You have just been hired as a new management trainee by Terre Inc., a manufactur
ID: 2566141 • Letter: Y
Question
You have just been hired as a new management trainee by Terre Inc., a manufacturer of potato chips. In the past, the company did very little in the way of budgeting and at certain times of the year experienced a shortage of cash.
Since you are well trained in budgeting, you have decided to prepare comprehensive budgets for the upcoming quarter to show management the benefits that can be gained from an integrated budgeting program. To this end, you worked with accounting and other areas to gather the information assembled below.
The company sells a single type of potato chip with a budgeted selling price of $5 per packet. Actual and budgeted sales of potato chip are provided as below (in units):
2017
38,000
From their experience, 30% of the sales are on cash with 10% discount. The remainder are on account. Collections for sales on account follow a stable pattern: 75% of a month's credit sales are collected in the month of sale, and 20% are collected in the month following sale, and the remaining 5% are uncollectible.
Due to the unstable sales, the company has been experienced the shortage of inventory. Hence, you plan to suggest a new inventory policy; the ending inventory for each month should be equal to 30% of the next month's sales in units. This requirement had been met at the end of June.
Each packet of potato chip requires 500g of potato. The company has a policy of maintaining the raw material at the end of each month equal to 20% of the next month's production needs. This requirement had been met at the end of June. Potatoes cost $1.2 per kg. 70% of a month’s purchases is paid for in the month of purchase; the remaining is paid in the following month. At the end of June, the accounts payable balance is $6,400.
Each packet of potato chip requires 0.1 direct labor-hours. Due to the recent increase in minimum wage, factory workers are paid $14 per direct labor-hour.
Terre bases its manufacturing overhead budget on budgeted direct labor-hours. The variable overhead rate is $5 per direct labor-hour. The company's budgeted fixed manufacturing overhead is $40,000 per month. Fixed manufacturing overhead includes depreciation on factory equipment, which is $27,000 per month.
At Terre, the selling and administrative (SG&A) expense budget is divided into variable and fixed components. The variable SG&A expense is $0.8 per unit sold. The budgeted fixed selling and administrative expense is $30,000 per month. This expense includes depreciation on office equipment, which is $10,000 per month.
Due to the recent customer claims on the packaging defects, Terre Inc. has decided to purchase a new packing equipment in August 2017. The new equipment costs $30,000 and will be paid in cash. Terre has declared a cash dividend of $0.50 per share, which will be paid on July 31, 2017. The company has 100,000 common shares outstanding. To finance potential cash deficit, Terre Inc. plans to borrow a $40,000 loan from a local bank in the beginning of July 2017 and repay the loan plus accumulated interest at the end of September 2017. The annual interest rate on the loan is 12% (i.e., 1% per month). At the end of June, the cash balance is $30,000.
Required:
5. Assume finished goods and direct materials inventories are insignificant and can be ignored. At the end of the 3rd quarter, the actual data is reported as follows:
Actual inputs for the 3rd quarter
Unit produced and sold
Assuming no guaranteed labor hours, compute the following variances for the 3rd quarter of 2017 and specify whether it is a favorable or unfavorable variances:
i. Material price and quantity variances
ii. Labor rate and efficiency variances
38,000
Explanation / Answer
i. Material Price and quantity variance
a. Material Price variance is the variance which occurs due to the change in the price of the raw materials(RM) used in the production of the product. Formula for Material price variance is given below:
Material Price Variance = (Standard price per unit of RM - Actual price per unit of RM) x Number of units of RM actually used.
Standard price per unit of RM = $1.2 per kg (Given in the question)
Actual Price per unit of RM = Direct materials purchased and used ($) / Direct materials purchased and used (kg)
= $87,975 / 70,380 = $1.25 per unit of RM
Actual unit of RM used in production = 70,380 Kg
Material Price Variance = ($1.2 - $1.25) x 70,380 = $3,519 unfavorable.
This means that the company has incurred more cost on RM than the standard to be incurred.
b. Material Quantity variance refers to the variance due to excess quantity of RM used for the production of actual number of units than the standard to be used. Formula for Material quantity variance is given below:
Material Quantity Variance = (Standard Quantity for actual output - Actual Quantity used) x Standard rate of RM.
Standard Quantity for actual output = Actual number of units produced x Standard quantity required for each unit of output
= 138,000 x 500g /1000g = 69,000 Kg
In the above formula, for converting the RM from grams to Kg we have divided it by 1000.
Actual Quantity used = 70,380 Kg.
Standard rate of RM per Kg = $1.2 per Kg
Material Quantity Variance = (69,000 - 70,380) x $1.2 = $1,656 unfavorable
This means that the company has incurred more quantity of RM on actual unit of output produced and is therefore unfavorable.
ii. Labor rate and efficiency variance
a. Labor rate variance refers to the variance occurring due to change in the rate of the labor. Formula for the same is given below:
Labor Rate Variance = (Standard Rate per labor hour – Actual Rate per labor hour) x Actual labor hours worked
Standard Rate per labor hour = $14 per direct labor hour (as given in question)
Actual Rate per Labor hour = Actual Direct labor cost incurred / Actual direct labor hours worked
= $186,300 / 12,420 = $15 per direct labor hour
Actual Labor hours worked = 12,420 labor hours
Labor Rate Variance = ($14 - $15) x 12,420 = $12,420 unfavorable
This means that there is unfavorable variance of $12,420 due to excess rate per labor hour incurred.
b. Labor efficiency variance is the variance due to the more labor hours used in the production of actual output than the standard required for producing. Formula for the same is given below:
Labor Efficiency variance = (Standard hours required for actual output – Actual hours taken) x Standard Rate per labor hour
Standard hours required for actual output = 0.1 labor hour x 138,000 units = 13,800 labor hours.
Actual Hours taken = 12,420 hours
Standard rate per labor hour = $14 per direct labor hour
Labor Efficiency Variance = (13,800 – 12,420) x $14 = $19,320 favorable
This means that workers have taken less time than the standard to produce 138,000 units of output. Therefore, there is a favorable variance
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