Question

Variable Production Cost Variance Analysis Iron Products Inc. produces prefabricated iron fencing used in commercial construction. Variable overhead is applied to products based on direct labor hours. The company uses a just-in-time production system and thus has insignificant inventory levels at the end of each month.

The company's income statement for the month of November comparing actual results with the flexible budget based on actual sales of 2,000 units is shown below.

	Actual	Budget	Variance
Sales	$1,805,000	$1, 800 ,000	$(5,000 )	Favorable
Variable cost of goods sold	867,4 00	800 ,000	67,4 00	Unfavorable
Variable selling and administrative expenses	250,000	240,000	10,000	Unfavorable
Contribution margin	687,600	760,000	72,400	Unfavorable
Fixed cost of goods sold Fixed selling	575,000	580,000	(5,000)	Favorable
administrative expenses	117,000	120,000	(3000)	Favorable
Net Profit	(4,400)	60,000	64,000	Unfavorable

Iron Products is disappointed with the actual results and has hired you as a consultant to provide further information as to why the company has been struggling to meet budgeted net profit. Your review of the above budget versus actual analysis identifies variable cost of goods sold as the main culprit. The unfavorable variance for this line item is $67,400.

After further research, you are able to track down the following standard cost information for variable production costs:

Direct materials (50 pounds per unit at $5 per pound)            $250

Direct labor (3 hours at $20 per hour)                                    60

Variable overhead (3 direct labor hours at $30 per hour)      90

Standard variable production cost per unit                         $400

Actual production information related to variable cost of goods sold for the month of November is as follows:

• 2,000 units were produced and sold.

• 110,000 pounds of material were purchased and used at a total cost

of $528,000.

• 5,600 direct labor hours were used during the month at a total cost

of $134,400.

• Variable overhead costs totaled $205,000.

Required

a. Calculate the material s price variance and materials quantity variance. Clearly

label each variance as favorable or unfavorable.

b. Identify the highest favorable variance and highest Calculate the labor rate

variance and labor efficiency variance. Clearly label each variance as favorable or

unfavorable.

c. Calculate the variable overhead spending variance and variable overhead

efficiency variance. Clearly label each variance as favorable or unfavorable.

d. List each of the six variances calculated in requirements a, b, and c, and total the

variances to show one net variance. Clearly label the net variance as favorable

or unfavorable. Explain how this net variance relates to variable cost of goods

sold on the income statement.

e. Identify the highest favorable variance and highest unfavorable variance from the

six listed in requirement d, and provide one possible cause of each variance.

Answer 1

Part 1 - Calculation of Material Price Variance and Material Quantity Variance

Particulars	Flexible Budget	Actual Data
Units	2000	2000
Pound of Material	100000 pound (50*2000)	110000 (Give)
Rate Per Pound	$5	$4.8 ($528000/110000)
Total Material Cost	$500000 (100000*$5)	$528000 (given)

Calculation of variances

Material Price Variance (Standard Price - Actual Price)*Actual Quantity	$22000 Favourable ($5-$4.8)*110000
Material Quantity Variance	$50000 Unfavourable (100000-110000)*$5

Part 2 - Direct Labour Variances

Particulars	Flexible Budget	Actual Data
Units	2000	2000
Total Hours	6000 (2000*3)	5600 (given)
Rate Per hour	$20	$24 ($134400/5600)
Total Labour cost	$120000 (6000*$20)	$134400 (given)

Calculation of variances

Labour Rate Variance (Standard rate - Actual rate)*Actual Hours	$22400 Unfavourable ($20-$24)*5600
Labour Efficiency Variance (Standard Hours - Actual Hours)*Standard Rate	$8000 Favourable (6000-5600)*20

Part 3 - Variable Overhead Variances Calculation

Particulars	Flexible budget	Actual data
Units	2000	2000
Hours	6000 (3*2000)	5600
Rate Per hour	$30	$36.607 ($205000/5600)
Total Variable overhead cost	$180000	$205000

Calculation of variances

Variable Overhead spending variance	$37000 Unfavourable ($30-$36.607)*5600
Variable Overhead Efficiency Variance	$12000 favourable (6000-5600)*30

Part 4 - Calculation of Net variance

Particulars	Amount	Highest Variance
Material Price Variance	$22000 F	Highest Favourable Variance
Material Quantity Variance	$50000 U	Highest Unfavourable Variance
Direct Labour Rate variance	$22400 U
Direct Labour Efficiency variance	$8000 F
Variable Overhead Spending variance	$37000 U
Variable overhead Efficiency Variance	$12000 F
Net Variance	$67400 U	This is variance of Variable cost of Goods sold

Explanation - Net Variance calculated is the same as combined Variance of variable cost of goods sold i.e. $67400.

The bifurcation of Combined variance of variable costvof goods sold helps us to analyse and Interpret the different items of variance viz. Material, Labour and Variable overhead to focus on better manage the business.

Part 5 - 1) Hence Highest Favourable variance = Material Price Variance i.e. $22000 F

Cause = Since Actual rate is lowen than budget rate, it is favourable for company

2) Highest Unfavourable variance = Material Quantity Variance i.e. $50000 U

Cause = Actual Pound used for 2000 units are more than budgeted pound to be uses to produce 2000 units hence it is unfavourable for Company

Causes for other Variances

1) Labour Variance

Favourable = In case of rate variance, When Actual rate is lower than budgeted rate per hour and in case of efficiency variance, When actual Hour worked are lower than budgeted hours for output/Produce

Unfavourable = in case of rate variance, Actual rate is more than budgeted rate and in case of efficiency variance, when actual efficiency is less than standard efficiency for a given output.

3) Variable Overhead variance

Favourable = in case of spending variance, Actual rate is lower than budgeted rate and in case of efficiency variance, Actual efficiency should by higher i.e. lower hours worked for same output

Unfavourable = In case of spending variance, Actual rate is higher than budgeted rate and in case of efficiency variance, Actual hours worked are more than Budgeted hours.