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Cost Accounting - Flexible Budgets

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Question I

You are preparing a short presentation for a group who wants learn performance reporting issues. One question that was raised during the discussion is about measuring variances when the actual output (or activity) does not match with the budgeted output (or activity). How will you explain to the group that an approach called flexible budgets can answer many questions on what variances are telling them? Explain to the group why the favorable variance or unfavorable variances are giving ineffective signals.

Question II

What assumption is implicitly made about cost behavior when all of the items in a budget are adjusted in proportion to a change in activity? Why is this assumption questionable?

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Solution Preview

1. There are three major components in business performance reporting:
a. Revenue - consists of all revenue streams such as sales and performing services
b. Working Capital - consists of receivables and payable position which tells short term business sustainability
c. Expenditure - consist of operating expenditure (such as man power cost, recruitment, utilities, rent) and capital expenditure (building, equipment)

Flexible budgets can help to explain factors that are impacting their forecasts. For example
When the oil price is $100/barrel and the budgeted sales is 100 barrels/month, our budgeted revenue will be $10,000/per ...

Solution Summary

Performance reporting issues and a discussion of the value of cost accounting.