I have computed the flexible variances and indicate whether favorable or unfavor

Question

I have computed the flexible variances and indicate whether favorable or unfavorable. Here is a bit of additional information: Headquarters are contemplating charging each store a 5% marketing expense based on sales.

1. How will that affect the operating profit of the store and the money available for managerial bonuses based on actual results for the past year?

2. Explain the flexible budget variances; how to interpret the information; and what action, if any to take. Comment on the 5% marketing proposal too.

Revenue Actual Budgeted Variance FAV/UNFAV. $1,325,000.00 $1,325,000.00 Cost of Sales $790,000.00 $740,000.00 -$50,000.00 U Management $208,000.00 $186,000.00 -$22,000.00 U Shop Assistants $230,000.00 $268,000.00 $38,000.00 F Rent $58,200.00 $54,450.00 -$3,750.00 U Utilities $31,000.00 $34,800.00 $3,800.00 F Marketing Expenses $66,250.00 $66,250.00 Net Profit -$58,450.00 -$24,500.00

Explanation / Answer

1) Impact of Charging Marketing Expense on Operating Profit

With the introduction of marketing expense, an additional amount will be charged in income statement,leading to additional expense, hence leading to decrease in profit.

Further, if due to marketing, organisation is able to generate additional revenue, and that additional revenue supercedes the amount of marketing expense, then additional expense on marketing is favourable for organisation.Increase in revenue greater than marketing expense will lead to increase in operating profit, hence giving a favourable benefit.

Impact of Charging Marketing Expense on Money Available for Managerial Bonus

If with Marketing expense, there is no increase in amount of revenue, then it will lead to decrease in amount of money available and as well as it will decrease operating profit.

If in case, with incurring marketing expense, there is increase in amount of revenue, and the amount of revenue, supercedes, expense of marketing, it will lead to increase in operating profit and money available. In this case with availability of more money and with better operating profit, managerial bonus can be given for their good performance.

2) How to interpret Variances

In order to understand variance, first step is to classify the information, i.e. whether it is revenue or expense.Like if there is increase in revenue than its budgeted figure, that is a favourable variance as revenue has exceeded budegeted amount of revenue. On the contrary if it is an expense item, then increase in expense as compared to its budgeted value is unfavourable, because you have spent more amount.

In the given ques, since actual revenue amount is equal to budgeted revenue but few expenses are incurred more than budgeted, this is unfavourable situation. But other situation also exists, that is few expenses have been incurred at less amount than its budgeted amount leading to saving in expense, hence favourable situation. The net impact of saving in expenses and additional expenses incurred can be interpreted from the amount of profit.The actual amount of profit is a loss and that loss is more than budgeted loss. Hence in overall situation, impact of both favourable and unfavourable variances is negative as it has led to increase in losses.

If additional amount of marketing is to be expensed, considering same level of revenue., then it is not recommended as it will not lead to any increase in revenue but it will increase the amount of losses.

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