Question

Direct cost and overhead variances; decision to automate

Plush pet toys are produced in a largely automated factory in standard lots of 100 toys each. A standard cost system is used to control costs and to assign cost to inventory.

	Price standard	Quantity standard
Plush fabric	$2 per metre	15 metres per lot
Direct labour	$10 per hour	2 hours per lot

Variable overhead, estimated at $5 per lot, consists of miscellaneous items such as thread, a variety of plastic squeakers, and paints that are applied to create features such as eyes and whiskers. Fixed overhead, estimated at $24 000 per month, consists largely of depreciation on the automated machinery and rent for the building. Variable overhead is allocated based on lots produced. The standard fixed overhead allocation rate is based on the estimated output of 1000 lots per month.

Actual data for last month follow.

Production	2,400	lots
Sales	1,600	lots
Plush fabric purchased	30,000	metres
Cost of fabric purchased	$62,000
Fabric used	34,000	metres
Direct labour	4,200	hours
Direct labour cost	$39,000
Variable overhead	$12,000
Fixed overhead	$24,920

The entity’s policy is to record materials price variances at the time materials are purchased.

Required

(a)    Calculate the commonly used direct cost and overhead variances.

(b)    Management is considering further automation in the factory. Robot-controlled forklifts could reduce the standard direct labour per lot to 1.5 hours.

(i)     Estimate the savings per lot that would be realised from this additional automation.

(ii)    Assume the company would be able to generate the savings as calculated. Considering only quantitative factors, calculate the maximum price the managers would be willing to pay for the robot-controlled forklifts. Assume the company’s management requires equipment costs to be recovered in five years, ignoring the time value of money.

Answer 1