Question

Problem:

Miller Toy Company manufactures a plastic swimming pool at its Westwood Plant. The plant has been experiencing problems as shown by its June contribution format income statement below:

	Flexible Budget		Actual
Sales (15,000 pools)	$	675,000		$	675,000
Variable expenses:
Variable cost of goods sold*		435,000			461,890
Variable selling expenses		20,000			20,000
Total variable expenses		455,000			481,890
Contribution margin		220,000			193,110
Fixed expenses:
Manufacturing overhead		130,000			130,000
Selling and administrative		84,000			84,000
Total fixed expenses		214,000			214,000
Net operating income (loss)	$	6,000		$	(20,890	)

*Contains direct materials, direct labor, and variable manufacturing overhead.

Janet Dunn, who has just been appointed general manager of the Westwood Plant, has been given instructions to “get things under control.” Upon reviewing the plant’s income statement, Ms. Dunn has concluded that the major problem lies in the variable cost of goods sold. She has been provided with the following standard cost per swimming pool:

	Standard Quantity or Hours	Standard Price or Rate			Standard Cost
Direct materials	3.0 pounds	$	5.00	per pound	$	15.00
Direct labor	0.8 hours	$	16.00	per hour		12.80
Variable manufacturing overhead	0.4 hours*	$	3.00	per hour		1.20
Total standard cost per unit					$	29.00

*Based on machine-hours.

During June the plant produced 15,000 pools and incurred the following costs:

1. Purchased 60,000 pounds of materials at a cost of $4.95 per pound.
2. Used 49,200 pounds of materials in production. (Finished goods and work in process inventories are insignificant and can be ignored.)
3. Worked 11,800 direct labor-hours at a cost of $17.00 per hour.
4. Incurred variable manufacturing overhead cost totaling $18,290 for the month. A total of 5,900 machine-hours was recorded.

It is the company’s policy to close all variances to cost of goods sold on a monthly basis.

Question:

2. Summarize the variances that you computed in (1) above by showing the net overall favorable or unfavorable variance for the month. What impact did this figure have on the company’s income statement? Show computations.

3. Pick out the two most significant variances that you computed in (1) above. Explain to Ms. Dunn possible causes of these variances.

Answer 1

2.
Direct material price variance:
Direct material quantity	Actual material used (pounds) (c)	Direct material price variance [(a)-(b)]*(c)	Favourable/ Unfavourable
Standard (a)	Actual (b)
$5.00	$4.95	60,000	$3,000	Favourable
Direct material quantity variance:
Direct material quantity	Standard material price (per pound) (c)	Direct material price variance [(a)-(b)]*(c)	Favourable/ Unfavourable
Standard (a)	Actual (b)
45,000	49,200	$5.00	-$21,000	Unfavourable
(=15,000*3)
Direct labour rate variance:
Direct labour rate per hour	Actual direct labour hours (c)	Direct labour rate variance [(a)-(b)]*(c)	Favourable/ Unfavourable
Standard (a)	Actual (b)
$16.00	$17.00	11,800	-$11,800	Unfavourable
Direct labour efficiency variance:
Direct labour hours	Standard direct labour rate per hour (c)	Direct labour efficiency variance [(a)-(b)]*(c)	Favourable/ Unfavourable
Standard (a)	Actual (b)
12,000	11,800	$16.00	$3,200	Favourable
(=15,000*0.8)
Variable overhead rate variance:
Overhead rate per hour	Actual machine hours (c)	Direct labour rate variance [(a)-(b)]*(c)	Favourable/ Unfavourable
Standard (a)	Actual (b)
$3.00	$3.10	5,900	-$590	Unfavourable
	(=$18,290/5900)
Variable overhead efficiency variance:
Machine hours	Standard overhead rate per hour (c)	Direct labour efficiency variance [(a)-(b)]*(c)	Favourable/ Unfavourable
Standard (a)	Actual (b)
6,000	5,900	$3.00	$300	Favourable
(=15,000*0.4)

Summary of variances
Head	Amount	Favourable/ Unfavourable
Direct material price variance	3,000	Favourable
Direct material quantity variance	(21,000)	Unfavourable
Direct labour rate variance	(11,800)	Unfavourable
Direct labour efficiency variance	3,200	Favourable
Variable overhead rate variance	(590)	Unfavourable
Variable overhead efficiency variance	300	Favourable
Overall variance	(26,890)	Unfavourable

The overall unfavouravble variance has lead to increase in total variable expenses by $26,890. This has lead to an overall loss of $20,890 for the plant.

3. The most significant variances are as follows:

A. Direct material quantity variance: This can be due to inadequate training of the workers which has lead to increase in material used per unit or increase in defective pieces.

B. Direct labour rate variance: This can be due to unexpected increase in wages of labour. It may also be due to mix change between skilled, semi-skilled and un-skilled workers as planned versus actual used.