Question

Question 1                                                                                                             [20 marks]

You oversee the production facility of CC Compounders Ltd. CC Compounders Ltd manufactures compound which is being used in various extrusion processes. You are preparing for a management meeting. One of the points on the agenda is the explanation of the variance between actual production cost and standard production cost and to decide on action plans to address the reasons for the variance.

The following is the standard cost per 1 ton of compound:

	Per Unit	Price	Standard Cost per ton (R)
Material: AC1032 Powder	175kg	R 3.75/kg	656.25
Labour
Mixing Department	1.5 Hours	R125/hour	187.50
Overheads: Overheads are allocated based on actual labour hours.		175.00/hour	262.50
Total standard cost per unit			1,106.25

Budgeted fixed costs amounts to R175,000 per month.

The cost clerk provided you with the following actual information for the month.

Per Unit			Price	Total cost
Material: AC1032 Powder	185		R3.50/kg	809,375
Labour		2	R126.50/hour	316,250
Overheads				365,219
Fixed Costs				169,000

Production for the month was 1,250 units of compound.

Required:

1.    Use standard cost variance analysis to analyse and explain the manufacturing variance. (Show all your calculations as method marks are being awarded)                         (18)

2.    Identify the two most important areas for management to focus on. Support your suggestion with reference to the relevant variance in point 1.                                (2)

Answer 1

Ans: Calculation of Manufactring variance is as follows:

1.) Manufactring variance cosist of direct material variance, direct labour variance and overhead variance.

These variance analysis shows the difference between standard cost estimated by company on manufactring and actual cost incurred by company.

A.) Direct Material Variance:

In direct material variance, there are 3 basic variances. We will discuss them one by one

a.)Direct Material Total Varinace:

This is the difference between Standard cost of direct material and actual cost of direct material.

Formula:  (SQ* SP- AQ*AP)

In this question, this variance will be= [(175*1250)*3.75-(185*1250)*3.5}

=(820,312.5-809,375)

10,937.5 (F)

Actual Direct material cost is less than standard cost so that's why this variance is favourable.

b.) Direct Material Usage variance

This variance shows differrence between standard quantity specified and actual quantity used at standard rate

Formula (SQ-AQ)*SP

in this question, this variance is =(175*1250-185*1250)*3.75

=46,875(A)

Actual Material usage for one unit of output is higher than standard(185-175=10), hence adverse ratio.

c.) Direct Material Price Variance

This variance shows the difference between standard purchase price of material and actual purchase price of material multiplied by actual quantity of material.

Formula (SP-AP)*AQ

=(3.75-3.5)*(185*1250)

=57812.5 (F)

Actual Purchase price is less than standard purchase price, so that's why favourable variance.

B.) Direct Labour Varinace:

This varianve shows difference between standard Direct labour cost and actual Direct labour cost incurred for production

a.) Direct Labour Total Variance

Formula =(SH*SR-AH*AR)

=[(1.5*1250)*125-(2*1250)*126.50]

= 234,375-316,250

=81,875 (A)

Adverse since actual direct labour cost ih higher than std. direct labour cost.

b.) Direct Labour Rate Variance

this variance shows difference between std. labour rate and actual labour rate for actual hour of labour used in production.

Formula =(SR-AR)*AH
=(125-126.5)*2*1250

=3750(A)

Adverse since autual rate in higher than std. rate.

c.) Direct Labour Efficiency Variance

this variance shows the difference between std. labour haour allowed for production and actual labour hour used for production.

Formula =(SH-AH)*SR

=[(1.5*1250)-(2*1250)*125]
=78,125(A)

Adverse since actual hour used is more than std. hours allowed for actual production.

C.) Variable overhead Variance

a.) Variable overhead Cost Variance;

This varianve shows the differrence between standard variable overhead for actual output and actual variable overhead

Formula = Variable overhead rate* actual production -Actual variable Overhead

=262.5*1250-365219

=37094(A)

D.) Fixed Overhead Variance

this variance shows the difference between budgeted fixed overhead and actual fixed overhead.

Formula = Budgeted Fixed overhead - actual fixed overhead

=175,000-169,000

= 9000(F)

2.) Two most important area to foucs on are:

a.) Improve Labour efficiency because Direct material usage varianve is adverse and direct labour efficiency variance is adverse.

b.) Improve in wage rate paid to labour becuase direct labour rate variance is adverse.