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7-1CHAPTERCHAPTER7FLEXIBLEBUDGETS,DIRECT-COSTVARIANCES,ANDANDMANAGEMENTMANAGEMENTCONTROLCONTROL7-1Management by exceptionis the practice of concentrating on areas not operating asexpected and giving less attention to areas operating as expected. Variance analysis helpsmanagers identify areas not operating as expected. The larger the variance, the more likely anarea is not operating as expected.7-27-2Two sources of information about budgeted amounts are (a) past amounts and (b)detailed engineering studies.7-3Afavorable variance––denoted F––is a variance that has the effect of increasingoperating income relative to the budgeted amount. Anunfavorable variance––denoted U––is avariance that has the effect of decreasing operating income relative to the budgeted amount.7-4The key difference is the output level used to set the budget. Astatic budgetis based onthe level of output planned at thestart of the budget period. Aflexible budgetis developed usingbudgeted revenues or cost amounts based on the actual output level in the budget period. Theactual level of output is not known until theend of the budget period.7-5A flexible-budget analysis enables a manager to distinguish how much of the differencebetween an actual result and a budgeted amount is due to (a) the difference between actual andbudgeted output levels, and (b) the difference between actual and budgeted selling prices,variable costs, and fixed costs.7-6The steps in developing a flexible budget are:Step 1: Identify the actual quantity of output.Step 2: Calculate the flexible budget for revenues based on budgeted selling price andactual quantity of output.Step 3: Calculate the flexible budget for costs based on budgeted variable cost per outputunit, actual quantity of output, and budgeted fixed costs.7-77-7Four reasons for using standard costs are:(i)cost management,(ii)pricing decisions,(iii)budgetary planning and control, and(iv)financial statement preparation.7-8A manager should subdivide the flexible-budget variance for direct materials into a pricevariance (that reflects the difference between actual and budgeted prices of direct materials) andan efficiency variance (that reflects the difference between the actual and budgeted quantities ofdirect materials used to produce actual output). The individual causes of these variances can thenbe investigated, recognizing possible interdependencies across these individual causes.
7-27-97-9Possible causes of a favorable direct materials price variance are:purchasing officer negotiated more skillfully than was planned in the budget,purchasing manager bought in larger lot sizes than budgeted, thus obtaining quantitydiscounts,materials prices decreased unexpectedly due to, say, industry oversupply,budgeted purchase prices were set without careful analysis of the market, andpurchasing manager received unfavorable terms on nonpurchase price factors (such aslower quality materials).