Question

a) we have seen, a lot of effort is involved in determining the cost of materials, labors and overhead in a manufacturing process. What’s the goal of all this effort? b)Assume that a company has met the goal described above, what does the company then do with the information obtained? c) Provide a specific example of the company’s use of the information gathered?

Answer 1

a)	The goal of all such effort is to ascertain the cost of goods produced
	as and when production takes place.
b)	The information so obtained can be used for:
	*Comparison of actual costs with standard or estimates so that
	adverse deviations from standards or estimates can be anlysed
	and costs can be controlled.
	*Create a base for decision making.
c)	One specific use can be the calculation of direct material cost
	variances.
	Suppose a product requires 1 kg of raw material (standard quantity)
	which is expected to cost $2 per kg.
	Further, if the actual figures for a particular period are:
	Units produced - 100
	Raw materials quantity - 105 kg
	Purchase price - $1.95/kg.
	Now the Total standard material cost would be 100*1*2 =	$      200.00
	Actual material cost = 105*1.95 =	$      204.75
	The total material cost variance is 204.75-200 = $4.75-Unfavorable.
	This means that the actual cost of production of one unit is more
	than the standard cost allowed for a unit by $4.75. It is an unfavorable
	cost variance.
	This total material cost variance can be split into two component
	variances:
	Direct material price variance = 105*(1.95-2.00) = $5.25- Favorable
	Direct material quantity variance = (105-100)*2 = $10.00- Unfaovrable
	This split highlights that the price variance is favorable indicating
	efficient purchases and the quantity variance is unfavorable indicating
	inefficient material utilisation (assuming the quality is as per standard)
	Based on this information management can take action to rectify the
	position.