Sol Electronics, a fast-growing electronic device producer, uses a standard cost

Question

Sol Electronics, a fast-growing electronic device producer, uses a standard costing system, with standards set at the beginning of each year. In the second quarter of 2011, Sol faced two challenges: It had to negotiate and sign a new short-term labor agreement with its workers’ union, and it also had to pay a higher rate to its suppliers for direct materials. The new labor contract raised the cost of direct manufacturing labor relative to the company’s 2011 standards. Similarly, the new rate for direct materials exceeded the company’s 2011 standards. However, the materials were of better quality than expected, so Sol’s management was confident that there would be less waste and less rework in the manufacturing process. Management also speculated that the per-unit direct manufacturing labor cost might decline as a result of the materials’ improved quality. At the end of the second quarter, Sol’s CFO, Terence Shaw reviewed the following results:

Shaw was relieved to see that the anticipated savings in material waste and rework seemed to have materialized. But, he was concerned that the union would press

hard for higher wages given that actual unit costs came in below standard unit costs and operating income continued to climb.

1. Prepare a detailed variance analysis of the second quarter results relative to the static budget. Show how much of the improvement in operating income

arose due to changes in sales volume and how much arose for other reasons. Calculative variances that isolate the effects of price and usage changes in

direct materials and direct manufacturing labor. Make sure you break down your variance analysis into Level 1, 2, 3 and make sure you identify and

disaggregate all variances to the extent possible.

2. Use the results of requirement 1 to prepare a rebuttal to the union’s anticipated demands in light of the second quarter results.

Variable Costs Per Unit Per Unit Variable Cost First Quarter 2011 Actual Results Second Quarter 201l Actual Results Standarod Direct materials 2.2 b. $5.70 lb.$12.54 2.3 lb. at $5.80 lb. $13.34 2.0 lb. $6.00 lb. $12.00 rect manufacturing labo 0.5 hrs. a S 12 hrs. 6.00 0.52 hrs. at 12 hrs. 6.24 0.45 hrs. 14 hrs. 6.30 $1000 Other variable costs Static Budget for First Quarter Second Quarter Each Quarter2011 Results2011 Results Based on 2011 4,800 71.50 Units Selling price Sales Variable costs 4,000 $70 $280,000 4,400 $ 72 Direct materials Direct manufacturing labor Other variable costs 50,160 24,000 40,000 58,696 27,456 44.000 130,152 186,648 66,000 $120,648 57,600 30,240 47,280 Total variable costs Contribution mar Fixed costs 165,840 68,000 208,080 68,400 ating 1ncome $139,68

Explanation / Answer

Variance Analysis of Second Quarter 2011 Actual Results Direct Material Price Variance= Actual Quantity(Std.price-Actual price) 4800*2*(6.00-5.70) 2880 UF Direct MaterialUsage Variance= Std. price(Std. Quantity for actual production- Actual quantity) 5.70*((4800*2.2)-(4800*2)) 5472 F Total Direct Material Cost Variance= Std.cost for actual prodn.- Actual costs                                                           =(4800*2.2*5.70)-(4800*2*6) = 2592 F 2880(UF) +5472(F) = 2592(F) Direct Labour Cost Variance= Actual hrs.(Std.Rate-Actual Rate) 4800*0.45*(12-14)= 4320(UF) Direct Labour Usage Variance= Std. rate(Std. hrs. for actual production- Actual hrs.) 12*((4800*0.5)-(4800*0.45)) 2880 F Total Direct Labour Cost Variance= Std.cost for actual hrs.- Actual costs (4800*0.5*12)-(4800*0.45*14) 1440(UF) Other Variable costs Standard costs for actual production - Actual costs (4800*10)-(4800*9.85) 720 F Summary of Variances for actual production Total Direct Material Cost Variance 2592 UF Total Direct Labour Cost Variance 1440 UF Other Variable Costs 720 F Total Variance of Variable costs(Net) 3312 UF Changes in Income due to Sales Volume variance =(4800-4000)*70 56000 Sales price Variance =(71.5-70)*4800 7200 63200 Price& usage variance as above -3312 Other Variable cost variance -17648 Variance in Fixed costs -400 Net Change in Income 41840 2. As per the actuals, both sales volume & sales price per unit has increased.Per unit labour hour has decreased but labour rate has increased- contrary to the speculation that it will decline. This can be used as a counter to the anticipated Union's demand.

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