 Hello and welcome to this session in which we will discuss flexible budgeting or flexible budget and specifically we're going to be learning about the activity variances or something called sales volume variances and revenue slash spending variances. Now if we are discussing flexible budgeting well we need to know what is flexible and what is budgeting hopefully we know what budgeting is we learn about budgeting in a prior session basically a budget or a budgeting is planning a budget to do what to run the company and usually the budget is prepared for a single planned level of activity. So it's a static or one budget so simply put we assume the activity is we're going to be selling 100 units or we're going to be selling 5000 units so one single level of activity. Now budgets are helpful and we talked about why budgets are important because it helps you plan but what happened if the level of activity differ so you plan to sell 100 units that's your budget but you might have sold more you might have sold 120 or you might have sold 80 what do you have to do if your level of activity differ this is where the flexible budget comes into place the flexible budget prepare the budget using various level of activities within the relevant range and the relevant range of the fixed cost or our capacity so rather than preparing a budget with 100 unit we can prepare with 120, 140, 160, 80, 60 or any number of units sold to determine what would happen to our financial status if the level of activity changes and this is going to show the cost and revenue that should have been incurred at the actual level of activity so the flexible budget we're going to prepare a planning budget then we can prepare flexible budget so if the planning budget differ we can compare that to the flexible budget to show us what we should have and cost and revenue given that new level of activity it enables to compare apples to apples so if you prepare a budget with 500 units then you sold 600 units well you cannot compare these two because they differ therefore you have to flex this budget to make it 600 unit then you can compare apples to apples and obviously we are going to see that in an example it helps improve performance and help control cost and that's the whole purpose of budgeting in the first place is help control control means what control means know what's happening plan ahead so we don't overspend we don't understand money the best way to illustrate the concept is to work with an example using actual numbers so we have Adam loan service company provide long care for senior citizen communities where all loans are approximately the same size at the end of May Adam prepared his June budget based on 750 loans so this is what we expect to do in June and this is basically the size of the loan and maybe he takes care of the flowers as well on average Adam charges $80 per loan and that's a variable in a sense that if you have more loans you will have more revenue if you have less you will have less revenue but we are planning to take care of 750 the wages that Adam pays are mixed Adam pays $6000 in fixed wages then he has a few individuals that work on an hourly basis and it costs them $30 per loan so it's a mixed cost part fixed and part variable we have a mixed cost here the wages the gasoline is variable and it's $9 per loan this is a variable the cost for the equipment maintenance is variable $3 per loan and the remainder of his expenses are fixed expenses so let's take a look first at a static or a planned budget for 750 units and this is what the budget what looks like this is the number of units this is a planning budget the revenue is $80 $750 $80 will give us $60,000 again the revenue would varies with the number of units wages are $6000 plus $30 times the number of units which will give us wages of $28,500 again this cost is mixed the reason I'm going whether this cost is mixed fixed or variable that's very important to understand gasoline and supplies it's $9 per loan nine times $9 times $750 will give us $6750 equipment $3 per loan $3 times $750 will give us $2250 office and shop supplies are $1,000 this is fixed it means it does not change it does not vary office and shop rent $2,000 this is fixed as well equipment depreciation should be fixed and insurance is fixed and the remainder of the costs are fixed based on our budget total expenses are $45 total revenue is $60 we expect operating income or net income to be $15,000 for the month of June so this is the budget knowing the various costs that we have now what we're going to do we're going to wait for the month of June and we're going to see what happened then make comparison and study the planning budget versus what actually happened to learn what happened this is the purpose of variances it's a form of a control so we know why did we did not make enough profit or that why did we incur more or less expenses it tells us about our business but before we look at the example we need to take a look at farhatlectures.com most likely you are a student or a CPA candidate and if that's what you are looking for flexible budgeting learning about this topic go to farhatlectures.com where I do have additional resources multiple choice through false exercises that's going to help you do better on your CPA exam as well as accounting courses if you have not connected with me on LinkedIn please do so like this recording share it with other connect with me on Instagram Facebook Twitter and Reddit now for the month of June these are the actual results okay we planned and these are these are the actual results the first thing I want you to notice is actually we the number of loans we service is seven rather than 750 we service 825 you know few other senior senior citizen communities ask us to do it so we added 75 units okay that's fine our total revenue actual total revenue was 64500 and those are the actual actual actual means this is what actually happens and what actually happens we end up earning a profit of 15725 our based on the static budget the profit was if you remember was 15000 so the first thing we are going to do is we are going to compare the planning budget to the actual results okay this is the planning or this is the budget and this is the actual result now we need to interpret this well revenue was planning budget was 60 our revenue was 64500 well it's we generated 4500 of revenues we consider this as favorable okay there's no pluses no minuses in this language it's either favorable or unfavorable how do I know it's favorable if I generate more revenues it's a favorable variance if I if I incur less expenses it's favorable if I incur more expenses it's unfavorable let's take a look at the wages and salaries we budgeted 28500 we incurred 31250 we are 2750 unfavorable now some students they get confused should I deduct actual minus planning or planning minus budget well guess what you need to understand that the actual was greater than the planning there's no pluses or minuses anyway you look at it just if the actual is more than the budget and it's for expenses it's unfavorable it's a you now you want this to be true for revenue more revenues actual than planning like for revenues here to be favorable so you have to be careful there's not plus and not minus this is not what we are looking at we are looking at whether it's a favorable or unfavorable again gasoline supplies we budgeted 6750 the actual results were 7700 it's unfavorable equipment maintenance we budgeted 2250 we incurred 2075 this is favorable because the actual was less than the planning same thing for office and shop supplies it was favorable these two are fixed they're not supposed to change and they did not change insurance supposed to be fixed also 2000 for some reason they increase our insurance by 10% it was unfavorable now what we do is we add up all the unfavorable and they add up to 3775 which is basically net them out and the net is 3775 4500 favorable in revenue 3777 3775 and expenses unfavorable the net is 725 that's fine we looked at the net it's favorable of 725 but this analysis doesn't help us at all what do I mean by this well you are comparing actual to the planning however the level of activity is different here your planning is based on 750 your actual your actual results are based on 8 I'm sorry 825 not 828 825 so what happened is you cannot compare apples to oranges so what do we need to do let's flex the budget so we're going to prepare a flex budget we're going to see what that what that is then do the comparison to learn more about the business now nothing wrong with this except it doesn't tell us much why you're going to see why once we look at the flexible budget so how to flex the budget well variable cost and variable revenue will change in proportion to the activities and total fixed cost you know remain the same assuming we are working within the relevant range so now what we're going to do we're going to prepare a flexible budget and our flexible budget it has to be based on the actual number of unit which is 825 now we take 825 times 80 will give us 66,000 so what is this 66,000 the 66,000 tells us this is how much revenue we should have based on our planning budget in this level of activity the planning budget is $80 and we we service 825 units therefore our total revenue should be 66,000 same thing with wages and salaries 6,000 plus $30 times 825 it should be 30,750 and the remainder is the same except that the fixed cost will stay the same fixed cost will stay the same and variable cost will change based on the flexible budget our profit should have been 17,850 so now we looked at the flexible budget now it makes more sense to compare the flexible budget to what actually happened don't you think because now we have the same numbers we're going to look at that in a moment okay so this is what should have been according to the budget that figure this is the flexible budget now the first variance we are going to compute is called activity variance or sales volume variance sales volume or activity variance how do we compute this variance so here's the formula you look at your planning budget which is planning budget of revenues and expenses and compare it to the flexible budget of revenues and expenses so this is basically the first thing is the activity or sales variance so let's take a look at it just simply put the flexible budget versus the planning budget so those are changes okay so the difference here is solely do we are we are computing the difference solely do to the changes in quantity in sales volume so notice the planning budget is 750 the flexible budget is 825 so by comparing those two first we're going to know do to volume what are the differences how do we look at the differences well activity variance if we look at the difference is 6000 favorable for sales simply put because we perform more we we we service more units more lawns 75 more well our revenue should have been $6000 more wages and salaries obviously all the expenses the variable should be unfavorable why because if you perform more generally speaking if you perform more and your expense is variable you should have more expenses so notice they are all unfavorable and this should make sense the fixed they should stay the same when we are performing this computation overall from the volume activity we can see that expenses are unfavorable which they should be unfavorable and when we net the favorable of revenues due to the quantity due to the increase in sales volume and the expenses overall we have a favorable volume variance or sales volume or activity variance of eight thousand five eight two thousand eight hundred and fifty again this variance has to do with the volume this is why it's called the activity or sales volume or sales activity okay so just do two changes and notice to remember this look do we have we have a different number of units 750 versus 825 so the change has to do with activity alone now we could also compute revenue and spending variance now the revenues and spending variance this is where we are really compute computing the analysis apples to apples we're going to look at actual revenue which was for 850 units compared to the flexible budget revenue which is 850 and the difference between them is called revenue variance we're going to do the same thing with the expenses called them spending variances we're going to look at the actual cost which is 850 versus the flexible budget of 850 and let's take a look at them and see how much we can learn about those now 825 825 actual results flexible budget revenue the actual revenue was sixty six thousand five hundred the flexible revenue based on this activity should have been sixty six thousand well guess what we really did not do a good job our revenue was unfavorable our revenue was unfavorable why could be many reasons but could be those 75 new loans that we got we charge them less than $80 maybe we charge some of them 70 some of them 65 so as a result our revenue end up to be our revenue end up to be unfavorable it should have been sixty six thousand if we charge everyone $80 it was 66 it could be we wanted to earn the goodwill earn their business that's why we lower the price it could be I'm not sure but we have to look at why maybe those new loans we shouldn't have service them because they're gonna you know take time from us and we can do something else and get loans that could charge us $80 I'm not sure but something we need to look into why don't you charge $80 okay so notice from a volume yes you did more work but you did not charge them $80 more work yes more quantity is it the same price no so you have to make a decision about what you want to do next month wages and salaries the actual was $31,250 the flexible should have been $30,750 it should have cost you based on our formula $30,750 if you service $825 which is $6000 plus $825 times $30 which is the formula here it costs us $31,250 somehow we spent an additional $500 why maybe we had to hire one or two employees to help extra and we had to pay them $500 maybe those 75 lawns we did not budget for them and now they came we had to hire more people or pay overtime we need to find out but it cost us $500 more gasoline based on our gasoline it should be $7,425 it cost us $7,800 again unfavorable well what could be the case here well gas prices went up there's nothing we can do we estimated to be $9 for each lawn gas prices went up and this is happening these days so you have no control over this equipment maintenance based on our formula $3 per lawn it should be $2,475 we only spent $2,075 well at face value this look favorable because we did not spend as much as we should have given the number of lawns we serviced however we could have also deferred the equipment maintenance we did not do any maintenance which is bad because this is going to increase the repair next month but we're not sure but we need to know why we did more work and the maintenance cost is lower because usually the maintenance cost the more work you do the more you have to maintain those equipments office and shop utilities we budgeted $1,000 and we only incur actual resorts with $950 based on $825 this is favorable but we need to know why it's a small amount office rent office and shop rent was the same depreciation was the same insurance was unfavorable $200 our insurance went up by 10% $200 just an increase in the premium next month we start to budget $2,200 but for this month it's unfavorable now we compute we take all the cost and it was total expenses $625 unfavorable and the revenue variance was unfavorable so the spending and the revenue was unfavorable the total unfavorable is $2,150 but this unfavorable is based on now comparing apples to apples $825 $825 unit versus $825 unit so this is revenue this is how we compute the revenue and the spending variance to compute them you have to have the same number of unit when you compute the activity variance well the activity variance is different you have to have them different because based on the activity sales value you're not done yet the best ways to put them together side by side this is the actual results these are the planning results this is what we did in the planning this is the budget this is the budget this is what we did first then we got the results too then we prepared a flexible budget the difference between the flexible budget and the planning budget notice $825 versus $750 is what we called activity or sales volume and notice it was favorable it should be favorable because we did more work but it wasn't as favorable as we thought but it was it was favorable we did more work from the activity variance perspective when you look from the when we compare actual results the flexible budget when we compare those two which is $825 and $825 it was unfavorable $2125 now obviously you can net them out and I believe the difference is what you saw earlier $750 I will go back and show you the difference $2850 minus $2125 and the difference is actually $725 let's do it again $2850 minus $2125 it's $725 the difference is favorable of $725 now we know it's favorable overall but from an activity variance just because we did more work we would not do a good job controlling cost and generating revenue and where did we see the $725 again let me go back and show you the first comparison we did you remember $725 but now we understand why it was $725 I would not be very happy with this result if I'm in charge of this company if this is my company I'm not happy with the results I did more work but I did not make the profit that I should have made I only made additional profit of $725 and I did more work okay so notice here I mean another way to look at it is basically sales went up by 10% sales went up we went from it should have went up by 10% we should go from 60 to 66000 well the profit did not go up by that much so I'm not happy with these results nevertheless I learned again it could be because we it could be because we took those additional jobs just to kind of gain their maybe we give them a discount the first month if that's the case that's fine but this is what budgeting is all about tell me what's going to happen what should you do now go to far hat lectures and work MCQs true false invest in yourself you need to learn this good luck study hard and of course stay safe