Reference no: EM131816883
Question: Interpretation of Favorable and Unfavorable Variances 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 sales were reduced ($6,000 less $4,000 = $2,000 operating profit) than if the replacement machine was obtained ($8,000 less $6,500 = $1,500 operating 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.
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