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Static vs. Flexible Budget Variances

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Scenario: Dan Ludwig is the manufacturing production supervisor for Atlantic Lighting Systems. Trying to explain why he did not get the year-end bonus that he had expected, he told his wife "This is the dumbest place I have ever worked. Last year the company set up this budget assuming it would sell 150,000 units. Well, it only sold 140,000. The company lost money and gave me a bonus for not using as much materials and labor as was called for in the budget. This year, the company has the same 150,000 units goal and it sells 160,000. The company's making all kinds of money. You'd think I'd get this big fat bonus. Instead, management tells me I used more materials and labor than was budgeted. They said the company would have made a lot more money if I'd stayed within budget. I guess I gotta wait for another bad year before I get a bonus. Like I said, this is the dumbest place I ever worked." (View attachment for data)

Questions:
a) Did Atlantic Lighting Systems increase unit sales by cutting prices or by using some other strategy?
b) Is Mr. Ludwig correct in his conclusion that something is wrong with the company's performance evaluation process? If so, what do you suggest be done to improve the system?
c) Prepare a flexible budget and recompute the budget variances.
d) Explain what might have caused the fixed costs to be different from the amount budgeted.
e) Assume that the company's material price variance was favorable and its material usage variance was unfavorable. Explain why Mr. Ludwig may not be responsible for these variances. Now, explain why he may have been responsible for the material usage variance.
f) Assume the labor price variance is unfavorable. Was the labor usage variance favorable or unfavorable?
g) Is the fixed cost volume variance favorable or unfavorable? Explain the effect of this variance on the cost of each unit produced.

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The expert examines static versus flexible budget variances.

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Please see attachment.

a. Did Atlantic increase unit sales by cutting prices or by using some other strategy?
Master Budget Actual Results Change
Units 150,000 160,000 10,000
Sales $33,000,000 $35,520,000 $2,520,000
Selling price $220 $222 $2

The above table shows that the selling price increased along with the sales units. It therefore goes on to show that prices were not the determining factor in the increase in sales volume. It means that the firm adopted another strategy in achieving the increase this might include increasing the advertising budget, offering free samples or sales promotions etc.

b. Is Mr. Ludwig correct in his conclusion that something is wrong with the company's performance evaluation process? If so, what do you suggest be done to improve the system?

The objective, of performance evaluation, is to create rewards when the goals are surpassed and create penalties for shortcomings. From the assessment, when the sales increased and affected some variance adversely, he was sanctioned. The end objective should be to see how the changes affect the total income earned. Income is usually the sole objective of most firms and also ensures the continuity of the business. From the results, you will observe that the net income changed as a result of the changed production level.

It is therefore plausible that the ...

Solution provided by:
Chidi Ngene, M. Sc.
Education
  • B. Sc., University of Nigeria
  • M. Sc., London South Bank University
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