Question

Genuine Spice Inc. began operations on January 1 of the current year. The company produces eight- ounce bottles of hand and body lotion called Eternal Beauty. The lotion is sold wholesale in 12-bottle cases for $100 per case. There is a selling commission of $20 per case. The January direct materials, direct labor, and factory overhead costs are as follows:

DIRECT MATERIALS
	Cost Behavior	Units per Case	Cost per Unit	Cost per Case
Cream base	Variable	100 oz.	$0.02	$ 2.00
Natural oils	Variable	30 oz.	0.30	9.00
Bottle (8-oz.)	Variable	12 bottles	0.50	6.00
				$17.00

DIRECT LABOR
Department	Cost Behavior	Time per Case	Labor Rate per Hour	Cost per Case
Mixing	Variable	20 min.	$18.00	$6.00
Filling	Variable	5	14.40	1.20
		25 min.		$7.20

FACTORY OVERHEAD
	Cost Behavior	Total Cost
Utilities	Mixed	$600
Facility lease	Fixed	14,000
Equipment depreciation	Fixed	4,300
Supplies	Fixed	660
		$19,560

Part A—Break-Even Analysis

The management of Genuine Spice Inc. wants to determine the number of cases required to break even per month. The utilities cost, which is part of factory overhead, is a mixed cost. The following information was gathered from the first six months of operation regarding this cost:

	Case Production	Utility Total Cost
January	500	$600
February	800	660
March	1,200	740
April	1,100	720
May	950	690
June	1,025	705

	Required-Part A:
1.	Determine the fixed and variable portion of the utility cost using the high-low method.
2.	Determine the contribution margin per case.
3.	Determine the fixed costs per month, including the utility fixed cost from part (1).
4.	Determine the break-even number of cases per month.

Part B—August Budgets

During July of the current year, the management of Genuine Spice Inc. asked the controller to prepare August manufacturing and income statement budgets. Demand was expected to be 1,500 cases at $100 per case for August. Inventory planning information is provided as follows:

Finished Goods Inventory:

	Cases	Cost
Estimated finished goods inventory, August 1	300	$12,000
Desired finished goods inventory, August 31	175	7,000

Materials Inventory:

	Cream Base	Oils	Bottles
	(oz.)	(oz.)	(bottles)
Estimated materials inventory, August 1	250	290	600
Desired materials inventory, August 31	1,000	360	240

There was negligible work in process inventory assumed for either the beginning or end of the month; thus, none was assumed. In addition, there was no change in the cost per unit or estimated units per case operating data from January.

	Required-Part B:
5.	Prepare the August production budget.*
6.	Prepare the August direct materials purchases budget.*
7.	Prepare the August direct labor cost budget. Round the hours required for production to the nearest hour.*
8.	Prepare the August factory overhead cost budget. If an amount box does not require an entry, leave it blank. (Entries of zero (0) will be cleared automatically by CNOW.)*
9.	Prepare the August budgeted income statement, including selling expenses. NOTE: Because you are not required to prepare a cost of goods sold budget, the cost of goods sold calculations will be part of the budgeted income statement.* *Enter all amounts as positive numbers.

Part C—August Variance Analysis

During September of the current year, the controller was asked to perform variance analyses for August. The January operating data provided the standard prices, rates, times, and quantities per case. There were 1,500 actual cases produced during August, which was 250 more cases than planned at the beginning of the month. Actual data for August were as follows:

	Actual Direct Materials
	Price per Unit	Quantity per Case
Cream base	$0.016 per oz.	102 oz.
Natural oils	$0.32 per oz.	31 oz.
Bottle (8-oz.)	$0.42 per bottle	12.5 bottles

	Actual Direct	Actual Direct Labor
	Labor Rate	Time per Case
Mixing	$18.20	19.50 min.
Filling	14.00	5.60 min.

Actual variable overhead	$305.00
Normal volume	1,600 cases

The prices of the materials were different from standard due to fluctuations in market prices. The standard quantity of materials used per case was an ideal standard. The Mixing Department used a higher grade labor classification during the month, thus causing the actual labor rate to exceed standard. The Filling Department used a lower grade labor classification during the month, thus causing the actual labor rate to be less than standard

	Required-Part C:
10.	Determine and interpret the direct materials price and quantity variances for the three materials.
11.	Determine and interpret the direct labor rate and time variances for the two departments. Round hours to the nearest tenth of an hour.
12.	Determine and interpret the factory overhead controllable variance.
13.	Determine and interpret the factory overhead volume variance.
14.	Why are the standard direct labor and direct materials costs in the calculations for parts (10) and (11) based on the actual 1,500-case production volume rather than the planned 1,375 cases of production used in the budgets for parts (6) and (7)?

Amount Descriptions-Part A
Controllable variance
Equipment depreciation
Facility lease
Supplies
Utilities
Volume variance

1. Determine the fixed and variable portion of the utility cost using the high-low method.

	At High Point	At Low Point
Variable cost per unit
Total fixed cost
Total cost

2. Determine the contribution margin per case.

3. Determine the fixed costs per month, including the utility fixed cost from part (1).

Answer 1

Answer:

Part A

1.         Variable Cost per Unit = Difference in Total Cost / Difference in Production

            Variable Cost per Unit = $740 - $600 / 1,200 cases - 500 cases = $0.20 per case

            Total Cost = (Variable Cost per Unit × Units of Production) + Fixed Cost

At the high point:                                                      At the low point:

$740 = ($0.20 × 1,200 units) + Fixed Cost                $600 = ($0.20 × 500 units) + Fixed Cost

Fixed Cost = $500                                                      Fixed Cost = $500

2.

Selling price……………………………	$100.00
Less variable costs per case:	$17.00
Direct materials………………………
Direct labor……………………………	7.20
Utilities [see part (1)]………………	0.20
Selling expenses……………………		20.00
Total variable costs per case………		44.40
Contribution margin per case………	$ 55.60

3.         Total fixed costs:

Utilities [see part (1)]……………………………………	$500
Facility lease……………………………………………	14,000
Equipment depreciation………………………………	4,300
Supplies…………………………………………………		660
	$19,460

4.         Break-Even Sales (units) = Fixed Costs / Unit Contribution Margin

            Break-Even Sales (units) = $19460 / $55.60 = 350 cases

Part B

5.

GENUINE SPICE INC.

Production Budget

For the Month Ended August 31, current year

Cases

Expected cases to be sold

1,500

Plus desired ending inventory

175

Total

1,675

Less estimated beginning inventory

300

Total units to be produced

1,375

6.

	GENUINE SPICE INC.
	Direct Materials Purchases Budget
	For the Month Ended August 31, current year
				Cream		Natural
				Base		Oils		Bottles			Total
				(ozs.)		(ozs.)		(bottles)
	Units required for production			137,5001		41,2502		16,500	3
	Plus desired ending inventory			1,000		360		240
	Less estimated beginning inventory		(250)		(290)		(600)
	Direct materials to be purchased			138,250		41,320		16,140
	× Unit price			$0.02		$0.30		$0.50
	Total direct materials to be purchased		$2,765		$12,396		$8,070			$23,231

¹Cream base: 1,375 cases × 100 ozs. = 137,500 ozs.

²Natural oils: 1,375 cases × 30 ozs. = 41,250 ozs.

³Bottles: 1,375 cases × 12 bottles = 16,500 bottles

7.

	GENUINE SPICE INC.
	Direct Labor Budget
For the Month Ended August 31, current year
		Mixing		Filling		Total
Hours required for production of:
Hand and body lotion		4581		1152
× Hourly rate		$18.00		$14.40
Total direct labor cost		$8,244		$1,656		$9,900

¹Mixing: (1,375 cases × 20.00 min.) ÷ 60 min. = 458 hrs.

²Filling: (1,375 cases × 5.00 min.) ÷ 60 min. = 115 hrs.

8.

		GENUINE SPICE INC.
		Factory Overhead Budget
	For the Month Ended August 31, current year
			Fixed1	Variable2	Total
	Factory overhead:
	Utilities		$	500	$275	$	775
	Facility lease			14,000			14,000
	Equipment depreciation			4,300			4,300
	Supplies			660			660
	Total		$	19,460	$275	$	19,735

¹Fixed costs [from part (3)]

²Variable utility cost: $0.20 × 1,375 cases = $275

9.

	GENUINE SPICE INC.
	Budgeted Income Statement
	For the Month Ended August 31, current year
	Sales1					$	150,000
	Finished goods inventory, August 1				$12,000
	Direct materials inventory, August 12		$	392
	Direct materials purchases [from part (6)]			23,231
	Less direct materials inventory, August 313			248
	Cost of direct materials for production		$	23,375
	Direct labor [from part (7)]			9,900
	Factory overhead [from part (8)]			19,735	53,010
	Less finished goods inventory, August 31				7,000
	Cost of goods sold						58,010
	Gross profit					$	91,990
	Selling expenses4						30,000
	Income before income tax					$	61,990

¹Sales: 1,500 cases × $100 per case = $150,000

²Direct materials inventory, August 1: (250 × $0.020) + (290 × $0.300) + (600 × $0.500)

= $392

³Direct materials inventory, August 31: (1,000 × $0.020) + (360 × $0.300) + (240 × $0.500)

= $248

⁴Selling expenses: 1,500 cases × $20 per case = $30,000.

Part C

10.       Direct Materials Price Variance:

			Cream				Natural
			Base				Oils				Bottles
Actual price…………………………	$	0.016			$	0.32		$	0.42
Standard price……………………			0.020					0.30				0.50
Difference…………………………	$	(0.004)		$	0.02		$	(0.08)
× Actual quantity (units)*………			153,000		ozs.			46,500	ozs.			18,750	btls.
Direct materials price variance…	$	(612) F	$	930	U	$	(1,500) F

* Actual quantity:

Cream base: 1,500 cases × 102 ozs. = 153,000 ozs.

Natural oils: 1,500 cases × 31 ozs. = 46,500 ozs.

Bottles: 1,500 cases × 12.5 bottles = 18,750 bottles

The fluctuation in market prices caused the direct material price variances. Prices increased for natural oils compared to standard and declined for cream base and bottles compared to standard.

Direct Materials Quantity Variance:

		Cream			Natural
		Base			Oils			Bottles
Actual quantity1………………………	153,000	ozs.		46,500		ozs.		18,750	btls.
Standard quantity2……………………	150,000			45,000				18,000
Difference………………………………		3,000	ozs.		1,500		ozs.		750	btls.
× Standard price………………………	$	0.02		$	0.30			$	0.50
Direct materials quantity variance…	$	60	U	$	450		U	$	375	U

All the direct materials quantity variances were unfavorable, indicating some material losses, scrap, and quality rejections. All the quantity variances were unfavorable because the standards were set at ideal quantity amounts.

Thus, only unfavorable variances were possible. The standard quantities were ideal standards for 12 8-ounce bottles per case (96 ozs. total), as shown below.

¹Actual quantity:

Cream base: 1,500 cases × 102 ozs. = 153,000 ozs.

Natural oils: 1,500 cases × 31 ozs. = 46,500 ozs.

Bottles: 1,500 cases × 12.5 bottles = 18,750 bottles

²Standard quantity:

Cream base: 1,500 cases × 100 ozs. = 150,000 ozs.

Natural oils: 1,500 cases × 30 ozs. = 45,000 ozs.

Bottles: 1,500 cases × 12 bottles = 18,000 bottles

11.       Direct Labor Rate Variance:

	Mixing		Filling
		Department	Department
	Actual rate…………………………………………………	$18.20	$	14.00
	Standard rate……………………………………………		18.00				14.40
	Difference…………………………………………………	$ 0.20		$	(0.40)
	× Actual time (hours)1…………………………………		487.5				140.00
	Direct labor rate variance………………………………		$97.50 U		$	(56.00) F

The Mixing Department has an unfavorable direct labor rate variance from using a higher classification of labor. The higher labor classification costs an additional $0.20 per hour. The Filling Department has a favorable direct labor rate variance due to using a lower classification of labor. The lower labor classification saved $0.40 per hour.

Direct Labor Time Variance:	Mixing	Filling
	Department	Department
Actual time (hours)1……………………………………			487.5			140
Standard time (hours)2…………………………………			500				125
Difference…………………………………………………			(12.5)			15
× Standard rate…………………………………………	$	18		$	14.40
Direct labor time variance……………………………		$	(225) F	$	216	U

¹ Actual time:

Mixing: (1,500 units × 19.50 min.) ÷ 60 min. = 487.5 hrs.

Filling: (1,500 units × 5.60 min.) ÷ 60 min. = 140 hrs.

²Standard time:

Mixing: (1,500 units × 20.00 min.) ÷ 60 min. = 500 hrs.

Filling: (1,500 units × 5.00 min.) ÷ 60 min. = 125 hrs.

The Mixing Department is producing at a labor time that is slightly better than standard, thus producing a favorable direct labor time variance. This may be the result of using a higher grade of labor. The net impact for the Mixing Department is favorable by $127.50 ($97.50 - $225). The Filling Department had an unfavorable direct labor time variance. This may be the result of using a lower grade of labor in the department. The net impact for the department is unfavorable by $160.00 ($216.00 - $56.00). Thus, the savings in the labor rate from using a lower grade classification of labor was insufficient to offset the loss of efficiency from such labor.

12.       Factory Overhead Controllable Variance:                                         

Actual variable overhead………………………………………………………	$	305
Variable overhead at standard cost*………………………………………		300
Factory overhead controllable variance……………………………………	$	5		U

^*Variance overhead (utility cost) at standard cost: $0.20 × 1,500 cases = $300

13.       Factory Overhead Volume Variance:

Normal volume (cases)………………………………………………………	1,600
Actual volume (cases)…………………………………………………………	1,500
Difference………………………………………………………………………	100
× Fixed factory overhead rate*………………………………………………	$ 12.1625
	$1,216.25 U

* Fixed factory overhead rate: $19,460** ÷ 1,600 cases = $12.1625 per case

** Total fixed factory overhead shown in part (8)

The unfavorable volume variance indicates the cost of underused capacity of 100 cases per month.

Alternative Computation of Overhead Variances

14.       The production volume of 1,375 cases determined in part (5) was planned at the beginning of August. The variances compare the actual cost and the standard cost of actual production for the month. Thus, the standard cost must be based on the 1,500 units of actual production. This amount is compared with an actual cost also based on 1,500 units. The variable costs of the budget must flex to the actual production volume so that variances are compared across the same production volume.