Flexible Budgets and
Overhead Analysis
Lesson Eleven
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Learning Objective 1
Explain Accounting
Income as Performance
Measure.
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Performance Measure
Divisional Income
Managers do financial
performance measure Return on
that consider the Investment
activities of the business
unit independently of
other units in the firm.
Using this three:
. Residual
income
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Accounting Income (Divisional Income) as
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Performance Measure
Summary
measure
Investors Weighting
revenue
Obvious
measure
Weighting
expense
Divisional Income= Division Revenues –
Division Costs
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Learning Objective 2
Interpret and use return
on investment and residual
income.
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Return on Investment
Return on Net Income × (1 – Tax Rate)] or After Tax
= Income
Investment
Divisional Total Assets
If manager has the responsibility for asset
acquisition, usage and disposal, an effective
measures include the effect of assets
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Limitations of Return of Investment Measure
Managers can make decisions that lower the
performance but increase the managers’
reported performance.
Difficulty in measuring Problems in measuring
profit. Investment.
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Residual Income
Residual After Tax Income – (Cost of capital *Divisional
= Assets)
Income
Cost of Capital is the payment required to
finance the projects.
Residual Income is similar to the
economist’s notion of profit as being the
amount left over after all costs, including the
cost of the capital employed in the business
unit, are subtracted.
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Residual Income
One of the problem identified with divisional
income as a business unit performance
measure is that it does not explicitly consider
the investment usage by the unit.
Accounting income is designed
to report the return to the
owners of the organization and
then let them compare the
return to their cost of capital .
.
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Residual Income
Incorporate Modify divisional income
investment usage. by the subtracting the cost
of invested capital which
measures the investment
from accounting income
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Learning Objective 3
Use budget for
performance evaluation.
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Using Budgets for Performance
Evaluation
Preparation of master budget
as part of planning and
control
Ensure
Ensure adequate
adequate
Coordinate
Coordinate activities.
activities. resources.
resources.
Communicate
Communicate
organizational
organizational
goals
goals
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Using Budgets for Performance
Evaluation
Benchmark on evaluation to
measure performance
Variance
Varianceanalysis
analysisuses
uses
for
fordifference
differenceof
of actual
actual
performance
performanceand and
budget
budget performance
performance
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Using Budgets for Performance
Evaluation
To identify possible
To evaluate performance
sources of deviations
of individuals and
between budgeted and
business units.
actual performance
Calculate the difference between a planned
(budgeted) number and actual performance and
attempt to explain the causes of the difference.
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Learning Objective 4
Develop and use flexible
budget and explain sales
activity variance
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Flexible Budgets
May be prepared for any activity
level in the relevant range.
Show costs that should have been
incurred at the actual level of
activity, enabling “apples to apples”
cost comparisons.
Reveal variances related to
cost control.
Improve performance evaluation.
Let’s look at Example.
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Preparing a Flexible Budget
To a budget we need to know that:
Total variable costs change
in direct proportion to
changes in activity.
Total fixed costs remain ble
aria
unchanged within the V
relevant range. Fixed
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The difference between operating
profits in the master budget and
operating profits in the flexible budget
is called a sales activity variance.
The ₱106,000 unfavorable variance is
due to the activity that resulted in a
20,000 unit difference between actual
sales and planned sales.
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Learning Objective 5
Explain the variable cost
variance
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Flexible Budget Performance Report
Let’s prepare a
budget performance
report
for CheeseCo.
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Variable Cost Variances – Example
• Be careful to distinguish the variable cost
variances in Columns (2) and (3) at the table
below, which are input variances, from the
variable cost variances in Column (6), which
are part of the sales activity variance.
Management expects the costs in the flexible
budget to be lower than the master budget,
creating a sales activity variance, because
the sales volume is lower than master budget
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Variable Cost Variances – Example
What
What isis the
the variance
variance for
for indirect
indirect labor
labor when
when the
the
flexible
flexible budget
budget forfor 8,000
8,000 hours
hours is
is compared
compared toto the
the
actual
actual results?
results?
a.
a. $2,000
$2,000 U U
b.
b. $2,000
$2,000 FF
c.
c. $6,000
$6,000 U U
d.
d. $6,000
$6,000 FF
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End of Chapter 11
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