Question

ATC 15-1 Business Applications Case   Static versus flexible budget variances

David Catrow is the manufacturing production supervisor for Faraday Motor Works (FMW), a company that manufactures electrical motors for industrial applications. Trying to explain why he did not get the year-end bonus that he had expected, he told his wife, “This is the dumbest place I’ve ever worked. Last year the company set up this budget assuming it would sell 150,000 units. Well, it sold only 140,000. The company lost money and gave me a bonus for not using as much materials and labor as was called for in the budget. This year, the company has the same 150,000 units goal and it sells 160,000. The company’s making all kinds of money. You’d think I’d get this big fat bonus. Instead, management tells me I used more materials and labor than was budgeted. They said the company would have made a lot more money if I’d stayed within my budget. I guess I gotta wait for another bad year before I get a bonus. Like I said, this is the dumbest place I’ve ever worked.”

FMW’s master budget and the actual results for the most recent year of operating activity follow.

	Master Budget	Actual Results	Variances	F or U
Number of units	150,000	160,000	10,000
Sales revenue	$33,000,000	$35,520,000	$2,520,000	F
Variable manufacturing costs
Materials	(4,800,000)	(5,300,000)	500,000	U
Labor	(4,200,000)	(4,400,000)	200,000	U
Overhead	(2,100,000)	(2,290,000)	190,000	U
Variable selling, general, and admin. costs	(5,250,000)	(5,450,000)	200,000	U
Contribution margin	16,650,000	18,080,000	1,430,000	F
Fixed costs
Manufacturing overhead	(7,830,000)	(7,751,000)	79,000	F
Selling, general, and admin. costs	(6,980,000)	(7,015,000)	35,000	U
Net income	$ 1,840,000	$ 3,314,000	$1,474,000	F

Required

1. Assume that the company’s materials price variance was favorable and its materials usage variance was unfavorable. Explain why Mr. Catrow may not be responsible for these variances. Now, explain why he may have been responsible for the materials usage variance.
2. Assume the labor price variance is unfavorable. Was the labor usage variance favorable or unfavorable?
3. Is the fixed cost volume variance favorable or unfavorable? Explain the effect of this variance on the cost of each unit produced.

Answer 1

a) Ans:-Mr. Catrow may not be responsible for the variance, since it could have been caused by the use of low quality materials causing waste during the production process. However, waste during the production process could also be caused by a lack of employee care in their duties (poor quality workmanship); which, would be attributed to poor supervision by Mr. Catrow, since he is responsible as their supervisor to monitor their performance.

b) If the labor price variance was unfavorable then the labor usage variance would have to be favorable, since the total variance was favorable. This is because the total variance is composed of both labor usage and labor price variances; and, they would have to offset each other in order for the total variance to be favorable. If both were unfavorable then the total variance would also have to be unfavorable, which it is not.

C)If more units were produced than what was budgeted (160,000 vs. 150,000), the fixed cost volume variance would be favorable. The effects of this variance on each unit would be a lower production cost per unit produced, since the total fixed overhead is spread over a larger number of units resulting in a lower per unit production cost and increased profitability