9-1

Chapter 9 Flexible Budgets and Performance Analysis

Solutions to Questions

9-1 The planning budget is prepared for the planned level of activity. It is static because it is not adjusted even if the level of activity subsequently changes.

9-2 A flexible budget can be adjusted to reflect any level of activity—including the actual level of activity. By contrast, a static planning budget is prepared for a single level of activity and is not subsequently adjusted.

9-3 Actual results can differ from the budget for many reasons. Very broadly speaking, the differences are usually due to a change in the level of activity, changes in prices, and changes in how effectively resources are managed.

9-4 As noted in 9-3 above, a difference between the budget and actual results can be due to many factors. Most importantly, the level of activity can have a very big impact on costs. From a manager’s perspective, a variance that is due to a change in activity is very different from a variance that is due to changes in prices and changes in how effectively resources are managed. A variance of the first kind requires very different actions from a variance of the second kind. Consequently, these two kinds of variances should be clearly separated from each other. When the budget is directly compared to the actual results, these two kinds of variances are lumped together.

9-5 An activity variance is the difference between a revenue or cost item in the static planning budget and the same item in the flexible budget. An activity variance is due solely to the difference in the level of activity assumed in the planning budget and the actual level of activity used in the flexible budget. Caution should be exercised in interpreting an activity variance. The “favorable” and “unfavorable” labels are perhaps misleading for activity variances that involve costs. A “favorable” activity variance for a cost occurs because the cost has some variable component and the actual level of activity is less than the planned level of activity. An “unfavorable” activity variance for a cost occurs because the cost has some variable component and the actual level of activity is greater than the planned level of activity.

9-6 A revenue variance is the difference between how much the revenue should have been, given the actual level of activity, and the actual revenue for the period. A revenue variance is easy to interpret. A favorable revenue variance occurs because the revenue is greater than expected for the actual level of activity. An unfavorable revenue variance occurs because the revenue is less than expected for the actual level of activity.

9-7 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. Like the revenue variance, the interpretation of a spending variance is straight-forward. A favorable spending variance occurs because the cost is lower than expected for the actual level of activity. An unfavorable spending variance occurs because the cost is higher than expected for the actual level of activity.

9-2

9-8 In a flexible budget performance report, the static planning budget is not directly compared to actual results. The flexible budget is interposed between the static planning budget and actual results. The differences between the static planning budget and the flexible budget are activity variances. The differences between the flexible budget and the actual results are the revenue and spending variances. The flexible budget performance report cleanly separates the differences between the static planning budget and the actual results that are due to changes in activity (the activity variances) from the differences that are due to changes in prices and the effectiveness with which resources are managed (the revenue and spending variances).

9-9 The only difference between a flexible budget based on a single cost driver and one based on two cost drivers is the cost formulas. When two cost drivers exist, some costs may be a function of the first cost driver, some costs may be a function of the second cost driver, and some costs may be a function of both cost drivers.

9-10 When the static planning budget is directly compared to actual results, it is implicitly assumed that costs (and revenues) should not change with a change in the level of activity. This assumption is valid only for fixed costs. However, it is unlikely that all costs are fixed. Some are likely to be variable or mixed.

9-11 When the static planning budget is adjusted proportionately for a change in activity and then directly compared to actual results, it is implicitly assumed that costs should change in proportion to a change in the level of activity. This assumption is valid only for strictly variable costs. However, it is unlikely that all costs are strictly variable. Some are likely to be fixed or mixed.

Exercise 9-1 (10 minutes)

Gator Divers Flexible Budget

For the Month Ended March 31

Actual diving-hours ....................................... 190

Revenue ($380.00q) ..................................... $72,200 Expenses:

Wages and salaries ($12,000 + $130.00q) ... 36,700 Supplies ($5.00q) ....................................... 950 Equipment rental ($2,500 + $26.00q) ......... 7,440 Insurance ($4,200) ..................................... 4,200 Miscellaneous ($540 + $1.50q) ................... 825

Total expense ............................................... 50,115 Net operating income .................................... $22,085

9-3

Exercise 9-2 (10 minutes)

1. The activity variances are shown below:

Air Meals Activity Variances

For the Month Ended December 31

Planning Budget

Flexible Budget

Activity Variances

Meals .......................................... 20,000 21,000

Revenue ($3.80q) ........................ $76,000 $79,800 $3,800 F Expenses:

Raw materials ($2.30q) ............. 46,000 48,300 2,300 U Wages and salaries

($6,400 + $0.25q) .................. 11,400 11,650 250 U Utilities ($2,100 + $0.05q) ........ 3,100 3,150 50 U Facility rent ($3,800) ................. 3,800 3,800 0 Insurance ($2,600) ................... 2,600 2,600 0 Miscellaneous ($700 + $0.10q) .. 2,700 2,800 100 U

Total expense .............................. 69,600 72,300 2,700 U Net operating income .................. $ 6,400 $ 7,500 $1,100 F

2. Management should note that the level of activity was above what had

been planned for the month. This led to an expected increase in profits of $1,100. However, the individual items on the report should not receive much management attention. The favorable variance for revenue and the unfavorable variances for expenses are entirely caused by the increase in activity.

9-4

Exercise 9-3 (15 minutes)

Olympia Bivalve Revenue and Spending Variances

For the Month Ended July 31

Flexible Budget

Actual Results

Revenue and

Spending Variances

Pounds ....................................... 7,000 7,000

Revenue ($4.20q) ........................ $29,400 $28,600 $ 800 U Expenses:

Packing supplies ($0.40q) .......... 2,800 2,970 170 U Oyster bed maintenance

($3,600) ................................ 3,600 3,460 140 F

Wages and salaries ($2,540 + $0.50q) ..................

6,040 6,450 410 U

Shipping ($0.75q) ..................... 5,250 4,980 270 F Utilities ($1,260) ....................... 1,260 1,070 190 F Other ($510 + $0.05q) .............. 860 1,480 620 U

Total expense .............................. 19,810 20,410 600 U Net operating income .................. $ 9,590 $ 8,190 $1,400 U

Exercise 9-11 (20 minutes)

Auto Lavage Activity Variances

For the Month Ended October 31

Planning Budget

Flexible Budget

Activity Variances

Cars washed (q) .............................. 8,000 8,100

Revenue ($5.90q) ............................ $47,200 $47,790 $590 F Expenses:

Cleaning supplies ($0.70q) ............. 5,600 5,670 70 U Electricity ($1,400 + $0.10q) ......... 2,200 2,210 10 U Maintenance ($0.30q).................... 2,400 2,430 30 U Wages and salaries

($4,700 + $0.40q) ...................... 7,900 7,940 40 U Depreciation ($8,300) .................... 8,300 8,300 0

9-5

Rent ($2,100) ............................... 2,100 2,100 0 Administrative expenses

($1,800 + $0.05q) ...................... 2,200 2,205 5 U Total expense .................................. 30,700 30,855 155 U Net operating income ....................... $16,500 $16,935 $435 F

Exercise 9-14 (10 minutes)

Pierr Manufacturing Inc. Planning Budget for Manufacturing Costs

For the Month Ended July 31

Budgeted machine-hours (q) ........ 4,000

Direct materials ($5.70q) .............. $22,800 Direct labor ($42,800) .................. 42,800 Supplies ($0.20q) ........................ 800 Utilities ($1,600 + $0.15q) ........... 2,200 Depreciation ($14,900) ................ 14,900 Insurance ($11,400) .................... 11,400 Total manufacturing cost .............. $94,900

9-6

Problem 9-20 (30 minutes)

1. The activity variances are shown below:

SecuriDoor Corporation Activity Variances

For the Month Ended April 30

Planning Budget

Flexible Budget

Activity Variances

Machine-hours (q) .......................... 20,000 18,000

Utilities ($16,500 + $0.15q) ............ $ 19,500 $ 19,200 $ 300 F Maintenance ($38,600 + $1.80q) .... 74,600 71,000 3,600 F Supplies ($0.50q) ........................... 10,000 9,000 1,000 F Indirect labor ($94,300 + $1.20q) ... 118,300 115,900 2,400 F Depreciation ($68,000) ................... 68,000 68,000 0 Total .............................................. $290,400 $283,100 $7,300 F

The activity variances are all favorable because the actual activity was

less than the planned activity and therefore all of the variable costs should be lower than planned in the original budget.

9-7

Problem 9-20 (continued)

2. The spending variances are computed below:

SecuriDoor Corporation Spending Variances

For the Month Ended April 30

Flexible Budget

Actual Results

Spending Variances

Machine-hours (q) .......................... 18,000 18,000

Utilities ($16,500 + $0.15q) ............ $ 19,200 $ 21,300 $2,100 U Maintenance ($38,600 + $1.80q) .... 71,000 68,400 2,600 F Supplies ($0.50q) ........................... 9,000 9,800 800 U Indirect labor ($94,300 + $1.20q) ... 115,900 119,200 3,300 U Depreciation ($68,000) ................... 68,000 69,700 1,700 U Total .............................................. $283,100 $288,400 $5,300 U

An unfavorable spending variance means that the actual cost was

greater than what the cost should have been for the actual level of activity. A favorable spending variance means that the actual cost was less than what the cost should have been for the actual level of activity. While this makes intuitive sense, sometimes a favorable variance may not be good. For example, the rather large favorable variance for maintenance might have resulted from skimping on maintenance. Since these variances are all fairly large, they should all probably be investigated.

9-8

Problem 9-22 (30 minutes) 1. Performance should be evaluated using a flexible budget performance

report. In this case, the report will not include revenues.

KGV Blood Bank Flexible Budget Performance Report For the Month Ended September 30

Planning Budget

Activity Variances

Flexible Budget

Spending Variances

Actual Results

Liters of blood collected (q) ................ 600 780 780

Medical supplies ($11.85q) ................. $ 7,110 $2,133 U $ 9,243 $ 9 U $ 9,252 Lab tests ($14.35q) ............................ 8,610 2,583 U 11,193 411 F 10,782 Equipment depreciation ($1,900) ........ 1,900 0 1,900 200 U 2,100 Rent ($1,500) .................................... 1,500 0 1,500 0 1,500 Utilities ($300) ................................... 300 0 300 24 U 324 Administration ($13,200 + $1.85q)...... 14,310 333 U 14,643 68 F 14,575 Total expense .................................... $33,730 $5,049 U $38,779 $246 F $38,533

2. The overall unfavorable activity variance of $5,049 was caused by the

30% increase in activity. There is no reason to investigate this particular variance. The overall spending variance is $246 F, which would seem to indicate that costs were well-controlled. However, the favorable $411 spending variance for lab tests is curious. The fact that this variance is favorable indicates that less was spent on lab tests than should have been spent according to the cost formula. Why? Did the blood bank get a substantial discount on the lab tests? Did the blood bank skimp on lab tests? If so, was this wise? In addition, the unfavorable spending variance of $200 for equipment depreciation requires some explanation. Was more equipment obtained to collect the additional blood?