Question

During 2017, the Malaysia Division of Acro-Cel Tool and Machine had specialized in the production of a single heavy-duty motorcycle component. Original engineering estimates and the use of Acro-Cel's total overhead flexible budget had yielded the following standard cost per unit based on an expected production of 10,000 units:

STANDARD COST

Direct materials           10 lbs.   @ $1.50 per lb.                      =          $15.00

Direct labor                 2 hours @ $6.00 per hr.                     =             12.00

Variable overhead       2 hours @ $1.00 per direct labor hr. =               2.00

Fixed overhead           2 hours @ $4.00 per direct labor       =               8.00

Total standard cost                                                                              $37.00

Tom, the Malaysia Division shop foreman, tends to communicate in brief, blunt reports. His analysis of 2017 is reproduced below:

As usual, the yo-yos in Purchasing and Personnel goofed and are trying to pass the buck to us. Your hotshot planners predicted an average wage rate of $6.00, and then your bleeding heart labor negotiators conceded to $6.60 an hour, for a 10% overrun. On top of that, Purchasing paid $1.80 per pound for materials they should have gotten for $1.50, or a whopping 20% over expenditure. Given that kind of incompetence, I feel the Malaysia production line deserves a big thank-you for holding actual total costs per unit down to $41.58, which works out to 12.4% over standard.

ACTUAL EXPENDITURES:

Direct materials            $226,800                    Total manufacturing cost     $498,920

Direct labor                  $166,320                    Actual output                  12,000 units

Variable overhead        $24,800                      Actual manufacturing

Fixed overhead            $81,000                      cost per unit                             $41.58

required

For ease of computation, assume that both the beginning and ending direct materials inventory balances were zero. Indeed, Acro-Cel uses a just-in-time inventory system, which means that no direct materials inventories are carried by Acro-Cel. Instead, materials are delivered to the factory couple of hours before use. Because labor is relatively plentiful, the production line is labor-intensive.

Tom's report is difficult to reconcile with a complaint from the controller's office that the Malaysia Division's cash expenditures were almost 35% higher than originally budgeted and had placed a severe strain on Acro-Cel's relationship with the bank. Rework Tom's report into a detailed variance analysis as best as you can.

            2.   Is Tom correct in his assessment of 2017 operating results? Be specific, supporting your analysis with as many numbers as possible.

Answer 1

A brief calculation and analysis of costs is given below:

I would not agree with Toms analysis on account of following points:

• Tom indicates that the actual costs were higher than budget only by 12%. However, the budget he is referring to is for 10,000 units. The actual production is 12,000 units. Therefore, the budgeted costs for a production of 12,000 units needs to be computed for correct analysis. As calculated above, the budgeted cost per unit, for 12,000 units, works out to 35.67 (because fixed costs get spread over a larger quantity. Therefore, the actual costs of 41.58 are higher than the budget by almost 17% and not 12% as indicated by Tom
• Tom says material rates were negotiated higher by 20% resulting in material cost variance. However, the material variance, on an overall basis works out to be 26%, indicating that there was some material quantity variance too, apart from the rate variance identified and reported by Tom.
• Likewise, the wage rates were negotiated 10% higher. But the wage rate variance is 16%, again budget for production of 10,000 units was 370,000 whereas the actual expenditure was 498,920, which is an increase of 35%. However, it fails to take into consideration that the budget of 370,000 was for an output of 10,000 units, whereas the actual cost of 498,920 was for an output of 12,000 units. Therefore, the output also has increased by 20%, which is one of the significant reasons for increased costs. This needs to be seen in light of the additional revenue generated from the additional output or benchmarked with a flexible budgeted costs for 12,000 units (428,000 as calculated above) rather than being seen in isolation or being benchmarked with budgeted costs of 10,000 units