Nội dung

Confirming Pages Chapter Flexible Budgets and Performance Analysis 9 BU SI NE SS FOCU S The Inevitability of Forecasting Errors While companies derive numerous benefits from planning for the future, they must be able to respond when actual results deviate from the plan. For example, just two months after telling Wall Street analysts that it would break even for the first quarter of 2005, General Motors (GM) acknowledged that its actual sales were far less than its original forecast and the company would lose $850 million in the quarter. For the year, GM acknowledged that projected earnings would be 80% lower than previously indicated. The company’s stock price dropped by $4.71. When a company’s plans deviate from its actual results, managers need to understand the reasons for the deviations. How much is caused by the fact that actual sales differ from budgeted sales? How much is caused by the actions of managers? In the case of GM, the actual level of sales is far less than the budget, so some actual costs are likely to be less than originally budgeted. These lower costs do not signal managerial effectiveness. This chapter explains how to analyze the sources of discrepancies between budgeted and actual results. ■ Source: Alex Taylor III, “GM Hits the Skids,” Fortune, April 4, 2005, pp. 71–74. LEARNING OBJECTIVES After studying Chapter 9, you should be able to: LO1 Prepare a flexible budget. LO2 Prepare a report showing activity variances. LO3 Prepare a report showing revenue and spending variances. LO4 Prepare a performance report that combines activity variances and revenue and spending variances. LO5 Prepare a flexible budget with more than one cost driver. LO6 Understand common errors made in preparing performance reports based on budgets and actual results. 383 gar11005_ch09_383-417.indd 383 19/11/10 7:40 PM Confirming Pages 384 Chapter 9 n the last chapter we explored how budgets are developed before a period begins. Budgeting involves a lot of time and effort and the results of the budgeting process should not be shoved into a filing cabinet and forgotten. To be useful, budgets should provide guidance in conducting actual operations and should be part of the performance evaluation process. However, managers need to be very careful about how budgets are used. In government, budgets often establish how much will be spent, and indeed, spending more than was budgeted may be a criminal offense. That is not true in other organizations. In for-profit organizations, actual spending will rarely be the same as the spending that was budgeted at the beginning of the period. The reason is that the actual level of activity (such as unit sales) will rarely be the same as the budgeted activity; therefore, many actual costs and revenues will naturally differ from what was budgeted. Should a manager be penalized for spending 10% more than budgeted for a variable cost like direct materials if unit sales are 10% higher than budgeted? Of course not. In this chapter we will explore how budgets can be adjusted so that meaningful comparisons to actual costs can be made. I Flexible Budgets Characteristics of a Flexible Budget LEARNING OBJECTIVE 1 Prepare a flexible budget. The budgets that we explored in the last chapter were planning budgets. A planning budget is prepared before the period begins and is valid for only the planned level of activity. A static planning budget is suitable for planning but is inappropriate for evaluating how well costs are controlled. If the actual level of activity differs from what was planned, it would be misleading to compare actual costs to the static, unchanged planning 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 activity 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 WHY DO COMPANIES NEED FLEXIBLE BUDGETS? The difficulty of accurately predicting future financial performance can be readily understood by reading the annual report of any publicly traded company. For example Nucor Corporation, a steel manufacturer headquartered in Charlotte, North Carolina, cites numerous reasons why its actual results may differ from expectations, including the following: (1) the supply and cost of raw materials, electricity, and natural gas may change unexpectedly; (2) the market demand for steel products may change; (3) competitive pressures from imports and substitute materials may intensify; (4) uncertainties regarding the global economy may affect customer demand; (5) changes to U.S. and foreign trade policy may alter current importing and exporting practices; and (6) new government regulations could significantly increase environmental compliance costs. Each of these factors could cause static budget revenues and/or costs to differ from actual results. Source: Nucor Corporation 2004 annual report, p. 3. gar11005_ch09_383-417.indd 384 19/11/10 7:40 PM Confirming Pages Flexible Budgets and Performance Analysis 385 E X H I B I T 9–1 Planning Budget Rick’s Hairstyling Planning Budget For the Month Ended March 31 Budgeted client-visits (q) . . . . . . . . . . . . . . . . . . . . . 1,000 Revenue ($180.00q) . . . . . . . . . . . . . . . . . . . . . . . . . Expenses: Wages and salaries ($65,000 + $37.00q) . . . . . . Hairstyling supplies ($1.50q) . . . . . . . . . . . . . . . . Client gratuities ($4.10q) . . . . . . . . . . . . . . . . . . . . Electricity ($1,500 + $0.10q) . . . . . . . . . . . . . . . . Rent ($28,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . Liability insurance ($2,800) . . . . . . . . . . . . . . . . . . Employee health insurance ($21,300) . . . . . . . . . Miscellaneous ($1,200 + $0.20q) . . . . . . . . . . . . Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net operating income . . . . . . . . . . . . . . . . . . . . . . . . $180,000 102,000 1,500 4,100 1,600 28,500 2,800 21,300 1,400 163,200 $ 16,800 Deficiencies of the Static Planning Budget To illustrate the difference between a static planning budget and a flexible budget, consider Rick’s Hairstyling, an upscale hairstyling salon located in Beverly Hills that is owned and managed by Rick Manzi. The salon has very loyal customers—many of whom are associated with the film industry. Recently Rick has been attempting to get better control of his revenues and costs, and at the urging of his accounting and business adviser, Victoria Kho, he has begun to prepare monthly budgets. Victoria Kho is an accountant in independent practice who specializes in small service-oriented businesses like Rick’s Hairstyling. At the end of February, Rick prepared the March budget that appears in Exhibit 9–1. Rick believes that the number of customers served in a month is the best way to measure the overall level of activity in his salon. He refers to these visits as client-visits. A customer who comes into the salon and has his or her hair styled is counted as one client-visit. 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 revenue 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 champagne that Rick gives to his customers while they are in the salon. Working with Victoria, Rick had already estimated a cost formula for each cost. For example, they determined that the cost formula for electricity should be $1,500 + $0.10q, where q equals the number of client-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, it was easy to compute the budgeted amount for each line item in the budget. For example, using the cost formula, the budgeted cost for electricity was set at $1,600 (= $1,500 + $0.10 × 1,000). At the end of March, Rick found that his actual profit was $21,230 as shown in the income statement in Exhibit 9–2. 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. Referring back to Exhibit 9–1, the budgeted net operating income was $16,800, so the actual profit was substantially higher than planned at the beginning of the month. This gar11005_ch09_383-417.indd 385 19/11/10 7:40 PM Confirming Pages 386 E X H I B I T 9–2 Actual Results—Income Statement Chapter 9 Rick’s Hairstyling Income Statement For the Month Ended March 31 Actual client-visits. . . . . . . . . . . . . . . Revenue . . . . . . . . . . . . . . . . . . . . . . Expenses: Wages and salaries. . . . . . . . . . . . Hairstyling supplies . . . . . . . . . . . . Client gratuities . . . . . . . . . . . . . . . Electricity . . . . . . . . . . . . . . . . . . . . . Rent . . . . . . . . . . . . . . . . . . . . . . . . . Liability insurance . . . . . . . . . . . . . . Employee health insurance . . . . . . Miscellaneous . . . . . . . . . . . . . . . . Total expense . . . . . . . . . . . . . . . . . . Net operating income . . . . . . . . . . . . . 1,100 $194,200 106,900 1,620 6,870 1,550 28,500 2,800 22,600 2,130 172,970 $ 21,230 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 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? Something 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 comparing actual to budgeted costs that appears in Exhibit 9–3. Note that most of the variances in this report are labeled unfavorable (U) rather than favorable (F) even though net operating income was actually higher than expected. For example, wages and salaries show an unfavorable variance of $4,900 because the budget called for wages and salaries of $102,000, whereas the actual wages and salaries expense was $106,900. The problem 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 and should be counted as a favorable variance, but the increase in activity has an apparently negative impact on most of the costs in the report. Rick knew that something 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 ACCOUNTING IN ACTION The Issue gar11005_ch09_383-417.indd 386 Victoria: How is the budgeting going? Rick: Pretty well. I didn’t have any trouble putting together the budget for March. I 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. 19/11/10 7:40 PM Confirming Pages Flexible Budgets and Performance Analysis E X H I B I T 9–3 Comparison of Static Planning Budget to Actual Results Rick’s Hairstyling Comparison of Planning Budget to Actual Results For the Month Ended March 31 Client-visits. . . . . . . . . . . . . . . . . . . . . . Revenue . . . . . . . . . . . . . . . . . . . . . . . . Expenses: Wages and salaries . . . . . . . . . . . . . . Hairstyling supplies . . . . . . . . . . . . . . Client gratuities . . . . . . . . . . . . . . . . . Electricity . . . . . . . . . . . . . . . . . . . . . . Rent . . . . . . . . . . . . . . . . . . . . . . . . . . Liability insurance . . . . . . . . . . . . . . . Employee health insurance . . . . . . . Miscellaneous . . . . . . . . . . . . . . . . . . Total expense . . . . . . . . . . . . . . . . . . . . Net operating income . . . . . . . . . . . . . . 387 Planning Budget 1,000 Actual Results 1,100 Variances $180,000 $194,200 $14,200 F 102,000 1,500 4,100 1,600 28,500 2,800 21,300 1,400 163,200 $ 16,800 106,900 1,620 6,870 1,550 28,500 2,800 22,600 2,130 172,970 $ 21,230 4,900 U 120 U 2,770 U 50 F 0 0 1,300 U 730 U 9,770 U $ 4,430 F How a Flexible Budget Works A flexible budget approach recognizes that a budget can be adjusted to show what costs should be for the actual level of activity. To illustrate how flexible budgets work, Victoria prepared the report in Exhibit 9–4 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 activity for March. For example, using the cost formula $1,500 + $0.10q, the cost of electricity in March should have been $1,610 (= $1,500 + $0.10 × 1,100). We can see from the flexible budget that the net operating income in March should have been $30,510, but recall from Exhibit 9–2 that the net operating income was actually only $21,230. The results are not as good as we thought. Why? We will answer that question shortly. E X H I B I T 9–4 Flexible Budget Based on Actual Activity Rick’s Hairstyling Flexible Budget For the Month Ended March 31 gar11005_ch09_383-417.indd 387 Actual client-visits (q) . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100 Revenue ($180.00q) . . . . . . . . . . . . . . . . . . . . . . . . . . . Expenses: Wages and salaries ($65,000 + $37.00q) . . . . . . . . . Hairstyling supplies ($1.50q) . . . . . . . . . . . . . . . . . . . Client gratuities ($4.10q) . . . . . . . . . . . . . . . . . . . . . . Electricity ($1,500 + $0.10q) . . . . . . . . . . . . . . . . . . Rent ($28,500) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liability insurance ($2,800) . . . . . . . . . . . . . . . . . . . . Employee health insurance ($21,300) . . . . . . . . . . . . Miscellaneous ($1,200 + $0.20q) . . . . . . . . . . . . . . . Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . $198,000 105,700 1,650 4,510 1,610 28,500 2,800 21,300 1,420 167,490 $ 30,510 19/11/10 7:40 PM Confirming Pages 388 Chapter 9 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, given the amount of business 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, we will need to break down the variances shown in Exhibit 9–3 into two types of variances—activity variances and revenue and spending variances. We do that in the next two sections. Activity Variances LEARNING OBJECTIVE 2 Prepare a report showing activity variances. E X H I B I T 9–5 Activity Variances from Comparing the Planning Budget to the Flexible Budget Based on Actual Activity gar11005_ch09_383-417.indd 388 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 discrepancy was due to this single factor? The report in Exhibit 9–5 is designed to answer this question. In that report, the planning budget from the beginning of the period is compared to the flexible budget based on the actual level of activity for the period. The planning budget shows what should have happened at the budgeted level of activity whereas the flexible budget shows what should have happened at the actual level of activity. Therefore, the differences between the planning budget and the flexible budget show what should have happened solely because the actual level of activity differed from what had been expected. For example, the budget based on 1,000 client-visits shows revenue of $180,000 (= $180 per client-visit × 1,000 client-visits). The flexible budget based on 1,100 clientvisits shows revenue of $198,000 (= $180 per client-visit × 1,100 client-visits). Because the salon had 100 more client-visits than anticipated in the budget, actual revenue should Rick’s Hairstyling Activity Variances For the Month Ended March 31 Planning Budget Client-visits . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 Flexible Budget 1,100 Activity Variances 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 28,500 Rent ($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 $198,000 $18,000 F 105,700 1,650 4,510 1,610 28,500 2,800 21,300 1,420 167,490 $ 30,510 3,700 U 150 U 410 U 10 U 0 0 0 20 U 4,290 U $13,710 F 19/11/10 7:40 PM Confirming Pages Flexible Budgets and Performance Analysis 389 have been higher than budgeted revenue by $18,000 (= $198,000 − $180,000). This activity variance is shown on the report as $18,000 F (favorable). Similarly, the budget based on 1,000 client-visits shows electricity costs of $1,600 (= $1,500 + $0.10 per client-visit × 1,000 client-visits). The flexible budget based on 1,100 client-visits shows electricity costs of $1,610 (= $1,500 + $0.10 per client-visit × 1,100 client-visits). Because the salon had 100 more client-visits than anticipated in the budget, actual electricity costs should have been higher than budgeted costs by $10 (= $1,610 − $1,600). The activity 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. Costs should be $10 higher for electricity simply because business was up by 100 client-visits; therefore, is this variance really unfavorable if 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 in the level of activity between the planning budget from the beginning of the period and the actual level of activity, 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 important. 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 purely 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 In the last section we answered the question “What impact did the change in activity have on our revenues, costs, and profit?” In this section we will answer the question “How well did we control our revenues, our costs, and our profit?” Recall that the flexible budget based on the actual level of activity in Exhibit 9–4 shows what should have happened given the actual level of activity. If we compare this flexible budget to actual results, we compare what should have happened to what actually happened. This is done in Exhibit 9–6. gar11005_ch09_383-417.indd 389 LEARNING OBJECTIVE 3 Prepare a report showing revenue and spending variances. 19/11/10 7:40 PM Rev.Confirming Pages 390 Chapter 9 E X H I B I T 9–6 Revenue and Spending Variances from Comparing the Flexible Budget to the Actual Results Rick’s Hairstyling Revenue and Spending Variances For the Month Ended March 31 Flexible Budget Revenue and Actual Spending Results Variances Client-visits . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,100 1,100 Revenue ($180.00q) . . . . . . . . . . . . . . . . . . . . . Expenses: Wages and salaries ($65,000 + $37.00q) . . . Hairstyling supplies ($1.50q) . . . . . . . . . . . . . Client gratuities ($4.10q) . . . . . . . . . . . . . . . . Electricity ($1,500 + $0.10q) . . . . . . . . . . . . . Rent ($28,500) . . . . . . . . . . . . . . . . . . . . . . . . Liability insurance ($2,800) . . . . . . . . . . . . . . Employee health insurance ($21,300) . . . . . . Miscellaneous ($1,200 + $0.20q) . . . . . . . . . Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . Net operating income . . . . . . . . . . . . . . . . . . . . $198,000 $194,200 $3,800 U 105,700 1,650 4,510 1,610 28,500 2,800 21,300 1,420 167,490 $ 30,510 106,900 1,200 U 1,620 30 F 6,870 2,360 U 1,550 60 F 28,500 0 2,800 0 22,600 1,300 U 2,130 710 U 172,970 5,480 U $ 21,230 $9,280 U Focusing first on revenue, the flexible budget indicates that, given the actual level of activity, revenue should have been $198,000. However, actual revenue totaled $194,200. 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 what the total revenue should have been, given the actual level of activity for the period, and the actual total revenue. 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 activity? Basically, the IN BUSINESS STATE OF THE UNION SPEECH HURTS CORPORATE JET INDUSTRY In December 2008, Detroit auto executives flew private corporate jets to Washington D.C. to plead for billions of taxpayer dollars to save their companies. The public outcry was loud and clear: How could companies on the verge of bankruptcy afford to transport their executives in private corporate jets? One month later President Obama’s State of the Union speech included criticism of CEOs who “disappear on a private jet.” The impact of these events on the corporate jet manufacturing industry was swift and severe. Dassault Aviation had 27 more order cancellations than new orders in the first quarter of 2009. Cessna Aircraft had 92 first-quarter order cancellations and laid off 42% of its workforce. Approximately 3,100 jets flooded the resale market compared to 1,800 jets for resale in the first quarter of the prior year. The CEO of Cessna and the president of Gulfstream Aerospace went to the White House in May 2009 to seek an end to the rhetoric that was destroying their sales. These facts illustrate how an activity variance can be affected by uncontrollable events. The actual first-quarter sales at these companies were substantially lower than their budgeted sales due to reasons that they could not foresee or control. Source: Carol Matlack, “Public Flak Grounds Private Jets,” BusinessWeek, June 8, 2009, p. 13. gar11005_ch09_383-417.indd 390 23/11/10 10:01 AM Confirming Pages Flexible Budgets and Performance Analysis 391 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 flexible budget indicates that electricity costs should have been $1,610 for the 1,100 client-visits in March. However, the actual electricity cost was $1,550. 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. By definition, a spending variance is the difference between how much a cost should have been, given the actual level of activity, and the actual amount of the cost. If the actual cost is greater than what the cost should have been, the variance 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 unfavorable 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 delve into this topic in greater detail. Note from Exhibit 9–6 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 investigate further. Rick may directly control the client gratuities himself. If not, he may want to know who authorized the additional expenditures. Why were they so large? Was more given away than usual? If so, why? Were more expensive gratuities given to clients? If so, why? Note 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. A Performance Report Combining Activity and Revenue and Spending Variances Exhibit 9–7 displays a performance report that combines the activity variances (from Exhibit 9–5) with the revenue and spending variances (from Exhibit 9–6). The report brings together information from those two earlier exhibits in a way that makes it easier to interpret what happened during the period. The format of this report 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 activity variances appear between the planning budget amounts and the flexible budget amounts. In Exhibit 9–5, the activity variances appeared after the planning budget and the flexible 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 (1,000 clientvisits). 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 9–7 provides much more useful information to managers than the simple comparison of budgeted to actual results in Exhibit 9–3. In Exhibit 9–3, the effects of changes in activity were jumbled together with the effects of gar11005_ch09_383-417.indd 391 LEARNING OBJECTIVE 4 Prepare a performance report that combines activity variances and revenue and spending variances. 19/11/10 7:41 PM Confirming Pages 392 Chapter 9 E X H I B I T 9–7 Performance Report Combining Activity Variances with Revenue and Spending Variances Rick’s Hairstyling Flexible Budget Performance Report For the Month Ended March 31 Revenue and Spending Variances (3) – (2) Activity Variances (2) – (1) Client-visits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1) Planning Budget 1,000 (2) Flexible Budget 1,100 (3) Actual Results 1,100 Revenue ($180.00q) . . . . . . . . . . . . . . . . . . . . . . $180,000 $18,000 F $198,000 $3,800 U $194,200 Expenses: Wages and salaries ($65,000 + $37.00q) . . . . Hairstyling supplies ($1.50q) . . . . . . . . . . . . . . Client gratuities ($4.10q) . . . . . . . . . . . . . . . . . Electricity ($1,500 + $0.10q) . . . . . . . . . . . . . Rent ($28,500) . . . . . . . . . . . . . . . . . . . . . . . . Liability insurance ($2,800) . . . . . . . . . . . . . . . Empoloyee health insurance ($21,300) . . . . . Miscellaneous ($1,200 + $0.20q) . . . . . . . . . 102,000 1,500 4,100 1,600 28,500 2,800 21,300 1,400 3,700 U 150 U 410 U 10 U 0 0 0 20 U 105,700 1,650 4,510 1,610 28,500 2,800 21,300 1,420 1,200 U 30 F 2,360 U 60 F 0 0 1,300 U 710 U 106,900 1,620 6,870 1,550 28,500 2,800 22,600 2,130 Total expense . . . . . . . . . . . . . . . . . . . . . . . . . . . 163,200 4,290 U 167,490 5,480 U 172,970 Net operating income . . . . . . . . . . . . . . . . . . . . . $ 16,800 $13,710 F $ 30,510 $9,280 U $ 21,230 how well prices were controlled and operations were managed. The performance report in Exhibit 9–7 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. In the planning budget, this cost was $1,500, whereas the actual cost for the period was $1,620. In the comparison of the planning budget to actual results in Exhibit 9–3, this difference is shown as an unfavorable variance of $120. Exhibit 9–3 uses a static planning budget approach that compares actual costs at one level of activity to budgeted costs at a different level of activity. As we said before, this is like comparing apples to oranges. This variance is actually a mixture of two very different effects. This becomes clear in the performance report in Exhibit 9–7. The difference between the budgeted amount and the actual results is composed of two different variances—an unfavorable activity variance of $150 and a favorable spending variance of $30. 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 favorable spending variance occurred because less was spent on hairstyling supplies than one would have expected, given the actual level of activity for the month. The flexible budget performance report in Exhibit 9–7 provides a more valid assessment of performance than simply comparing static planning budget costs to actual 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 9–3). 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 discussion took place the next day at Rick’s salon. gar11005_ch09_383-417.indd 392 19/11/10 7:41 PM