Question

Chapter 7 in Horngren's cost accounting 16th edition textbook In summarizing its painstaking analysis of revenue and direct cost variances, the textbook refers to three levels of analysis. What specifics are revealed with regard to the difference between a master budget and actual results at each level?

Please use the textbook only.

Answer 1

Possible explanations for the price variances are: (a) Unexpected outcomes from purchasing and labour negotiations during the year. (b) Higher quality of flannelette and less experienced employees. (c) Less overtime because production levels were lower than expected (d) Standards set incorrectly at the start of the year. Possible explanations for the favourable material usage variance and the unfavourable labour efficiency variance are: (a) Lower usage of flannelette higher quality flannelette purchased at higher price. Note that the labour efficiency variance (which would also be influenced by higher quality) is unfavourable. Furthermore the net effect of the favourable material usage variance and the unfavourable material price variance is significantly negative. (b) Lesser trained workers hired at lower rates result in lower levels of labour efficiency. Once again the net effect is negative even if the favourable material usage variance is taken into account. (c) Standards set incorrectly at the start of the year.

Management by exception is the practice of concentrating on areas not operating as expected and giving less attention to areas operating as expected. Variance analysis helps managers identify areas not operating as expected. The larger the variance, the more likely an area is not operating as expected.

The performance of variance analysis should not be based on a static budget as it ignores actual levels of output. It compares the budgeted costs/revenues for a planned level of output versus actual costs/revenues for an actual level of output. The actual level of output may differ from the planned level, and may necessitate different levels of costs.Thus, the results could be misleading. For example, a favorable cost variance based on aflexible budget can be changed to an unfavorable cost variance based on a static budget and,therefore, lead to wrong decision/s. This is why performance of variance analyses should be basedon flexible budgets.