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CHAPTER 7
FLEXIBLE BUDGETS, DIRECT-COST VARIANCES,
AND MANAGEMENT CONTROL
7-1 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.
7-2 Two sources of information about budgeted amounts are (a) past amounts and (b)
detailed engineering studies.
7-3 A favorable variance––denoted F––is a variance that has the effect of increasing
operating income relative to the budgeted amount. An unfavorable variance––denoted U––is a
variance that has the effect of decreasing operating income relative to the budgeted amount.
7-4 The key difference is the output level used to set the budget. A static budget is based on
the level of output planned at the start of the budget period. A flexible budget is developed using
budgeted revenues or cost amounts based on the actual output level in the budget period. The
actual level of output is not known until the end of the budget period.
7-5 A flexible-budget analysis enables a manager to distinguish how much of the difference
between an actual result and a budgeted amount is due to (a) the difference between actual and
budgeted output levels, and (b) the difference between actual and budgeted selling prices,
variable costs, and fixed costs.
7-6 The 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 and
actual quantity of output.
Step 3: Calculate the flexible budget for costs based on budgeted variable cost per output
unit, actual quantity of output, and budgeted fixed costs.
7-7 Four reasons for using standard costs are:
(i) cost management,
(ii) pricing decisions,
(iii) budgetary planning and control, and
(iv) financial statement preparation.
7-8 A manager should subdivide the flexible-budget variance for direct materials into a price
variance (that reflects the difference between actual and budgeted prices of direct materials) and
an efficiency variance (that reflects the difference between the actual and budgeted quantities of
direct materials used to produce actual output). The individual causes of these variances can then
be investigated, recognizing possible interdependencies across these individual causes.
7-1
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