CHAPTER 8

BUDGETARY CONTROL AND VARIANCE ANALYSIS

TRUE/FALSE

1. If sales volume exceeds expectations, actual profit will always be higher than budgeted profit.
LO1 False Actual profit may be lower than budgeted profit even though sales volume exceeds
expectations.

2. Variance analysis may be performed to isolate the profit impact of individual input and output
factors.
LO1 True

3. Variance analysis is a technique used for determining the profit effect due to differences between
the actual and budgeted size of the market for a product.
LO1 False Variance analysis is a technique for determining why actual revenues, costs, and profit
differ from their budgeted amounts.

4. For most organizations, a budget is the benchmark for evaluating actual performance.
LO1 True

5. A good plan is the foundation for effective control.

LO1 True

6. The input quantity variance is also referred to as the input efficiency variance because it captures
the efficiency of input resource use.
LO2 True

7. A variance is the difference between a budgeted amount and a forecasted amount.

LO2 False A variance is the difference between an actual result and a budgeted amount.

8. Any profit difference between the master and flexible budgets is due solely to the difference
between budgeted and actual sales.
LO2 True

9. Total Profit Variance = Actual Profit Master Budget Profit.

LO2 True

10. Sales Volume Variance = (Actual Sales Quantity Budgeted Sales Quantity) x Actual Unit
Contribution Margin
LO2 False Sales Volume Variance = (Actual Sales Quantity Budgeted Sales Quantity) x Budgeted
Unit Contribution Margin)

11. A budget reconciliation is a report that uses variances to reconcile the difference between master
budget profit and actual profit.
LO3 True

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12. If a materials input price is higher than budgeted, the result is an unfavorable materials efficiency
variance.
LO3 False If an input price is higher than budgeted, the result is an unfavorable materials price
variance.

13. Small variances probably indicate random factors at work while large variances could signal a
permanent change in the operating environment.
LO3 True.

14. Cost variance analysis in a single-product company differs significantly from a multi-product
company.
LO3 False We calculate and interpret all of the cost variances in a multi-product firm exactly as we
would for a single-product firm.

15. Cheaper ingredients lead to a favorable price variance, but also may lead to unfavorable quantity
variances.
LO3 True

16. The primary limitations of variance analysis pertain to relevance and feedback.
LO4 False The primary limitations of variance analysis pertain to timeliness and specificity.

17. The lack of timeliness and specificity in financial variances force organizations to use primarily non-
financial controls to ensure that they are meeting organizational objectives.
LO4 True

18. Many firms use process control charts and statistical control methods to help employees track
performance on a real-time basis.
LO4 True

19. In a process control chart, observations outside the control limits are likely due to random
fluctuations.
LO4 False In a process control chart, observations outside the control limits likely indicate a
significant change, and trigger an investigation.

20. In general, financial controls are more useful for evaluating managers at higher levels in an
organizational hierarchy, while non financial controls are more useful in monitoring and evaluating
employees at lower levels.
LO4 True

21. Organizations always compute the materials price variance using the actual quantity of materials
used.
Appendix A False Many organizations compute the materials price variance using the actual
quantity of materials purchased rather than the actual quantity of materials
used.

22. The materials price variance helps reconcile actual profit with master budget profit.
Appendix A True

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23. A favorable or unfavorable sales volume variance could arise due to a change in the market as a
whole or the firms share of the market.
Appendix B True

24. The market share variance holds market share constant while examining variations between
budgeted and actual market size.
Appendix B False The market share variance holds market size constant while examining
variations between budgeted and actual market share.

25. The sales mix variance and the sales quantity variance together add up to the sales volume variance.
Appendix C True

26. The sales mix variance tells us the effect of the aggregate change in sales quantity, holding the sales
mix at the budgeted level.
Appendix C False The sales mix variance captures the profit effect of changes in the sales mix
from the budgeted level.

27. For the flexible budget, we calculate the weighted unit contribution margin using all the budget
assumptions of the master budget except sales volume.
Appendix C True

28. In a single-product case, the weighted unit contribution margin in the master budget will always be
higher than in the flexible budget.
Appendix C False In the single-product case, the WUCM in the master and flexible budgets is
identical because we have only one product.

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MULTIPLE CHOICE

29. Without a well-conceived plan against which to compare actual performance:

A. It is difficult to determine how a company is doing.
B. It is difficult to determine what a company could do to improve.
C. A company will not be able to make a profit.
D. Both A and B.
E. A, B, and C.
LO1 D

30. The starting point for preparing a monthly budget is:

A. Projecting sales.
B. Projecting production.
C. Projecting cash inflows.
D. Projecting cash outflows.
E. Projecting material needs.
LO1 A

31. The purpose of creating a flexible budget is to:

A. Determine how much of the difference between actual and budgeted profits was due strictly to
the difference between budgeted and actual sales.
B. Determine how much of the difference between actual and budgeted profits was due strictly to
the difference between budgeted and actual variable costs.
C. Determine how much of the difference between actual and budgeted profits was due strictly to
the difference between budgeted and actual fixed costs.
D. Determine which department is responsible for the overall budget variance.
LO1 Self-test A

32. The controller for Navia, Inc. created a budget prior to the current period. At the end of the period,
the controller compared the budget with the actual results. For what purpose is the controller using
budgets?
A. Coordination
B. Control
C. Variances
D. Planning
LO1 Pre-test B

33. Which of the following is not a component of the total profit variance?
A. Sales volume variance.
B. Flexible budget variance.
C. Sales price variance.
D. Market size and share variance.
E. All of the above are components of the total profit variance.
LO2 E

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34. Which of the following statements is not true?

A. If actual sales are greater than budgeted sales, the result is a favorable variance.
B. If actual cost is greater than budgeted cost, the result is an unfavorable variance.
C. If budgeted sales are greater than actual sales, the result is an unfavorable variance.
D. If budgeted cost is greater than actual cost, the result is an unfavorable variance.
E. If actual cost is less than budgeted cost, the result is a favorable variance.
LO2 D

35. Given the following data, calculate total profit variance.

Master Budget Actual Results

Revenue $73,000 $75,000
Variable costs $23,000 $20,000
Contribution margin $50,000 $55,000
Fixed costs $15,000 $10,000
Profit before taxes $35,000 $45,000
A. $2,000 Favorable.
B. $2,000 Unfavorable.
C. $10,000 Unfavorable.
D. $10,000 Favorable.
E. $5,000 Favorable.
LO2 D

36. The two major components of the total profit variance are:
A. Sales volume variance and flexible budget variance.
B. Price variance and quantity variance.
C. Sales volume variance and sales mix variance.
D. Flexible budget variance and quantity variance.
E. None of the above.
LO2 A

37. The formula for the sales volume variance is:

A. (Actual Sales Quantity Budgeted Sales Quantity) x Actual Unit Contribution Margin
B. (Budgeted Sales Quantity Actual Sales Quantity) x Total Profit Variance
C. Flexible Budget Profit Master Budget Profit.
D. (Budgeted Sales Quantity Actual Sales Quantity) Total Profit Variance
E. (Actual Sales Quantity Budgeted Sales Quantity) Actual Unit Contribution Margin
LO2 C

38. If the labor efficiency variance is $1,000unfavorable, then:

A. Budgeted labor rate exceeded actual labor rate.
B. Actual labor rate exceeded budgeted labor rate.
C. Budgeted labor input exceeded actual labor input.
D. Actual labor input exceeded budgeted labor input.
E. None of the above.
LO2 D

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39. Variance analysis is an important tool because:

A. It helps management determine where bottlenecks in the production process occurred
B. It helps management determine better pricing strategies
C. It helps management determine why actual profits varied from budgeted profits
D. It helps management determine which department operated most efficiently.
LO2 Self-test C

40. A favorable materials price variance will occur when:

A. Actual costs of materials were less than budgeted
B. More material was used than was budgeted
C. Actual cost of materials were greater than budgeted
D. Less material was used than was budgeted
LO2 Self-test A

41. The formula for calculating an input price variance is:

A. (Actual volume less budgeted volume) x actual price.
B. (Budgeted volume less actual volume) x budgeted price.
C. (Budgeted price less actual price) x actual volume.
D. (Actual price less budgeted price) x budgeted volume,
LO2 Self-test C

42. Which of the following would not result in a variance from budget:
A. A machine breaks down.
B. Budgets are set in a manner making them difficult to achieve.
C. A supplier raises prices.
D. The Chief Executive Officer takes a week of vacation.
LO2 Self-test D

43. Sales commissions for the Grant Company are budgeted based on a percent of sales. The sales
department budgeted sales of $150,000 for total commissions of $4,500. If actual sales totaled
$170,000 the flexible budget will show total commissions of:
A. $24,500
B. $5,100
C. $4,500
D. $15,500
LO2 Self-test B

44. The Farmington Company has a flexible budget based on direct labor hours. At the 100,000 hours
level, the budget shows the following variable overhead costs:
Indirect materials $16,000
Indirect labor $44,000
At an activity level of 120,000 hours, total variable costs will be:
A. $19,200
B. $60,000
C. $52,800
D. $72,000
LO2 Self-test D

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45. Jackies Jewelry Company reported the following budgeted and actual results based on sales of 100
units of product:
Flexible Budget As if Budget Actual Results
Direct Labor $800 $700 $850
Direct Materials $400 $450 $450
Overhead $600 $600 $610

The companys total input quantity variance is:

A. $50 favorable.
B. $160 unfavorable.
C. $150 favorable.
D. $50 unfavorable.
LO2 Self-test A

46. The following material budgets have been developed for the Criders Company.
Price per pound $6.50
Pounds per unit 1
Purchase price variance $3,200 unfavorable

If the company purchased 16,000 units, the actual price per pound of material purchased must have
been:
A. $6.70
B. $5.00
C. $6.30
D. $5.80
LO2 Self-test A

47. For what purpose is a flexible budget used?

A. To provide various possible outcomes for management to consider.
B. To adjust input prices so that future variances are eliminated.
C. To insure that profit does not drop below a predetermined level.
D. To identify the sources of variances.
LO2 Pre-test D

48. Which of the following items would differ in amount when comparing the master and flexible
budgets for a freight company in which actual sales resulted in $2,500,000 based on 8,000
shipments during a period that 7,800 shipments were budgeted?
A. Total sales revenue.
B. Equipment costs.
C. Rent.
D. All of the above will differ.
LO2 Pre-test A

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49. PVC Pro produces PVC pipe in 12 foot lengths. The following information was provided concerning
its labor and materials
Actual Data
Produced 12,200 units
Materials used 4,650 lbs. @ $7.00 per pound
Labor worked 7,450 hrs. costing $80,460

Budget Data
Budgeted units 12,000 units
Budgeted materials per pipe 0.40 lb. @ $7.10 per pound
Budgeted labor per pipe 0.60 hours @ $11.00 per hour

How much is the materials price variance?

A. $1,530 F
B. $465 F
C. $1,050 F
D. $1,065 F
LO2 Pre-test B

50. Cico Buckets had budgeted unit sales of 41,600 buckets. Actual sales during May totaled 42,000
buckets at $4.25 per bucket. Its budgeted sales price was $4.00 per bucket. The master budget
contribution margin totaled $62,400 and the budgeted variable cost per unit was $2.50. How much
is Haslos sales volume variance?
A. $600 F
B. $100 F
C. $1,600 F
D. $1,700 F
LO2 Pre-test A

51. The Parsons Company has budgeted to capture 25% of the market in which they operate which
currently contains 1,000 stores. The budgeted contribution margin per unit sold is $4.50. If they
were actually able to capture only 20% of the market, but their actual contribution margin was
$5.00 per unit, their market share variance was:
A. $250 favorable
B. $225 unfavorable
C. $250 unfavorable
D. $225 favorable
LO2 Self-test B

52. Variances could arise:

A. During the normal course of operations because a machine unexpectedly breaks down.
B. Because of a permanent change in the firms operating environment such as a competitor
introduces a new product.
C. Because budgets or standards are either too tight or too loose.
D. Both A and B.
E. A, B, and C.
LO3 E

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53. Which of the following is not a general rule to follow in a variance investigation?
A. Adjust budgeted amounts to agree with actual amounts.
B. Investigate all significant variances, whether favorable or unfavorable.
C. Examine trends.
D. Consider the total picture.
E. All of the above are general rules to follow.
LO3 A

54. Which of the following trends in variances may not indicate an inherent problem?
A. Marketing personnel overstating costs to give themselves additional leeway in operations.
B. Repeatedly having unfavorable labor efficiency variances.
C. An unexpected increase in demand.
D. A developing problem in the manufacturing process.
E. Finding mostly favorable variances over time.
LO3 C

55. The primary limitations of variance analysis pertain to

A. Controllability and budgeting.
B. Timeliness and specificity.
C. Timeliness and controllability.
D. Controllability and specificity.
E. Budgeting and controllability.
LO3 B

56. Which of the following is a method firms used to help track employee performance on a real-time
basis?
A. Budget reconciliation report.
B. Process control charts.
C. Labor efficiency variance.
D. Spending variance.
E. None of the above.
LO3 B

57. Firms use non-financial measures to:

A. Identify problems with their processes.
B. Help align goals.
C. Provide on-going feedback to employees.
D. Evaluate employees.
E. All of the above.
LO3 E

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58. In general, non-financial controls are more useful than financial controls for:
A. Monitoring employees at lower levels.
B. Evaluating workers at lower-levels.
C. Evaluating managers at higher levels.
D. Both A and B.
E. A, B, and C.
LO3 D

59. A company may experience a favorable labor rate variance but an unfavorable labor efficiency
variance when:
A. Sales lagged behind the budgeted amounts of the sales department.
B. There were breakdowns in machinery.
C. The product mix changed during the period.
D. The company experienced a high amount of turnover in its workforce.
LO3 Self-test D

60. A spending variance results when there is a difference between actual and budgeted:
A. Fixed costs
B. Variable costs
C. Sales Revenue
D. Unit sales
LO3 Self-test A

61. Thurston Companys budget allows for one pound of material to be used for each unit produced.
The budget indicates that the material costs $2.50 per pound. Actual units produced totaled 8,000.
The company used a total of 8,200 pounds of material at an actual cost of $2.40 per pound. There
were no beginning or ending inventories of raw materials. The input price and input quantity
variances, respectively, would be:
Input Price Input Quantity
A. Favorable Favorable
B. Unfavorable Favorable
C. Unfavorable Unfavorable
D. Favorable Unfavorable
LO3 Self-test D

62. A sales mix variance:

A. If unfavorable, indicates that a greater percentage of products with higher contribution margins
are being sold than were budgeted.
B. Indicates which products are having a negative impact on profits.
C. Reports the effect on profits due to a change in the sales mix from the master budget.
D. Reports the effect on profits due to an overall change in sales quantity.
LO3 Self-test C

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63. Which of the following would lead to a variance resulting from a permanent change in a firms
operating environment?
A. An abnormally high incidence of employees calling in sick during a period.
B. A new competitor entering the market.
C. Upper-level management failing to consult lower level workers and instituting extremely tight
budgetary controls.
D. A critical machine unexpectedly breaking down for a number of days.
LO3 Pre-test B

64. In comparison to financial measures, nonfinancial measures tend to be?

A. Less timely, less specific.
B. More timely, less specific.
C. Less timely, more specific.
D. More timely, more specific.
LO4 Pre-test D

65. Using the following data, calculate the purchase price variance for Rizzo Company.
Budgeted quantity per unit of output 5 yards
Budgeted price per yard $18.00
Actual yards purchased 8,000 yards
Actual cost of material purchase $140,000
Material used in production 8,500 yards
A. $13,000 Favorable.
B. $4,250 Favorable.
C. $4,000 Favorable.
D. $2,000 Unfavorable.
E. None of the above.
Appendix A C

66. Using the following data, calculate the sales volume variance for Rizzo Company.
Actual sales quantity 5,000 units
Budgeted sales quantity 5,500 units
Budgeted sales price per unit $10
Budgeted unit contribution margin $6
A. $3,000 Favorable.
B. $3,000 Unfavorable.
C. $5,000 Favorable.
D. $5,000 Unfavorable.
E. None of the above.
Appendix B B

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67. Given the following data, what is the sales mix variance for Rizzo Company?
Actual total sales $7,475
Budgeted total sales $7,500
Weighted unit contribution margin in the flexible budget $12
Weighted unit contribution margin in the master budget $8
A. 200 Favorable.
B. 200 Unfavorable.
C. 29,900 Favorable.
D. 29,900 Unfavorable.
E. 300 Unfavorable.
LO4 C

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Problems

1. Fancy Feast Bakery makes cakes for special occasions. Fancy Feast estimates the following
revenue and costs for the upcoming month.

Expected sales 300 cakes @ $20 per cake

Expected cost of Ingredients $4 per cake
Expected labor costs $20 per hour
Estimated labor hours required hour per cake
Estimated variable overhead $1 per baker hour
Estimated total fixed costs:
Rent $250
Equipment costs $1,000
Cake Delivery costs $150

Required:

Prepare the Master Budget for Fancy Feast.

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2. A variance is the difference between an actual result and a budgeted amount. Variance analysis
helps organizations determine whether their people and processes are performing as expected.

Required:
Enter the identifying letters in the blanks below to indicate the term that best matches each
description.

A. Favorable variance F. Sales price variance

B. Flexible budget G. Sales volume variance
C. Input price variance H. Spending variance
D. Input quantity variance I. Total profit variance
E. Master budget J. Variance analysis

a._____ The difference between actual profit and master budget profit.

b._____ Profit effect associated with the difference between the budgeted and actual price of
an input.

c._____ Technique for determining why actual revenues, costs, and profit differ from their
budgeted amounts.

d._____ A difference between an actual result and a budgeted amount that leads to an
increase in profit.

e._____ The difference in profit between the flexible budget and the master budget.

f._____ A budget for the actual level of sales, retaining all other plan assumptions in the
master budget.

g._____ The difference between actual revenues and flexible budget revenues.

h._____ The budget as prepared at the start of the accounting period.

i._____ The difference between budgeted fixed costs and actual fixed costs.

j._____ Profit effect associated with the difference between the budgeted and actual input
quantity used.

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 Budgetary Control and Variance Analysis

3. Piney Creek Manufacturing Company produces high-end extreme weather tents. Piney Creek
has established the following budget for producing its XWT model for the most recent month.

Master Budget Actual Results

Number of tents sold 50 60
Sales price per tent $650 $635
Variable cost per tent $250 $240
Fixed costs $10,000 $10,000

Required:

a. What is Piney Creeks total profit variance for the most recent month

b. Calculate Piney Creeks sales volume variance for the month.

c. Calculate Piney Creeks sales price variance for the month.

4. Eagle Manufacturing makes extreme weather coveralls. Eagles budget called for 5 yards of
fabric at a cost of $12 per yard per unit. Actual production of 200 coveralls required 1,200 yards
of fabric at an actual cost of $11 per yard.
Required:

a. Calculate the material price variance.

b. Calculate the quantity variance.

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5. Hester and Gann, CPAs have a successful practice specializing in tax planning and preparation.
The firm, in addition to the two partners, employs 32 professional staff and 5 administrative
assistants. Hester and Gann do monthly variance analysis to keep apprised of excess labor costs
or materials costs (printing, software costs, etc.). However, the partners believe that increasing
employee morale and providing some extra incentives might increase productivity and decrease
errors.

Required:

a. What kinds of controls might Hester and Gann implement to decrease errors?

b. What kind of financial incentives might Hester and Gann implement to increase
productivity?

c. What kind of non-financial incentives might Hester and Gann implement to increase
productivity?

6. For the current month, Silversmiths Cutlery shop budgeted sales of 300 knives based on
capturing a 20% share of the market, estimated at 1,500 knives. The actual sales volume was
319 knives representing a 22% share of the market of 1,450 knives. Silversmiths budgeted
contribution margin per knife was $8.

Required:

a. Calculate Silversmiths sales volume variance.

b. Calculate Silversmiths market share variance.

c. Calculate Silversmiths sales volume variance.

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Solutions to Problems

1. Master Budget (LO1)

Fancy Feast Bakery

Master Budget

Revenue (300 cakes @ $20) $6,000

Variable costs (300 cakes)
Ingredients (300 @$4) $1,200
Labor 3,000
Overhead 150 4.350
Contribution margin $1,650
Fixed costs
Rent $250
Equipment costs 1,000
Cake delivery costs 150 1,400
Profit before taxes $ 250

2. Terms (LO1, LO2, LO3)

a.__I___ The difference between actual profit and master budget profit.

b._C____ Profit effect associated with the difference between the budgeted and actual price
of an input.

c.__J___ Technique for determining why actual revenues, costs, and profit differ from their
budgeted amounts.

d.__A___ A difference between an actual result and a budgeted amount that leads to an
increase in profit.

e.__G___ The difference in profit between the flexible budget and the master budget.

f.__B___ A budget for the actual level of sales, retaining all other plan assumptions in the
master budget.

g.__F___ The difference between actual revenues and flexible budget revenues.

h.__E___ The budget as prepared at the start of the accounting period.

i.___H__ The difference between budgeted fixed costs and actual fixed costs.

j.__D___ Profit effect associated with the difference between the budgeted and actual input
quantity used.

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3. Calculating and interpreting sales variances (LO1, LO2, LO3)

Master Budget Flexible Budget Actual Results

Revenue Revenue Revenue
(50 x $650) $32,500 (60 x $650) $39,000 (60 x $635) $38,100
Variable costs Variable costs Variable costs
(50 x $250) 12,500 ($60 x $250) 15,000 (60 x $240) 14,400
Contribution Contribution Contribution
margin 20,000 margin 24,000 margin 23,700
Fixed costs 10,000 Fixed costs 10,000 Fixed costs 10,000
Profit before taxes $10,000 Profit before taxes $14,000 Profit before taxes $13,700

a. Total profit variance = Actual profit Master budget profit

Total profit variance = $13,700 - $10,000 = 3,700 Favorable

b. Sales volume variance = Flexible Budget Profit Master Budget Profit

$14,000 - $10,000 = $4,000 Favorable

c. Sales price variance = Actual Revenue Flexible Budget Revenue

$38,100 - $39,000 = $900 Unfavorable.

4. Materials price and quantity variance (LO2)

a. Material price variance = (Actual price Budgeted price) x Actual quantity
($11 - $12) x 1,200 = 1,200 F

b. Quantity variance = (Actual quantity Budgeted quantity) x Budgeted price

(1,200 1,000) x $12 = $2,400 U

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 Budgetary Control and Variance Analysis

5. Choosing performance measures (LO4)

a. Controls to decrease errors:
Answers may vary. Several possible controls include:
Establish mentorship for new professional staff which includes methods of
helping staff minimize errors.
Hold periodic training on technical matters.
Hold periodic training on software to insure that the staff is fully utilizing
features that help minimize errors.
Set up teams to give weaker or new staff a tool for improvement.
Establish consequences when errors are unreasonably high.

b. Financial incentives to increase productivity:

Answers may vary. Several possible incentives include:
Establish cash rewards for individual levels of productivity.
Establish pay-raise standards for levels of productivity.
Establish bonus plans for teams.
Establish cash rewards for team productivity.

c. Non-financial incentives to increase productivity:

Answers may vary. Several possible incentives include:
Provide timely feedback to staff on productivity.
Establish consequences for non-productivity.
Establish rewards for the fewest errors (one day off, special parking, etc).
Provide time management training

6. Sales Volume, Market Size and Market Share Variances (App B)

a. Sales volume variance.

(Actual sales quantity budgeted sales quantity) x Budgeted unit contribution margin
(319 300) x $8 = $152 F

b. Market share variance.

Actual market size x (Actual market share budgeted market share) x budgeted unit
contribution margin
1,450 x (.22 - .20) x $8 = $232 F

c. Sales volume variance.

(Actual market size Budgeted market size) x Budgeted market share x budgeted unit
contribution margin.
(1,450 1,500) x .20 x $8 = $80 U

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End of Chapter Content

Short Answer

1. For many organizations, what is the benchmark for evaluating actual performance?

2. What is a master budget?

3. What is a variance?

4. What does it mean when a variance is favorable? What does it mean when a variance is
unfavorable?

5. What is the total profit variance?

6. What two subsidiary variances make up the total profit variance?

7. What is a flexible budget?

8. What is the sales volume variance?

9. What is the flexible budget variance? What three subsidiary variances make up the flexible budget
variance?

10. What is the sales price variance?

11. What is the fixed cost spending variance?

12. Each variable cost variance can be decomposed into two variances. What are these variances?

13. What is an input price variance?

14. What is an input quantity variance?

15. What is the function of a budget-reconciliation report?

16. What are the three primary reasons variances occur?

17. What are the three main rules to follow when conducting a variance investigation?

18. What are the two primary reasons organizations use nonfinancial measures in addition to financial
measures for control purposes?

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 Budgetary Control and Variance Analysis

Solutions to Short Answer

1. (LO-1) Many organizations use a budget as a benchmark for evaluating actual performance.

2. (LO-1) A plan that represents the expected revenues, costs, and profit corresponding to the
expected sales volume as of the beginning of the period.

3. (LO-2) The difference between an actual result and a budgeted amount is called a variance.

4. (LO-2) A favorable variance means that performance exceeded expectations actual revenue
exceeded budgeted revenue or actual cost was less than budgeted cost. An unfavorable variance
means that performance fell short of expectations actual revenue was less than budgeted revenue
or actual cost exceeded budgeted cost.

5. (LO-2) The total profit variance equals actual profit less master budget profit.

6. (LO-2) The sales volume variance and the flexible budget variance.

7. (LO-2) The budget at the actual level of sales.

8. (LO-2) The difference in profit between the flexible and master budgets.

9. (LO-2) The difference in profit between the actual results and the flexible budget. It is
comprised of the sales price variance, the fixed cost variance, and the variable cost variance.

10. (LO-2) The difference between actual revenues and flexible budget revenues.

11. (LO-2) The difference between budgeted and actual fixed costs.

12. (LO-2) A quantity variance and a price variance.

13. (LO-2) The difference between the as if budget and actual results for an input.

14. (LO-2) The difference between the flexible budget and the as if budget for an input.

15. (LO-3) It provides management with a summary that bridges actual and expected performance.
It helps pinpoint which areas to investigate in order to take appropriate corrective actions.

16. (LO-3) Variances could arise (1) during the normal course of operations, (2) a more permanent
change in the firms operating environment, and (3) budgets/standards are too tight or too loose.

17. (LO-3) (1) Investigate all significant variances, whether favorable or unfavorable, (2) Examine
trends, and (3) Consider the total picture.

18. (LO-4) (1) Timeliness, and (2) Specificity.

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Short Essay

1. Each of us regularly uses budgets and benchmarks to evaluate how we are doing or what we could
do to improve. Can you list three examples from everyday life?

2. Some argue that making the master budget hard to achieve or tight can help eliminate waste and
make organizations more efficient. Others argue that master budgets should be loose because
they provide room for discretion in decision making. What do you think?

3. List some examples of variances that you calculate in everyday life? Think about getting a test back
or analyzing other peoples actions (e.g., we often say things like I cant believe they did that!). Do
you think variances influence the behavior of animals such as family pets? What does this say
about the widespread use of variance analysis?

4. When will the sales volume variance be unfavorable? When will the sales price variance be
unfavorable? Is it possible to have an unfavorable sales volume variance and an unfavorable sales
price variance?

5. If the sales volume variance is favorable, does this imply that for inputs such as materials and labor,
the actual quantity of the input used will be greater than the flexible budget quantity of the input?
Why or why not?

6. When will the materials price variance be unfavorable? Does an unfavorable materials price
variance necessarily indicate a control problem? Explain why or why not.

7. When will the materials quantity variance be unfavorable? Might an unfavorable materials quantity
variance be related to other variances, such as the materials price variance and the labor quantity
variance? Explain why or why not.

8. Many firms (particularly firms using a Just-in-Time inventory philosophy) enter into long-term
contracts with a few suppliers. Do you believe this has implications for the materials price variance?
Just-in-Time firms also encourage workers to stop production rather than produce a defective unit.
Could this policy have implications for the labor quantity variance?

9. Why might a favorable sales volume variance lead to an unfavorable fixed cost spending variance?
How does your answer reconcile with the fixed cost/ variable cost classification of costs?

10. Statistical control charts establish upper and lower control limits. Observations falling outside these
limits or a sequence of observations above or below the expected value, even if within the control
limits, trigger an investigation. How does this practice conform to our description of how firms use
profit variance analysis?

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11. If nonfinancial measures are both more timely and more specific than financial measures, why do
firms use financial measures at all? (Hint: Consider whether a manager should implement a decision
that increases one nonfinancial measure but decreases another nonfinancial measure. For example,
decreasing the mean time per call handled increases the efficiency of customer support staff but
potentially decreases service quality and customer satisfaction.)

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Solutions to Short Essay

1. (LO-1) Think of a budget you may have in any given month for eating out, for entertainment --
playing video games in the local arcade or going to the movies, and for clothing. At the end of the
month, you may realize that you have spent a lot more on video games that you had budgeted
because you had gotten addicted to a new game!

2. (LO-1) Both arguments are valid. Tight but achievable budgets are a way to motivate people in
organization to become more careful and efficient. However, tight budgets could be very
demotivating if they are unachievable, and could lead to a loss in employee morale. Tight budgets
are especially effective when the tasks involved are specific, well-defined, and routine. Loose
budgets are more suitable when tasks are not well-specified and outcomes are uncertain. A good
example is research and development efforts in, say, pharmaceutical company. These companies
have to invest in R&D to stay ahead of competition, but it is difficult to specify a tight budget when it
comes to the discovery of new drugs. Planning and control for such activities have to be more
informal and inter-active.

3. (LO-2) Think about the mid-terms you take. You plan to spend a certain amount of time on
each subject based on your assessment of the difficulty of each subject. When you get your grades
back, you may not have done as well as you might have expected in some subjects, and you may
have done exceedingly well in others. This helps you in allocating your time to study for the finals.
Variances influence the behavior of any intelligent living being. For example, they are extremely
useful in modifying the behavior of pet dogs and cats. They can detect changes in patterns and
modify their behavior accordingly.

4. (LO-2) Sales volume variance will be unfavorable when the actual sales volume is less than
planned sales volume underlying the master budget. Sales price variance will be unfavorable when
the actual sales price is less than the expected sales price at the time of preparing the master
budget. Yes, it is possible. Think of the reduced demand for trucks and SUVs in response to steeply
rising fuel price in the first six months of 2008. The auto companies are reducing the prices on these
vehicles drastically to increase sales. Yet, despite such price cuts, the sales of these vehicles
plummeted during this period.

5. (LO-2) Not necessarily. The sales volume variance has nothing to do with input quantities. It
will be favorable when the actual sales volume (i.e., output sold) is greater than the planned sales
volume underlying the master budget.

6. (LO-2, LO-3) The materials price variance will be unfavorable if the actual price of materials is higher
than the budgeted price. It may not always indicate a control problem. Unexpected shortages in the
market can cause the price of materials to increase. The purchase manager cannot be held
responsible for such eventualities.

7. (LO-2, LO-3) The material quantity variance will be unfavorable if the actual quantity consumed is
more than the budgeted quantity for the actual output produced. A favorable materials price may
well be related to an unfavorable quantity variance if substandard materials are bought (hence a
favorable price variance) and used in the production process (use of more materials than required

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because of low quality). For similar reasons, an unfavorable labor quantity variance (use of more
labor than budgeted) may be related to favorable quantity variance if inexperienced labor is used.

8. (LO-3) Some of the traditional variances lose their meanings in lean production environments
such as JIT, FMS environments. Entering into long-term contracts with suppliers ensures stable
supply of critical inputs. However, firms often pay a premium for such arrangements. Budgets have
to reflect this philosophy so that traditional variances can serve a meaningful control role (if at all).
By the same token, new variances may have to be designed that can be useful in such environments.
Turning to the labor quantity variance, the focus in a JIT environment is to achieve high quality levels
with minimal defective production. Instead of focusing on the traditional labor quantity variance in
such settings, simple variances such as the deviation of the output rate from an expected rate can
be effective for control purposes.

9. (LO-3) As we know, Sales volume variance will be favorable when the actual sales volume is
more than planned sales volume underlying the master budget. Unexpected demand spurts can lead
such a favorable variance. But when such a spurt occurs, capacity resources get stretched, in which
case the actual fixed costs are likely to increase (e.g., rental of additional equipment, overtime paid
for supervision etc.)

10. (LO-4) We can think of the expected value as being similar to budgets. Any deviation within the
control limits is acceptable if it does not persist over time, or if it is just a chance deviation.
Persisting deviations even within control limits is often an indication of a shift in the process that
may worsen if not corrected. In principle, profit variance analysis is very similar. If production costs
go up, unfavorable variances will be generated. Persisting variances may be indicative of a shift in
cost structure or process efficiencies.

11. (LO-4) While non-financial measures are specific and timely, they are often numerous and they
interact with one another. Increasing customer satisfaction often requires spending more time with the
customer. Both customer satisfaction measures and mean time per call are non-financial measures that
are (typically) related to each other. Deciding how much time to spend on each customer requires
trading off the long-term financial benefit from keeping customers satisfied against the cost of time and
resources needed.

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Exercises

1. Garnets Gym is a fitness and aerobic center located in Atlanta, Georgia. The following table reports
Garnets master budget and actual results for the most recent year:

Master Budget Actual Results

Membership fee (per member) $500 $550
Number of members 5,000 4,000
Variable cost (per member) $200 $200
Fixed costs $1,200,000 $1,200,000

With regard to the discrepancies between the budgeted and actual membership fee and the budgeted
and actual number of members, the owners of Garnets Gym inform you that in early January they
decided to raise the membership fee from $500 to $550. The owners believed that such an action would
only reduce membership by 500 rather than 1,000, as actually occurred.

Required:
a. What was Garnets total profit variance for the most recent year?

b. Calculate Garnets sales volume variance and sales price variance for the most recent year. Did
raising the membership fee turn out to be a good idea?

c. Would raising the membership fee have been a good idea if membership decreased by 500 (as
predicted) rather than 1,000?

2. The Glass Vessel Company has established the following budget for producing one of its hand-blown
vases:
Materials (silica) 2 pounds @ 1.25 per pound
Labor 1.5 hours @ $15.00 per hour
In March of the most recent year, Glass Vessel produced 300 vases using 650 pounds of materials.
Glass Vessel purchased the 650 pounds of materials for $845. Labor costs for March were $7,200 for
480 hours worked.

Required:
a. What were Glass Vessels materials price and materials quantity variances for March?

b. What were Glass Vessels labor price and labor quantity variances for March?

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 Budgetary Control and Variance Analysis

3. Assume that you are a franchisee of a fast-food chain, Pita Palace, that serves made-to-order
pitas. The menu, prices, and decor are dictated by the national office; further, you are required to
purchase all of your supplies through a specified distributor. Your primary responsibility is to ensure
adequate staffing and to exercise quality control. Naturally, as the franchisee, you also are keenly
interested in your stores profitability.

Required:
a. As the franchisee, list two financial measures and two nonfinancial measures that you
would monitor on a short-term (e.g., weekly) basis.

b. Why do think it is important to use both financial and nonfinancial measures?

4. Tom and Lynda own Hercules Health Club. For the month of April, they had forecasted gym
membership at 700 individual members and 300 family memberships. Individual members pay $100
per month and families pay $150 per month. Variable costs are $35 and $60 per month,
respectively. Actual results for April show membership at 750 individual and 250 family members.

Required:
a. Determine Hercules sales volume variance.

b. Decompose the sales volume variance into a sales mix variance and a sales quantity variance.

c. Why did Hercules contribution decrease even though the total memberships were the same?

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Solutions to Exercises

1. (LO1, LO2, LO3)

a. The total profit variance = actual profit master budget profit. With the information provided,
we have:
Master Actual
Budget Results
# of members 5,000 4,000
Revenue $2,500,000 $2,200,000
Variable costs 1,000,000 800,000
Contribution margin $1,500,000 $1,400,000
Fixed costs 1,200,000 1,200,000
Profit $300,000 $200,000

Garnets total profit variance = $200,000 $300,000 = ($100,000) or $100,000 U. That is,
Garnets profit was $100,000 lower than expected.

b. To arrive at the sales volume variance and the sales price variance, we need to calculate
Garnets flexible budget. With the data provided, we have:
Flexible
Budget
# of members 4,000
Revenue1 $2,000,000
Variable costs2 800,000
Contribution margin $1,200,000
Fixed costs 1,200,000
Profit $0

1
$2,000,000 = 4,000 $500.
2
$2,800,000 = 4,000 $200.

The following table shows Garnets master budget, flexible budget, and actual results for the
most recent year.

Master Flexible Actual

Budget Budget Results
# of members 5,000 4,000 4,000
Revenue $2,500,000 $2,000,000 $2,200,000
Variable costs 1,000,000 800,000 800,000
Contribution margin $1,500,000 $1,200,000 $1,400,000
Fixed costs 1,200,000 1,200,000 1,200,000
Profit $300,000 $0 $200,000

The sales volume variance equals the difference between flexible budget profit and master
budget profit. For Garnets Gym, we have $0 $300,000 = ($300,000) or $300,000 U sales
volume variance.

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 Budgetary Control and Variance Analysis

The sales price variance equals the difference between actual revenue and flexible budget
revenue. For Garnets Gym, we have $2,200,000 $2,000,000 = $200,000 F sales price variance.

NOTE: Garnets total profit variance of $100,000 U = $300,000 U sales volume variance +
$200,000 F sales price variance. This occurs because actual fixed and variable costs equaled
budgeted fixed and variable costs (i.e., both the fixed cost spending variance and the flexible
budget variable cost variance = $0).

Based on the sales variances, it appears that raising the membership fee was not a good idea as
it reduced Garnets profit by $100,000. In essence, the increased revenue generated from
raising the membership fee (i.e., the favorable sales price variance) did not compensate for the
reduction in members from raising the membership fee (i.e., the unfavorable sales volume
variance).

c. This question links back to the material covered in Chapters 4 and 5. At the time the decision
was made, raising the membership fee to $550 was expected to increase profit by $75,000.
This can be seen by comparing expected profit with and without the increase in the
membership fee:
Budgeted Profit Expected Profit
(without fee increase) (with fee increase)
# of members 5,000 4,500
Revenue1 $2,500,000 $2,475,000
Variable costs2 1,000,000 900,000
Contribution margin $1,500,000 $1,575,000
Fixed costs 1,200,000 1,200,000
Profit $300,000 $375,000

1
: $2,500,000 = 5,000 $500; $2,475,000 = 4,500 $450.
2
: $1,000,000 = 5,000 $200; $900,000 = 4,500 $200.

Alternatively, we could calculate the benefit of increasing the membership fee as 4,500 $50 =
$225,000 and the cost (lost contribution margin due to 500 fewer members) as 500 ($500
$200) = $150,000, again netting to a $75,000 increase in profit. Either way, the decision
appeared to be a good one based on the data available at the time the decision was made.
Unfortunately, the actual decrease in membership was double that expected (1,000 vs. 500),
leading to a $100,000 reduction in profit, as documented earlier.
This problem underscores the importance of conducting variance analysis what appeared to
be a good decision turned out to be a poor decision (in terms of the bottom line, anyway). Had
we not undertaken a retrospective examination of the owners decision to increase the
membership fee (i.e., by calculating the sales price and sales volume variances) the negative
effect on profit might have gone unnoticed. With variance analysis, the owners are in a position
to correct the decision they previously made based on our calculations, the owners should
seriously consider going back to a $500 annual membership fee in the coming year.

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2. LO2
a. To calculate the materials price and quantity variances, we need to know: (1) the flexible
budget for materials; (2) the as if budget for materials with actual efficiencies; and (3) the
actual results. The table below provides the required computations and accompanying
variances.
Flexible Quantity As if Price Actual
1 2
Budget Variance budget Variance Results3
Materials $750 $62.50 U $812.50 $32.50 U $845

1
$750 = 300 vases actually produced 2 pounds of materials budgeted per vase $1.25
budgeted cost per pound.
2
$812.50 = 650 pounds of materials actually used $1.25 budgeted cost per pound.
3
Given.

Thus, Glass Vessels materials price and quantity variances were $32.50 U and $62.50U,
respectively, for March.

b. As in part [a], to calculate the labor price and quantity variances, we need to know: (1) the
flexible budget for labor; (2) the as if budget; and (3) the actual results. The table below
provides the required computations and accompanying variances.

Flexible Quantity As if Price Actual

Budget1 Variance budget2 Variance Results3
Labor $6,750 $450 U $7,200 $0 $7,200

1
$6,750 = 300 vases actually produced 1.5 hours of labor budgeted per vase $15.00
budgeted cost per labor hour.
2
$7,200 = 480 hours actually worked $15 budgeted cost per labor hour.
3
Given.

c Thus, Glass Vessels labor price and quantity variances were $0 and $450 U, respectively, for
March.

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3. LO4
a.
As the franchisee, you need to monitor both financial measures (for assessing business profit)
and non-financial metrics (for ensuring adherence to policies and to identify future problems
and opportunities).

Financial Performance Measures:

On a short-term (daily and/or weekly) basis, you probably will monitor total sales (as per the
register) and receipts (as per the cash drawer). This informs you of what is coming into the
business and whether it differs from the prior week or budget. Further, a reconciliation between
total sales (per the register) and receipts informs you of whether you have problems with regard
to employee theft (i.e., employees taking money and/or not charging their friends for meals).

You also probably would track total purchases and total labor costs. In this business, purchases
of food items and supplies and labor represent the bulk of your variable costs. Similar to sales,
these items can be compared to the budget, with any significant deviations being followed up.
Finally, by tracking sales, purchases, and labor costs, you monitor your weekly contribution
margin; again, this enables you to assess any increases or decreases relative to the budget.

Non-Financial Performance Measures:

Here, you probably would track things like customer complaints and employee
absenteeism/turnover (complaints and absent employees are early warning signs that
something is wrong). You also might track materials usage, which is important both to ensure
that customers are not getting short-changed in the amount of food served and to prevent
pilferage. Finally, you would track the cleanliness of the restaurant and facilities and assure
general adherence to daily procedures (e.g., employees wear gloves, all doors are locked at days
end, counters are wiped down).

b.
Non-financial measures are more immediate (timely) and actionable (specific); they ensure that
people are doing what they are supposed to be doing and that processes are performing as
expected. Such measures can help identify and correct problems before they become severe
(e.g., for a sports analogy, if players are not showing up for practice, this decreases the chances
of doing well).

Financial measures tend to be more aggregate in nature; they are excellent summary measures
showing how a business has performed for a given period of time. These measures allow us to
quickly assess whether the business is on track or in need of help (similar to the win-loss record
of a sports team).

The two types of measures clearly are related. For example, employee absenteeism would show
up eventually in the financial statements both in the form of reduced sales and increased
staffing cost. Tracking absenteeism directly allows for immediate identification of problem
employees with a ready-made solution.

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4. Appendix C
a. Using the information provided, we have:

Master Budget Flexible Budget

Individuals 700 750
Families 300 250
Revenue Individual $70,000 $75,000
Revenue Family 45,000 37,500
Variable costs - Individual 24,500 26,250
Variable costs - Family 18,000 15,000
Contribution margin $72,500 $71,250

Sales volume variance = flexible budget profit master budget profit = $71,250 $72,500 =
$1,250 U.

b.
We gain intuition into the operating results by recasting the above data using a Weighted Unit
Contribution Margin (WUCM). We have the

WUCMmaster = $72,500 / (700 + 300 memberships) = $72.50 / membership.

WUCMflexible = $71,250 / (750 + 250 memberships) = $71.25 / membership.

We could compute the answers using the formulae provided in Appendix C.

Sales Mix Variance = Actual Total Sales (WUCMflexible budget WUCMmaster budget).

Sales Quantity Variance = (Actual Total Sales Budgeted Total Sales)

WUCMmaster budget.
Plugging in the numbers we have:

Sales Mix Variance = 1,000 ($72.5 - $71.25) = ($1,250) or $1,250 U.

Sales Quantity Variance = (1,000 1,000) $72.50 = $0.

c.
The change in the sales mix is the sole reason for the change. The sales mix has shifted toward
the less profitable (on a per unit basis) individual memberships and away from the more
profitable family memberships. Consequently, the average member now only yields $71.25 in
contribution margin rather than the budgeted amount of $72.50. This change in mix over
1,000 total memberships leads to a net drop of $1,250 in profit ($1,250 = 1,000 $1.25).

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