Summary
Highlights
This module introduces flexible budgets, noting their connection to traditional budgeting and variance analysis. While budgets typically look forward, flexible budgets use budgeting to analyze past performance. The presenter shares an example, based on a true story, to illustrate the concept.
A friend, a head greenskeeper at a fancy golf course, has a budget of half a million dollars for maintaining the greens. His initial budget was based on the golf course being open for 250 days. However, due to favorable weather, the course was actually open for 300 days. Despite this, his boss criticized him for exceeding his budget, presenting unfavorable variances in wages and supplies. The greenskeeper's total actual costs for the year were $530,000, compared to his initial budget of $500,000.
The presenter argues that the greenskeeper's performance should not be compared to the static, initial budget because the actual operating days significantly exceeded the planned days. A flexible budget is needed to adjust the initial budget to reflect the actual activity level (300 days open), thereby providing a fairer basis for evaluation. This involves re-calculating variable costs based on the actual activity.
The flexible budget is created by adjusting variable costs (wages and supplies) to match the actual 300 operating days, while fixed costs (depreciation) remain the same. For 300 days, budgeted wages would be $300,000 and supplies would be $120,000. Depreciation remains at $150,000. This results in a total flexible budget of $570,000 for 300 days of operation.
Comparing the actual costs to the flexible budget reveals a favorable variance of $25,000 for wages and $10,000 for supplies, making a total of $35,000 favorable for these variable costs. Including the $5,000 favourable depreciation variance, the overall flexible variance is $40,000 favorable. The presenter concludes that flexible budgets provide better ammunition for explaining performance and understanding a company's financial results, especially when activity levels differ significantly from the original plan.