Budgetary Control and Variance Analysis

CHAPTER 8
BUDGETARY CONTROL AND VARIANCE ANALYSIS

TRUE/FALSE

1. If sales volume exceeds expectations, actual profit will always be higher than budgeted profit.

2. Variance analysis may be performed to isolate the profit impact of individual input and output
factors.

3. Variance analysis is a technique used for determining the profit effect due to differences between
the actual and budgeted size of the market for a product.

4. For most organizations, a budget is the benchmark for evaluating actual performance.

5. A good plan is the foundation for effective control.

6. The input quantity variance is also referred to as the input efficiency variance because it captures
the efficiency of input resource use.

7. A variance is the difference between a budgeted amount and a forecasted amount.

8. Any profit difference between the master and flexible budgets is due solely to the difference
between budgeted and actual sales.

9. Total Profit Variance = Actual Profit – Master Budget Profit.

10. Sales Volume Variance = (Actual Sales Quantity – Budgeted Sales Quantity) x Actual Unit
Contribution Margin

11. A budget reconciliation is a report that uses variances to reconcile the difference between master
budget profit and actual profit.

12. If a materials input price is higher than budgeted, the result is an unfavorable materials efficiency
variance.

13. Small variances probably indicate random factors at work while large variances could signal a
permanent change in the operating environment.

14. Cost variance analysis in a single-product company differs significantly from a multi-product
company.

15. Cheaper ingredients lead to a favorable price variance, but also may lead to unfavorable quantity
variances.

16. The primary limitations of variance analysis pertain to relevance and feedback.
Balakrishnan/Managerial Accounting, 2e

17. The lack of timeliness and specificity in financial variances force organizations to use primarily non-
financial controls to ensure that they are meeting organizational objectives.

18. Many firms use process control charts and statistical control methods to help employees track
performance on a real-time basis.

19. In a process control chart, observations outside the control limits are likely due to random
fluctuations.

20. In general, financial controls are more useful for evaluating managers at higher levels in an
organizational hierarchy, while non financial controls are more useful in monitoring and evaluating
employees at lower levels.

21. Organizations always compute the materials price variance using the actual quantity of materials
used.

22. The materials price variance helps reconcile actual profit with master budget profit.

23. A favorable or unfavorable sales volume variance could arise due to a change in the market as a
whole or the firm’s share of the market.

24. The market share variance holds market share constant while examining variations between
budgeted and actual market size.

25. The sales mix variance and the sales quantity variance together add up to the sales volume variance.

26. The sales mix variance tells us the effect of the aggregate change in sales quantity, holding the sales
mix at the budgeted level.

27. For the flexible budget, we calculate the weighted unit contribution margin using all the budget
assumptions of the master budget except sales volume.

28. In a single-product case, the weighted unit contribution margin in the master budget will always be
higher than in the flexible budget.
 Budgetary Control and Variance Analysis

MULTIPLE CHOICE

29. Without a well-conceived plan against which to compare actual performance:

A. It is difficult to determine how a company is doing.
B. It is difficult to determine what a company could do to improve.
C. A company will not be able to make a profit.
D. Both A and B.
E. A, B, and C.

30. The starting point for preparing a monthly budget is:

A. Projecting sales.
B. Projecting production.
C. Projecting cash inflows.
D. Projecting cash outflows.
E. Projecting material needs.

31. The purpose of creating a flexible budget is to:

A. Determine how much of the difference between actual and budgeted profits was due strictly to
the difference between budgeted and actual sales.
B. Determine how much of the difference between actual and budgeted profits was due strictly to
the difference between budgeted and actual variable costs.
C. Determine how much of the difference between actual and budgeted profits was due strictly to
the difference between budgeted and actual fixed costs.
D. Determine which department is responsible for the overall budget variance.

32. The controller for Navia, Inc. created a budget prior to the current period. At the end of the period,
the controller compared the budget with the actual results. For what purpose is the controller using
budgets?
A. Coordination
B. Control
C. Variances
D. Planning

33. Which of the following is not a component of the total profit variance?
A. Sales volume variance.
B. Flexible budget variance.
C. Sales price variance.
D. Market size and share variance.
E. All of the above are components of the total profit variance.

34. Which of the following statements is not true?

A. If actual sales are greater than budgeted sales, the result is a favorable variance.
B. If actual cost is greater than budgeted cost, the result is an unfavorable variance.
C. If budgeted sales are greater than actual sales, the result is an unfavorable variance.
D. If budgeted cost is greater than actual cost, the result is an unfavorable variance.
E. If actual cost is less than budgeted cost, the result is a favorable variance.
Balakrishnan/Managerial Accounting, 2e

35. Given the following data, calculate total profit variance.

Master Budget Actual Results

Revenue $73,000 $75,000
Variable costs $23,000 $20,000
Contribution margin $50,000 $55,000
Fixed costs $15,000 $10,000
Profit before taxes $35,000 $45,000
A. $2,000 Favorable.
B. $2,000 Unfavorable.
C. $10,000 Unfavorable.
D. $10,000 Favorable.
E. $5,000 Favorable.

36. The two major components of the total profit variance are:
A. Sales volume variance and flexible budget variance.
B. Price variance and quantity variance.
C. Sales volume variance and sales mix variance.
D. Flexible budget variance and quantity variance.
E. None of the above.

37. The formula for the sales volume variance is:

A. (Actual Sales Quantity – Budgeted Sales Quantity) x Actual Unit Contribution Margin
B. (Budgeted Sales Quantity – Actual Sales Quantity) x Total Profit Variance
C. Flexible Budget Profit – Master Budget Profit.
D. (Budgeted Sales Quantity – Actual Sales Quantity) ÷ Total Profit Variance
E. (Actual Sales Quantity – Budgeted Sales Quantity) ÷ Actual Unit Contribution Margin

38. If the labor efficiency variance is $1,000unfavorable, then:

A. Budgeted labor rate exceeded actual labor rate.
B. Actual labor rate exceeded budgeted labor rate.
C. Budgeted labor input exceeded actual labor input.
D. Actual labor input exceeded budgeted labor input.
E. None of the above.

39. Variance analysis is an important tool because:

A. It helps management determine where bottlenecks in the production process occurred
B. It helps management determine better pricing strategies
C. It helps management determine why actual profits varied from budgeted profits
D. It helps management determine which department operated most efficiently.

40. A favorable materials price variance will occur when:

A. Actual costs of materials were less than budgeted
B. More material was used than was budgeted
C. Actual cost of materials were greater than budgeted
D. Less material was used than was budgeted
 Budgetary Control and Variance Analysis

41. The formula for calculating an input price variance is:

A. (Actual volume less budgeted volume) x actual price.
B. (Budgeted volume less actual volume) x budgeted price.
C. (Budgeted price less actual price) x actual volume.
D. (Actual price less budgeted price) x budgeted volume,

42. Which of the following would not result in a variance from budget:
A. A machine breaks down.
B. Budgets are set in a manner making them difficult to achieve.
C. A supplier raises prices.
D. The Chief Executive Officer takes a week of vacation.

43. Sales commissions for the Grant Company are budgeted based on a percent of sales. The sales
department budgeted sales of $150,000 for total commissions of $4,500. If actual sales totaled
$170,000 the flexible budget will show total commissions of:
A. $24,500
B. $5,100
C. $4,500
D. $15,500

44. The Farmington Company has a flexible budget based on direct labor hours. At the 100,000 hours
level, the budget shows the following variable overhead costs:
Indirect materials $16,000
Indirect labor $44,000
At an activity level of 120,000 hours, total variable costs will be:
A. $19,200
B. $60,000
C. $52,800
D. $72,000

45. Jackie’s Jewelry Company reported the following budgeted and actual results based on sales of 100
units of product:
Flexible Budget “As if” Budget Actual Results
Direct Labor $800 $700 $850
Direct Materials $400 $450 $450
Overhead $600 $600 $610

The company’s total input quantity variance is:

A. $50 favorable.
B. $160 unfavorable.
C. $150 favorable.
D. $50 unfavorable.

46. The following material budgets have been developed for the Criders Company.
Price per pound $6.50
Pounds per unit 1
Purchase price variance $3,200 unfavorable
Balakrishnan/Managerial Accounting, 2e

If the company purchased 16,000 units, the actual price per pound of material purchased must have
been:
A. $6.70
B. $5.00
C. $6.30
D. $5.80

47. For what purpose is a flexible budget used?

A. To provide various possible outcomes for management to consider.
B. To adjust input prices so that future variances are eliminated.
C. To insure that profit does not drop below a predetermined level.
D. To identify the sources of variances.

48. Which of the following items would differ in amount when comparing the master and flexible
budgets for a freight company in which actual sales resulted in $2,500,000 based on 8,000
shipments during a period that 7,800 shipments were budgeted?
A. Total sales revenue.
B. Equipment costs.
C. Rent.
D. All of the above will differ.

49. PVC Pro produces PVC pipe in 12 foot lengths. The following information was provided concerning
its labor and materials
Actual Data
Produced 12,200 units
Materials used 4,650 lbs. @ $7.00 per pound
Labor worked 7,450 hrs. costing $80,460

Budget Data
Budgeted units 12,000 units
Budgeted materials per pipe 0.40 lb. @ $7.10 per pound
Budgeted labor per pipe 0.60 hours @ $11.00 per hour

How much is the materials price variance?

A. $1,530 F
B. $465 F
C. $1,050 F
D. $1,065 F

50. Cico Buckets had budgeted unit sales of 41,600 buckets. Actual sales during May totaled 42,000
buckets at $4.25 per bucket. Its budgeted sales price was $4.00 per bucket. The master budget
contribution margin totaled $62,400 and the budgeted variable cost per unit was $2.50. How much
is Haslo’s sales volume variance?
A. $600 F
B. $100 F
C. $1,600 F
D. $1,700 F
 Budgetary Control and Variance Analysis

51. The Parsons Company has budgeted to capture 25% of the market in which they operate which
currently contains 1,000 stores. The budgeted contribution margin per unit sold is $4.50. If they
were actually able to capture only 20% of the market, but their actual contribution margin was
$5.00 per unit, their market share variance was:
A. $250 favorable
B. $225 unfavorable
C. $250 unfavorable
D. $225 favorable

52. Variances could arise:

A. During the normal course of operations because a machine unexpectedly breaks down.
B. Because of a permanent change in the firm’s operating environment such as a competitor
introduces a new product.
C. Because budgets or standards are either too tight or too loose.
D. Both A and B.
E. A, B, and C.

53. Which of the following is not a general rule to follow in a variance investigation?
A. Adjust budgeted amounts to agree with actual amounts.
B. Investigate all significant variances, whether favorable or unfavorable.
C. Examine trends.
D. Consider the total picture.
E. All of the above are general rules to follow.

54. Which of the following trends in variances may not indicate an inherent problem?
A. Marketing personnel overstating costs to give themselves additional leeway in operations.
B. Repeatedly having unfavorable labor efficiency variances.
C. An unexpected increase in demand.
D. A developing problem in the manufacturing process.
E. Finding mostly favorable variances over time.

55. The primary limitations of variance analysis pertain to

A. Controllability and budgeting.
B. Timeliness and specificity.
C. Timeliness and controllability.
D. Controllability and specificity.
E. Budgeting and controllability.

56. Which of the following is a method firms used to help track employee performance on a real-time
basis?
A. Budget reconciliation report.
B. Process control charts.
C. Labor efficiency variance.
D. Spending variance.
E. None of the above.
Balakrishnan/Managerial Accounting, 2e

57. Firms use non-financial measures to:

A. Identify problems with their processes.
B. Help align goals.
C. Provide on-going feedback to employees.
D. Evaluate employees.
E. All of the above.

58. In general, non-financial controls are more useful than financial controls for:
A. Monitoring employees at lower levels.
B. Evaluating workers at lower-levels.
C. Evaluating managers at higher levels.
D. Both A and B.
E. A, B, and C.

59. A company may experience a favorable labor rate variance but an unfavorable labor efficiency
variance when:
A. Sales lagged behind the budgeted amounts of the sales department.
B. There were breakdowns in machinery.
C. The product mix changed during the period.
D. The company experienced a high amount of turnover in its workforce.

60. A spending variance results when there is a difference between actual and budgeted:
A. Fixed costs
B. Variable costs
C. Sales Revenue
D. Unit sales

61. Thurston Company’s budget allows for one pound of material to be used for each unit produced.
The budget indicates that the material costs $2.50 per pound. Actual units produced totaled 8,000.
The company used a total of 8,200 pounds of material at an actual cost of $2.40 per pound. There
were no beginning or ending inventories of raw materials. The input price and input quantity
variances, respectively, would be:
Input Price Input Quantity
A. Favorable Favorable
B. Unfavorable Favorable
C. Unfavorable Unfavorable
D. Favorable Unfavorable

62. A sales mix variance:

A. If unfavorable, indicates that a greater percentage of products with higher contribution margins
are being sold than were budgeted.
B. Indicates which products are having a negative impact on profits.
 Budgetary Control and Variance Analysis

C. Reports the effect on profits due to a change in the sales mix from the master budget.
D. Reports the effect on profits due to an overall change in sales quantity.

63. Which of the following would lead to a variance resulting from a permanent change in a firm’s
operating environment?
A. An abnormally high incidence of employees calling in sick during a period.
B. A new competitor entering the market.
C. Upper-level management failing to consult lower level workers and instituting extremely tight
budgetary controls.
D. A critical machine unexpectedly breaking down for a number of days.

64. In comparison to financial measures, nonfinancial measures tend to be?

A. Less timely, less specific.
B. More timely, less specific.
C. Less timely, more specific.
D. More timely, more specific.

65. Using the following data, calculate the purchase price variance for Rizzo Company.
Budgeted quantity per unit of output 5 yards
Budgeted price per yard $18.00
Actual yards purchased 8,000 yards
Actual cost of material purchase $140,000
Material used in production 8,500 yards
A. $13,000 Favorable.
B. $4,250 Favorable.
C. $4,000 Favorable.
D. $2,000 Unfavorable.
E. None of the above.

66. Using the following data, calculate the sales volume variance for Rizzo Company.
Actual sales quantity 5,000 units
Budgeted sales quantity 5,500 units
Budgeted sales price per unit $10
Budgeted unit contribution margin $6
A. $3,000 Favorable.
B. $3,000 Unfavorable.
C. $5,000 Favorable.
D. $5,000 Unfavorable.
E. None of the above.
Balakrishnan/Managerial Accounting, 2e

67. Given the following data, what is the sales mix variance for Rizzo Company?
Actual total sales $7,475
Budgeted total sales $7,500
Weighted unit contribution margin in the flexible budget $12
Weighted unit contribution margin in the master budget $8
A. 200 Favorable.
B. 200 Unfavorable.
C. 29,900 Favorable.
D. 29,900 Unfavorable.
E. 300 Unfavorable.

Problems

1. Fancy Feast Bakery makes cakes for special occasions. Fancy Feast estimates the following
revenue and costs for the upcoming month.

Expected sales 300 cakes @ $20 per cake

Expected cost of Ingredients $4 per cake
Expected labor costs $20 per hour
Estimated labor hours required ½ hour per cake
Estimated variable overhead $1 per baker hour
Estimated total fixed costs:
Rent $250
Equipment costs $1,000
Cake Delivery costs $150

Required:

Prepare the Master Budget for Fancy Feast.

2. A variance is the difference between an actual result and a budgeted amount. Variance analysis
helps organizations determine whether their people and processes are performing as expected.

Required:
Enter the identifying letters in the blanks below to indicate the term that best matches each
description.

A. Favorable variance F. Sales price variance

B. Flexible budget G. Sales volume variance
C. Input price variance H. Spending variance
D. Input quantity variance I. Total profit variance
E. Master budget J. Variance analysis
 Budgetary Control and Variance Analysis

a._____ The difference between actual profit and master budget profit.

b._____ Profit effect associated with the difference between the budgeted and actual price of
an input.

c._____ Technique for determining why actual revenues, costs, and profit differ from their
budgeted amounts.

d._____ A difference between an actual result and a budgeted amount that leads to an
increase in profit.

e._____ The difference in profit between the flexible budget and the master budget.

f._____ A budget for the actual level of sales, retaining all other plan assumptions in the
master budget.

g._____ The difference between actual revenues and flexible budget revenues.

h._____ The budget as prepared at the start of the accounting period.

i._____ The difference between budgeted fixed costs and actual fixed costs.

j._____ Profit effect associated with the difference between the budgeted and actual input
quantity used.

3. Piney Creek Manufacturing Company produces high-end extreme weather tents. Piney Creek
has established the following budget for producing its XWT model for the most recent month.

Master Budget Actual Results

Number of tents sold 50 60
Sales price per tent $650 $635
Variable cost per tent $250 $240
Fixed costs $10,000 $10,000

Required:

a. What is Piney Creek’s total profit variance for the most recent month

b. Calculate Piney Creek’s sales volume variance for the month.

c. Calculate Piney Creek’s sales price variance for the month.

Balakrishnan/Managerial Accounting, 2e

4. Eagle Manufacturing makes extreme weather coveralls. Eagle’s budget called for 5 yards of
fabric at a cost of $12 per yard per unit. Actual production of 200 coveralls required 1,200 yards
of fabric at an actual cost of $11 per yard.
Required:

a. Calculate the material price variance.

b. Calculate the quantity variance.

 Budgetary Control and Variance Analysis

Hester and Gann, CPAs have a successful practice specializing in tax planning and preparation. The firm,
in addition to the two partners, employs 32 professional staff and 5 administrative assistants. Hester
and Gann do monthly variance analysis to keep apprised of excess labor costs or materials costs
(printing, software costs, etc.). However, the partners believe that increasing employee morale and
providing some extra incentives might increase productivity and decrease errors.

Required:

a. What kinds of controls might Hester and Gann implement to decrease errors?

b. What kind of financial incentives might Hester and Gann implement to increase
productivity?

c. What kind of non-financial incentives might Hester and Gann implement to increase
productivity?

5. For the current month, Silversmith’s Cutlery shop budgeted sales of 300 knives based on
capturing a 20% share of the market, estimated at 1,500 knives. The actual sales volume was
319 knives representing a 22% share of the market of 1,450 knives. Silversmith’s budgeted
contribution margin per knife was $8.

Required:

a. Calculate Silversmith’s sales volume variance.

b. Calculate Silversmith’s market share variance.

c. Calculate Silversmith’s sales volume variance.

Balakrishnan/Managerial Accounting, 2e

End of Chapter Content

Short Answer

1. For many organizations, what is the benchmark for evaluating actual performance?

2. What is a master budget?

3. What is a variance?

4. What does it mean when a variance is favorable? What does it mean when a variance is
unfavorable?

5. What is the total profit variance?

6. What two subsidiary variances make up the total profit variance?

7. What is a flexible budget?

8. What is the sales volume variance?

9. What is the flexible budget variance? What three subsidiary variances make up the flexible budget
variance?

10. What is the sales price variance?

11. What is the fixed cost spending variance?

12. Each variable cost variance can be decomposed into two variances. What are these variances?

13. What is an input price variance?

14. What is an input quantity variance?

15. What is the function of a budget-reconciliation report?

16. What are the three primary reasons variances occur?

17. What are the three main rules to follow when conducting a variance investigation?

18. What are the two primary reasons organizations use nonfinancial measures in addition to financial
measures for control purposes?
 Budgetary Control and Variance Analysis

Short Essay

1. Each of us regularly uses budgets and benchmarks to evaluate how we are doing or what we could
do to improve. Can you list three examples from everyday life?

2. Some argue that making the master budget hard to achieve or “tight” can help eliminate waste and
make organizations more efficient. Others argue that master budgets should be “loose” because
they provide room for discretion in decision making. What do you think?

3. List some examples of variances that you calculate in everyday life? Think about getting a test back
or analyzing other people’s actions (e.g., we often say things like “I can’t believe they did that!”). Do
you think “variances” influence the behavior of animals such as family pets? What does this say
about the widespread use of variance analysis?

4. When will the sales volume variance be unfavorable? When will the sales price variance be
unfavorable? Is it possible to have an unfavorable sales volume variance and an unfavorable sales
price variance?

5. If the sales volume variance is favorable, does this imply that for inputs such as materials and labor,
the actual quantity of the input used will be greater than the flexible budget quantity of the input?
Why or why not?

6. When will the materials price variance be unfavorable? Does an unfavorable materials price
variance necessarily indicate a control problem? Explain why or why not.

7. When will the materials quantity variance be unfavorable? Might an unfavorable materials quantity
variance be related to other variances, such as the materials price variance and the labor quantity
variance? Explain why or why not.

8. Many firms (particularly firms using a Just-in-Time inventory philosophy) enter into long-term
contracts with a few suppliers. Do you believe this has implications for the materials price variance?
Just-in-Time firms also encourage workers to stop production rather than produce a defective unit.
Could this policy have implications for the labor quantity variance?

9. Why might a favorable sales volume variance lead to an unfavorable fixed cost spending variance?
How does your answer reconcile with the fixed cost/ variable cost classification of costs?

10. Statistical control charts establish upper and lower control limits. Observations falling outside these
limits or a sequence of observations above or below the expected value, even if within the control
limits, trigger an investigation. How does this practice conform to our description of how firms use
profit variance analysis?
Balakrishnan/Managerial Accounting, 2e

11. If nonfinancial measures are both more timely and more specific than financial measures, why do
firms use financial measures at all? (Hint: Consider whether a manager should implement a decision
that increases one nonfinancial measure but decreases another nonfinancial measure. For example,
decreasing the mean time per call handled increases the efficiency of customer support staff but
potentially decreases service quality and customer satisfaction.)

Exercises

1. Garnet’s Gym is a fitness and aerobic center located in Atlanta, Georgia. The following table reports
Garnet’s master budget and actual results for the most recent year:

Master Budget Actual Results

Membership fee (per member) $500 $550
Number of members 5,000 4,000
Variable cost (per member) $200 $200
Fixed costs $1,200,000 $1,200,000

With regard to the discrepancies between the budgeted and actual membership fee and the budgeted
and actual number of members, the owners of Garnet’s Gym inform you that in early January they
decided to raise the membership fee from $500 to $550. The owners believed that such an action would
only reduce membership by 500 rather than 1,000, as actually occurred.

Required:
a. What was Garnet’s total profit variance for the most recent year?

b. Calculate Garnet’s sales volume variance and sales price variance for the most recent year. Did
raising the membership fee turn out to be a good idea?

c. Would raising the membership fee have been a good idea if membership decreased by 500 (as
predicted) rather than 1,000?

2. The Glass Vessel Company has established the following budget for producing one of its hand-blown
vases:
Materials (silica) 2 pounds @ 1.25 per pound
Labor 1.5 hours @ $15.00 per hour
In March of the most recent year, Glass Vessel produced 300 vases using 650 pounds of materials.
Glass Vessel purchased the 650 pounds of materials for $845. Labor costs for March were $7,200 for
480 hours worked.

Required:
a. What were Glass Vessel’s materials price and materials quantity variances for March?

b. What were Glass Vessel’s labor price and labor quantity variances for March?
 Budgetary Control and Variance Analysis

3. Assume that you are a franchisee of a fast-food chain, “Pita Palace,” that serves made-to-order
pitas. The menu, prices, and decor are dictated by the national office; further, you are required to
purchase all of your supplies through a specified distributor. Your primary responsibility is to ensure
adequate staffing and to exercise quality control. Naturally, as the franchisee, you also are keenly
interested in your store’s profitability.

Required:
a. As the franchisee, list two financial measures and two nonfinancial measures that you
would monitor on a short-term (e.g., weekly) basis.

b. Why do think it is important to use both financial and nonfinancial measures?

4. Tom and Lynda own Hercules Health Club. For the month of April, they had forecasted gym
membership at 700 individual members and 300 family memberships. Individual members pay $100
per month and families pay $150 per month. Variable costs are $35 and $60 per month,
respectively. Actual results for April show membership at 750 individual and 250 family members.

Required:
a. Determine Hercules’ sales volume variance.

b. Decompose the sales volume variance into a sales mix variance and a sales quantity variance.

c. Why did Hercules’ contribution decrease even though the total memberships were the same?