Question

While looking at budgeting this week, we encountered numerous forms of variances (the difference between a standard and the actual cost). We read how variances can be favorable (the company makes money) or unfavorable. Sometimes, a favorable variance leads to an unintended negative consequence (such as when a burger joint uses less meat in its patties, which causes dissatisfied customers who fail to return to the restaurant).

Now it’s your turn to come up with an example of variances. Think of a company that is manufacturing a product. What kind of materials are required? What is the standard for employee productivity? What are the alternatives for cheaper materials and labor? Provide enough information in your example so that your peers can answer the following questions:

What is the quantity standard and the price standard in your peer’s example?

What effect, if any, would you expect poor-quality materials to have on direct labor variances?

If variable manufacturing overhead is applied to production on the basis of direct labor-hours and the direct labor efficiency variance is unfavorable, will the variable overhead efficiency variance be favorable or unfavorable? Could it be either?

Answer 1

The cost records of a company are as following:

Material Purchased: 20,000 pieces for $88,000.

Material consumed: 19,000 pieces.

Actual wages paid for 4950 hours is $ 24,750.

Factory Overhead incurred: $44,000.

Factory Overhead Budgeted: 40,000.

Units Produced: 1,800

Standard Rates are:

Material rate: $4/pc

Input: 10 pc. / Unit.

Labor Rate: $4/Hour

Time: 2.5 hours/ Units

Overhead $8 / Labor hour.

Variances:

Material Cost Variance: Standard Cost of material for actual output – Actual Material cost

                                                (1800*10 pc. *4) – (88000/20000) * 19000

                                                11,600 Unfav.

Material Price Variance: Actual quantity (Standard price per piece – Actual price per piece)

                                                19000 * [4* (88000/20000)]

                                                7600 Unfav.

Material Usage Variance: Standard Price (Standard Quantity – Actual Quantity)

                                                4 (18000 – 19000)

                                                4000 Unfav.

Labor Cost Variance: Standard Cost of Labor for actual output – Actual Labor Cost

                                                (1800*2.5*4) – 24750

                                                6750 Unfav.

Labor Rate variance: Actual Hours (Standard Rate – Actual Rate)

                                                4950 (4-5)

                                                4950 Unfav.

Labor Efficiency Variance: Standard Rate (Std. Hours – Actual Hours)

                                                4 [(2.5 * 1800) – 4950]

                                                1800 Unfav.

Variable Overhead Cost Variance: Overhead Recovered on Actual Output – Actual Overhead

                                                                (1800 * 2.5 * 8) – 44000

                                                                8000 Unfav.

As it is seen that the company’s policies of production are not giving a favorable result to be carried on, the company is in need of the policy change. The company will have to either lower its production or will have to increase its Standards. Customer satisfaction is the prime aim of any company to be maintained, in first hand. But companies aim is to use available capital and resources for production in the most efficient way to bring a desirable profit, too. So, the customer satisfaction and the company’s desired profit should go simultaneously.

Material Cost, Labor Cost, Overhead all are over-utilized in the given case, which is to be checked. Or standards are in need to be revalued.

Poor material quality may or may not have any effect on the direct labor variance depending on how the quality of the material begs time for the production of a unit.

If variable manufacturing overhead is applied to production on the basis of direct labor-hours and the direct labor efficiency variance is unfavorable, it definitely is affecting the variable overhead efficiency variance, but it can be either depending on the difference in Actual and Standard Overhead.

[Efficiency variance = Standard Rate(Actual Overhead- Standard Overhead)]