Question

Zippo manufactures plastic outdoor chairs. The controller put together the following static budget and actual income statements and the following additional information.

	Actual	Static Budget
Revenue	715,000	600,000
Direct materials	287,375	250,000
Direct manufacturing labor	250,250	150,000
Variable overhead	96,250	50,000
Fixed overhead	90,000	100,000
Operating income	(8,875)	50,000

Budget Information

• Zippo expects to sell 50,000 chairs during the year
• Each chair is budgeted to use 10 pounds of plastic and take 1/2 hour to manufacture
• Variable and fixed overhead are allocated based on direct manufacturing labor hours

Actual Performance

• Zippo sells 55,000 chairs during the year
• Each chair used 9.5 pounds of plastic and 0.7 hour to manufacture

Chapter 7 Questions

1. Prepare a flexible budget
2. What are the level 1 variances?
3. Compute price and efficiency variance for both direct material and direct manufacturing labor
4. Comment on the level 3 variances you computed

Answer 1

Budget Comparison from above data is as follows:

Particulars	Actual Amt	Actual Qty	Actual Rate	Budget Amt	Budget Qty	Budgeted Rate
Revenue	715,000	55,000	13.00	600,000	50,000	12.00
Direct Materials	287,375	9.50	0.55	250,000	10	0.50
Direct Manufacturing Labour	250,250	0.70	6.50	150,000	0.50	6.00
Gross Contribution	177,375			200,000
Variable Overhead	96,250	55,000	1.75	50,000	50,000	1.00
Fixed Overhead	90,000			100,000
Net Profit / (Loss)	(8,875)			50,000

Flexible Budget

Particulars	Variable Cost p.u.	Units Level of Activity
		45,000	50,000	55,000
Direct Materials	5.00	225,000	250,000	275,000
Direct Manufacturing Labour	3.00	135,000	150,000	165,000
Variable Overhead	1.00	45,000	50,000	55,000
Total Variable Cost		405,000	450,000	495,000
Fixed Cost		100,000	100,000	100,000
Total Cost		505,000	550,000	595,000

Level 1 Variance Analysis refers to the variance identified in a static budget to calculate operating income. First, we calculate the operating income as per static budget and then compare with Actual operating income to get the variance.

Labour Efficiency Variance = (Budgeted Labour Rate - Actual Labour Rate) * Actual Labour Hours Worked

= (6 - 6.5) * (0.7*55,000 Units)

= 19,250 Unfavourable

Direct Labour Rate Variance = (Actual Hours * Actual Rate) - (Actual Hours * Budgted Rate)

Actual Hours worked = 0.7*55,000 Units actually produced

= 38,500 Hours

Direct Labour Rate Variance = (38,500*6.5) - (38,500*6)

= 19,250 Unfavourable

Based on the above price variances, we can conclude that the actual cost paid towards direct material and labour rate were higher than the budgeted rate resulting into unfavourable variances and need to be amended in the next flexible budget.