Question I: You are preparing a short presentation for a group who wants learn performance reporting issues. One question that was raised during the discussion is about measuring variances when the actual output (or activity) does not match with the budgeted output (or activity). How will you explain to the group that an approach called flexible budgets can answer many questions on what variances are telling them? Explain to the group why the favorable variance or unfavorable variances are giving ineffective signals.
Question II: What assumption is implicitly made about cost behavior when all of the items in a budget are adjusted in proportion to a change in activity? Why is this assumption questionable?