Chapter 14, Problem 24E

1.

To determine

Compute the actual operating income for the period.

Explanation of Solution

Variances consist of differences between financial budgeting and actualization amounts.

A variance in budget is the difference in the amount of expense or revenue budgeted or baseline, and the actual amount. The variance in budget is favorable if the actual revenue is higher than the budget or if the actual expense is less than the budget.

The difference between the actual operating income and the operating income of the master budget is called the total variance in operating income. This variance also referred to as a master (static) variance of the budget for the period.

OR

The total variance of a period's operating income is the difference between the period’s actual operating income and the period’s budgeted operating income; also called the period's master (static) budget variance.

The formula to calculate actual operating income for the period is as follows:

$\text{Actual operating income}=\text{Actual sales revenue}-\text{actual variable costs}-\text{actual fixed costs}$

Calculate actual operating income for the period:

$\begin{array}{c}\text{Actual operating income}=\$380,000-\$210,000-\$145,000\\ =\text{\$380,000}-\text{\$355,000}\\ =\text{\$25,000}\end{array}$

Thus, the actual operating income for the period is $25,000.

Working notes:

Actual sales revenue for the period is $380,000.

Actual costs are as follows: variable, $210,000, and fixed, $145,000.

2.

To determine

Calculate the master budget operating income of the company for the given period.

Explanation of Solution

Variances consist of differences between financial budgeting and actualization amounts.

A variance in budget is the difference in the amount of expense or revenue budgeted or baseline, and the actual amount. The variance in budget is favorable if the actual revenue is higher than the budget or if the actual expense is less than the budget.

The difference between the actual operating income and the operating income of the master budget is called the total variance in operating income. This variance also referred to as a master (static) variance of the budget for the period.

OR

The total variance of a period's operating income is the difference between the period’s actual operating income and the period’s budgeted operating income; also called the period's master (static) budget variance.

The formula to calculate the master budget operating income of the company for the period is as follows:

$\text{Master (static) budget operating income}=\text{Budgeted sales revenue}-\text{Budegted variable costs}-\text{Budgeted fixed costs}$

Calculate the master budget operating income of the company for the period:

$\begin{array}{c}\text{Master (static) budget operating income}=\text{\$450,000}-\text{\$270,000}-\$135,000\\ =\$450,000-\$405,000\\ =\$45,000\end{array}$

Thus, the master budget operating income of the company for the period is $45,000.

Working notes:

Budgeted sales revenue for the period is $450,000.

Budgeted costs are as follows: variable, $270,000, and fixed, $135,000.

3.

To determine

Compute the total master (static) budget variance in terms of the operating income, for the period and also mention that the variance will be favorable (F) or unfavorable (U) and explain its reason.

Explanation of Solution

Variances consist of differences between financial budgeting and actualization amounts.

A variance in budget is the difference in the amount of expense or revenue budgeted or baseline, and the actual amount. The variance in budget is favorable if the actual revenue is higher than the budget or if the actual expense is less than the budget.

The difference between the actual operating income and the operating income of the master budget is called the total variance in operating income. This variance also referred to as a master (static) variance of the budget for the period.

OR

The total variance of a period's operating income is the difference between the period’s actual operating income and the period’s budgeted operating income; also called the period's master (static) budget variance.

The formula to calculate total master (static) budget variance, in terms of operating income for the period is as follows:

$\text{Total master (static) budget variance}=\text{Actual opearting income}-\text{Master budget operating income}$

Calculate total master (static) budget variance, in terms of operating income for the period:

$\begin{array}{c}\text{Total master (static) budget variance}=\text{\$25,000}-\text{\$}45,000\\ =\$20,000\text{ U}\end{array}$

As the actual income is less than the budgeted income, thus, total master (static) budget variance, in terms of operating income for the period is $20,000 U.

4.

To determine

Mention that it will be feasible to decompose the total master (static) budget variance into a total flexible-budget variance and a sales volume variance and explain its reason also.

Explanation of Solution

Variances consist of differences between financial budgeting and actualization amounts.

A variance in budget is the difference in the amount of expense or revenue budgeted or baseline, and the actual amount. The variance in budget is favorable if the actual revenue is higher than the budget or if the actual expense is less than the budget.

The difference between the actual operating income and the operating income of the master budget is called the total variance in operating income. This variance also referred to as a master (static) variance of the budget for the period.

OR

The total variance of a period's operating income is the difference between the period’s actual operating income and the period’s budgeted operating income; also called the period's master (static) budget variance.

A flexible-budget (FB) variance for any item on the revenue statement specifies the difference between the actual amount of this item and the budget-flexible amount for that item.

Particulars	Actual results	Flexible result	Master budget
Unit sales	40,000	40,000	45,000
Sales	$380,000	$400,000	$450,000
Total variable expenses	210,000	240,000	270,000
Contribution margin	$170,000	$160,000	$180,000
Fixed expenses	145,000	135,000	135,000
Operating income	$25,000	$25,000	$45,000

The first-level decomposition of the total master (static) budgetary variance in operating income is achieved by introducing a flexible-budget (based on the actual sales volume for the period). Here, the flexible-budget operating income is calculated as:

Flexible-budget operating income = $400,000 − $240,000 − $135,000 = $25,000

Calculate total flexible-budget variance:

Total flexible budget variance = Actual operating income − flexible-budget operating income = $25,000 − $25,000 = $0

Calculate sales volume variance, in terms of operating income:

Sales volume variance = flexible-budget operating income − master budget operating income = $25,000 − $45,000 = $20,000U.

Calculate master budget variance:

Master budget variance = Total flexible-budget variance + Sales Volume variance

Master budget variance = $0 + $20,000U = $20,000U

5.

To determine

Explain the term total flexible- budget variance and the sales volume variance.

Explanation of Solution

Variances consist of differences between financial budgeting and actualization amounts.

A variance in budget is the difference in the amount of expense or revenue budgeted or baseline, and the actual amount. The variance in budget is favorable if the actual revenue is higher than the budget or if the actual expense is less than the budget.

A flexible-budget (FB) variance for any item on the revenue statement specifies the difference between the actual amount of this item and the budget-flexible amount for that item. The flexible-budget variance represents the composite effect of changes in three factors on the operating income: selling price per unit, variable cost per unit, and total fixed cost. Thus we "hold constant" sales volume when calculating the flexible-budget variance. There is a zero variance in the flexible-budget here. However, this does not imply that there is no variance in selling prices, or flexible budget variance in variable costs, or any variance in fixed cost spending. It simply means the three variances are net to zero.

The variance in the sales volume is the difference between the flexible operating budget income and the master budget operating income for that period. The variance in sales volume represents the impact of selling a different volume of sales on operating profit as compared to the volume budgeted reflected in the master budget. As such, the variance calculation includes 3 other factors constant: sale price per unit, variable cost per unit, and total fixed cost. This variance can be defined in terms of contribution margin, in which case the calculation looks at the impact of selling a different amount on contribution margin than the sales volume reflected in the period's master budget.