2.2 Flexible Budgets and Variance Analysis

Question 1

What are….

1. Static Budgets?
2. Flexible/ Variable Budgets?

and when are they used?

Answer 1

Static
- SB for one expected level of activity only, e.g. sale of 9000 units

Flexible / Variable
- adjusts for changes in sales volume and other cost-driver activities
- develop flexible budget based on revenue and cost behavior using flexible budget formulas
- budget formula can be used for forecasting based on expected level of cost driver activities

Question 2

What are (un-)favourable variances?

1.
2.
3.
4.

Answer 2

• deviations from plans are called variances
• variances are favourable or unfavourable depending on the direction of the effect on profitability
• favourable and unfavourable labels indicate only directional relationship, no indication whether variance is good or bad
• managers need to carefully determine reasons and evaluate implications of variances

Question 3

Definition Variances | What is the static budget variance? (static budget versus actual)

Answer 3

• difference between actual results and the static budget (where budgeted level and actual level of output achieved might differ)

Question 4

Definition Variances | What is the flexible budget variance? (flexible budget versus actual)

Answer 4

• difference between actual results and the flexible budget for the actual level of output achieved

Question 5

Definition Variances | What is the activity level variance? (flexible budget versus static budget)

1.
2.
3.

Answer 5

• differences beween flexibile budget amounts and the amounts in the static budget
• use of identical standard variable cost and standard fixed costs
• variance results from different assumptions in activity level

Question 6

Example for Activity Based Flexible Budgets | Four different activities and cost drivers

Answer 6

• processing (number of machine hours)
• setup (number of setups)
• marketing (number of orders)
• administration (number of units)

Question 7

What is the role of Standards in Determining Variances? What are standard prices and standard costs?

1.
2.
3.

Answer 7

• variances depend on prices and costs used in budget formulas
• standard prices and standard costs: prices and costs used in budget formulas are called standards are benchmarks
• level at which standrads and thus benchmarks are set create certain incentives for managers

Question 8

Setting standards and their impact on variance & managers incentives

1. easily attendable standards
2. attainable standards
3. unattainable standards

Answer 8

1. result in large favourable incentives | does not provide much motivation
2. result in that variances are useful for management by exception | accepted as reasonable perfomance goals
3. result in large unfavourable variances | unrealistic goals will be ignored

Question 9

What is Effectiveness?

Answer 9

• The degree to which a predetermined target, goal or objective is met
• “are we doing the right things?”

Question 10

What is Efficiency?

Answer 10

• The relative amount of inputs used to achieve a given output level
• The fewer inputs used for a given level of output or the greater the output for a given level of input, the greater the efficiency
• “are we doing things right?”
  DEGREE to which an organization minimizes resources used to achieve an objective

Question 11

What are trade offs among variances?

Answer 11

• level of performance in one area of operations affects performance in other areas

Question 12

When should we investigate Variances?

1.
2.
3.

Answer 12

• Have to differentiate between critical and non-critical items
• For non-critical items, define absolute and relative range of acceptable variances so that benefits > cost of investigation
• e.g. investigate all variances exceeding either €5000 or 15% of expected cost

Question 13

What can be said regarding Variances and comparison with prior periods?

1.
2.

Answer 13

• Some organizations compare most recent budget period´s actual results with last year´s results for the same period
• Even comparisons with the prior month´s actual results may not be as useful as comparisons with an up to date flexible budget

Question 14

Formula for Flexible Budget

Answer 14

units of actual output achieved * standard input allowed per unit of output * standard price/ cost per unit of input

Question 15

Formula for Price Variance

Answer 15

(Actual Price per unit - Standard price per unit) * actual qty used

Question 16

Formula for Quantity Variance

Answer 16

( Actual Quantity Used - Standard Quanitty) * standard price per unit

Question 17

Formula for Flexible Budget Variance

Answer 17

Price Variance + Quantity Variance

Question 19

What is the formula for static BV

Answer 19

Flexible BV + Activity Level V