ACCOUNTING PRINCIPLES II-MANAGERIAL CHAPTER 8-TBC-Variance Analysis Last year, L

Question

ACCOUNTING PRINCIPLES II-MANAGERIAL CHAPTER 8-TBC-Variance Analysis Last year, Lopez Industries, Inc., researched and perfected a cure for the common cold. Called Cold-Gone, the product sells for $28.00 per package, each of which contains five tablets. Standard unit costs for this product were developed late last year for use this year. Per package, the standard unit costs were as follows: chemical ingredients, 6 ounces at $1.00 per ounce; packaging, $1.20; direct labor, 0.8 hour at $14.00 per hour; standard variable overhead, $4.00 per direct labor hour; and standard fixed overhead, $6.40 per direct labor hour. Normal capacity is 46,875 units per week. In the first quarter or this year, demand for the new product rose well beyond the expectations of management. During those three months, the peak season for colds, the company produced and over 500,000 packages of Cold-Gone. During the first week in April, it produced 50,000 packages but used materials for 50,200 packages costing $60,240. It also used 305,000 ounces of chemical ingredients costing $292,800. The total cost of direct labor for the week was $579,600; direct labor hours totaled 40,250. Total variable overhead was $161,100, and total fixed overhead was $242,000. Budgeted fixed overhead for the week was $240,000. 1. Compute for the first week of April and indicate whether the variance is favorable or unfavorable: (a) all direct materials price variances (b) all direct materials quantity variances (c) the direct labor rate variance (d) the direct labor efficiency variance (e) the variable overhead spending variance, (f) the variable overhead efficiency variance, (g) the fixed overhead budget variance, and (h) the fixed overhead volume variance. 2. Prepare a performance report based on your variance analysis (following example on page 310) and suggest possible causes for each significant variance.

Explanation / Answer

(a) All Direct Materials Price Variances (chemical ingredients and packaging)

All direct materials price variances (chemical ingredients and packaging)

Direct material price is the product of actual quantity of direct material is used and the difference between standard price and actual price per unit of direct material. It is calculated as follows:

DM price variance = (Standard unit price of direct material –Actual Price per unit of direct material ) x Actual quantity

DM Price variance =(SP-AP)x AQ

Standard unit quantity is 6 ounce

Standard unit price= 6x $1= $ 6

It also used 305,000 ounces of chemical ingredients costing $292,800

Actual cost per unit= 292800/305000=$ 0.96

Standard unit packaging cost = $1.20

but used materials for 50,200 packages costing $60,240

Actual cost per unit packaging = 60240/50200= $1.2

All Direct Materials Price Variances (chemical ingredients and packaging)

= Standard cost of chemical ingredients and packaging= $1+ $1.2= $2.2

Actual cost of chemical ingredients and packaging = $0.96 + $1.2= $2.16

So all direct material price variance = (2.2-2.16)x 305000= 0.04x305000=$12200

A positive value of direct material price variance is favorable which means that direct material was purchased for lesser amount than the standard price.

(b) All Direct Materials Quantity Variances (chemical ingredients and packaging)

Direct material quantity variance is the product of standard price of a unit of direct material and the difference between the standard quantity of direct material allowed and actual quantity of direct material used. The formula is

DM quantity variance =(AQ-SQ)x SP

Where SQ is standard quantity allowed

AQ is the actual quantity of direct material used

SP is the standard price per unit of direct material

DM quantity Variance = (50200-50000)x1= 200

The variance is unfavorable because the actual usage of materials   is more than what has been allowed by standard to manufacture units.

(c) The Direct Labor Rate Variance

The total cost of direct labor for the week was $579,600

The labor rate variance measures the difference between the actual and expected cost of labor. It is calculated as the difference between the actual labor rate paid and the standard rate, multiplied by the number of actual hours worked. The formula is:

(Actual rate - Standard rate) x Actual hours worked = Labor rate variance

Standard direct labor, 0.8 hour at $14.00 per hour

Actual direct labor hours totaled 40,250

579600/40250=$14.4 is the actual rate of labour

So labour rate variance = (14.4-14)x 40250=16100

An unfavorable labour rate variance means that the cost of labor was more expensive than standard, while a favorable variance indicates that the cost of labor was less expensive than standard. It is unfavourable as 14.4 is more than standard rate of $ 14.

(d) The Direct Labor Efficiency Variance

Standard labour hour = 0.8 hour per package

Actual labour hour per package =

Actual units produced = 50000

Standard labour hour per unit= 0.8

Standard direct labour hours allowed= 40000 hrs

Actual direct labour hour used = 40250

Difference = 40000-40250= -250

X standard direct labour hour( .8)= -250x 0.8= -200

Since the direct labor efficiency variance is negative, it is unfavorable.

(e) The Variable Overhead Spending Variance

The variable overhead spending variance is the difference between the actual and budgeted rates of spending on variable overhead. The variance is used to focus attention on those overhead costs that vary from expectations. The formula is:

Actual hours worked x (Actual overhead rate - standard overhead rate)
= Variable overhead spending variance

Actual hours worked = 40250

Actual variable overhead was $161,100

Actual variable overhead per direct labour hour= 161100/40250=4

standard variable overhead, $4.00 per direct labor hour

So variable overhead spending variance=( 4-4)x 40250=0

Favourable

f) The Variable Overhead Efficiency Variance

The variable overhead efficiency variance is the difference between the actual and budgeted hours worked, which are then applied to the standard variable overhead rate per hour. The formula is:

Standard overhead rate x (Actual hours - standard hours)
= Variable overhead efficiency variance

Standard variable overhead rate = $4

Actual hours = 40250

Standard hours allowed = 40000

Variable overhead efficiency variance = (40250-40000)x4= 1000

It is Positive and hence favorable.

(g) The Fixed Overhead Budget Variance

Fixed overhead budget variance is the difference between total fixed overhead budgeted for a given accounting period and actual fixed overheads incurred during the period.

total fixed overhead was $242,000. Budgeted fixed overhead for the week was $240,000.

Here actual is more than budgeted by $2000. Hence it is unfavorable .

This variance is favorable when actual fixed overhead incurred are less than the budgeted amount. and it is unfavorable when actual fixed overheads exceed the budgeted amount

(h) The Fixed Overhead Volume Variance

The fixed overhead volume variance is the difference between the amount of fixed overhead actually applied to produced goods based on production volume, and the amount that was budgeted to be applied to produced goods. This variance is reviewed as part of the period-end cost accounting reporting package.

total fixed overhead was $242,000. Budgeted fixed overhead for the week was $240,000.

Fixed overhead volume variance= actual fixed overhead – budgeted fixed overhead =242000- 240000= 2000

It is positive and hence favorable.

2)   Material price variance is favorable because of following possible reasons  

Reasons for a favourable material price variance may include:

An unfavorable direct materials quantity variance means excessive use of direct materials. Here direct materials are used more to produce a little less no of product packages. :

An Unfavourable labor rate variance indicates higher labor costs incurred during a period compared with the standard.

Causes for unfavourable labour rate variance may include:

An unfavourable labor efficiency variance suggests lower productivity of direct labor during a period compared with the standard. The common reason of an unfavorable labor rate variance is inappropriate use of labor by production supervisors.

  Reasons of unfavorable direct labor efficiency variance are as follows:

Favorable variable overhead spending variance indicates that the company incurred a lower expense than the standard cost.

Possible reasons for favorable variance include:

Favorable variable overhead efficiency variance indicates that fewer manufacturing hours were expended during the period than the standard hours required for the level of actual output.

Reasons for a favorable variance may include:

An unfavourable fixed overhead budget variance may be caused by the following:

Fixed overhead volume variance may arise due to change in capacity, variation in efficiency or change in budgeted and actual no of working days.

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