Question

Jackson Sound produces amplifiers and mixing boards in a modern production facility. The company is well known for its quality products. Each item is thoroughly tested before it leaves the plant. Workers are highly skilled. The company considers direct labor to be a fixed cost because it does not reduce the workforce when there is a small downturn in business, and it can accommodate production increases of up to 10 percent due to excess capacity.

In the production process, workers in the circuit department prepare circuit boards that are sent to the case department for installation in custom cases. In the past 6 months, the workers in the circuit department have pursued a number of process improvement initiatives that have resulted in much shorter production times. For example, the Model LE7 amplifier used to require 12.5 standard labor hours in the circuit department, but the standard was revised last month to only 10.4 standard hours.

Although the circuit department has made production improvements, the chief financial officer of the company, Christopher Carlson, is concerned about a major buildup of in-process inventory that is occurring between the circuit department and the case department. “What's going on?” he asked his assistant, Megan Welles. “I was walking through the plant yesterday and I saw a tremendous amount of in-process inventory. I thought we had implemented a JIT system and we were working to balance our production processes. That investment in work in process is just going to drag down company performance.”

Megan replied that the source of the problem might be related to the process improvements and the fact that bonuses for production workers are tied to standard cost performance. Christopher, however, didn't see how a process improvement could actually make things worse.

REQUIRED

Assume that the company is reluctant to fire workers in the circuit department even if they are not really needed. (After all, they have just worked hard to improve productivity.) Given the production improvements and the institution of new standards, explain why the circuit department has an incentive to overproduce (i.e., produce more output than can be handled by the case department).

(Hint: If the circuit department does not overproduce, what will be the effect of the process improvements on the labor efficiency variance?)

Answer 1

Refer to the below image for the above asked question, in a detailed way of solution with explanation.