Question

Video Tech Ltd manufactures video game machines. Market saturation and technological innovations have caused pricing pressures that have resulted in declining profits. To stem the slide in profits until new products can be introduced, top management has started to focus on achieving cost savings in manufacturing and increases in sales volume. Sales can be increased only if production volume increases. Therefore, an incentive program has been developed to reward those production managers who contribute to an increase in the number of units produced and achieve cost reductions. In addition, a just-in-time purchasing program has been implemented, and raw materials are purchased on an as-needed basis.

The production managers have responded to the pressure to improve manufacturing performance and this has resulted in an increase in the number of completed units over normal production levels. The video game machines are put together by the assembly group, which requires parts from both the printed circuit boards (PCB) and the reading heads (RH) groups. To increase production levels, the PCB and RH groups started to reject parts that previously would have been tested and modified to meet manufacturing standards. Preventative maintenance on machines used in the production of these parts has been postponed, with only emergency repair work being performed to keep production lines moving. The maintenance department is concerned that there will be serious breakdowns and unsafe operating conditions.

The more aggressive assembly group production supervisors have pressured maintenance personnel to attend to their machines at the expense of other groups. This has resulted in machine downtime in the PCB and RH groups which, when coupled with demands for accelerated parts delivery by the assembly group, has led to more frequent parts rejections and increased friction between departments. Video Tech uses a standard costing system. The standard costs for video game machines are as follows:

  

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Standard cost per unit
Quantity Cost	Total

Direct material: Housing unit
Printed circuit boards Reading heads

Direct labour: Assembly group PCB group
RH group
Total

Variable overhead*
Total standard cost per unit

1 unit
2 boards 4 heads

4.5 hours

$20    $20
 15     30
 10     40

 24     48
 27     27
 30     45

2 9 $219

    

2.0 hours 1.0 hours 1.5 hours

            

* Applied on the basis of direct labour: 4.5 direct labour hours @ $2 per hour.

Video Tech prepares monthly performance reports based on standard costs. The following table shows the contribution report for May, when production and sales both reached 2 200 units. The budgeted and actual unit sales price in May were the same, at $300.

Video Tech Ltd Contribution report for the month ending 31 May
	Budgeted Actual Variance

Units

Revenue Variable costs:

Direct material Direct labour Variable overhead

Total variable costs Contribution margin

2 000 $600 000

180 000 240 000 18 000 $438 000 $162 000

2 200 $660 000

220 400 280 380 18 800 $519 580 $140 420

200 F $60 000 F

40 400 U 40 380 U 800 U $81 580 U $21 580 U

Video Tech’s top management was surprised by the unfavourable contribution margin variance in spite of the increased sales in May. The management accountant, Robert Smith, was assigned to identify and report on the reasons for the unfavourable results as well as the individuals or groups responsible. After a thorough review of the data, Robert prepared the following usage report:

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Video Tech Ltd Usage report for the month ending 31 May
Cost item	Actual quantity Actual cost

Direct material: Housing units Printed circuit boards Reading heads

Direct labour: Assembly

Printed circuit boards Reading heads
Total

Variable overhead Total variable cost

2 200 units 4 700 boards 9 200 heads

9 800 hours

$ 44 000 75 200 101 200

93 600

71 280 115 500

18 800 $519 580

   

3 900 hours 2 400 hours 3 500 hours

           

Robert reported that the PCB and RH groups had supported the increased production levels but had experienced abnormal machine downtime, resulting in idle personnel. This led to the use of overtime to keep up with the accelerated demand for parts. The idle time was charged to direct labour. Robert also reported that the production managers of these two groups had resorted to rejecting faulty parts, as opposed to testing and modifying those parts. Robert determined that theassembly group had met management’s objectives by increasing production while utilising lower than standard hours.

Required:

1. Calculate the variances from (a) to (h) below, and prepare an explanation of the $21 580 unfavourable variance between the budgeted and actual contribution margin for May. Assume that all raw material purchased during May was placed into production.

   1. (a) direct labour rate variance

   2. (b) direct labour efficiency variance

   3. (c) direct material price variance

   4. (d) direct material quantity variance

   5. (e) variable overhead spending variance

   6. (f) variable overhead efficiency variance

   7. (g) sales price variance

   8. (h) sales volume variance

2. Identify and briefly explain the factors that might have led to friction between the production managers, and between the production managers and the maintenance manager.

3. Evaluate Robert Smith’s analysis of the unfavourable contribution results in terms of its completeness and its effect on the behaviour of the production groups.

4. Prepare a revised contribution report showing proper operating variances based on the flexible budget instead of the static budget used by Robert Smith.

Answer 1

Answer 1:

Variances:

Direct material price variance = ($13,900) Unfavorable

Direct material quantity variance = ($8,500) Unfavorable

Direct labor rate variance = ($16,980) Unfavorable

Direct labor efficiency variance = $600 Favorable

Variable overhead spending variance = $1,000 Favorable

Variable overhead efficiency variance = $200 Favorable at 9,800 actual hours; $0 at 9,900 actual hours

Contribution margin volume variance = $16,200 Favorable

Sales price variance = $0 (Because both actual and budgeted selling price are same)

Sales volume variance = $60,000 Favorable

Reconciliation of contribution margin variance:

(When actual hours are 9,800)

Material price_______________________(13,900)_Unfavorable

Material quantity_____________________(8,500)_Unfavorable

Labor rate___________________________(16,980)_Unfavorable

Labor efficiency_______________________ 600__Favorable

Variable overhead spending__________1,000__Favorable

Variable overhead efficiency___________200__Favorable

Contribution margin volume_________16,200__Favorable

Contribution margin variance____(21,380)_Unfavorable

Note: Difference of $200 is due to variable overhead efficiency variance. It can be reconciled only if actual hours are 9,900 for variable overhead. Please check again your data regarding actual hours for variable overhead.

(When actual hours are 9,900)

Material price__________________ (13,900) Unfavorable

Material quantity________________ (8,500) Unfavorable

Labor rate______________________ (16,980) Unfavorable

Labor efficiency___________________ 600 Favorable

Variable overhead spending______1,000 Favorable

Variable overhead efficiency__________0

Contribution margin volume_____16,200 Favorable

Contribution margin variance_(21,580) Unfavorable

Answer 2:

Following are some behavioral factors that may cause friction between production managers, and production managers and maintenance managers:

• The managers of Printed circuit boards and Reading heads groups will have conflicts with the maintenance department because equipment downtime brings about extra overtime costs.
• The Assembly group is subject to the inputs of the other production departments. So as to enhance its production level, it is probably going to put pressure on other departments. This kind of reasons may encourage the printed circuit boards group and Reading heads group towards rejecting the parts that would normally have been modified and utilized.

Answer 3:

An assessment of Robert Smith's analysis prompts to the conclusion that it is incomplete because he has not recognized the real reasons for the unfavorable outcomes and has left the management to make its own conclusions.

Furthermore, Robert Smith has just addressed to the labor issues but failed to consider for the materials related issues or notice the maintenance issues that brought about downtime for some departments. The managers are probably going to despise the report as being unfair.

Answer 4:

Particular_________Flexible budget_________Actual_____Variance

Sales units_____________2,200______________2,200__________0

Selling price____________$300______________$300__________0

Sales revenue_____$660,000_________$660,000__________0

Variable costs:

   Direct materials__$198,000_________$220,400____($22,400) Unfavorable

   Direct labor ______$264,000_________$280,380____($16,380) Unfavorable

   Variable overhead__$19,800__________$18,800 ______$1,000 Favorable

Total variable costs_$481,800_________$519,580____($37,780) Unfavorable

Contribution margin_$178,200________$140,420____($37,780) Unfavorable

(See working note 2)

Working note 1:

Computing direct labor rate variance:

Computing direct labor efficiency variance:

Computing material price variance:

Computing direct material quantity variance:

Computing variable overhead spending variance:

= (Standard hours allowed x Standard rate) - Actual variable overhead

= (9,900* x $2) - $18,800

= $19,800 - $18,800

= $1,000 Favorable

*Standard hours allowed:

= Actual units x Standard hours per unit

= 2,200 x 4.5

= 9,900 hours

Computing variable overhead efficiency variance (When actual hours are 9,800):

= Standard rate x (Standard hours allowed - Actual hours)

= $2 x (9,900 - 9,800)

= $200 Favorable

Computing variable overhead efficiency variance (When actual hours are 9,900):

= Standard rate x (Standard hours allowed - Actual hours)

= $2 x (9,900 - 9,900)

= $0

Computing contribution margin volume variance:

= Budgeted unit contribution x (Actual units - Budgeted units)

= $81** x (2,200- 2,000)

= $16,200 Favorable

**Budgeted unit contribution margin:

= Budgeted total contribution margin/ Budgeted units

= $162,000/ 2,000

= $81 per unit

Computing sales price variance:

= (Actual selling price - Budgeted selling price) x Actual sales units

= ($300 - $300) x 2,200

= $0

Computing sales volume variance:

= (Actual sales units - Budgeted sales units) x Budgeted selling price

= (2,200 - 2,000) x $300

= $60,000 Favorable

Contribution margin report with operating variances between actual and flexible budget: