A Linear Programming Framework for Flexible Budgeting and Its Application to Classroom Teaching

Abstract

Accounting educators and practitioners are well aware of the importance of increased competencies in analytical areas. In response to this need, authors of management accounting textbooks typically offer brief introductions to linear programming (LP), regression analysis, and decision theory. Most textbooks introduce LP in the context of optimal product-mix decisions. However, it is possible to incorporate LP into the discussion of other accounting topics, such as product costing and pricing, and financial and operational budgeting. (For a pioneering article on the subject of integrating activity-based costing and the theory of constraints, see Kee [1995], who applies integer programming to a numerical example in a fashion similar to what is done in this article.) The paper demonstrates a method of incorporating LP into flexible budgeting and variance analysis. By incorporating production and market constraints into budgeting and variance analysis, the proposed method resolves some of the weaknesses of traditional flexible budgeting and offers a framework for integration of marketing and operations factors into accounting procedures. More specifically, the paper offers a revised definition of the flexible budget and a new procedure for determining flexible budget direct cost variances, overhead cost variances, and revenue variances. Further, this paper introduces a method of incorporating variance analysis into the theory of constraints and offers alternative measures of controlling throughput and operating expenses to companies implementing it.