Question

Amethyst has a standard variable overhead rate of $5 per direct labour hour. The standard quantity of direct labour per unit of production is 2 hours. The company's static budget was based on 50,000 units. Actual results for the year are as follows.

Actual units produced               45,000

Actual direct labour hours         100,000

Actual variable overhead           $495,000

The time has come for the company to compare of actual results with planned results.

Required

1. What is the company’s (i) static budget and (ii) flexible budget for the variable overhead costs?
2. What is the company’s variable overhead costs’ (i) spending variance and (ii) efficiency variance?
3. Regarding the company’s actual results, flexible budget, and static budget, does having a small static-budget variance always implies a good budgeting process? Use your calculations to support your argument.

Answer 1

a) Budgets

(i) Amethyst's Static Budget for the period

	Particulars
a	Budgeted Units of prodution	50,000 units
b	Direct labour hours / Unit	2 hours
c	Budgeted Total Hours	100,000 hours
d	Budgeted Variable overhead rate per hour	$ 5
e	Budgeted Variable Overheads for the period	$ 500,000

(ii) Amethyst's Flexible Budget for the period

	Particulars
a	Actual Units produced	45,000 Units
b	Direct labour hours / Unit	2 hours
c	Bugeted Total Hours	90,000 Hours
d	Budgeted Variable overhead rate per hour	$ 5
e	Budgeted Variable Overheads for the period	$ 450,000

2.

Computation of Variances

(i) Spending variance

= Actual Hours at Standard Rate - Actual Variable Overheads

= 1,00,000 hours X $5 - $ 4,95,000

= $ 500,000 - $ 4,95,000

= $ 5000 FAVOURABLE

(ii) Efficiency variance

= Standard Variable Overhead Cost for Actual Output - Actual Hours at Standard Rate

= 45000 unit X 2 hours X $ 5 - 100,000 hours X $ 5

= $ 450,000 - $ 500,000

= ($ 50,000) Unfavourable

3.

STATIC BUDGET vs ACTUAL RESULTS

	Particulars	Static Budget	Actual		Variance
a	Units produced	50,000	45,000		-
b	Direct labour hours / Unit	2	2.22		-
c	Total Hours	100,000	100,000		-
d	Variable overhead rate per hour	$ 5	$ 4.95		-
e	Variable Overheads for the period	$ 500,000	$ 495,000		$ 5,000

FLEXIBLE BUDGET vs ACTUAL RESULTS

	Particulars	Flexible Budget	Actual		Variance
a	Actual Units produced	45,000	45,000		-
b	Direct labour hours / Unit	2	2.22		-
c	Total Hours	90,000	100,000		-
d	Variable overhead rate per hour	$ 5	$ 4.95		-
e	Variable Overheads for the period	$ 450,000	$ 495,000		($ 45,000)

No. Static budget, having a small static-budget variance does not always implies a good budgeting proces.

The information form the static budget shows a favourable variance of $ 5000, denoting that there has been a decrease in the costs. In this question you have to bear in mind that the actual production had been just 45,000 units .The total variable cost in the Static budget is in relation to the budgeted sales units of 50,000 units and not for 45,000 units. This is the reaons why the actual costs is less than budgeted costs in static budget.

The flexible budget changes with the actual production units. Thus the budgeted variable costs in the flexible budget is in relation to 45,000 units. On comparison with the figures of the flexible budget, the actual variable overheads has increased by $45,000 from the budget for the same leve of production.

The Labour Efficiency Variance computed earlier shows an unfavourable variance of $ 50,000. The increase in costs was due to the increase in the number of hours of production. For 45000 units the standard hours is 90,000 hours where as the actual hours operated during the period was 100,000 hours.

There has been a slight savings in the variable overheads rate as the rate fell to $4.95 from $5. This lead to a favourable spening variance of $5000.

The net change is 45,000 unfavourable ( $ 50,000 unfavourable + $5,000 favourable ).