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EXERCISE 9–1 Prepare a Flexible Budget [LO1] Gator Divers is a company that provides diving services such as underwater ship repairs to clients in the Tampa Bay area. The company’s planning budget for March appears below:

Required: During March, the company’s activity was actually 190 diving-hours. Prepare a flexible budget for that level of activity. EXERCISE 9–2 Prepare a Report Showing Activity Variances [LO2] Air Meals is a company that prepares in-flight meals for airlines in its kitchen located next to the local airport. The company’s planning budget for December appears below:

In December, 21,000 meals were actually served. The company’s flexible budget for this level of activity is as follows:

Required: 1. Prepare a report showing the company’s activity variances for December. 2. Which of the activity variances should be of concern to management? Explain. EXERCISE 9–3 Prepare a Report Showing Revenue and Spending Variances [LO3] Olympia Bivalve farms and sells oysters in the Pacific Northwest. The company harvested and sold 7,000 pounds of oysters in July. The company’s flexible budget for July appears below:

The actual results for July appear below:

Required: Prepare a report showing the company’s revenue and spending variances for July. EXERCISE 9–4 Prepare a Flexible Budget Performance Report [LO4] Mt. Hood Air offers scenic overflights of Mt. Hood and the Columbia River gorge. Data concerning the company’s operations in August appear below:

The company measures its activity in terms of flights. Customers can buy individual tickets for overflights or hire an entire plane for an overflight at a discount. Required: 1. Prepare a flexible budget performance report for August. 2. Which of the variances should be of concern to management? Explain. EXERCISE 9–6 Analyze a Performance Report [LO6] The Exterminator Inc. provides on-site residential pest extermination services. The company has several mobile teams who are dispatched from a central location in company-owned trucks. The company uses the number of jobs to measure activity. At the beginning of May, the company budgeted for 200 jobs, but the actual number of jobs turned out to be 208. A report comparing the budgeted revenues and costs to the actual revenues and costs appears below:

Required: Is the above variance report useful for evaluating how well revenues and costs were controlled during May? Why or why not? EXERCISE 9–7 Critique a Variance Report [LO6] Refer to the data for The Exterminator Inc. in Exercise 9–6 . A management intern has suggested that the budgeted revenues and costs should be adjusted for the actual level of activity in May before they are compared to the actual revenues and costs. Because the actual level of activity was 4% higher than budgeted, the intern suggested that all budgeted revenues and costs should be adjusted upward by 4%. A report comparing the budgeted revenues and costs, with this adjustment, to the actual revenues and costs appears below:

Required: Is the above variance report useful for evaluating how well revenues and costs were controlled during May? Why or why not? EXERCISE 9–8 Flexible Budgets and Activity Variances [LO1, LO2] Harold’s Roof Repair has provided the following data concerning its costs:

For example, wages and salaries should be $21,380 plus $15.80 per repair-hour. The company expected to work 2,500 repair-hours in June, but actually worked 2,400 repair-hours. The company expects its sales to be $43.50 per repair-hour. Required: Prepare a report showing the company’s activity variances for June.

EXERCISE 9–15 Critique a Report; Prepare a Performance Report [LO1, LO4, LO6] Wings Flight School offers flying lessons at a small municipal airport. The school’s owner and manager has been attempting to evaluate performance and control costs using a variance report that compares the planning budget to actual results. A recent variance report appears below:

After several months of using such variance reports, the owner has become frustrated. For example, she is quite confident that instructor wages were very tightly controlled in August, but the report shows an unfavorable variance. The planning budget was developed using the following formulas, where q is the number of lessons sold:

Required: 1. Should the owner feel frustrated with the variance reports? Explain. 2. Prepare a flexible budget performance report for the school for August. 3. Evaluate the school’s performance for August.

PROBLEM 9–20 Activity and Spending Variances [LO1, LO2, LO3] You have just been hired by SecuriDoor Corporation, the manufacturer of a revolutionary new garage door opening device. The president has asked that you review the company’s costing system and “do what you can to help us get better control of our manufacturing overhead costs.” You find that the company has never used a flexible budget, and you suggest that preparing such a budget would be an excellent first step in overhead planning and control. After much effort and analysis, you determined the following cost formulas and gathered the following actual cost data for April:

During April, the company worked 18,000 machine-hours and produced 12,000 units. The company had originally planned to work 20,000 machine-hours during April. Required: 1. Prepare a report showing the activity variances for April. Explain what these variances mean. 2. Prepare a report showing the spending variances for April. Explain what these variances mean.

Solutions Exerc Exercise ise 9-1 Gator Divers Flexible Budget For the Month Ended March 31

Actual diving-hours...................................................................................

190

Revenue ($380.00q).................................................................................. Expenses: Wages and salaries ($12,000 + $130.00q)........................................ Supplies ($5.00q).............................................................................. Equipment rental ($2,500 + $26.00q).............................................. Insurance ($4,200)............................................................................ Miscellaneous ($540 + $1.50q)........................................................ Total expense............................................................................................. Net operating income................................................................................

$72,200 36,700 950 7,440 4,200 825 50,115 $22,085

Exerc Exercise ise 9-2 1. The activity variances are shown below: Air Meals Activity Variances For the Month Ended December 31

Meals........................................................................... Revenue ($3.80q)......................................................... Expenses: Raw materials ($2.30q)....................................... Wages and salaries ($6,400 + $0.25q)................................................ Utilities ($2,100 + $0.05q).................................. Facility rent ($3,800).......................................... Insurance ($2,600).............................................. Miscellaneous ($700 + $0.10q)........................... Total expense............................................................... Net operating income...................................................

Planning Budget 20,000

Flexible Budget 21,000

Activity Variances

$76,000

$79,800

$3,800

F

46,000

48,300

2,300

U

11,400 3,100 3,800 2,600 2,700 69,600 $ 6,400

11,650 3,150 3,800 2,600 2,800 72,300 $ 7,500

250 50 0 0 100 2,700 $1,100

U U U U F

2. Management should note that the level of activity was above what had been planned for the month. This led to an expected increase in profits of $1,100. However, the individual items on the report should not receive much management attention. The favorable variance for revenue and the unfavorable variances for expenses are entirely caused by the increase in activity.

Exerc Exercise ise 9-3 Olympia Bivalve Revenue and Spending Variances For the Month Ended July 31

Pounds......................................................................... Revenue ($4.20q)......................................................... Expenses: Packing supplies ($0.40q)................................... Oyster bed maintenance ($3,600)....................... Wages and salaries ($2,540 + $0.50q)................................................ Shipping ($0.75q)............................................... Utilities ($1,260)................................................. Other ($510 + $0.05q)......................................... Total expense............................................................... Net operating income...................................................

Revenue and Spending Variances

Flexible Budget 7,000

Actual Results 7,000

$29,400

$28,600

$ 800

U

2,800 3,600 6,040

2,970 3,460 6,450

170 140 410

U F U

5,250 1,260 860 19,810 $ 9,590

4,980 1,070 1,480 20,410 $ 8,190

270 190 620 600 $1,400

F F U U U

Exerc Exercise ise 9-4 1. Mt. Hood Air Flexible Budget Performance Report For the Month Ended August 31

Planning Budget Flights (q)................................................... 50 Revenue ($360.00q)....................................$18,000 Expenses:

Activity Variances $720

F

Flexible Budget 52 $18,720

Revenue and Spending Variances $1,740

U

Actual Results 52 $16,980

Wages and salaries 8,400 ($3,800 + $92.00q)............................... Fuel ($34.00q)...................................... 1,700 Airport fees ($870 + $35.00q).............. 2,620 Aircraft depreciation ($11.00q)............ 550 Office expenses ($230 + $1.00q)......... 280 Total expense.............................................. 13,550 Net operating income..................................$ 4,450

184

U

8,584

44

F

8,540

68 70 22 2 346 $374

U U U U U F

1,768 2,690 572 282 13,896 $ 4,824

162 0 0 168 286 $2,026

U

1,930 2,690 572 450 14,182 $ 2,798

U U U

2. The overall activity variance is $374 favorable and is due to an increase in activity. The $1,740 unfavorable revenue variance is very large relative to the company’s net operating income and should be investigated. Was this due to discounts given or perhaps a lower average number of passengers per flight than usual? The other variances are relatively small, but are worth some management attention — particularly if they recur next month. Exerc Exercise ise 9-6 The variance report compares the planning budget to actual results and should not be used to evaluate how well costs were controlled during May. The planning budget is based on 200 jobs, but the actual results are for 208 jobs. Consequently, the actual revenues and many of the actual costs should have been different from what was budgeted at the beginning of the period. Direct comparisons of budgeted to actual costs are valid only if the costs are fixed. To evaluate how well revenues and costs were controlled, it is necessary to estimate what the revenues and costs should have been for the actual level of activity using a flexible budget. The flexible budget amounts can then be compared to the actual results to evaluate how well revenues and costs were controlled. Exerc Exercise ise 9-7 The adjusted budget was created by multiplying each item in the budget by the ratio 208/200; in other words, each item was adjusted upward by 4%. This procedure provides valid benchmarks for revenues and for costs that are strictly variable, but overstates what fixed and mixed costs should be. Fixed costs, for example, should not increase at all if the activity level

increases by 4%—providing, of course, that this level of activity is within the relevant range. Mixed costs should increase less than 4%. To evaluate how well revenues and costs were controlled, it is necessary to estimate what the revenues and costs should have been for the actual level of activity using a flexible budget that explicitly recognizes fixed and mixed costs. The flexible budget amounts can then be compared to the actual results to evaluate how well revenues and costs were controlled. Exerc Exercise ise 9-8 Harold's Roof Repair Activity Variances For the Month Ended June 30

Repair-hours (q)........................................................... Revenue ($43.50q)....................................................... Expenses: Wages and salaries ($21,380 + $15.80q)............................................ Parts and supplies ($7.50q).................................. Equipment depreciation ($2,740 + $0.60q)................................................ Truck operating expenses ($5,820 + $1.90q)................................................ Rent ($4,650)....................................................... Administrative expenses ($3,870 + $0.70q)................................................ Total expense................................................................ Net operating income...................................................

Planning Budget 2,500

Flexible Budget 2,400

Activity Variances

$108,750

$104,400

$4,350

U

60,880 18,750

59,300 18,000

1,580 750

F F

4,240

4,180

60

F

10,570 4,650

10,380 4,650

190 0

F

5,620 104,710 $ 4,040

5,550 102,060 $ 2,340

70 2,650 $1,700

F F U

Exerc Exercise ise 9-15 1. The variance report should not be used to evaluate how well costs were controlled. In August, the planning budget was based on 200 lessons, but the actual results are for 210 jobs—an increase of 5% over budget. Consequently, the actual revenues and many of the actual costs should have been different from what was budgeted at the beginning of the period. For example, instructor wages, a variable cost, should have increased by 5% because of the increase in activity, but the variance report assumes that they should not have increased at all. This results in a spurious unfavorable variance for instructor wages. Direct comparisons of budgeted to actual costs are valid only if the costs are fixed.

2. See the following page. 3. The overall activity variance for net operating income was $670 F (favorable). That means that as a consequence of the increase in activity from 200 lessons to 210 lessons, the net operating income should have been up $670 over budget. However, it wasn’t. The budgeted net operating income was $6,880 and the actual net operating income was $7,110, so the profit was up by only $230—not $670 as it should have been. There are many reasons for this—as shown in the revenue and spending variances. Perhaps most importantly, fuel costs were much higher than expected. The spending variance for fuel was $740 U (unfavorable) and may have been due to an increase in the price of fuel that is beyond the owner/manager’s control. Most of the other revenue spending variances were favorable or small, so with the exception of this item, costs seem to have been adequately controlled.

Wings Flight School Flexible Budget Performance Report For the Month Ended August 31 Flexible Budget 210

Revenue and Spending Variances

Planning Budget Lessons (q)........................................................... 200

Activity Variances

Revenue ($225q)..................................................$45,000 Expenses: Instructor wages($62q)....................................... 12,400 Aircraft depreciation ($57q)............................... 11,400 Fuel ($21q).......................................................... 4,200 Maintenance ($670 + $13q)................................ 3,270 Ground facility expenses 2,440 ($1,640 + $4q).............................................. Administration ($4,210 + $1q)........................... 4,410 Total expense....................................................... 38,120 Net operating income........................................... $ 6,880

$2,250

F

$47,250

$ 50

F

$47,300

620 570 210 130 40

U U U U U

13,020 11,970 4,410 3,400 2,480

110 0 740 70 130

F U U F

12,910 11,970 5,150 3,470 2,350

10 1,580 $ 670

U U F

4,420 39,700 $ 7,550

80 490 $440

F U U

4,340 40,190 $ 7,110

Actual Results 210

Problem 9-20 (30 minutes) 1. The activity variances are shown below: SecuriDoor Corporation Activity Variances For the Month Ended April 30

Machine-hours (q)............................................................

Planning Budget 20,000

Flexible Budget 18,000

Utilities ($16,500 + $0.15q)............................................. Maintenance ($38,600 + $1.80q)..................................... Supplies ($0.50q)............................................................. Indirect labor ($94,300 + $1.20q).................................... Depreciation ($68,000).................................................... Total.................................................................................

$ 19,500 74,600 10,000 118,300 68,000 $290,400

$ 19,200 71,000 9,000 115,900 68,000 $283,100

Activity Variances $ 300 3,600 1,000 2,400 0 $7,300

The activity variances are all favorable because the actual activity was less than the planned activity and therefore all of the variable costs should be lower than planned in the original budget.

2. The spending variances are computed below: SecuriDoor Corporation Spending Variances

F F F F F

For the Month Ended April 30 Actual Results 18,000

Spending Variances

Machine-hours (q)............................................................

Flexible Budget 18,000

Utilities ($16,500 + $0.15q)............................................. Maintenance ($38,600 + $1.80q)..................................... Supplies ($0.50q)............................................................. Indirect labor ($94,300 + $1.20q).................................... Depreciation ($68,000).................................................... Total.................................................................................

$ 19,200 71,000 9,000 115,900 68,000 $283,100

$ 21,300 68,400 9,800 119,200 69,700 $288,400

$2,100 2,600 800 3,300 1,700 $5,300

An unfavorable spending variance means that the actual cost was greater than what the cost should have been for the actual level of activity. A favorable spending variance means that the actual cost was less than what the cost should have been for the actual level of activity. While this makes intuitive sense, sometimes a favorable variance may not be good. For example, the rather large favorable variance for maintenance might have resulted from skimping on maintenance. Since these variances are all fairly large, they should all probably be investigated.

U F U U U U...