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CHAPTER 7 FLEXIBLE BUDGETS, DIRECT-COST VARIANCES, AND MANAGEMENT CONTROL 7-1 Management by exception is the practice of concentrating on areas not operating as expected and giving less attention to areas operating as expected. Variance analysis helps managers identify areas not operating as expected. The larger the variance, the more likely an area is not operating as expected. 7-2 Two sources of information about budgeted amounts are (a) past amounts and (b) detailed engineering studies. 7-3 A favorable variance ––denoted F––is a variance that has the effect of increasing operating income relative to the budgeted amount. An unfavorable variance––denoted U––is a variance that has the effect of decreasing operating income relative to the budgeted amount. 7-4 The key difference is the output level used to set the budget. A static budget is based on the level of output planned at the start of the budget period. Aflexible budget is developed using budgeted revenues or cost amounts based on the actual output level in the budget period. The actual level of output is not known until the end of the budget period. 7-5 A flexible-budget analysis enables a manager to distinguish how much of the difference between an actual result and a budgeted amount is due to (a) the difference between actual and budgeted output levels, and (b) the difference between actual and budgeted selling prices, variable costs, and fixed costs. 7-6 The steps in developing a flexible budget are: Step 1: Identify the actual quantity of output. Step 2: Calculate the flexible budget for revenues based on budgeted selling price and actual quantity of output. Step 3: Calcula