Fixed Budgets and Variances

Question 1

What is the control element of budgets and why are flexed budgets used?

Answer 1

The control element of a budget is the comparison between budget performance and actual performance. Flexed budgets are used to make the comparison meaningful by flexing the budget on actual activity levels.

Question 2

Where should care be taken when flexing budgets?

Answer 2

When dealing with fixed and variable costs.

Question 3

What are the limitations of budget flexing?

Answer 3

The budget is made from assumptions and these should be revisited when flexing the budget such as, limiting factors, inflation, future assumptions and demand.
Splitting mixed costs can be complex and time consuming.
Fixed costs can be stepped with changing activity.
Moral can be affected when continuously changing budgets.

Question 4

When looking at profit how does absorption costing differ from marginal costing?

Answer 4

Absorption costing applies a part of the overhead for the period into the cost units whereas marginal costing writes off the overhead costs in each accounting period. When inventories are rising using absorption costing profits appear more favourable as overhead costs are carried forward to the next period. However when inventories are falling profits will appear less favourable as additional overheads are being written off in the current period.

Question 5

How do you reconcile profit between marginal and absorption costing?

Answer 5

Absorption cost profit + Increase/decrease in inventory x fixed cost per unit = Marginal cost profit

Question 6

What are the three direct labour variances?

Answer 6

Direct labour rate variance.
Labour efficiency variances.
Total labour cost variance.

Question 7

How do you calculate the direct labour rate variance?

Answer 7

1. Calculate standard rate: Budgeted total cost/budgeted labour hours
2. Calculate actual rate: Actual total cost/actual labour hours
3. Calculate labour rate variance: (Standard rate-actual rate) x actual hours

Question 8

How do you calculate the labour efficiency variance?

Answer 8

1. Calculate standard efficiency: Budgeted labour hours/budged output volume
2. Calculate actual efficiency: Actual labour hours/actual output volume
3. Calculate labour efficiency variance: (standard efficiency-actual efficiency) x standard rate x actual output volume

Question 9

How do you calculate the labour cost variance?

Answer 9

This is the sum of direct labour rate variance and direct labour efficiency variance. It can also be calculated as follows:

1. Calculate budgeted cost per item: budgeted total cost/budgeted output volume
2. Calculate actual cost of output: budgeted cost per item x actual output volume
3. Calculate total labour cost variance: budgeted cost of actual output – cost of actual output.

Question 10

What are the three direct material variances?

Answer 10

Direct material unit price variance.
Direct material usage variance.
Total material cost variance.

Question 11

How do you calculate the direct material unit price variance?

Answer 11

1. Calculate standard price: Budgeted total cost/budgeted materials used
2. Calculate actual price: Actual total cost/actual materials used
3. Calculate material price variance: (Standard price-actual price) x actual usage

Question 12

How do you calculate the direct material usage variance?

Answer 12

1. Calculate standard usage: Budgeted material usage/budgeted output volume
2. Calculate actual materials usage: Actual material usage/actual output volume
3. Calculate material usage variance: (Standard usage – actual usage) x standard price x actual number of items

Question 13

How do you calculate the total material cost variance?

Answer 13

This is the sum of direct material price variance and direct material usage variance. Or can be calculated as follows:

1. Calculate budgeted cost per item: Budgeted total cost/items
2. Calculate budgeted cost of actual output: Budgeted cost per item x actual number of items
3. Calculate total material cost variance: Budgeted cost of actual output - Cost of actual output.

Question 14

What are the six different reasons for variances?

Answer 14

Materials: Price & usage
Labour: Labour rate per hour and labour hours per unit
Overhead: Fixed overheads and variable overhead costs
Control factors: buying material of a lower grade, taking advantage of discounts.
Planning factors: When setting the budget many factors are calculated guesses and it is important to differentiate those from variances caused by other decisions.
Standard costs are out of date.

Question 15

How does an increase in sales affect a flexed budget?

Answer 15

An increase in sales is already accounted for within a flexed budget and any sales variances are not due the the increased activity.

Question 16

What is an interdependence of variables?

Answer 16

An interdépendance of variables is when two or more variables may relate to each other such as the purchase of new machinery will increase the overhead utility bill by causing an adverse variance but labour and idle time will be more efficient causing generally an overall favourable variance.

Question 17

Who are responsible for variance?

Answer 17

Managers are responsible for their area of management and the variances within it.

Question 18

What is responsibility accounting?

Answer 18

Responsibility accounting is a method of budgeting that compares actual costs to budgets for each of the responsibility centres. Managers of a profit centre will be responsible for both cost and revenue variances. Managers of an investment centre will have responsibility of costs and revenue, asset and liability and capital employed variances.

Question 19

How often should standard costs be reviewed and when should they be changed?

Answer 19

Standard costs should be reviewed at least annually and only changed when there is a long term or permanent change in the cost or the resource or the usage.

Question 20

How should variances be calculated generally?

Answer 20

Variances should be calculated by comparing the actual results to a flexed budget for the same level of activity.

Question 21

What three aspects of variances define whether they should be investigated or not?

Answer 21

• Materialaility and significance
• Trend
• Controllability

Question 22

Describe how materiality and significance defines whether a variance should be investigated.

Answer 22

Variances that are significant to the operations and results of the business will need to be investigated. Materiality will be set by each organization but there are two methods of determining whether a variance is material:

1. An absolute amount may be set such as £10,000 and all adverse and favourable variances will be investigated over that.
2. A percentage of the standard costs, such as 10% adverse or favourable will be investigated.

Question 23

Describe how trend defines whether a variance should be investigated.

Answer 23

Sometimes a variance alone in a period may not be deemed material, but if that trend continues throughout the year it will need to be investigated as it suggests there is an underlying reason for the variance rather than simply random factors.

Question 24

Describe how controllability defines whether a variance should be investigated.

Answer 24

If a manager has control over a cost then variances arising from it can be investigated but first it must be clear that the manager is responsible for that cost.

Question 25

How is the motivation of managers affected by controllable costs and revenues?

Answer 25

Identifying controllable costs can motivate and de-motivate managers. If costs and revenues are reported as being part of the managers role but they have no control over them this can be de-motivating.

Question 26

What us feedback and feedforward?

Answer 26

Feedback is the process of analysing actual results to the budget to enable decision making whereas feedforward is the use of actual current results to influence the budgeting process for the next period.

Question 27

What does the budgeting cycle consist of?

Answer 27

The budgeting cycle consist of setting the organizational goals, planning, using budgets, obtaining feedback from comparison of actual results to budgeted results and implementing feed forward from actual results to the budgeting process.