Question

A division budgeted an operating profit of $3,000 on sales of $8,000 and costs of $5,000. However, at the beginning of the period, one of the division's machines broke down and could not be fixed until the end of the period. When the machine broke, the division manager determined that there were two feasible alternatives: First, production and sales could be cut back by 25%, reducing sales to $6,000 and costs to $4,000. (Note that costs are not reduced by 25% because some of the costs are fixed.) Second, a replacement machine could be obtained and installed, allowing sales to be maintained at $8,000 but increasing costs to $6,500. The division manager analyzed the alternatives and concluded that revenues less costs would be greater if sale:s were reduced ($6,000 less $4,000 $2,000 operat ing profit) than if the replacement machine was obtained ($8,000 less $6,500 profit). The manager, therefore, chose not to replace the machine. However, because revenue was lower than planned by $2,000, there is an unfavorable revenue variance of $2,000. Comment on how the unfavorable revenue variance should be interpreted in evaluating the performance of the manager.

Answer 1

The unfavorable revenue variance of $2000 was due to break down of one of the divisions machine
at the beginning of the period rather than ineffectiveness of the manager.
The managers performance should be evaluated by calculating the flexible budget variance which gives
the information how much more the company expended to making the product and sell the actual level
of output,than they have to spend if the processes has been effective and cost of the particular product
have not changed.
The static budget variance is affected by three factors
1.price changes ,
2.Efficiency,
3.Sales Activity
But it cannot be surely be confirmed how much of these unfavorable variance is caused by the price changes,
Efficiency and sales activity only on the basis of the static budget variance.