Question

In: Accounting

"I thought lean production was supposed to make us more efficient" commented Ben Carrick, manufacturing vice...

"I thought lean production was supposed to make us more efficient" commented Ben Carrick, manufacturing vice president of Vorelli Industries. "But just look at June’s manufacturing variances for Zets. The labor efficiency variance was $240,000 unfavorable—four times higher than it’s ever been before. If you add on the $102,000 unfavorable materials price variance, that’s $342,000 down the drain in a single month on just one product."

"Now take it easy, Ben," replied Sandi Shipp, the company’s purchasing manager. "We knew the switch to lean production was going to increase our material costs. But now we’re partnering with top-notch suppliers who deliver raw materials to our plant three times a day. In a few months, we’ll be able to offset most of our higher purchasing costs by vacating three rented warehouses."

"And I know our labor efficiency variance looks bad," responded Raul Duvall, the company’s production manager, "but it doesn’t tell the whole story. The just-in-time flow in our production lines has made our plant more efficient than ever before. Plus our investment in automation is reducing our materials waste each month."

"How can you say you’re being more efficient when you took 90,000 direct labor-hours to produce just 30,000 Zets last month?" asked Ben Carrick. "That’s an average of 3 hours per unit, whereas the Zets’ standard cost card only allows 2.5 hours per unit."

Raul explained that "part of our lean transformation requires cutting back production to reduce excess finished goods inventories. In a few months our finished goods inventories will be depleted and we’ll be able to match production with demand. In the meantime, don’t forget that our line people aren’t just standing around when their machines are idle. Under the lean approach, they’re doing their own inspections and equipment maintenance."

Ben replied, "We can’t let this go on a few more months . . . at least not if you want to earn a bonus this year. I’ve been looking at these reports for 30 years, and I know inefficiency when I see it. Let’s get things back under control."

After leaving Ben’s office, Raul asked for your help in developing some performance measures that will highlight the benefits of the company’s lean transformation. Working with Raul, you gathered the following information:

  1. A standard cost card for Zets (one of the company’s many products) is given below:

Standard Quantity
or Hours
Standard Price
or Rate
Standard
Cost
Direct materials 18 feet $ 3.00 per foot $ 54.00
Direct labor 2.5 hours $ 16.00 per hour 40.00
Variable manufacturing overhead 2.5 hours $ 2.80 per hour 7.00
Total standard cost $ 101.00
  1. During June the company purchased 510,000 feet of material for production of Zets at a cost of $3.20 per foot. All of this material was used to make 30,000 units during the month.

  2. The company maintains a stable workforce to produce Zets. Employees who previously performed inspections and maintenance have been reassigned as direct labor workers. During June, direct laborers worked 90,000 hours on the Zets production lines at an average pay rate of $15.85 per hour.

  3. Variable manufacturing overhead cost is allocated to products based on direct labor-hours. During June, the company incurred $207,000 in variable manufacturing overhead costs associated with the manufacture of Zets.

  4. As workers have become more familiar with lean production methods, the following trends (per unit) have emerged over the last three months:

April May June
Processing time 2.6 hours 2.5 hours 2.4 hours
Inspection time 1.3 hours 0.9 hours 0.1 hours
Move time 1.9 hours 1.4 hours 0.6 hours
Queue time 8.2 hours 5.2 hours 1.9 hours

Integration Exercise 9 Part 1-4

Required:

1. For direct materials:
a. Compute the price and quantity variances.
b. Is the decrease in waste that was mentioned by Raul apparent from your variance calculations?
c. What standard price per foot should the company use going forward to compute the materials price variance? (Round your answer to 1 decimal place.)

2. For direct labor:
a. Compute the rate and efficiency variances.
b. Is the company’s labor efficiency variance a useful performance measure in its lean environment?

3. For variable manufacturing overhead:
a. Compute the rate and efficiency variances.
b. Is direct labor-hours an appropriate cost driver for variable manufacturing overhead in the company’s lean environment?

4. Compute the following for April, May, and June: (Round your answers to 1 decimal place.)
a. The throughput time per unit.
b. The manufacturing cycle efficiency (MCE)

Solutions

Expert Solution

Information collected from Question

Standard Cost Card

Std. Qty of Hours Std. Rate
Direct Materials 18 $3 per foot
Direct Labour 2.5 $16 per hour
Variable manufacturing overhead 2.5 $ 2.80 per hour

During June,

Material purchase = 510,000 feet @ $ 3.20 per foot = $1,632,000
Actual production in June = 30,000 zets

1. Direct Material Price and Quantity Variance

a)

Price Variance = (Std. price - Actual Price) x Actual Qty
= (3-3.20) x 510,000 = (102,000)

Quantity Variance = (Std. qty - Actual qty) x Std Price
= ((30000 units x 18 feet)- 510,000) x $3 = 90,000

b) As far as purchase of materials is concerned, Raul is right as in June the company was able to produce the same 30,000 zets with just 510,000 feet instead of 540,000 feet saving $ 90,000 in purchase cost. This sets off the unfavourable price variance.
c)

2. Direct Labour Variances

Actual hours worked = 90,000 hours, Actual rate per hour = $15.85
a)Direct Labour Price Variance = (Std. rate - Actual Rate) x Actual Hours
= ( 16 - 15.85) x 90,000 = 13,500
Direct Labour efficiency variance = (Std. Hours - Actual hours) x Std. rate
= ((2.5 hrs x 30,000 units) - 90,000) x 16 = (240,000)

b) The direct labour variance on the face of it shows an unfavourable difference of (226,500). More hours are being worked to produce the same amount of zets. However, this will improve as employees as now doing inspection and equipment maintenance as well.

3. Variable Manufacturing Overhead variance

Actual overhead incurred = $ 207,000
a) Variable overhead spending/ rate variance = (Actual overhead rate - Std overhead rate) x Actual hours worked
= 207,000 - (2.80 x 90,000) = 45,000
Variable overhead efficency variance = (Actual hours worked - Std hours) x Std rate
= (90,000 - 75,000) x 2.80 = (42,000)

b) It would seem that direct labour hours is not an appropriate cost driver for allocating variable overheads in the lean environment. With automation in place, the wastage would be lesser and direct labour hours would not be the perfect base for variable overheads.

4. Other computations

a) Throughput time per unit (the time for which one unit stays in the entire process)
= Processing time + inspection time+ move time + queue time

April = 14 hrs , May = 10 hrs , June = 5 hours

This means more products can be sold. Learning curve benefits are clearly visible

b) Manufacturing Cycle Efficiency = Value added time/ total cycle time

April = 2.6 hrs / (1.3 +1.9+8.2) = 22.8 %
May = 2.5 / (0.9 + 1.4 + 5.2) = 33.33%
June = 2.4 / (0.1+0.6+1.9) = 92.3 %


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