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Unformatted text preview: Chapter 8 Performance Evaluation Answers to Questions 1. A static budget is based on the expected or planned volume of activity. An example of a static budget would be the master budget prepared for planning purposes. Flexible budgets differ from static budgets in that they show the estimated amount of revenues and costs that are planned at a variety of different levels of activity. Static budgets are used for planning purposes in determining labor, material, cash, and equipment needs for a variety of different poten- tial activity levels. Flexible budgets are used also for performance evaluation. Since flexible budgets can be prepared for the actual level of activity, volume influences on budget variances can be isol- ated allowing departments, managers, or employees to be evaluated on the price and usage of materials, labor, and overhead. These are factors over which they have control and would be reasonable measures of performance. 2. Mr. Smith is assessing his performance based on a comparison between a static budget and actual results. Since a static budget is based on the planned level of activity, Mr. Smiths numbers could be the result of a decrease in production. The volume of sales determ- ines the level of production. Costs would be less if fewer units were produced than planned. To judge Mr. Smiths performance fairly, his results should be compared with a flexible budget in order to eliminate the effects of sales volume over which Mr. Smith has no control. 3. Sales variances are favorable when actual sales are greater than planned sales and are unfavorable when actual sales are less than planned sales. Cost variances are favorable when actual costs are less than planned costs and are unfavorable when actual costs are greater than planned costs. 8-1 Chapter 8 Performance Evaluation 4. Many circumstances at the production level could affect Joans sales. Low quality control in the production process could lead to lower quality goods that are difficult to sell. Delays in the produc- tion process could affect the availability of products and inhibit sales volume. Failures in the production department to satisfy customer specifications could also limit sales. Careful investiga- tion of significant sales volume variances can substantiate who is responsible for poor sales performance. 5. To determine volume variances a static budget based on planned volume is compared to a flexible budget based on actual volume. When actual volume is greater, variable costs are planned to be greater under the flexible budget. Variable costs increase propor- tionately with volume increases. Since sales revenues also in- crease proportionately with increases in volume, the increase in costs is off set by an increase in volume, thereby resulting in a higher contribution margin. Unfavorable variable cost volume variances should not be interpreted as poor performance until there is a significant decrease in contribution margin. If the in- crease in volume affects costs per unit, there may be some justi-...
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This note was uploaded on 11/05/2008 for the course ACC U301 taught by Professor Udihoitash during the Fall '08 term at Northeastern.
- Fall '08
- Managerial Accounting