Chapter 10 Flexible Expense Budget - Management … · 7/9/2014 · Introduction This chapter...

Chapter 10

Flexible Expense Budget

Omar Maguiña Rivero

Learning Objectives

After studying this chapter, the student will be able

to classify costs according to its nature and prepare

a variable budget for any given company.


Introduction

This chapter discusses the concept of flexible expense budget.

Flexible budget functions:

1. Provide expense plans for the tactical profit plan.

2. Provide expense plans adjusted to actual output, for comparison with actual expenses in periodic performance reports.


Concepts of Flexible Expense Budgets

All expenses are incurred because of:

a. The passage of time

b. Output or productive activity

c. A combination of time and output activity


• Application of the Concepts of Flexible Expense Budgets 1. Expenses must be identified as to their fixed and variable components when related to output activity.

2. Expense must be reasonably related to output activity.

3. Output activity must be reliably measurable.

4. Formulas for each expense must be for a specified time period and relevant range of output activity.

5. For planning and control, formulas must be developed for each responsibility center.


Relationship of Expenses to Output or Productivity Activity

As output or activity varies a responsibility center, what should be the behavior of each expense incurred in that center?

The primary objective of the flexible budget approach is to show how, and to what extent, each expense in a responsibility center is changed by the amount of work done in that center.


• Cost Classification

Because some expenses are part fixed and part

variable, expenses are classified into three

categories:

1. Fixed cost

2. Variable cost

3. Semi-variable costs


• Cost Classification

• Fixed Expenses Defined

• Fixed expenses are those that do not vary with output or productive activity.

• They remain constant in amount for a given short-term period within a relevant range of activity.

• Type I: Executive management decisions establish commitments to certain fixed expenses (depreciation, taxes, insurance, etc.)

• Type II: Set by management discretion on a short-term basis (salaries, advertising, expenditure and research).


Two Types of Fixed Expenses


• Characteristics of Fixed Expenses

1. Relationship to output activity

2. Relevant range

3. Time cost

4. Management regulated

5. Fixed in total but variable per unit

6. Practical application


• Variable Cost Defined

• Variable expenses vary in direct proportion to change in output or activity in a responsibility center.

• They are activity based because they are incurred as a direct result of output.

• A variable expense is necessarily zero at zero activity.

• Type I: Variable expenses that varies directly with volume from zero to full capacity activity.

• Type II: Variable expenses that varies with output within ranges of activity.


• Types of Variable Expenses


• Characteristics of Variable Expenses

1. Proportionally related to activity

2. Relevant range

3. Activity cost

4. Management regulated

5. Variable in total but fixed per unit

6. Practical considerations


• Semivariable Expenses Defined

• Semivariable expenses have some of the characteristics of both fixed and variable costs.

• The variability is caused by the combined effect of:

– Passage of time

– Activity or output

– Discretionary management decisions

• Type I: Fix component and a variable component.

• Type II: A step expense .

• Type III and IV: Curved expenses (concave and convex)


• Types of Semivariable Expenses

Relevant Range

• Selection of the Activity Base

• One activity base should be selected for each

responsibility center.

• Fix expenses are time related to a short

time span such a month.

• Variable expenses must be related to an

activity based in each responsibility center. Omar Maguiña Rivero

• Criteria for Selecting an Activity Base

1. Should measure fluctuations in the output that cause the expenses to vary.

2. Should be affected as little as possible by factors other than output.

3. Should be easily understood.

4. Should be reliably measurable and cost-effective.


• Identifying the Relevant Range of Activity

• The relevant range relate to a responsibility center.

• There are not separate relevant range for each expense in the center.

• The relevant range should approximate the monthly high and monthly low of output activity.

• The narrower the relevant range, the greater the reliability of the budget estimates.


Methods of Determining Cost Variability

• The classification of expenses by variability should begin with a careful study of each expense in the responsibility center under consideration.

• The purpose of the study is to identify those expenses that contain only “pure” fixed or variable components.

• When the fixed and variable expenses are separately identified, the remaining accounts can be viewed as semivariable.


• Methods of Determining Cost Variability (cont.)

• Semivariable expenses should be analyzed to determine their fixed and variable components.

• The analytical methods used for this purpose can be classified under three broad categories:

a. Direct estimate method

b. Budgeted high and low point method

c. Correlation method


• Direct Estimate Methods

A. Industrial Engineering Studies


• Direct Estimate Methods

B. Direct Analysis of Historical Data and Management Policies


Budgeted High and Low Point Method

At maximum level: 12,000 units $28,000

At minimum level: 9,000 units $22,000

Budgeted Activity

Expense Units

At maximum level: $28,000 12,000 units

At minimum level: $22,000 9,000 units

Difference $ 6,000 / 3,000 units = $2.00 variable rate per unit


Budgeted High and Low Point Method (cont.)

To compute the fixed component

Budgeted Activity

Expense Units Total Expense: $ 28,000 $ 22,000

Less variable component:

(12,000 x $2) $ 24,000 (9,000 x $2) $ 18,000

Difference – fixed

Component $ 4,000 $ 4,000


• Correlation Methods


• Correlation Methods (cont.)


Y = a + b x

Middle Term Exam Structure

• Week 04: Schedule 21


• Week 06: Schedule 24-25, 26, 27, 28-29


Chapter 10 Flexible Expense Budget - Management … · 7/9/2014 · Introduction This chapter...

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