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Supplement_VarianceAnalysis

# Supplement_VarianceAnalysis - 6A:002 Berg Flexible Budgets...

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6A:002 Berg Flexible Budgets and Variances Page 1 Supplement to Chapter 11 Flexible Budgets and Variances Budgets are often used as benchmarks to determine how successful (or unsuccessful) a firm was in meeting its financial plan during a particular period. In Chapter 10, we examined how these plans are developed. In chapter 11 and this supplement, we examine how the Master Budget (the planned income statement) is used as a benchmark for evaluating the firm’s performance. To make things more concrete, we’ll examine Excelsior, Inc., a manufacturer of high quality metal replica cars. In planning for the month of May, Excelsior prepares the following budget. The budget contains information about planned sales volume, planned selling price, planned variable costs, and planned fixed costs. Generally it is valuable to present the budget in contribution margin format to highlight the way costs behave. Excelsior, Inc. Master Budget: May Sales Volume 5,000 Sales Revenue (\$100 * 5,000 units) \$500,000 Variable Costs: Direct Materials (\$20 * 5,000 units) \$100,000 Direct Labor (\$60 * 5,000 units) 300,000 Contribution Margin \$100,000 Fixed Costs 50,000 Profit \$ 50,000 From this budget, you can tell that Excelsior’s planned profit function (where Q represents quantity sold) is: Profit = \$100 * Q - \$80 * Q - \$50,000 = \$20* Q - \$50,000 and that the firm plans to sell 5,000 units. At the end of May, Excelsior reports the following actual income statement: Excelsior, Inc Actual Income Statement Sales Volume 6,000 Sales Revenue \$540,000 Variable Costs: Direct Materials \$132,000 Direct Labor 300,000 Contribution Margin \$108,000 Fixed Costs 64,000 P r o f i t \$ 4 4 , 0 0 0

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6A:002 Berg Flexible Budgets and Variances Page 2 These are very different results than Excelsior expected. Management will want to know why things differed from their plan so that they can fix problems or adjust future budgets. Both these actions are important. If there are correctable reasons that actual results differed from the budget, management will want to make those correction so that future profit is higher. If, on the other hand, the firm’s environment has changed so that the assumptions underlying the original budget are no longer valid, the firm will want to re-plan around those new conditions so that it can take advantage of the increased profit that results from improved coordination and communication. What can cause actual results to differ from the budget? This is the same as asking what assumptions were made when the plan was developed. Recall that the firm made assumptions about sales volume, planned selling price, planned variable costs, and planned fixed costs. And, in planning each of the variable costs, the firm planned both the amount of the variable input that would be used and the purchase price of that input. So, the things that could cause actual results to differ from the budget are: Customers demanded less or more than we expected (that is, sales volume differed) The price we charged was less or more than we planned to charge (selling price differed)
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Supplement_VarianceAnalysis - 6A:002 Berg Flexible Budgets...

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