Question

Miller Toy Company manufactures a plastic swimming pool at its Westwood Plant. The plant has been experiencing problems for some time as shown by its June contribution format income statement below:

	Budgeted	Actual
Sales (15,500 pools)	$511,500	$511,500
Less variable expenses:
Variable cost of goods sold*	232,965	243,970
Variable selling expenses	21,700	21,700
Total variable expenses	254,665	265,670
Contribution margin	256,835	245,830
Less fixed expenses:
Manufacturing overhead	120,000	120,000
Selling and administrative	86,000	86,000
Total fixed expenses	206,000	206,000
Net operating income	$ 50,835	$ 39,830

*Contains direct materials, direct labor, and variable manufacturing overhead.

Janet Dunn, who has just been appointed general manager of the Westwood Plant, has been given instructions to “get things under control.” Upon reviewing the plant’s income statement, Ms. Dunn has concluded that the major problem lies in the variable cost of goods sold. She has been provided with the following standard cost per swimming pool:

	Standard Quantity or Hours		Standard Price or Rate		Standard Cost
Direct materials	3.0	pounds	$2.05	per pound	$  6.15
Direct labor	0.8	hour	$9.50	per hour	7.60
Variable manufacturing overhead	0.4	hour *	$3.20	per hour	1.28
Total standard cost					$15.03
* Based on machine-hours.

Ms. Dunn has determined that during June the plant produced 15,500 pools and incurred the following costs:

a. Purchased 58,000 pounds of materials at a cost of $2.00 per pound.

b. Used 51,000 pounds of materials in production. (Finished goods and work in process inventories are insignificant and can be ignored.)

c. Worked 12,100 direct labor-hours at a cost of $10.20 per hour.

d. Incurred variable manufacturing overhead cost totaling $18,900 for the month. A total of 6,000 machine-hours was recorded.

It is the company’s policy to close all variances to cost of goods sold on a monthly basis.

Required:

1. Compute the following variances for June:

a. Direct materials price and quantity variances.

b. Direct labor rate and efficiency variances.

c. Variable overhead spending and efficiency variances.

2. Summarize the variances that you computed in (1) above by showing the net overall favorable or unfavorable variance for the month. What impact did this figure have on the company’s income statement? Show computations.

3. Pick out the two most significant variances that you computed in (1) above. Explain to Ms. Dunn possible causes of these variances.

Answer 1

1 a)

Standard rate of direct material = $ 2.05 per pound

Actual rate of direct material = $ 2 per pound

Actual quantity of direct material used = 51000 pounds

Standard quantity material needed for actual production of 15500 pools = 15500 * 3 = 46500 pounds

Direct material price variance = ( Actual price - standard price ) * Actual quantity used

= ( 2 - 2.05 ) * 51000 = 2550 Fovorable

Direct material quantity variance = ( actual quantity - standard quantity ) * standard price

= ( 51000 - 46500 ) * 2.05 = 9225 Unfavorable.

1 b)

Actual rate of direct labor hour = $ 10.20

Actual hours of direct labor used = 12100 hours

Standard rate of direct labor hour = $ 9.5

Stanadard hours of direct labor needed for actual production of 15500 pools = 15500 * .8 = 12400 hours

Labor rate variance = ( Actual rate - standard rate ) * Actual hours worked = ( 10.2 - 9.5 ) * 12100

= 8470 Unfavorable

labor efficiency variance = ( Actual hours - Standard hours ) * Standard rate = ( 12100 - 12400)* 9.5

= 2850 Favorable

1 c )

Actual machine hours worked = 6000

Actual rate of variable overhead = total overhead/ total machine hours = 18,900 / 6000 = $ 3.15 per hour

Standard rate of variable overhead = $ 3.2 per hour

Standard hours needed for actual production of 15500 pools = 15500 * .4 = 6200 hours

Variable overhead spending variance = ( Actual rate - Standard rate ) * Actual hours = ( 3.15 - 3.2) * 6000

= 300 Favorable

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

= ( 6000 - 6200 ) * 3.2 = 640 Favorable

2.)

Variable cost of goods sold variance = Actual - budgeted = 243,970 - 232,965 = 11005 Unfavorable.

Cost of goods sold include direct material, direct labor and variable manufacturing overhead.

Diect material cost variance = ( actual hours * actual rate ) - ( Standard hours * Standard rate )

= ( 51000 * 2 ) - ( 46500 * 2.05) = 102000 - 95325 = 6675 Unfavorable

( It is the sum of material rate variance and quantity variance . that is   2550 Favorable + 9225 unfavorable

= 6675 Unfavorable).

Direct labor cost variance = ( Actual labor hours worked * Actual labor rate ) - ( Standard hours for actual production * Standard labor rate ) = ( 12100*10.2) - ( 12400 * 9.5)

= 123420 - 117800 = 5620 Unfavorable

( It is the sum of labor rate variance and labor efficiency variance , that is

= 8470 Unfavorable + 2850 Favorable = 5620 unfavorable )  

Variable overhaed variance = Actual variable overhead incurred - variable overhaed applied

= 18900 - ( Standard hours for actual production * Standard rate) = 18900 - (6200*3.2)

= 18900- 19840 = 940 favorable

( It is the sum of variable overhead spending variance and variable overhead efficincy variance ,

that is = 300 F + 640 F = 940 favorable )  

Sum of Diect material cost variance, Direct labor cost variance and Variable overhaed variance

= 6675 Unfavorable + 5620 Unfavorable + 940 favorable = 11355 Unfavorable

= variance in variable cost goods sold (Slight diference is there in the amounts. That can be show as follows

Actual direct material incurred= AR×AQ
= 2×510000
= 102,000
Actual labor cost incurred= AH×AR
= 12100×10.2
= 123, 420
Actual variable manufacturing overhead incurred=AH×AR
= 6000×3.15
= 18900 ( given)
Total variable cost incurred= 102000+123420+18900
= 244,320
Variable cost of goods sold given in the question is 243, 970
The difference is 350 ( 244,320-243,970).

There is a difference in the actual variable cost of goods sold computed and the cost given in the question by $ 350. This may be due to the moderation in the decimal places done in setting the standards. This caused the variable cost of goods sold variance computed by summarizing the variances in question 1 and the flexible budget variable cost of goods sold from the total figures provided in the question to be different by $ 350. )

Variance in bugeted and actual variable costs of goods sold increases it will affect the income statement. If the variance is  Favorable it will increase net operating income and if it is Unfavorable it will decrease the net operating income. In the present scenario variable cost of goods sold variance is unfavourable, means costs increased from the budgeted so the net operating income will be decreased comparing to the budgeted.

3. In the variances we are computed the variances which are producing high amounts are direct material quantity variance amounting 9225 Unfavorable and Labor rate variance amounting 8470 Unfavorable. So thses will be the two most significant variances. Direct material quantity variance is arising due to more direct materials used comaparing to the budgeted. It will be due to low quality materials used or tha company's standards are outdated and it results into the consumption of more materials during the production.

Labor efficiency variance is positive. It implies that comapany may used more expertised or skilled service. So it may increased the cost of the labor or labor standards may be upgraded but the company's standards may be outdated and not revised according to this.