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Lecture

budgets.docx

3 Pages
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Department
Accounting
Course Code
ACC 410
Professor
Else Grech

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Description
Flexible Budgets A budget report is prepared to show how actual results compare to the budgeted numbers. It has columns for the actual and budgeted amounts and the differences, or variances, between these amounts. A variance may be favorable or unfavorable. On an income statement budget report, think of how the variance affects net income, and you will know if it is a favorable or unfavorable variance. If the actual results cause net income to be higher than budgeted net income (such as more revenues than budgeted or lower than budgeted costs), the variance is favorable. If actual net income is lower than planned (lower revenues than planned and/or higher costs than planned), the variance is unfavorable. So higher revenues cause a favorable variance, while higher costs and expenses cause an unfavorable variance. Although the budget report shows variances, it does not explain the reasons for the variance. The budget report is used by management to identify the sales or expenses whose amounts are not what were expected so management can find out why the variances occurred. By understanding the variances, management can decide whether any action is needed. Favorable variances are usually positive amounts, and unfavorable variances are usually negative amounts. Some textbooks show budget reports with “F” for favorable and “U” for unfavorable after the variances to further highlight the type of variance being reported. Actual net income is unfavorable compared to the budget. What is not known from looking at it is why the variances occurred. For example, were more units sold? Was the selling price different than expected? Were costs higher? Or was it all of the above? These are the kinds of questions management needs answers to. In fact, an analysis of this budget report shows sales were actually 17,500 pickup trucks instead of the 17,000 pickup trucks planned; the average selling price was $14.80 per truck instead of the expected $15.00 per truck; and the cost per truck was $11.25 as budgeted. Static budgets are geared to one level of activity. They work well for evaluating performance when the planned level of activity is the same as the actual level of activity, or when the budget report is prepared for fixed costs. However, if actual performance in a given month or quarter is different from the planned amount, it is difficult to determine whether costs were controlled. Flexible budgets are one way companies deal with different levels of activity. Aflexible budget provides budgeted data for different levels of activity. Another way of thinking of a flexible budget is a number of static budgets. For example, a restaurant may serve 100, 150, or 300 customers an evening. If a budget is prepared assuming 100 customers will be served, how will the managers be evaluated if 300 customers are served? Similar scenarios exist with merchandising and manufacturing companies. To effectively evaluate the restaurant's performance in controlling costs, management must use a budget prepared for the actual level of activity. This does not mean management ignores differences in sales level, or customers eating in a restaurant, because those differences and the management actions that caused them need to be evaluated, too. The budget report for the Pickup Trucks Company is a static budget because the budgeted level of units is the same number of units as the original budget. It was not changed for the higher sales level. If it had, the budget report would be as follows: The flexible budg
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