Fundamentals of Variance Analysis: Solutions to Review Questions

REVIEW QUESTIONS 16 Fundamentals of Variance Analysis Solutions to Review Questions 16-1. What are the advantages of the contribution margin format based on variable costing compared to the traditional format based on full absorption costing? For performance evaluation purposes, the costing format should identify the actual costs for comparison with expected costs during the relevant period. Under absorption costing, the manufacturing fixed costs are allocated on a per unit basis. An increase in production results in a lower per unit cost. If all of the production is sold, all of the fixed cost will be charged against profit. However, if some of the costs are assigned to inventory, the result can be a deferral of costs that should be evaluated at this time. This problem is highlighted by the suggestion that one can increase production in times of declining sales in order to “help the bottom line by spreading fixed costs over more units.” Because variable costing excludes fixed overhead for inventory valuation (fixed overhead is treated as a period expense), there is no motivation to produce goods for inventory. 16-2. How can a budget be used for performance evaluation? The budget can be used as a benchmark against which to evaluate actual results. It can be used in the same way that actual results of competitors or the actual results from previous years can be used. 16-3. “The flexible budget for costs is computed by multiplying average total cost at the master budget activity level by the activity at some other level.” Is this true or false? Explain. False. Only variable costs and revenues “flex” with changes in activity. Fixed costs are expected to remain the same when operations are in the relevant range. 16-4. A flexible budget is: a) Appropriate for control of factory overhead but not for control of direct materials and direct labor. b) Appropriate for control of direct materials and direct labor but not for control of factory overhead. c) Not appropriate when costs and expenses are affected by fluctuations in volume. d) Appropriate for any level of activity. (CPA adapted) Answer: (d) Appropriate for any level of activity. 16-5. What is the standard cost sheet? The standard cost sheet provides the quantities of each input required to produce a unit output along with the budgeted unit prices for each input. 16-6. What is the basic difference between a master budget and a flexible budget? a) A flexible budget considers only variable costs; a master budget considers all costs. b) A master budget is based on a predicted level of activity; a flexible budget is based on the actual level of activity. c) A master budget is for an entire production facility; a flexible budget is applicable only to individual departments. d) A flexible budget allows management latitude in meeting goals; a master budget is based on a fixed standard. Answer: (b) A master budget is based on a predicted level of activity, while a flexible budget is based on the actual level of activity. 16-7. Standards and budgets are the same thing. True or false? False. A standard is related to a cost per unit. Budgets focus on totals. 16-8. Actual direct materials costs differ from the master budget amount. What are the three primary reasons for the difference? The three primary sources of variances are: a. price variances, which arise because actual material prices differ from standards; b. efficiency variances which occur when the relationship between the usage of input factors (labor, materials, variable overhead) differs from that which would be expected to produce a given level of output; and c. activity variances, which represent differences between, planned (master budget) output levels and the output levels actually attained during the period. 16-9. Fixed cost variances are computed differently from the variances for variable costs. Why? The fixed cost variances differ from variable cost variances because fixed costs do not vary with the level of production activity. Therefore, the fixed costs in the flexible budget will be the same as in the master budget (within the relevant range). Additionally, there are no efficiency variances for fixed costs because there is no input-output relationship that can be applied.