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Chapter 9

Management Accounting (University of Dhaka)

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Chapter 9
Flexible Budgets and Performance Analysis

Solutions to Questions

9-1 The planning budget is prepared for the perhaps misleading for activity variances that
planned level of activity. It is static because it is involve costs. A “favorable” activity variance for
not adjusted even if the level of activity a cost occurs because the cost has some
subsequently changes. variable component and the actual level of
activity is less than the planned level of activity.
9-2 A flexible budget can be adjusted to An “unfavorable” activity variance for a cost
reflect any level of activity—including the actual occurs because the cost has some variable
level of activity. By contrast, a static planning component and the actual level of activity is
budget is prepared for a single level of activity greater than the planned level of activity.
and is not subsequently adjusted.
9-6 A revenue variance is the difference
9-3 Actual results can differ from the budget between the actual revenue for the period and
for many reasons. Very broadly speaking, the how much the revenue should have been, given
differences are usually due to a change in the the actual level of activity. A revenue variance is
level of activity, changes in prices, and changes easy to interpret. A favorable revenue variance
in how effectively resources are managed. occurs because the revenue is greater than
expected for the actual level of activity. An
9-4 As noted above, a difference between unfavorable revenue variance occurs because
the budget and actual results can be due to the revenue is less than expected for the actual
many factors. Most importantly, the level of level of activity.
activity can have a very big impact on costs.
From a manager’s perspective, a variance that is 9-7 A spending variance is the difference
due to a change in activity is very different from between the actual amount of the cost and how
a variance that is due to changes in prices and much a cost should have been, given the actual
changes in how effectively resources are level of activity. Like the revenue variance, the
managed. A variance of the first kind requires interpretation of a spending variance is straight-
very different actions from a variance of the forward. A favorable spending variance occurs
second kind. Consequently, these two kinds of because the cost is lower than expected for the
variances should be clearly separated from each actual level of activity. An unfavorable spending
other. When the budget is directly compared to variance occurs because the cost is higher than
the actual results, these two kinds of variances expected for the actual level of activity.
are lumped together.
9-8 In a flexible budget performance report,
9-5 An activity variance is the difference the actual results are not directly compared to
between a revenue or cost item in the flexible the static planning budget. The flexible budget is
budget and the same item in the static planning interposed between the actual results and the
budget. An activity variance is due solely to the static planning budget. The differences between
difference in the actual level of activity used in the flexible budget and the static planning
the flexible budget and the level of activity budget are activity variances. The differences
assumed in the planning budget. Caution should between the actual results and the flexible
be exercised in interpreting an activity variance. budget are the revenue and spending variances.
The “favorable” and “unfavorable” labels are The flexible budget performance report cleanly

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separates the differences between the actual 9-10 When actual results are directly
results and the static planning budget that are compared to the static planning budget, it is
due to changes in activity (the activity implicitly assumed that costs (and revenues)
variances) from the differences that are due to should not change with a change in the level of
changes in prices and the effectiveness with activity. This assumption is valid only for fixed
which resources are managed (the revenue and costs. However, it is unlikely that all costs are
spending variances). fixed. Some are likely to be variable or mixed.

9-9 The only difference between a flexible 9-11 When the static planning budget is
budget based on a single cost driver and one adjusted proportionately for a change in activity
based on two cost drivers is the cost formulas. and then directly compared to actual results, it
When there are two cost drivers, some costs is implicitly assumed that costs should change in
may be a function of the first cost driver, some proportion to a change in the level of activity.
costs may be a function of the second cost This assumption is valid only for strictly variable
driver, and some costs may be a function of both costs. However, it is unlikely that all costs are
cost drivers. strictly variable. Some are likely to be fixed or
mixed.

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The Foundational 15

1. The amount of revenue in the flexible budget for May is:

Revenue:
Variable element per customer served (a) ....... $5,000
Actual activity (b) .......................................... 35
Amount in flexible budget (a) × (b) ................ $175,000

2. The amount of employee salaries and wages in the flexible budget for
May is:
Employee salaries and wages:
Variable element per customer served (a) ....... $1,100
Actual activity (b) .......................................... 35
Variable portion of the amount (a) × (b) ......... $38,500

Variable portion of the amount ....................... $38,500

Fixed element per month ............................... 50,000
Amount in flexible budget .............................. $88,500

3. The amount of travel expenses in the flexible budget for May is:
Travel expenses:
Variable element per customer served (a) ....... $600
Actual activity (b) .......................................... 35
Amount in flexible budget (a) × (b) ................ $21,000

4. The amount of Other Expenses included in the flexible budget for May
would be the fixed element per month of $36,000.

5. The net income reported in the flexible budget can be derived by

combining the answers to questions 1-4 as follows:

Revenue .............................................. $175,000

Employee salaries and wages ................ $88,500
Travel expenses ................................... 21,000
Other expenses .................................... 36,000 145,500
Net operating income ........................... $ 29,500

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The Foundational 15

6. The revenue variance for May is:

Actual results Revenue Variance Flexible Budget
$160,000 $15,000 U $175,000

7. The employee salaries and wages spending variance for May is:
Actual results Spending Variance Flexible Budget
$88,000 $500 F $88,500

8. The travel expenses spending variance for May is:

Actual results Spending Variance Flexible Budget
$19,000 $2,000 F $21,000

9. The other expenses spending variance for May is:

Actual results Spending Variance Flexible Budget
$34,500 $1,500 F $36,000

10. The amount of revenue in the planning budget for May is:
Revenue:
Variable element per customer served (a) ....... $5,000
Planned level of activity (b) ............................ 30
Amount in planning budget (a) × (b) .............. $150,000

11. The amount of employee salaries and wages in the planning budget for
May is:
Employee salaries and wages:
Variable element per customer served (a) ....... $1,100
Actual activity (b) .......................................... 30
Variable portion of the amount (a) × (b) ......... $33,000

Variable portion of the amount ....................... $33,000

Fixed element per month ............................... 50,000
Amount in planning budget ............................ $83,000

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The Foundational 15

12. The amount of travel expenses in the planning budget for May is:
Travel expenses:
Variable element per customer served (a) ....... $600
Actual activity (b) .......................................... 30
Amount in planning budget (a) × (b) .............. $18,000

13. The amount of Other Expenses included in the planning budget for
May would be the fixed element per month of $36,000.

14. The activity variance for revenue for May is:

Flexible Budget Activity Variance Planning Budget
$175,000 $25,000 F $150,000

15. The activity variances for the expenses for May are as follows:
Flexible Activity Planning
Budget Variance Budget
Employee salaries and wages $88,500 $5,500 U $83,000
Travel expenses $21,000 $3,000 U $18,000
Other expenses $36,000 $0 $36,000

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Exercise 9-1 (10 minutes)

Puget Sound Divers
Flexible Budget
For the Month Ended May 31
Actual diving-hours ..................................... 105
Revenue ($365.00q) ................................... $38,325
Expenses:
Wages and salaries ($8,000 + $125.00q) ... 21,125
Supplies ($3.00q) ..................................... 315
Equipment rental ($1,800 + $32.00q) ....... 5,160
Insurance ($3,400) ................................... 3,400
Miscellaneous ($630 + $1.80q) ................. 819
Total expense ............................................. 30,819
Net operating income .................................. $ 7,506

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Exercise 9-2 (15 minutes)

1. The activity variances are shown below:

Flight Café
Activity Variances
For the Month Ended July 31
Flexible Planning Activity
Budget Budget Variances
Meals .......................................... 17,800 18,000
Revenue ($4.50q) ........................ $80,100 $81,000 $900 U
Expenses:
Raw materials ($2.40q) ............. 42,720 43,200 480 F
Wages and salaries ($5,200 +
$0.30q).................................. 10,540 10,600 60 F
Utilities ($2,400 + $0.05q) ........ 3,290 3,300 10 F
Facility rent ($4,300) ................. 4,300 4,300 0
Insurance ($2,300) ................... 2,300 2,300 0
Miscellaneous ($680 + $0.10q) .. 2,460 2,480 20 F
Total expense.............................. 65,610 66,180 570 F
Net operating income .................. $14,490 $14,820 $330 U

2. Management should be concerned that the level of activity fell below

what had been planned for the month. This led to an expected decline
in profits of $330. However, the individual items on the report should
not receive much management attention. The unfavorable variance for
revenue and the favorable variances for expenses are entirely caused by
the drop in activity.

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Exercise 9-3 (15 minutes)

Quilcene Oysteria
Revenue and Spending Variances
For the Month Ended August 31
Revenue
and
Actual Flexible Spending
Results Budget Variances
Pounds ....................................... 8,000 8,000
Revenue ($4.00q) ........................ $35,200 $32,000 $3,200 F
Expenses:
Packing supplies ($0.50q) .......... 4,200 4,000 200 U
Oyster bed maintenance 3,100 3,200 100 F
($3,200) ................................
Wages and salaries ($2,900 + 5,640 5,300 340 U
$0.30q)..................................
Shipping ($0.80q) ..................... 6,950 6,400 550 U
Utilities ($830) .......................... 810 830 20 F
Other ($450 + $0.05q) .............. 980 850 130 U
Total expense.............................. 21,680 20,580 1,100 U
Net operating income .................. $13,520 $11,420 $2,100 F

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Exercise 9-4 (20 minutes)

1.
Vulcan Flyovers
Flexible Budget Performance Report
For the Month Ended July 31
Revenue
and
Actual Spending Flexible Activity Planning
Results Variances Budget Variances Budget
Flights (q) ...................................... 48 48 50
Revenue ($320.00q) ....................... $13,650 $1,710 U $15,360 $640 U $16,000
Expenses:
Wages and salaries ($4,000 +
$82.00q) ................................... 8,430 494 U 7,936 164 F 8,100
Fuel ($23.00q) ............................. 1,260 156 U 1,104 46 F 1,150
Airport fees ($650 + $38.00q) ...... 2,350 124 F 2,474 76 F 2,550
Aircraft depreciation ($7.00q) ....... 336 0 336 14 F 350
Office expenses ($190 + $2.00q) .. 460 174 U 286 4 F 290
Total expense................................. 12,836 700 U 12,136 304 F 12,440
Net operating income ..................... $ 814 $2,410 U $ 3,224 $336 U $ 3,560
2. The overall $336 unfavorable activity variance is due to activity falling below what had been planned
for the month. The $1,710 unfavorable revenue variance is very large relative to the company’s net
operating income and should be investigated. Was this due to discounts given or perhaps a lower
average number of passengers per flight than usual? The $494 unfavorable spending variance for
wages and salaries is also large and should be investigated. The other spending variances are
relatively small, but are worth some management attention—particularly if they recur next month.

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Exercise 9-5 (15 minutes)

Alyeski Tours
Planning Budget
For the Month Ended July 31
Budgeted cruises (q1) .......................................................... 24
Budgeted passengers (q2) ................................................... 1,400
Revenue ($25.00q2) ............................................................ $35,000
Expenses:
Vessel operating costs ($5,200 + $480.00q1 +$2.00q2) ...... 19,520
Advertising ($1,700) ......................................................... 1,700
Administrative costs ($4,300 + $24.00q1 +$1.00q2) ........... 6,276
Insurance ($2,900)........................................................... 2,900
Total expense ..................................................................... 30,396
Net operating income .......................................................... $ 4,604

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Exercise 9-6 (10 minutes)

The variance report compares actual results to the planning budget and
should not be used to evaluate how well costs were controlled during April.
The planning budget is based on 100 jobs, but the actual results are for
105 jobs. Consequently, the actual revenues and many of the actual costs
should have been different from what was budgeted at the beginning of
the period. Direct comparisons of budgeted to actual costs are valid only if
the costs are fixed.
To evaluate how well revenues and costs were controlled, it is necessary to
estimate what the revenues and costs should have been for the actual level
of activity using a flexible budget. The flexible budget amounts can then be
compared to the actual results to evaluate how well revenues and costs
were controlled.

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Exercise 9-7 (15 minutes)

The adjusted budget was created by multiplying each item in the budget
by the ratio 105/100; in other words, each item was adjusted upward by
5%. This procedure provides valid benchmarks for revenues and for costs
that are strictly variable, but overstates what fixed and mixed costs should
be. Fixed costs, for example, should not increase at all if the activity level
increases by 5%—providing, of course, that this level of activity is within
the relevant range. Mixed costs should increase less than 5%.
To evaluate how well revenues and costs were controlled, it is necessary to
estimate what the revenues and costs should have been for the actual level
of activity using a flexible budget that explicitly recognizes fixed and mixed
costs. The flexible budget amounts can then be compared to the actual
results to evaluate how well revenues and costs were controlled.

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Exercise 9-8 (20 minutes)

Flexible Planning Activity

Budget Budget Variances
Repair-hours (q) .......................... 2,900 2,800
Revenue ($44.50q) ...................... $129,050 $124,600 $4,450 F
Expenses:
Wages and salaries
($23,200 + $16.30q) .............. 70,470 68,840 1,630 U
Parts and supplies ($8.60q) ....... 24,940 24,080 860 U
Equipment depreciation
($1,600 + $0.40q) .................. 2,760 2,720 40 U
Truck operating expenses
($6,400 + $1.70q) .................. 11,330 11,160 170 U
Rent ($3,480) ........................... 3,480 3,480 0
Administrative expenses
($4,500 + $0.80q) .................. 6,820 6,740 80 U
Total expense .............................. 119,800 117,020 2,780 U
Net operating income ................... $ 9,250 $ 7,580 $1,670 F

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Exercise 9-9 (10 minutes)

Wyckam Manufacturing Inc.
Planning Budget for Manufacturing Costs
For the Month Ended June 30
Budgeted machine-hours (q) ........ 5,000
Direct materials ($4.25q).............. $21,250
Direct labor ($36,800) .................. 36,800
Supplies ($0.30q) ........................ 1,500
Utilities ($1,400 + $0.05q) ........... 1,650
Depreciation ($16,700) ................ 16,700
Insurance ($12,700) .................... 12,700
Total manufacturing cost .............. $90,600

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Exercise 9-10 (15 minutes)

Lavage Rapide
Planning Budget
For the Month Ended August 31
Budgeted cars washed (q) ............................. 9,000
Revenue ($4.90q) ......................................... $44,100
Expenses:
Cleaning supplies ($0.80q) .......................... 7,200
Electricity ($1,200 + $0.15q) ...................... 2,550
Maintenance ($0.20q)................................. 1,800
Wages and salaries ($5,000 + $0.30q) ........ 7,700
Depreciation ($6,000) ................................. 6,000
Rent ($8,000) ............................................ 8,000
Administrative expenses ($4,000 + $0.10q) . 4,900
Total expense ............................................... 38,150
Net operating income .................................... $ 5,950

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Exercise 9-11 (15 minutes)

Lavage Rapide
Flexible Budget
For the Month Ended August 31
Actual cars washed (q) .................................. 8,800
Revenue ($4.90q) ......................................... $43,120
Expenses:
Cleaning supplies ($0.80q) .......................... 7,040
Electricity ($1,200 + $0.15q) ...................... 2,520
Maintenance ($0.20q)................................. 1,760
Wages and salaries ($5,000 + $0.30q) ........ 7,640
Depreciation ($6,000) ................................. 6,000
Rent ($8,000) ............................................ 8,000
Administrative expenses ($4,000 + $0.10q) . 4,880
Total expense ............................................... 37,840
Net operating income .................................... $ 5,280

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Exercise 9-12 (20 minutes)

Flexible Planning Activity

Budget Budget Variances
Cars washed (q) .............................. 8,800 9,000
Revenue ($4.90q) ............................ $43,120 $44,100 $980 U
Expenses:
Cleaning supplies ($0.80q) ............. 7,040 7,200 160 F
Electricity ($1,200 + $0.15q) ......... 2,520 2,550 30 F
Maintenance ($0.20q).................... 1,760 1,800 40 F
Wages and salaries
($5,000 + $0.30q) ................... 7,640 7,700 60 F
Depreciation ($6,000) .................... 6,000 6,000 0
Rent ($8,000) ............................... 8,000 8,000 0
Administrative expenses
($4,000 + $0.10q) ...................... 4,880 4,900 20 F
Total expense .................................. 37,840 38,150 310 F
Net operating income ....................... $ 5,280 $ 5,950 $670 U

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Exercise 9-13 (20 minutes)

Lavage Rapide
Revenue and Spending Variances
For the Month Ended August 31

Revenue
and
Actual Flexible Spending
Results Budget Variances
Cars washed (q) .......................... 8,800 8,800
Revenue ($4.90q) ........................ $43,080 $43,120 $ 40 U
Expenses:
Cleaning supplies ($0.80q) ......... 7,560 7,040 520 U
Electricity ($1,200 + $0.15q) ..... 2,670 2,520 150 U
Maintenance ($0.20q)................ 2,260 1,760 500 U
Wages and salaries
($5,000 + $0.30q) ............... 8,500 7,640 860 U
Depreciation ($6,000) ................ 6,000 6,000 0
Rent ($8,000) ........................... 8,000 8,000 0
Administrative expenses
($4,000 + $0.10q) .................. 4,950 4,880 70 U
Total expense .............................. 39,940 37,840 2,100 U
Net operating income ................... $ 3,140 $ 5,280 $2,140 U

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Exercise 9-14 (30 minutes)

Lavage Rapide
Flexible Budget Performance Report
For the Month Ended August 31
Revenue
and
Actual Spending Flexible Activity Planning
Results Variances Budget Variances Budget
Cars washed (q) ................................... 8,800 8,800 9,000
Revenue ($4.90q) ................................. $43,080 $ 40 U $43,120 $980 U $44,100
Expenses:
Cleaning supplies ($0.80q) .................. 7,560 520 U 7,040 160 F 7,200
Electricity ($1,200 + $0.15q) .............. 2,670 150 U 2,520 30 F 2,550
Maintenance ($0.20q)......................... 2,260 500 U 1,760 40 F 1,800
Wages and salaries
($5,000 + $0.30q) ........................... 8,500 860 U 7,640 60 F 7,700
Depreciation ($6,000) ......................... 6,000 0 6,000 0 6,000
Rent ($8,000) .................................... 8,000 0 8,000 0 8,000
Administrative expenses
($4,000 + $0.10q) ........................... 4,950 70 U 4,880 20 F 4,900
Total expense ....................................... 39,940 2,100 U 37,840 310 F 38,150
Net operating income ............................ $ 3,140 $2,140 U $ 5,280 $670 U $ 5,950

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Exercise 9-15 (45 minutes)

1. The planning budget appears below. Note that the report does not
include revenue or net operating income because the production
department is a cost center that does not have any revenue.

Packaging Solutions Corporation

Production Department Planning Budget
For the Month Ended March 31
Budgeted labor-hours (q) ............................. 8,000
Direct labor ($15.80q) .................................. $126,400
Indirect labor ($8,200 + $1.60q)................... 21,000
Utilities ($6,400 + $0.80q) ............................ 12,800
Supplies ($1,100 + $0.40q) .......................... 4,300
Equipment depreciation ($23,000 + $3.70q) .. 52,600
Factory rent ($8,400) ................................... 8,400
Property taxes ($2,100) ................................ 2,100
Factory administration ($11,700 + $1.90q) .... 26,900
Total expense .............................................. $254,500

2. The flexible budget appears below. Like the planning budget, this report
does not include revenue or net operating income because the
production department is a cost center that does not have any revenue.

Packaging Solutions Corporation

Production Department Flexible Budget
For the Month Ended March 31
Actual labor-hours (q) .................................. 8,400
Direct labor ($15.80q) .................................. $132,720
Indirect labor ($8,200 + $1.60q)................... 21,640
Utilities ($6,400 + $0.80q) ............................ 13,120
Supplies ($1,100 + $0.40q) .......................... 4,460
Equipment depreciation ($23,000 + $3.70q) .. 54,080
Factory rent ($8,400) ................................... 8,400
Property taxes ($2,100) ................................ 2,100
Factory administration ($11,700 + $1.90q) .... 27,660
Total expense .............................................. $264,180

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Exercise 9-15 (continued)

3. The flexible budget performance report appears below. This report does not include revenue or net
operating income because the production department is a cost center that does not have any
revenue.

Packaging Solutions Corporation

Production Department Flexible Budget Performance Report
For the Month Ended March 31

Actual Spending Flexible Activity Planning

Results Variances Budget Variances Budget
Labor-hours (q) ............................... 8,400 8,400 8,000
Direct labor ($15.80q) ...................... $134,730 $2,010 U $132,720 $6,320 U $126,400
Indirect labor ($8,200 + $1.60q) ...... 19,860 1,780 F 21,640 640 U 21,000
Utilities ($6,400 + $0.80q)................ 14,570 1,450 U 13,120 320 U 12,800
Supplies ($1,100 + $0.40q) .............. 4,980 520 U 4,460 160 U 4,300
Equipment depreciation
($23,000 + $3.70q) ....................... 54,080 0 54,080 1,480 U 52,600
Factory rent ($8,400) ....................... 8,700 300 U 8,400 0 8,400
Property taxes ($2,100).................... 2,100 0 2,100 0 2,100
Factory administration
($11,700 + $1.90q) ....................... 26,470 1,190 F 27,660 760 U 26,900
Total expense .................................. $265,490 $1,310 U $264,180 $9,680 U $254,500

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Exercise 9-15 (continued)

4. The overall unfavorable activity variance of $9,680 occurred because the
actual level of activity exceeded the budgeted level of activity. The
production manager certainly should not be held responsible for this
unfavorable variance if this increased activity was due to more orders or
more sales. On the other hand, the overall unfavorable spending
variance of $1,310 may be of concern to management. Why did the
unfavorable—and favorable—variances occur? Even the relatively small
unfavorable spending variance for supplies of $520 should probably be
investigated because, as a percentage of what the cost should have
been ($520/$4,460 = 11.7%), this variance is fairly large.

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Exercise 9-16 (20 minutes)

Via Gelato
Revenue and Spending Variances
For the Month Ended June 30
Revenue and
Actual Flexible Spending
Results Budget Variances
Liters (q) ..................................... 6,200 6,200
Revenue ($12.00q) ...................... $71,540 $74,400 $2,860 U
Expenses:
Raw materials ($4.65q) ............. 29,230 28,830 400 U
Wages ($5,600 + $1.40q) ......... 13,860 14,280 420 F
Utilities ($1,630 + $0.20q)......... 3,270 2,870 400 U
Rent ($2,600) ........................... 2,600 2,600 0
Insurance ($1,350) ................... 1,350 1,350 0
Miscellaneous ($650 + $0.35q) .. 2,590 2,820 230 F
Total expense .............................. 52,900 52,750 150 U
Net operating income................... $18,640 $21,650 $3,010 U

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Exercise 9-17 (30 minutes)

AirQual Test Corporation
Flexible Budget Performance Report
For the Month Ended February 28
Revenue
and
Actual Spending Flexible Activity Planning
Results Variances Budget Variances Budget
Jobs (q) ............................................... 52 52 50
Revenue ($360.00q) ............................. $18,950 $230 F $18,720 $720 F $18,000
Expenses:
Technician wages ($6,400) ................. 6,450 50 U 6,400 0 6,400
Mobile lab operating expenses
($2,900 + $35.00q) ......................... 4,530 190 F 4,720 70 U 4,650
Office expenses ($2,600 + $2.00q) ..... 3,050 346 U 2,704 4 U 2,700
Advertising expenses ($970) ............... 995 25 U 970 0 970
Insurance ($1,680)............................. 1,680 0 1,680 0 1,680
Miscellaneous expenses
($500 + $3.00q) .............................. 465 191 F 656 6 U 650
Total expense ....................................... 17,170 40 U 17,130 80 U 17,050
Net operating income ............................ $ 1,780 $190 F $ 1,590 $640 F $ 950

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Exercise 9-18 (45 minutes)

1. The planning budget based on 3 courses and 45 students appears
below:
Gourmand Cooking School
Planning Budget
For the Month Ended September 30
Budgeted courses (q1) .............................................. 3
Budgeted students (q2) ............................................. 45
Revenue ($800q2) .................................................... $36,000
Expenses:
Instructor wages ($3,080q1) ................................... 9,240
Classroom supplies ($260q2) .................................. 11,700
Utilities ($870 + $130q1) ........................................ 1,260
Campus rent ($4,200) ............................................ 4,200
Insurance ($1,890) ................................................ 1,890
Administrative expenses ($3,270 + $15q1 +$4q2) .... 3,495
Total expense .......................................................... 31,785
Net operating income ............................................... $ 4,215

2. The flexible budget based on 3 courses and 42 students appears below:

Gourmand Cooking School
Flexible Budget
For the Month Ended September 30
Actual courses (q1) ................................................... 3
Actual students (q2).................................................. 42
Revenue ($800q2) .................................................... $33,600
Expenses:
Instructor wages ($3,080q1) ................................... 9,240
Classroom supplies ($260q2) .................................. 10,920
Utilities ($870 + $130q1) ........................................ 1,260
Campus rent ($4,200) ............................................ 4,200
Insurance ($1,890) ................................................ 1,890
Administrative expenses ($3,270 + $15q1 +$4q2) .... 3,483
Total expense .......................................................... 30,993
Net operating income ............................................... $ 2,607

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Exercise 9-18 (continued)

3. The flexible budget performance report for September appears below:
Gourmand Cooking School
Flexible Budget Performance Report
For the Month Ended September 30
Revenue
and
Actual Spending Flexible Activity Planning
Results Variances Budget Variances Budget
Courses (q1) .................................. 3 3 3
Students (q2) ................................. 42 42 45
Revenue ($800q2).......................... $32,400 $1,200 U $33,600 $2,400 U $36,000
Expenses:
Instructor wages ($3,080q1) ........ 9,080 160 F 9,240 0 9,240
Classroom supplies ($260q2) ........ 8,540 2,380 F 10,920 780 F 11,700
Utilities ($870 + $130q1) ............. 1,530 270 U 1,260 0 1,260
Campus rent ($4,200) .................. 4,200 0 4,200 0 4,200
Insurance ($1,890) ...................... 1,890 0 1,890 0 1,890
Administrative expenses
($3,270 + $15q1 +$4q2)........... 3,790 307 U 3,483 12 F 3,495
Total expense ................................ 29,030 1,963 F 30,993 792 F 31,785
Net operating income ..................... $ 3,370 $ 763 F $ 2,607 $ 1,608 U $ 4,215

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Problem 9-19 (30 minutes)

1. The activity variances are shown below:

FAB Corporation
Activity Variances
For the Month Ended March 31
Flexible Planning Activity
Budget Budget Variances
Machine-hours (q) .......................... 26,000 30,000
Utilities ($20,600 + $0.10q) ............ $ 23,200 $ 23,600 $ 400 F
Maintenance ($40,000 + $1.60q) .... 81,600 88,000 6,400 F
Supplies ($0.30q) ........................... 7,800 9,000 1,200 F
Indirect labor ($130,000 + $0.70q) . 148,200 151,000 2,800 F
Depreciation ($70,000) ................... 70,000 70,000 0
Total .............................................. $330,800 $341,600 $10,800 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.

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Problem 9-19 (continued)

2. The spending variances are computed below:

FAB Corporation
Spending Variances
For the Month Ended March 31
Actual Flexible Spending
Results Budget Variances
Machine-hours (q) .......................... 26,000 26,000
Utilities ($20,600 + $0.10q) ............ $ 24,200 $ 23,200 $1,000 U
Maintenance ($40,000 + $1.60q) .... 78,100 81,600 3,500 F
Supplies ($0.30q) ........................... 8,400 7,800 600 U
Indirect labor ($130,000 + $0.70q) . 149,600 148,200 1,400 U
Depreciation ($70,000) ................... 71,500 70,000 1,500 U
Total .............................................. $331,800 $330,800 $1,000 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 performing less maintenance.
Since these variances are all fairly large, they should all probably be
investigated.

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Problem 9-20 (30 minutes)

1.
Milano Pizza
Flexible Budget Performance Report
For the Month Ended November 30
Revenue
and
Actual Spending Flexible Activity Planning
Results Variances Budget Variances Budget
Pizzas (q1) ...................................... 1,240 1,240 1,200
Deliveries (q2) ................................. 174 174 180
Revenue ($13.50q1) ........................ $17,420 $680 F $16,740 $540 F $16,200
Expenses:
Pizza ingredients ($3.80q1) ............ 4,985 273 U 4,712 152 U 4,560
Kitchen staff ($5,220) ................... 5,281 61 U 5,220 0 5,220
Utilities ($630 + $0.05q1) .............. 984 292 U 692 2 U 690
Delivery person ($3.50q2).............. 609 0 609 21 F 630
Delivery vehicle ($540 + $1.50q2).. 655 146 F 801 9 F 810
Equipment depreciation ($275) ...... 275 0 275 0 275
Rent ($1,830) ............................... 1,830 0 1,830 0 1,830
Miscellaneous ($820 + $0.15q1) .... 954 52 F 1,006 6 U 1,000
Total expense ................................. 15,573 428 U 15,145 130 U 15,015
Net operating income ...................... $ 1,847 $252 F $ 1,595 $410 F $ 1,185

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Problem 9-20 (continued)

2. Some of the activity variances are favorable and some are unfavorable.
This occurs because there are two cost drivers (i.e., measures of
activity) and one is up while the other is down. The actual number of
pizzas delivered is greater than budgeted, so the activity variance for
revenue is favorable, but the activity variances for pizza ingredients,
utilities, and miscellaneous are unfavorable. In contrast, the actual
number of deliveries is less than budgeted, so the activity variances for
the delivery person and the delivery vehicle are favorable.

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Problem 9-21 (45 minutes)

1. The variance report should not be used to evaluate how well costs were
controlled. In July, the planning budget was based on 150 lessons, but
the actual results are for 155 lessons—an increase of more than 3%
over budget. Consequently, the actual revenues and many of the actual
costs should have been different from what was budgeted at the
beginning of the period. For example, instructor wages, a variable cost,
should have increased by more than 3% because of the increase in
activity, but the variance report assumes that they should not have
increased at all. This results in a spurious unfavorable variance for
instructor wages. Direct comparisons of budgeted to actual costs are
valid only if the costs are fixed.

2. See the following page.

3. The overall activity variance for net operating income was $435 F
(favorable). That means that as a consequence of the increase in
activity from 150 lessons to 155 lessons, the net operating income
should have been up $435 over budget. However, it wasn’t. The
budgeted net operating income was $8,030 and the actual net operating
income was $8,080, so the profit was up by only $50—not $435 as it
should have been. There are many reasons for this—as shown in the
revenue and spending variances. Perhaps most importantly, fuel costs
were much higher than expected. The spending variance for fuel was
$425 U (unfavorable) and may have been due to an increase in the
price of fuel that is beyond the owner/manager’s control. Most of the
other spending variances were favorable, so with the exception of this
item, costs seem to have been adequately controlled. In addition, the
unfavorable revenue variance of $200 indicates that revenue was
slightly less than they should have been. This variance is very small
relative to the size of the revenue, so it may not justify investigation.

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Problem 9-21 (continued)

TipTop Flight School
Flexible Budget Performance Report
For the Month Ended July 31
Revenue
and
Actual Spending Flexible Activity Planning
Results Variances Budget Variances Budget
Lessons (q) ..................................... 155 155 150
Revenue ($220q) ............................. $33,900 $200 U $34,100 $1,100 F $33,000
Expenses:
Instructor wages ($65q) ................ 9,870 205 F 10,075 325 U 9,750
Aircraft depreciation ($38q) ........... 5,890 0 5,890 190 U 5,700
Fuel ($15q) ................................... 2,750 425 U 2,325 75 U 2,250
Maintenance ($530 + $12q)........... 2,450 60 U 2,390 60 U 2,330
Ground facility expenses
($1,250 + $2q)........................... 1,540 20 F 1,560 10 U 1,550
Administration ($3,240 + $1q) ....... 3,320 75 F 3,395 5 U 3,390
Total expense .................................. 25,820 185 U 25,635 665 U 24,970
Net operating income ....................... $ 8,080 $385 U $ 8,465 $ 435 F $ 8,030

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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.

St. Lucia Blood Bank

Flexible Budget Performance Report
For the Month Ended September 30
Actual Spending Flexible Activity Planning
Results Variances Budget Variances Budget
Liters of blood collected (q) ................ 620 620 500
Medical supplies ($15.00q) ................. $ 9,250 $ 50 F $ 9,300 $1,800 U $ 7,500
Lab tests ($12.00q) ............................ 6,180 1,260 F 7,440 1,440 U 6,000
Equipment depreciation ($2,500) ........ 2,800 300 U 2,500 0 2,500
Rent ($1,000) .................................... 1,000 0 1,000 0 1,000
Utilities ($500) ................................... 570 70 U 500 0 500
Administration ($10,000 + $2.50q)...... 11,740 190 U 11,550 300 U 11,250
Total expense .................................... $31,540 $ 750 F $32,290 $3,540 U $28,750

2. The overall unfavorable activity variance of $3,540 was caused by the 24% increase in activity. There
is no reason to investigate this particular variance. The overall spending variance is $750 F, which
would seem to indicate that costs were well-controlled. However, the favorable $1,260 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 fail to perform required lab tests? If so,
was this wise? In addition, the unfavorable spending variance of $300 for equipment depreciation
requires some explanation. Was more equipment obtained to collect the additional blood?

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Problem 9-23 (45 minutes)

1. The report prepared by the bookkeeper compares average budgeted per
unit revenues and costs to average actual per unit revenues and costs.
This approach implicitly assumes that all costs are strictly variable; only
variable costs should be constant on a per unit basis. The average fixed
cost should decrease as the level of activity increases and should
increase as the level of activity decreases. In this case, the actual level
of activity was greater than the budgeted level of activity. As a
consequence, the average cost per unit for any cost that is fixed or
mixed (such as office expenses, equipment depreciation, rent, and
insurance) should decline and show a favorable variance. This makes it
difficult to interpret the variance for a mixed or fixed cost. For example,
was the favorable $9 variance per exchange for rent due simply to the
increased volume or did the company actually save any money on its
rent? Because of this ambiguity, the report prepared by the bookkeeper
is not as useful as a performance report prepared using a flexible
budget.

2. A flexible budget performance report would be much more helpful in

assessing the performance of the company than the report prepared by
the bookkeeper. To construct such a report, we first need to determine
the cost formulas as follows, where q is the number of exchanges
completed:

Revenue .......................... $395q The revenue all comes

from fees.
Legal and search fees ....... $165q Variable cost
Office expenses ............... $5,200 + $5q $5,200 is fixed;
$5 = ($135 × 40 −
$5,200)/40
Equipment depreciation .... $400 $400 = $10 × 40
Rent ................................ $1,800 $1,800 = $45 × 40
Insurance ........................ $200 $200 = $5 × 40

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Problem 9-23 (continued)

Exchange Corp.
Flexible Budget Performance Report
For the Month Ended May 31
Revenue
and
Actual Spending Flexible Activity Planning
Results Variances Budget Variances Budget
Exchanges completed (q) ............. 50 50 40
Revenue ($395q) ......................... $19,250 $500 U $19,750 $3,950 F $15,800
Expenses:
Legal and search fees ($165q).... 9,200 950 U 8,250 1,650 U 6,600
Office expenses 5,600 150 U 5,450 50 U 5,400
($5,200 + $5q) .......................
Equipment depreciation ($400) ... 400 0 400 0 400
Rent ($1,800) ............................ 1,800 0 1,800 0 1,800
Insurance ($200) ....................... 200 0 200 0 200
Total expense .............................. 17,200 1,100 U 16,100 1,700 U 14,400
Net operating income ................... $ 2,050 $1,600 U $ 3,650 $2,250 F $ 1,400

3. On the one hand, the increase in the number of exchanges completed was positive. The overall
favorable activity of $2,250 indicates that the net operating income should have increased by that
amount because of the increase in activity. However, the net operating income did not actually
increase by nearly that much. This was due to the unfavorable revenue variance and a number of
unfavorable spending variances, all of which should be investigated by the owner.

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Problem 9-24 (45 minutes)

1. The cost reports are of little use for assessing how well costs were
controlled. The problem is that the company is comparing budgeted
costs at one level of activity to actual costs at another level of activity.
Costs that are variable will naturally be different at these two different
levels of activity. Although the cost reports do a good job of showing
whether fixed costs were controlled, they do not do a good job of
showing whether variable costs were controlled. Since sales have
chronically failed to meet budget, the level of activity in the factory is
also likely to have chronically been below budget. Consequently, the
variances for variable costs have likely been favorable simply because
activity has been less than budgeted in the production departments. No
wonder the production supervisors have been pleased with the reports.

2. The company should use a flexible budget approach to evaluate cost

control. Under the flexible budget approach, the actual costs incurred in
working 35,000 machine-hours are compared to what the costs should
have been for that level of activity.

3. See the following page.

4. The flexible budget performance report provides a much clearer picture

of the performance of the Assembly Department than the original cost
control report prepared by the company. The overall activity variance is
$13,500 F (favorable) which simply reflects the fact that the actual level
of activity was significantly less than the budgeted level of activity. The
variable costs would naturally be less than budgeted.
The spending variances indicate that costs were not controlled by the
Assembly Department. All three of the variable costs have large
unfavorable spending variances and those variances are significantly
larger than the one favorable spending variance on the report.

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Problem 9-24 (continued)

3.
Westmont Corporation
Assembly Department
Flexible Budget Performance Report
For the Month Ended March 31
Actual Spending Flexible Activity Planning
Results Variances Budget Variances Budget
Machine-hours (q) ........................... 35,000 35,000 40,000
Supplies ($0.80q)* .......................... $ 29,700 $ 1,700 U $ 28,000 $4,000 F $ 32,000
Scrap ($0.50q)* .............................. 19,500 2,000 U 17,500 2,500 F 20,000
Indirect materials ($1.40q)*............. 51,800 2,800 U 49,000 7,000 F 56,000
Wages and salaries ($80,000) .......... 79,200 800 F 80,000 0 80,000
Equipment depreciation ($60,000).... 60,000 0 60,000 0 60,000
Total .............................................. $240,200 $ 5,700 U $234,500 $13,500 F $248,000

*The variable cost per machine-hour is obtained by dividing the total variable cost from the planning
budget by 30,000 machine-hours.

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Problem 9-25 (45 minutes)

1. The cost control report compares the planning budget, which was
prepared for 35,000 machine-hours, to actual results for 38,000
machine-hours. This is like comparing apples to oranges. Costs that are
variable or mixed should be higher when the activity level is 38,000
rather than 35,000 machine-hours. Direct comparisons of budgeted to
actual costs are valid only if the costs are fixed. The cost control report
prepared by the company should not be used to evaluate how well costs
were controlled.

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Problem 9-25 (continued)

2. A report that would be helpful in assessing how well costs were controlled appears below:

Freemont Corporation—Machining Department

Flexible Budget Performance Report
For the Month Ended June 30
Actual Spending Flexible Activity Planning
Results Variances Budget Variances Budget
Machine-hours (q) ........................ 38,000 38,000 35,000
Direct labor wages ($2.30q) .......... $ 86,100 $ 1,300 F $ 87,400 $6,900 U $ 80,500
Supplies ($0.60q) ......................... 23,100 300 U 22,800 1,800 U 21,000
Maintenance ($92,000 + $1.20q) .. 137,300 300 F 137,600 3,600 U 134,000
Utilities ($11,700 + $0.10q) .......... 15,700 200 U 15,500 300 U 15,200
Supervision ($38,000) .................. 38,000 0 38,000 0 38,000
Depreciation ($80,000) ................. 80,000 0 80,000 0 80,000
Total ........................................... $380,200 $ 1,100 F $381,300 $12,600 U $368,700

Note that in this new report the overall spending variance is favorable—indicating that costs were
most likely under control.

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