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CHAPTER 7
FLEXIBLE BUDGETS, DIRECT-COST VARIANCES,
AND MANAGEMENT CONTROL
7-1 What is the relationship between management by exception and variance analysis?
Management by exception is the practice of concentrating on areas not operating as expected and
7-2 What are two possible sources of information a company might use to compute the bud-
geted amount in variance analysis?
7-3 Distinguish between a favorable variance and an unfavorable variance.
7-4 What is the key difference between a static budget and a flexible budget?
7-5 Why might managers find a flexible-budget analysis more informative than a static-bud-
get analysis?
7-6 Describe the steps in developing a flexible budget.
The steps in developing a flexible budget are:
Step 1: Identify the actual quantity of output.
7-7 List four reasons for using standard costs.
Four reasons for using standard costs are:
(i) cost management,
7-8 How might a manager gain insight into the causes of a flexible-budget variance for direct
materials?
A manager should subdivide the flexible-budget variance for direct materials into a price
7-9 List three causes of a favorable direct materials price variance.
Possible causes of a favorable direct materials price variance are:
purchasing officer negotiated more skillfully than was planned in the budget,
purchasing manager bought in larger lot sizes than budgeted, thus obtaining quantity
discounts,
7-10 Describe three reasons for an unfavorable direct manufacturing labor efficiency variance.
Some possible reasons for an unfavorable direct manufacturing labor efficiency variance are the
7-11 How does variance analysis help in continuous improvement?
Variance analysis, by providing information about actual performance relative to standards, can
form the basis of continuous operational improvement. The underlying causes of unfavorable
7-12 Why might an analyst examining variances in the production area look beyond that busi-
ness function for explanations of those variances?
An individual business function, such as production, is interdependent with other business
functions. Factors outside of production can explain why variances arise in the production area.
For example:
poor design of products or processes can lead to a sizable number of defects,
7-13 Comment on the following statement made by a plant manager: “Meetings with my plant
accountant are frustrating. All he wants to do is pin the blame on someone for the many vari-
ances he reports.”
7-14 When inputs are substitutable, how can the direct materials efficiency variance be decom-
posed further to obtain useful information?
7-15 “Benchmarking against other companies enables a company to identify the lowest-cost
producer. This amount should become the performance measure for next year.” Do you agree?
Evidence on the costs of other companies is one input managers can use in setting the
performance measure for next year. However, caution should be taken before choosing such an
7-16 Metal Shelf Company’s standard cost for raw materials is $4.00 per pound and it is ex-
pected that each metal shelf uses two pounds of material. During October Year 2, 25,000 pounds
of materials are purchased from a new supplier for $97,000 and 13,000 shelves are produced us-
ing 27,000 pounds of materials. Which statement is a possible explanation concerning the direct
materials variances?
a. The production department had to use more materials since the quality of the materials was
inferior.
b. The purchasing manager paid more than expected for materials.
c. Production workers were more efficient than anticipated.
d. The overall materials variance is positive; no further analysis is necessary.
SOLUTION
Choice "a" is correct. The materials price variance is $3,000 favorable since 25,000 pounds of
Choice "b" is incorrect. The purchasing manager paid less than expected for materials. The
Choice "c" is incorrect. Production workers used more materials than expected. The materials
Choice "d" is incorrect. The overall material variance is unfavorable. Even if the overall variance
7-17 All of the following statements regarding standards are accurate except:
a. Standards allow management to budget at a per-unit level.
b. Ideal standards account for a minimal amount of normal spoilage.
c. Participative standards usually take longer to implement than authoritative standards.
d. Currently attainable standards take into account the level of training available to employees.
SOLUTION
Choice "b" is correct. Ideal standards do not make any provisions for normal spoilage or
Choice "a" is incorrect. Standards are thought of as per unit budgets.
7-18 Amalgamated Manipulation Manufacturing’s (AMM) standards anticipate that there will
be 3 pounds of raw material used for every unit of finished goods produced. AMM began the
month of May with 5,000 pounds of raw material, purchased 15,000 pounds for $19,500 and
ended the month with 4,000 pounds on hand. The company produced 5,000 units of finished
goods. The company estimates standard costs at $1.50 per pound. The materials price and effi-
ciency variances for the month of May were:
Price Variance Efficiency Variance
1. $3,000 U $1,500 F
2. $3,000 F $ 0
3. $3,000 F $1,500 U
4. $3,200 F $1,500 U
SOLUTION
Choice "3" is correct.
Efficiency variance = Standard Price x (Standard Quantity Allowed – Actual Quantity Used)
Choice "4" is incorrect. Computation inappropriately uses the quantity used in the price variance.
7-19 Atlantic Company has a manufacturing facility in Brooklyn that manufactures robotic
equipment for the auto industry. For Year 1, Atlantic collected the following information from its
main production line:
Actual quantity purchased 200 units
Atlantic isolates price variances at the time of purchase. What is the materials price variance for
Year 1?
1. $400 favorable.
2. $400 unfavorable.
3. $220 favorable.
4. $220 unfavorable.
SOLUTION
Choice "1" is correct.
7-20 Basix Inc. calculates direct manufacturing labor variances and has the following informa-
tion:
Actual hours worked: 200
Standard hours: 250
Actual rate per hour: $12
Standard rate per hour: $10
Given the information above, which of the following is correct regarding direct manufacturing labor
variances?
a. The price and efficiency variances are favorable.
b. The price and efficiency variances are unfavorable.
c. The price variance is favorable, while the efficiency variance is unfavorable.
d. The price variance is unfavorable, while the efficiency variance is favorable.
SOLUTION
Choice "d" is correct. The direct labor variance is an expense variance. Therefore, when the
actual hours worked are less (greater) than the standard hours worked, this is favorable
(unfavorable). Also, when the actual rate per hour is less (greater) than the standard hours
worked, this is favorable (unfavorable).
Choice "a" is incorrect. The efficiency variance is favorable, but because the actual rate per hour
is greater than the standard rate, the price variance is unfavorable.
Choice "b" is incorrect. The price variance is unfavorable, but the efficiency variance is
favorable because fewer hours were worked than budgeted.
7-21 Flexible budget. Sweeney Enterprises manufactures tires for the Formula I motor racing
circuit. For August 2017, it budgeted to manufacture and sell 3,600 tires at a variable cost of $71
per tire and total fixed costs of $55,000. The budgeted selling price was $114 per tire. Actual re-
sults in August 2017 were 3,500 tires manufactured and sold at a selling price of $116 per tire.
The actual total variable costs were $280,000, and the actual total fixed costs were $51,000.
Required:
1. Prepare a performance report (akin to Exhibit 7-2, page 254) that uses a flexible budget and a
static budget.
2. Comment on the results in requirement 1.
SOLUTION
(20–30 min.) Flexible budget.
Variance Analysis for Sweeney Enterprises for August 2017
Actual
Results
Flexible-Budg
et Variances
Flexible
Budget
Sales-Volume
Variances
Static
Budget
(1) (2) = (1) – (3) (3) (4) = (3) – (5) (5)
Units (tires) sold 3 ,500g 0 3,500 100 U 3,600g
Revenues $406,000a$ 7,000 F $399,000b$11,400 U $410,400c
Variable costs 280 ,000d 31,500 U 248,500e 7,100 F 255,600f
Contribution margin 126,000 24,500 U 150,500 4,300 U 154,800
Fixed costs 51 ,000g 4,000 F 55,000g 0 55,000g
Operating income $ 75 ,000 $20,500 U $ 95,500 $ 4,300 U $ 99,800
2. The key information items are:
Actual Budgeted
The total static-budget variance in operating income is $24,800 U. There is both an unfavorable
total flexible-budget variance ($20,500) and an unfavorable sales-volume variance ($4,300).
7-22 Flexible budget. Bryant Company’s budgeted prices for direct materials, direct manufac-
turing labor, and direct marketing (distribution) labor per attaché case are $43, $6, and $13, re-
spectively. The president is pleased with the following performance report:
Actual Costs Static Budget Variance
Direct materials $438,000 $473,000 $35,000 F
Direct manufacturing labor 63,600 66,000 2,400 F
Direct marketing (distribution)
labor
133,500 143,000 9,500 F
Required:
Actual output was 10,000 attaché cases. Assume all three direct-cost items shown are variable
costs.
Is the president’s pleasure justified? Prepare a revised performance report that uses a flexible
budget and a static budget.
SOLUTION
(15 min.) Flexible budget.
The existing performance report is a Level 1 analysis, based on a static budget. It makes no
adjustment for changes in output levels. The budgeted output level is 11,000 units––direct
materials of $473,000 in the static budget ÷ budgeted direct materials cost per attaché case of
$43.
Variance Analysis for Bryant Company
Actual
Results
(1)
Flexible-
Budget
Variances
(2) = (1) – (3)
Flexible
Budget
(3)
Sales-
Volume
Variances
(4) = (3) – (5)
Static
Budget
(5)
Output units
10 ,000
0
10 ,000
1 ,000 U
11 ,000
The Level 1 analysis shows total direct costs have a $46,900 favorable variance.
However, the Level 2 analysis reveals that this favorable variance is due to the reduction in
output of 1,000 units from the budgeted 11,000 units. Once this reduction in output is taken into
account (via a flexible budget), the flexible-budget variance shows each direct cost category to
have an unfavorable variance indicating less efficient use of each direct cost item than was
budgeted, or the use of more costly direct cost items than was budgeted, or both.
Each direct cost category has an actual unit variable cost that exceeds its budgeted unit
cost:
Actual Budgeted
7-23 Flexible-budget preparation and analysis. Bank Management Printers, Inc., produces
luxury checkbooks with three checks and stubs per page. Each checkbook is designed for an indi-
vidual customer and is ordered through the customer’s bank. The company’s operating budget for
September 2017 included these data:
Number of checkbooks 15,000
Selling price per book $ 20
Variable cost per book $ 8
Fixed costs for the month $145,000
The actual results for September 2017 were as follows:
Number of checkbooks produced and sold 12,000
Average selling price per book $ 21
Variable cost per book $ 7
Fixed costs for the month $150,000
The executive vice president of the company observed that the operating income for September
was much lower than anticipated, despite a higher-than-budgeted selling price and a low-
er-than-budgeted variable cost per unit. As the company’s management accountant, you have
been asked to provide explanations for the disappointing September results.
Bank Management develops its flexible budget on the basis of budgeted per-output-unit rev-
enue and per-output-unit variable costs without detailed analysis of budgeted inputs.
Required:
1. Prepare a static-budget-based variance analysis of the September performance.
2. Prepare a flexible-budget-based variance analysis of the September performance.
3. Why might Bank Management find the flexible-budget-based variance analysis more infor-
mative than the static-budget-based variance analysis? Explain your answer.
