXERCISE 9–8 Flexible Budgets and Activity Variances LO9–1, LO9–2

Fixed Cost Cost per

EXERCISE 9–9 Planning Budget LO9–1

Fixed Cost Cost per

EXERCISE 9–10 Planning Budget LO9–1

Fixed Cost Cost per

EXERCISE 9–11 Flexible Budget LO9–1

EXERCISE 9–12 Activity Variances LO9–2

EXERCISE 9–13 Revenue and Spending Variances LO9–3

EXERCISE 9–14 Prepare a Flexible Budget Performance Report LO9–4

Actual Cost Incurred in March

Fixed Element Variable Element Actual Total

EXERCISE 9–17 Flexible Budget Performance Report LO9–1, LO9–2, LO9–3, LO9–4

Fixed Component Variable Actual Total

Fixed Cost Cost per Cost per

PROBLEM 9–20 Activity and Spending Variances LO9–1, LO9–2, LO9–3

Fixed Cost Cost per Cost per

TipTop Flight School

Freemont Corporation–Machining Department

Wichita Manufacturing Facility

CASE 9–28 Critiquing a Report; Calculating Spending Variances LO9–3, LO9–5, LO9–6

Boyne University Motor Pool