CHAPTER 11 CONTROL AND EVALUATION OF COST CENTERS

11-1 Outsourcing and Standard Costs The short life cycle of toys suggests that manufacturers would not benefit from using standard costs. However, they must bid for business, which indicates that they examine the toy closely before setting a price. This analysis is tantamount to developing a standard cost. 11-2 Responsibility for Variances

1. The material price variance will be favorable, while the material use, labor efficiency, and VOH efficiency variances will probably be unfavorable. Quality could also suffer. 2. Before the company changes its standards, we should expect all efficiency variances to be favorable because of the reduced diversity. The company might even find material price savings from buying fewer types of materials and components. 3. The same things we mentioned in part 2 should happen here. Here the company is reducing complexity of products. Simplification should result in products that are easier to manufacture. 4. The labor rate variance will be favorable, the labor and variable overhead efficiency variances probably unfavorable. 11-3 Learning Curves

Auto assembly plants do experience learning effects during changeovers. Assembly lines run slower for a while, then move up to full speed as the workers become more familiar with the operations on the new models. Aircraft plants experience learning effects. The learning effect was discovered in an aircraft plant in the 1930s. The others will not show learning effects because they are machine-driven, processing operations. 11-4 Long-Term Contracts

The principal reasons for using long-term contracts are to ensure supplies and to obtain firm prices. Many companies willingly sacrifice the possibility of paying too much (if prices subsequently fall) to manage the risk of paying too much (if prices rise) or not having an ensured supply. For Stanley the ensured supply is not a reason because supplies are available at competitive prices. The price risk is therefore Stanleys principal motivation. The principal disadvantage is the possibility of losing lower prices in the future. Depending on the terms of the agreement and the commodity or product, companies might also risk having too great a supply. If demand for the end product falls and the agreement requires taking a minimum quantity, the company could have unwanted inventory. The company might also lose flexibility to substitute other commodities

or products if it is required to take a minimum quantity. Consider the following statement from alm!s "##$ %orm $#&'. (Due to supply constrained inventories experienced during the first three quarters of fiscal year "##$, we built inventory levels for certain components with long lead times and entered into certain longer&term commitments for certain components. In the fourth quarter, the sudden and unanticipated significant decrease in demand for our products caused our inventory levels to exceed our forecasted requirements. )e do not currently anticipate that the excess inventory sub*ect to this provision will be used at a future date based on our current $"&month forecast.+ $$&, roductivity -ains

.fficiency variances were favorable /or at least some efficiency variances were favorable0 and at least some price or rate variances were unfavorable. Increases in productivity typically mean increases in efficiency. The statement that increased productivity 1partially offset increase in our input costs1 indicates that the company paid more for inputs, which gives rise to rate or price variances. 11-6 Responsibility for Variances Memorandum To: From: Date: Subj: Henry Berger Student Today Identification of rejects

Jack Smith has questioned our allocation of rejects that we cannot identify by department on the basis of identifiable rejects. The validity of Smith's claim can neither be verified nor refuted, given the available information. Obviously, the claim of discrimination would be valid if the proportions, by department, of unidentifiable rejects do not equal the proportion of identifiable rejects. But, by definition, it is impossible to determine the responsibility for unidentifiable rejects. Hence, Smith's claim can be neither proved nor disproved. And, from this analysis, it is clear that we are actually charging managers with an arbitrary allocation: they are being charged with costs over which they cannot be shown to have control. This violates the principle of controllability in responsibility reporting. One possibility is to stop the allocation entirely, charging the managers with only the rejects specifically identifiable as having been caused by their departments. If we were to adopt JIT principles, we would perform continual inspection, which would eliminate the problem. Another possibility is to develop new evaluation procedures that can better identify the sources of rejects. This might require inspecting after each operation rather than after the total assembly operation is complete. Even with revised inspection procedures, it might not be possible to assign all rejects. Moreover, the cost of the new inspection approach requires justification on the basis that the benefits to be received will be greater than the cost of the procedure. 11-7 Significance of Variances

Even if total actual costs do not exceed total budgeted costs: (1) there can be offsetting total variances for individual elements of cost (materials, labor, individual overhead costs); and (2) a particular cost element can be as budgeted in total, but still have offsetting prices and quantity variances. In both cases, investigation may be needed. A cheaper material might have been introduced into the production process, creating a favorable material price variance, but also leading to increased labor time requirements, or an increase in scrapped materials. These would create, respectively, an unfavorable labor efficiency variance and an unfavorable material use variance. The use of lower-paid temporary workers might result in offsetting labor rate and labor efficiency variances. Any of these situations is acceptable if the result of properly approved decisions. One danger in relying on a comparison of totals is that surprises may be in store in future periods. For example, a decline in labor efficiency may have occurred and require action. The decline could be masked in one month because of a nonrecurring favorable variance in another cost factor. Even if future costs related to some elements can be expected to be lower because of more favorable circumstances, the failure to correct the unfavorable situation with labor efficiency will result in profits being lower than they could have been. Failure to investigate variances wastes the potential of a major tool for spotting areas for possible saving--areas where control might not be effective. Variance analysis does not tell you why costs are lower or higher than budgeted, only that rates and quantities of resources differed from standards. 11-8 Basic Material and Labor Variances (10 minutes)

This exercise stresses that actual output is the basis for calculating variances. The standard quantities, from the budget column, are 0.4 yards of material (36,000/90,000) and 0.2 hours of labor (18,000/90,000). Material use variance (45,000 - [110,000 x 0.4]) x $5 Labor efficiency variance (21,500 - [110,000 x 0.2]) x $15 11-9 Basic Variance Analysis (15 minutes) $5,000 U $7,500 F

This exercise is straightforward, but some students will have trouble with materials because the quantity used exceeds the quantity purchased. Despite their continual exposure to inventories, students sometimes miss the point that purchases can well be less than use. Some students also might have difficulty determining standard labor hours. They do not have to make the calculation ($24/$12 = 2 standard hours) to complete the assignment. We also give the materials variances in a different format. You might wish to show students that format is not the critical element. Materials variances Price variance: Actual cost of purchases, $5.90 x 3,200 Budgeted cost, 3,200 pounds at $6 Favorable variance $18,880 19,200 $ 320 F

Use variance: Standard cost of materials used, 6,200 x $6 Standard cost of standard quantity, 1,200 x 5 x $6 Unfavorable use variance Labor variances Actual Cost $27,225

$37,200 36,000 $ 1,200 U

Budget for 2,250 hours Budget for 1,200 Units $12 x 2,250 1,200 x 2 x $12 or 1,200 x $24 $27,000 $28,800 $225 U $1,800 F Rate variance Efficiency variance

Variable overhead variances Actual Cost Budget for 2,250 Hours Budget for 1,200 Units $6 x 2,250 1,200 x 2 x $6 or 1,200 x $12 $13,800 $13,500 $14,400 $300 U $900 F Budget variance Efficiency variance

This exercise lends itself to using the differences between standard and actual rates to determine price/rate variances. Material price variance = ($6.00 - $5.90) x 3,200 Labor rate variance = ($12.00 - $12.10) x 2,250 11-10 Standard Cost Relationships (15-20 minutes) $ $ 320 F 225 U

This basic exercise deals with the concept of standards as "should be" quantities and costs. It also treats relationships. 1. (a) $12 (b) $48 (c) $18 $420,000 (4 pounds x $3) (3 hours x $16) (3 hours x $6) 70,000 x $6

2. 3. 4.

30,000 units (90,000 hours/3 hours per unit) 25,000 units (100,000 pounds/4 pounds per unit)

5. 80,000 pounds (60,000 hours/3 hours per unit) = 20,000 units; 4 pounds x 20,000 units = 80,000 pounds 6. $297,000 variable overhead 66,000 lbs/4 lbs per unit = 16,500 units, 16,500 units x 3 hours per unit = 49,500 hours x $6 per hour = $297,000 variable overhead $792,000 labor, 11-11 49,500 hours x $16 per hour = $792,000 labor (10-15 minutes)

Basic Learning Curve

1. and 2. Output 1 2 4 8

The schedule below shows results through 8 units. Average Time 1,000 850 (1,000 x .85) 722 (850 x .85) 614 (722 x .85) Average x Output = Total Time 1,000 1,700 2,888 4,912

b -.23446 Y = aX , Y = 1,000 x 8 Y = 614 The natural logarithm of .85 is about -.16251, of 2 is .69315, for b = -.23446 11-12 Relationships 8 5,000 39,680 $227,000 (10-15 minutes) $40 standard cost/$5 standard price 40,000 standard use/8 standard pounds per unit 40,000 - ($1,600 favorable use variance/$5 standard price per pound) $2,000 U price variance + (45,000 x $5) (10 minutes)

Standard pounds Units produced Pounds used Amount paid 11-13

Ethics and Overhead Assignment

Grayson has a legitimate complaint. The controller is certainly not doing the job she should, from a strictly managerial perspective. The company is not getting the best information about product costs and managers could be making poor decisions. From an ethical viewpoint the situation is less clear. However, it is certainly possible to argue that the controller is violating the Standards. She is probably violating the objectivity standard by not presenting all of the " . . . relevant information that could reasonably be expected to influence an intended user's understanding . . . ." She is probably violating the competence standard to ". . . prepare complete and clear reports and recommendations after appropriate analyses of relevant and reliable information." 11-14 1. $74 Clay (20 pounds x $3) Direct labor (1/2 hour x $16) Variable overhead (1/2 hour at $12) Total standard variable cost 2. Materials: Actual Cost $71,800 Budgeted Cost $3 x 25,000 $75,000 $3,200 F Price variance Budget for Actual Use $3 x 22,000 Standard Cost $3 x 20 x 1,000 or 1,000 x $60 $66,000 $60,000 $6,000 U Use variance Standard Cost $16 x 1/2 x 1,000 $60 8 6 $74 Fundamentals of Standard Costs and Variances (10-15 minutes)

Direct labor: Actual Cost Budget for Actual Hours $16 x 480

$7,350 $330 F Rate variance Variable overhead: Actual Cost $5,400 $360 F Budget variance 11-15 Spoilage Variance

$7,680 $320 F Use variance

or 1,000 x $8 $8,000

Budget for Actual Hours $12 x 480 $5,760

Standard Cost $12 x 1/2 x 1,000 or 1,000 x $6 $6,000

$240 F Use variance (15-20 minutes)

This is a challenging exercise, though the appendix provides the format for solving it. Materials: Actual Cost $41,200 Budgeted Cost $6 x 7,000 $42,000 $800 F Price variance Standard Quantity Quantity Actual Quantity at Units Standard Price Price 6,200 x $6 $37,200 $1,200 U Use variance Direct labor: Standard Quantity Standard Quantity Actual Quantity at for 2,000 units at for 1,800 Good Units Actual Cost Standard Price Standard Price at Standard Price $41,200 3,900 x $10 $39,000 2,000 x $20 1,800 x $20 $40,000 $36,000 $1,000 F $4,000 U Use variance Spoilage variance for 2,000 units at Standard Price 2,000 x 3 x $6 $36,000 Standard for 1,800 Good at Standard 1,800 x 3 x $6 $32,400 $3,600 U Spoilage variance

$2,200 U Rate variance Variable overhead:

Standard Quantity Standard Quantity Actual Quantity at for 2,000 units at for 1,800 Good Units Standard Price Standard Price at Standard Price 3,900 x $4 2,000 x $8 1,800 x $8 $16,500 $15,600 $16,000 $14,400 $900 U $400 F $1,600 U Budget variance Efficiency variance Spoilage variance Actual Cost 11-16 Evaluation in JIT Manufacturing (10 minutes)

The company has improved in all ways but one.

Both processing time and cycle time have dropped since July. The drop in cycle time could be especially important for meeting customer demands. The inventory data suggest that the company could cut cycle time even more because there is still a 19 day cycle of materials to in-process goods to finished goods (6 + 9 + 4 days). Production rose from July to September, which is good if demand was higher in September. We do not know whether the rise is good or bad, from production's point of view. Defective units fell, as did the percentage of defectives, from 1.2% (90/7,440) to .8% (62/7,720). The company would like defectives to drop to zero and is still short of that goal. The decline in days supply of materials is good. The drop from 9 days to 6 days supply (50%) is considerable. The decline in in-process inventory is also good, but the increase in finished goods supply is not. However, the increase in finished goods supply might be the result of market forces or temporary conditions having to do with shipping goods to customers. 11-17 1. Revising Standard Costs, Target Costs (15 minutes)

Revised Standard Variable Cost Materials ($20 x 1.20 x .95) Direct labor (0.45 hrs. x $16.80)* Variable overhead (0.45 hrs. x $9) Total standard variable cost $22.80 7.56 4.05 $34.41

* A 5% pay raise brings the direct labor rate to $16.80 per hour and a 10% increase in efficiency reduces the required hours to 0.45 (0.50 hrs x 90%). 2. About 0.3566 hours $32.00 22.80 9.20 25.80 .3566

Target cost Material cost Target direct labor and variable overhead Divided by direct labor/variable overhead rate, $16.80 + $9 Equals target direct labor hours

The .3356 hour target is 79% of the expected .45 hours, which means the company needs another 21% decline in labor time after the expected 10%. Even with this simple assignment, you might wish to point out that increases in efficiency can offset increases in rates, and in some industries, must so offset rate increases for companies to remain competitive. 11-18 Learning Curve (15 minutes)

1. and 2.

$40,960 and $327,680 (b) Average Cost $80,000 64,000 ($80,000 x .80) 51,200 ($64,000 x .80) (a) x (b) Total Cost $ 80,000 128,000 204,800

(a) Output 1 2 4

40,960

($51,200 x .80)

327,680

b -.3219 Y = aX , Y = $80,000 x 8 Y = $40,960 rounded The natural logarithm of .80 is -.2231, of 2 is .69315, for b = -.3219. 11-19 1. Learning Curve (continuation of 11-18) (20-25 minutes)

$80,960 Materials and components Average direct labor and variable overhead (from 11-18) Total variable cost Desired contribution margin Required price It is also possible to use the totals. Materials and components ($25,000 x 8) Direct labor and variable overhead (from 16-11) Total variable cost Desired contribution margin ($15,000 x 8) Required price Dividing $647,680 by 8 gives $80,960. $200,000 327,680 $527,680 120,000 $647,680 $25,000 40,960 $65,960 15,000 $80,960

2. $72,768 All we need to do is extend the analysis in assignment 16-11 by one row, from 8 to 16 batches. At 8 batches we had an average cost of $40,960, so after 16 batches we have $32,768 ($40,960 x .80) Materials and components Direct labor and variable overhead Total variable cost Desired contribution margin Required price $25,000 32,768 $57,768 15,000 $72,768

3. $89,130 We must first redo the learning curve using the 85% rate. We show the total costs, even though they are not needed for the solution. Output 1 2 4 8 Average Cost $80,000 68,000 ($80,000 x .85) 57,800 ($68,000 x .85) 49,130 ($57,800 x .85) $ Total Cost 60,000 136,000 231,200 393,040 $25,000 49,130 $74,130 15,000 $89,130

Materials and components Direct labor and variable overhead, above Total variable cost Desired contribution margin Required price Or, b -.23446 Y = aX , Y = $80,000 x 8 Y = $49,130 Note to the Instructor:

You might wish to point out two important

items related to the sensitivity of costs to changes in volume. One is that changes in the learning rate (80% to 85% here) make a sizable difference in average costs, total costs, and therefore target prices. There was an $8,170 decline in average costs ($74,130 - $65,960) and therefore in prices, as learning declined. The other is that increasing volume has a significant effect, as the difference in costs and prices as we went from four batches to eight batches shows. This might also be a good time to emphasize that the lower the learning rate, the better the results. Students should see this when reminded that the learning rate is the percentage to which the average declines as output doubles. The lower the rate, the lower each successive average. 11-20 Relationships--Labor Variances (20 minutes)

(a) 0.50 produced

standard hours, 2,000 total standard hours/4,000 units

$23,110 actual labor cost, 1,900 actual hours x $12 standard rate + $310 unfavorable rate variance $1,200 favorable efficiency variance, 2,000 standard hours - 1,900 actual hours = 100 hours under standard; 100 x $12 = $1,200 (b) $400 favorable rate variance, 8,400 actual hours x $10 = $84,000 budgeted cost less $83,600 actual cost = $400 8,200 standard hours, 8,400 actual hours - ($2,000 unfavorable efficiency variance/$10) standard rate per hour. Or, $2,000/$10 = 200 hours over standard, so that 8,400 actual hours are 200 over standard. 16,400 units produced, 8,200 standard hours/0.50 standard hours per unit (c) 6,000 standard hours, 3,000 units x 2 hours per unit 5,850 actual hours, efficiency variance of $1,800F/$12 standard rate = 150 hours below standard; 6,000 standard - 150 = 5,850 $71,100 actual labor cost (5,850 actual hours x $12 = $70,200 budget for 5,850 hours, plus $900 unfavorable rate variance = $71,100) (d) 2,000 units produced, 6,000 standard hours/3 hours per unit $4 standard rate, $24,500 actual cost + $300 favorable rate variance - $800 unfavorable efficiency variance = $24,000 standard cost for 6,000 standard hours. $24,000/6,000 = $4 6,200 actual hours, 6,000 standard hours + ($800 unfavorable efficiency variance/$4 standard rate). Or, 200 hours over standard, from $800/$4. 11-21 Variance Analysis (15-20 minutes) Budget for Actual Quantity 1,800,000 x $1.10

Materials: Actual Cost

$2,108,000 $128,000 U Price variance

$1,980,000

Budget for Actual Use 1,588,000 x $1.10 $1,746,800 Labor: Actual Cost 200,000 $645,750 $1,750 U Rate variance Overhead: Actual Cost $1,288,500 Budgeted Cost for Actual Quantity 32,200 x $20 $644,000

Standard Cost for 200,000 200,000 x 8 x $1.10 $1,760,000 $13,200 F Use variance Standard Cost for Production of

200,000 x 1/6 x $20 $666,667 $22,667 F Efficiency variance

Budgeted Cost for Production of 200,000 $840,000 + ($11 x 200,000/6) $1,206,667 $81,833 U Total variance

Note to the Instructor: You might wish to point out that the company can find the variable overhead efficiency variance and the combined fixed and variable overhead budget variances. The efficiency variance is $12,467 F, which is the 1,133 favorable direct labor hours (33,333 standard minus 32,200 actual) times the $11 variable overhead rate. Then there is a $80,700 unfavorable total budget variance. This assignment relies on the discussion of separating actual overhead into its fixed and variable components. 11-22 Performance Reporting (15 minutes)

1. Because the report uses static budget allowances based on budgeted output, not actual output, we cannot tell from it whether performance was above or below standard. A revised, more informative report follows. Budget Production, in units Costs:* Direct labor, $2 Supplies, $0.10 Repairs, $0.25 Power, $0.20 Total 4,800 $ 9,600 480 1,200 960 $12,240 Actual 4,800 $ 9,300 580 1,120 880 $11,880 $ 300F 100U 80F 80F 360F Variance

* All listed costs are variable, so we can compute per-unit budgeted costs by dividing the original budgeted amounts by budgeted production of 4,000 units. Alternatively, we could simply multiply the budgeted costs at 4,000 units by 120%, to give budgeted amounts for 4,800 units.

2.

The memorandum to Woods should cover the following points.

One purpose of variance analysis is to identify the sources of differences between actual costs and standard costs. Standard costs should be related to flexible budgets that change with the quantity of output. We have been comparing actual costs with static budgets. Static budgets are set at the beginning of the period and are not revised if output differs from the original budget. To evaluate production managers requires that we analyze the differences that they can control. Accordingly, we should show efficiency variances on the reports. Whether we should show rate or budget variances depends on whether the production managers can control those variances. Although we should adjust our budgets based on actual output, we should be concerned if actual output differs from budget. Manufacturing managers under our current system are motivated to underproduce (in relation to budget) to keep their costs low. In the proposed system, managers might overproduce to keep workers busy and eliminate efficiency variances. 11-23 1. (a) Variances--Relationships Among Costs (30 minutes)

$2.00 per pound, $8.00 per unit of product.

Actual material cost (from 3) $62,000 Plus favorable material price variance (from 6) 2,000 Standard material cost for the 32,000 pounds purchased $64,000 Divided by the number of pounds purchased (from 3) 32,000 Equals standard cost per pound $2.00 Times the number of pounds in each finished unit (from 1a) 4 Equals standard material cost per pound $8.00 (b) 6.00 Divided by standard cost per hour (from 1b) $12.00 Equals standard number of hours per finished unit 0.50 (c) $8.00 Times number of hours per unit (from 1b, computed above) 0.50 Equals standard variable overhead per unit $4.00 $4.00 per unit 0.50 hours $

Standard labor cost per unit (from 1b)

Standard rate per hour, given

4.

$62,400

Number of pounds of material used, given 31,200 Times standard material cost per pounds (from 1a above) $2 Equals material used at standard cost $62,400 5. 4,100 hours Total actual labor cost Plus favorable labor rate variance (from 8) Budgeted labor cost for actual hours Divided by standard labor rate per hour Equals actual labor hours 7. $1,600 favorable $47,200 2,000 $49,200 $12 4,100

Material used, at standard rates (computed in 4 above) $62,400 Standard use, 8,000 x 4 pounds per unit x $2 per pound 64,000 Favorable material use variance 1,600 9. 4,000 Actual hours worked (computed in 5) 4,100 Hours over standard 100 11. 100 Times standard variable overhead cost per hour (from 1c) $8 Equals favorable variance overhead efficiency variance $800 12. $31,300 $800 unfavorable Hours over standard (from 9) $1,200 unfavorable (100 hours x $12) Standard number of hours required to produce 8,000 units 8,000 units x 0.50 hours per unit (computed in 1b)

Standard variable overhead at standard rates 8,000 units x $4 per unit (computed in 1c) $32,000 Plus unfavorable efficiency variance (from 11) 800 Budget for actual hours, = 4,100 x $8 32,800 Less favorable spending variance (from 10) 1,500 Actual overhead $31,300 A shorter solution is to go immediately to budgeted variable overhead for 4,100 hours, $32,800 (4,100 x $8) and subtract the $1,500

favorable budget variance. 11-24 1. Standards--Machine-Hour Basis (25 minutes)

$6.00 Materials (1 pound x $4 per pound) Variable overhead ($10 x 1/5 hours) $ 4.00 2.00 $6.00

2.

Materials variances Budget for Actual Quantity Purchased 33,000 x $4 $132,000 $1,500 U Price variance Budget for Standard Cost Actual Quantity Used for 31,000 units 31,500 x $4 31,000 x $4 $126,000 $124,000 $2,000 U Use variance

Actual Cost $133,500

Variable overhead variances Actual Cost Budget for Standard Cost for Actual Quantity Used 31,000 units 6,140 x $10 31,000 x $2 $62,200 $61,400 $62,000 $800 U $600 F Budget variance Efficiency variance Standards in a Service Function (20 minutes)

11-25

Labor rate variance = $26,500 - (1,790 x $14) = $26,500 - $25,060 = $1,440 Unfavorable Standard time allowed in minutes: Blood sugar 11 x 4,100 Cell count 9 x 2,200 Others 6 x 4,900 Total Divided by 60 equals standard hours Times standard rate Equals standard labor cost Minus actual hours x standard rate, above Unfavorable labor efficiency variance 45,100 19,800 29,400 94,300 1,572 $14 $22,008 25,060 $ 3,052

rounded

2. At least some of the labor efficiency variance is probably attributable to idle time, rather than inefficiency. Each technician worked an average of 120 hours (1,790/15), and a normal work month is about 154 hours (22 days times 7 hours). If the volume of work does not support keeping everyone busy, the labor efficiency variance does not reflect the inability to perform work in the standard time.

Note to the Instructor: You might wish to pursue this assignment further. Remind the class that using standards (and budgets, to which standards are related) to pressure employees might result in cutting corners. Were that to happen here, the consequences could be much worse than they are in most other situations because a poorly done test might lead to a patient's receiving the wrong treatment. 11-26 Target Costing (15 minutes)

We first need to calculate the combined direct labor and variable overhead rate, $18.45, ($15 x 1.03) + $3 Target cost Materials Target for direct labor and variable overhead Divided by combined rate, above Target hours Percentage reduction, (.40 - .3794)/.40 $24.50 17.50 $ 7.00 $18.45 0.3794 0.0515

A 5.2% reduction in direct labor time will meet the objective. Of course, we cannot determine whether the company can meet that objective. That is a task for value engineering. 11-27 1. Wage Rate per Hour Historical performance $15 Ideal performance $15 Currently attainable performance $15 Units per Hour 15 20 18 Standard Cost $1.000 $0.750 $0.833 Determining a Base for Cost Standards (15-20 minutes)

2. Budgeted Cost for Efficiency Basis for Standard Historical Ideal Currently attainable Standard Cost (1,410,000 x $1.00) $1,410,000 (1,410,000 x $0.75) $1,057,500 (1,410,000 x $0.833) $1,174,530 80,000 hours $1,200,000 $1,200,000 $1,200,000 Variance $210,000 F $142,500 U $ 25,470 U

3. The requirement to comment on the results focuses on the interpretation of "standard" and provides an opportunity to discuss the problems of setting standards. Actual results were closest to the standard set using currently attainable performance, as we would expect. It could be that the new materials-handling equipment is not yet broken in, giving rise to the variance. Both alternatives, historical and ideal performance, gave large variances for obvious (in this case) reasons. Historical performance ignores the changed conditions, ideal performance is much above currently attainable performance.

Memorandum To: From: Date: Subj: Bonnie Gardella Student Today Basis for standard costs

Currently attainable performance gives the best standard for planning and budgeting. Both of the alternatives gave large variances in labor cost, so they will create problems if we use them for budgeting. However, some JIT manufacturers do use ideal performance as a goal and we might therefore consider ideal standards if we can resolve the problem of budgets. We might also have motivational problems using ideal standards unless we adopt JIT principles wholeheartedly. 11-28 Kaizen Costing (15 minutes) Two Quarters 76.8 28.8 105.6 $1,901 Three Quarters 75.3 28.2 103.5 $1,863

Current One Quarter Cutting time Polishing time Total time Total cost 80 30 110 $1,980 78.4 29.4 107.8 $1,940

Each time is 98% of the previous value. Note that the reductions slow because they are percentages of a declining base. Nonetheless, the fall is significant. The managers will use these values as targets for the coming periods, instead of the static targets that regular standards provide. 11-29 Learning Curve in Administrative Work (20 minutes)

About eight to nine days, as calculated below. This assignment differs from others because it states time in days, not hours or cost. Some students will have trouble deciding how to proceed, but the calculations are straight-forward. The total requirement of 640 forms for each worker is 16 batches of 40 forms each, so the task is to find out how long it takes to process 16 batches. Without learning the task will take about 16 days. Output 1 2 4 8 16 Average Time 1.0 .85 .7225 .614125 .522 (in days) (1 x .85) (.85 x .85) (.7225 x .85) (.614125 x .85) Total Time (in days) 1.0 1.7 2.89 4.913 8.352

b -.2345 Y = aX , Y = 1 x 16 Y = .522 11-30 Learning Curve in Administrative Work (extension of 11-29) (20 minutes) About seven to eight days, as calculated below. The increase in learning occurs two ways: the learning percentage is 70% rather than 85%, and the batch size is smaller so the learning occurs more rapidly. The total requirement of 640 forms for each worker is 64 batches of 10

each, so the task is to find out how long it takes to process 64 batches. Without learning the task will still take about 16 days. b -.51457 Y = aX , Y = 1 x 64 Y = .1176 64 .1176 = 7.529 days 11-31 Learning Curve in Make-or-Buy Decision (20 minutes)

Oxwright should make the component. The schedule below shows the average and total costs, either of which can be used in solving the assignment. Oxwright needs 32 batches of 1,000 units each. Output 1 2 4 8 16 32 Average Cost Total Cost $15,000 $ 15,000 12,750 ($15,000 x .85) 25,500 10,838 ($12,750 x .85) 43,352 9,212 ($10,838 x .85) 73,696 7,830 ($9,212 x .85) 125,280 6,656 ($7,830 x .85) 212,992

Average Total Materials $13,000 $416,000 ($13,000 x 32) Labor and variable overhead 6,656 212,992 Cost to make $19,656 $628,992 Cost to buy 22,000 704,000 ($22 x 32,000) Advantage to making $ 2,344 $ 75,008 Or, b -.2344 Y = aX , Y = $15,000 x 32 Y = $6,657 The natural logarithm of .85 is about -.1625, of 2 is .69315, for b = -.2344.

11-32

Activity-Based Variances

(25 minutes) Standard for 10 10 x $320 $3,200

Labor-related Overhead Actual Cost Batches $3,250

Budget for 190 Hours 190 x $16 3,040

$210 U budget variance

$160 F efficiency variance $50 U total variance

Setup-related Overhead Actual Cost Batches $16,500

Budget for 820 Hours 820 x $20 $16,400

Standard for 10 10 x $1,400 $14,000

$100 U budget variance

$2,400 U efficiency variance $2,500 U total variance

Lab Test-related Overhead Actual Cost Budget for 47 Tests Standard for 10 Batches 47 x $60 10 x $300 $2,870 $2,820 $3,000 $50 U $180 F budget variance efficiency variance $130 F total variance The interpretation of the ABC variances is the same as for those driven by labor or machine time. The budget variance reflects spending to perform the activity as many times as required, and the efficiency variance reflects efficient or inefficient use of the driver--labor, setups, and lab tests. The company spent more time doing setups and did fewer lab tests than standard. 11-33 1. Standards and Variances, Two Products (25-30 minutes)

It is best to start by determining the standard quantities. Harcombe Exeter 8,000 2,000 2,000

Total Standard quantities: Feet of materials, 2,000 x 6; 1,000 x 8 12,000 20,000 Direct labor, 2,000 x 1; 1,000 x 2 4,000 Variances: Material price variance, 22,000 x $0.10 Material use variance, (19,900 - 20,000) x $5 Direct labor rate variance, 4,200 x $0.20 Direct labor efficiency variance, (4,200 - 4,000) x $14 Variable overhead budget variance, $31,500 - (4,200 x $8) Variable overhead efficiency, (4,200 - 4,000) x $8 $2,200 F $ 500 F $ 840 U $2,800 U $2,100 F $1,600 U

2. In previous editions the problem stated that the company could not calculate variances by product. Even lacking that statement, it is clear that the company needs information about the quantities of inputs used for each product to calculate variances by product. The principal reason to compute variances by product is that offsetting favorable and unfavorable variances might exist. Managers need to know whether such is the case because product standards might not reflect currently attainable costs. Short-term decisions such as special orders, make or buy, and pricing, require currently attainable standard variable cost data. 11-34 1. Materials Direct labor at $12/hour Variable overhead: Labor-related at $4/DLH Machine setups at $9 Number of parts at $0.50 Total variable overhead Overhead Rates, ABC, and Pricing (25 minutes) Major Product $35 36 $12 9 5 26 $12 72 9 93 Minor Product $65 36

Total standard variable cost 2. To: From: Date: Subj: Memorandum Laura Hurlbut Student Today Activity-based overhead costs

$97

$194

The standard costs I developed using activity-based rates are more informative than those we have been using. Our current overhead costs are based only on direct labor, so high-volume products are allocated the most overhead cost. High-volume products therefore subsidize lowvolume products. The difficulty is that low-volume products generate many costs that are not associated with direct labor. In our case, setups and numbers of parts are significant cost drivers and the laborbased rate does not recognize this. Low-volume products increase our costs in various ways because they make our operations more complex. Obviously, we could lower costs if we made only one or two high-volume products. ABC rates overcome the bias that labor-based rates have: that lowvolume products will appear more profitable and high-volume products less profitable. The low-volume products bear more overhead costs, as they should. The specific cases illustrate the point. The cost of the minor product increases 25% ($155 to $194) and that of the major product declines 22% ($125 to $97). The margin we earn on the major product is very high and we can afford to cut its price to meet the competition. We should raise the price on the minor product. 3. This requirement is covered in requirement 2. give students a hint about requirement 2. 11-35 Input Standards versus Output Standards We included it to

(25-30 minutes)

Note to the Instructor: Many students will find this problem quite difficult because they will fail to see that the key is to express the budget based on 51,000 gallons, or 10,200 standard hours, instead of on the input value of 10,000 hours, because 10,200 is 102% of 10,000. It is also possible to relate gallons and hours. Thus, with 51,000 gallons for 10,200 hours, gallons per hour = 5 (51,000/10,200) or each gallon requires 1/5th of an hour. (The calculation could also be made using 50,000 budgeted gallons and 10,000 budgeted hours.) Using the budgeted costs for 10,000 hours gives the bases for calculating the standards. Material use variance There is no material price variance, or, more correctly, the production manager is not responsible for it because the report shows materials used at standard prices. Actual material cost at standard prices (given) Standard material cost at standard prices $24,000 x 102% Material use variance Direct labor variances Actual labor cost Budgeted cost for 10,000 hours $26,700 24,480 $ 2,220 U $69,200 68,000

Rate variance Standard cost for 51,000 gallons ($68,000 x 102%) Budgeted cost for 10,000 actual hours Efficiency variance Indirect labor variances Actual cost Budgeted cost for 10,000 hours Budget variance Budgeted cost for 10,000 hours, as above Standard cost for 51,000 gallons ($26,500 x 102%) Efficiency variance Other variable overhead variances Actual cost Budgeted cost for 10,000 hours Budget variance Budgeted cost for 10,000 hours, as above Standard cost for 51,000 gallons ($27,300 x 102%) Efficiency variance

$ 1,200 U $69,360 68,000 $ 1,360 F $28,100 26,500 $ 1,600 U $26,500 27,030 $ 530 F $26,100 27,300 $ 1,200 F $27,300 27,846 $ 546 F

Note to the Instructor: This problem can be used to discuss the interpretation of budgets when the basis for comparison is not units of product. This company is not getting as much information as it could because it is using an input factor to determine budgeted costs. It is not calculating efficiency variances. It is relatively easy to determine the standards for a unit of product and use those in calculating variances. Materials ($24,000/50,000) Direct labor ($68,000/50,000) Indirect labor ($26,500/50,000) Other variable overhead ($27,300/50,000) Total standard cost 11-36 Standards and Idle Time (15-20 minutes) $0.48 1.36 0.53 0.546 $2.916

Note to the Instructor: This assignment shows that the usual calculation of the labor efficiency variance assumes that workers are producing goods all of the time, that there is no idle time. The chapter introduces the problem of idle time. While this assignment extends the chapter material, it is stated clearly enough that most students will see the problem, and many will make the points covered in requirement 2 below. Cost accounting courses pay more attention to this point. 1. $35,000 U Actual hours Standard hours allowed (1,200,000/100 x 2) Unfavorable labor time Times $7 standard rate = unfavorable efficiency variance 29,000 24,000 5,000 $35,000

2. No. The enforced idle time results from company policy, not from labor inefficiency. Using the company's estimate of idle time it is possible to separate the $35,000 variance in requirement 1 into two parts. There is a $38,500 unfavorable variance (5,500 x $7) resulting from the company's policy. During the time that they actually had work

to do, the workers were efficient, spending 23,500 hours (29,000 total - 5,500 idle) accomplishing 24,000 standard hours worth of work. This yields a $3,500 favorable variance. 11-37 Evaluation in JIT Manufacturing (15-20 minutes) Memorandum To: Sharon Fennell From: Student Date: Today Subj: Performance evaluation The measures that we will use as we convert to JIT differ from those we used before. We are now more concerned about overall operations, about quality, and about progress than we were before. are also less concerned about the performance of individual cost centers. I have summarized the major features of each item below. Unit production: This measure serves several purposes. It allows us to calculate percentages of some items to total production (such as defectives). It also tells us how we are using our capacity--how much work we are doing. Number of defectives: This measure is important because quality is a primary concern. We will track both the number of defectives and their percentage to total output. Percentage of orders shipped on time: This tells us how well we are meeting our customers' demands. It should be used in conjunction with measures of cycle time. The quicker we can manufacture products, the quicker we can ship them. Faster deliveries give us an advantage over the competition. Manufacturing interval (cycle time): This tells us how long we spend from the time we receive an order until we ship it. The closer this time comes to actual manufacturing time (value-adding time), the less non-value-adding time. The lower the interval, the less time we waste. Supply of inventories: Inventories hide defects and generate many costs. The lower the supply we keep, the more efficiently we are manufacturing. This is a basic measure of JIT efficiency. Cost of scrap: This is a financial measure of quality. We track defective units, and should also be concerned about the cost of those units. Scrap as percentage of output: This is a percentage measure of physical quality, as opposed to a dollar quality. This is the number of defectives divided by total output. Number of line disruptions: This is a measure of how efficiently we are operating. People can shut down lines for various reasons, including defectives. Time spent dealing with disruptions is not value-adding time. Percentage of people cross-trained: As we move toward manufacturing cells, our people must be able to do several jobs to

We

ensure better flow of products. Moreover, people who can do several jobs are usually better motivated and more productive. Note to the Instructor: Not all of these are mentioned in the chapter. Some require a return to the description of JIT in Chapter 1. 11-38 Analyzing Results--Sales and Cost Variances (35-40 minutes)

Note to the Instructor: This is a very difficult problem. Although students analyzed contribution margin variances in Chapter 4, they did so without the complication of changes in variable costs. Another difficulty is that students fail to adjust the original budget for variable costs, and so show a variance of $4.0 M ($44.0 - $40.0). Preliminary calculations Budgeted selling price Actual selling price Budgeted contribution margin Contribution margin variances CM at Actual Volume and Actual Price with Standard Unit Variable Cost CM for Actual Volume at Budgeted Price $12 ($120.0/10.0) $11.306 ($122.1/10.8) $ 8.00 ($12 - $4)

Budgeted CM

10.8 x ($11.306 - $4) 10.8 x $8 10.0 x $8 $78.9 $86.4 $80.0 $7.5 U $6.4 F sales price variance sales volume variance $1.1 U total contribution margin variances Variable cost variances: Budgeted Variable Costs at 10.8 M units * $21.6 16.2 5.4 $43.2 Actual Variable Costs $21.8 17.0 5.2 $44.0

Cost Factor Materials Direct labor Variable overhead Totals *

Variance ( U ) ($0.20) ( 0.80) 0.20 ($0.80)

Original budget divided by 10.0 M and multiplied by 10.8 M.

Fixed cost variances: Manufacturing ($50.8 - $50.0) Selling and administrative ($19.9 - $20.0) Total A summary is: Budgeted profit Contribution margin variances Variable cost variances Fixed cost variances Total variances Actual profit 11-39 $0.80 U 0.10 F $0.70 U $10.00 $ 1.10 U 0.80 U 0.70 U 2.60 U $ 7.40 (30 minutes)

Actual to Actual Comparisons--JIT

Memorandum To: From: Date: Subj: Controller Student Today Manufacturing performance I

Our unit cost increased slightly, but much of the increase is attributable to price differences over which we have little control. have analyzed costs into price and efficiency variances below. The price variances simply reflect the difference between May and June prices multiplied by June use of the input factor.

The efficiency variances are based on using May input quantities as the "standard." I adjust May costs to reflect the higher output in June (10,300 units to 11,000 units). I calculate June input use at May prices, and the difference is attributable to using more or less of the input factor in June. For variable overhead I made only one calculation. Labor time per unit decreased slightly from about 1.9612 hours (20,200/10,300) to 1.9545 (21,500/11,000), which is an improvement. gained $512 from increased efficiency, using May as the base and holding the $7.00 wage rate constant. Cost for June Output Actual Cost at May Rate at May Rate 21,500 x $7.00 $150,500 20,200/10,300 x 11,000 x $7.00 $151,010 $510 favorable efficiency variance We

The wage rate increased by $0.20, which gave us a $4,300 (21,500 DLH x $0.20 increase) unfavorable rate variance. Material prices declined by $0.02 per pound, giving a $900 ($0.02 x 45,000) favorable price variance. We used more material per unit of product, from 3.98 (41,000/10,300) to 4.091 (45,000/11,000) gallons, costing $1,189. June Cost with May Actual Cost at May Price Price and Quantity 41,000/10,300 x 11,000 x $0.98 $42,911 $1,189 unfavorable use variance Variable overhead increased in total, but declined per unit. Actual Overhead $85,800 June Cost Adjusted from May Base $83,400/10,300 x 11,000 $89,068 45,000 x $0.98 $44,100

$3,268 F In summary, the following factors contributed to the cost difference. Labor efficiency Labor rate Material price Material use $ 510 4,300 900 1,189 F U F U

Variable overhead Total

3,268 F 811 U

Note to the Instructor: You might wish to use the following analysis to show the difference of $811. June costs: Materials, 45,000 x $0.96 Direct labor, 21,500 x $7.20 Variable overhead Total $283,800 $ 43,200 154,800 85,800

Cost for 11,000 units at May prices and quantities: Materials, (41,000/10,300) x 11,000 x $0.98 $ 42,911 Direct labor, (20,200/10,300) x 11,000 x $7.00 151,010 Variable overhead, ($83,400/10,300) x 11,000 89,068 Total 282,989 Difference 811 11-40 Variance Analysis--Changed Conditions (35 minutes)

Material use variance Budget for Standard Cost Actual Quantity Used for 3,700 units (12,300 x $4) (3,700 x $12) $49,200 $44,400 $4,800 U Unfavorable use variance Direct labor variances Actual Cost $66,100 $700 F Favorable rate variance Budget for Standard Cost for Actual Quantity Used Production of 3,700 (8,350 x $8) (3,700 x $16) $66,800 $59,200 $7,600 U Unfavorable efficiency variance

Variable overhead variances Budget for Standard Cost for Actual Quantity Used Production of 3,700 (8,350 x $4) (3,700 x $8) $34,200 $33,400 $29,600 $800 U $3,800 U Unfavorable Unfavorable budget variance efficiency variance Summary of Variances Favorable Unfavorable Material use $4,800 Direct labor rate $700 Direct labor efficiency 7,600 Variable overhead spending 800 Variance overhead efficiency ____ 3,800 Total $700 $17,000 Actual Cost 2. Because the problem states that the standards are currently

attainable and that variances have been small, we can conclude that the September variances resulted from using the new material. The equal quality of the finished product does not preclude differences in working with the material. There is a question whether the workers will soon adjust to the new material, reducing the variances as they become more familiar with it. If not, the variances will likely continue. 3. The material price variance will average about $6,000 favorable using the new material (average purchases of 4,000 units x 3 pounds x $0.50 saved = $6,000) The saving is considerably less than the $17,000 unfavorable variances that seem attributable to using the new material. (We might, however, calculate the material use variance using the $3.50 figure instead of the $4. We do that below.) Those variances were for 3,700 units; at 4,000 units they will probably be higher. We can almost certainly ignore the favorable labor rate variance, unless we could determine that it was caused by using unskilled workers who would therefore have been less efficient than usual. One thing we could do is compute a new standard cost assuming that the September experience becomes the currently attainable standard. The result is $2.74 higher than the currently attainable standard. Materials (3.32 pounds x $3.50) Direct labor (2.26 hours x $8) Variable overhead, $4 per DLH Total standard variable cost $11.62 18.08 9.04 $38.74

Materials: 12,300/3,700 = 3.32 pounds (rounded) Direct labor: 8,350/3,700 = 2.26 hours 11-41 Economic Cost of Labor Inefficiency (30 minutes)

General Note to the Instructor: This problem makes two important points. First, it emphasizes the cost of labor inefficiency is not limited to labor cost, but also includes the variable overhead cost associated with labor. Second, and more subtle, is that if the company is operating at capacity, labor inefficiency is best measured by the opportunity cost of lost sales. And of course, the opposite holds true when labor performance is better than standard. 1. Actual labor hours 280,000 Standard hours, 12,500 x 14 and 19,200 x 14 268,800 Excess hours 11,200 Times standard rate of $10 equals DLEV $112,000 Excess hours times $8 rate VOH equals VOHEV 89,600 Total variances related to labor inefficiency $201,600 January 179,400 175,000 4,400 $44,000 35,200 $79,200 June

2. The January variances reflect the economic cost, but not the June variances. In June the company could have produced 20,000 units at normal labor efficiency (280,000/14), but only produced 19,200.

Lost sales Contribution margin: Selling price Material cost Labor and VOH, 14 x $18 Lost contribution margin Variances above Total cost of inefficiency

800 units $620 ( 82) (252)

$286 $228,800 201,600 $430,400

Some students might believe that the variances involve double counting. The following alternative format shows the actual results compared with those the company would have achieved at normal efficiency. Potential Revenue at $620 x 20,000, 19,200 Standard cost at $334 Contribution margin at standard Less variances Contribution margin The difference is $430,400. 11-42 Unit Costs and Total Costs (20 minutes) $12,400,000 6,680,000 5,720,000 $ 5,720,000 Actual $11,904,000 6,412,800 5,491,200 201,600 $ 5,289,600

Matthews is not correct. The reason that unit cost was less than budgeted is that production was greater than budgeted, spreading the fixed manufacturing overhead over 100,000 units instead of 90,000. The variances that we can identify appear below. The approach is to compute the total variances for materials, labor, and overhead, and then back out the variances for which Matthews is not responsible. Material use variance: Total material cost Standard for 100,000 units [($288,000/90,000) x 100,000] Total materials variances Less material price variance (from text) Material use variance Labor efficiency variance: Total labor cost Standard for 100,000 units [($679,500/90,000) x 100,000] Total labor variances Less labor rate variance (from text) Labor efficiency variance Variable overhead variances: Total variable overhead cost Standard for 100,000 units [($339,750/90,000) x 100,000] Total variable overhead variances* Fixed overhead budget variance, $860,700 - $850,000 Total variances under Matthews' control $341,800 320,000 21,800 16,000 $ 5,800 U $773,800 755,000 18,800 15,100 $ 3,700 U $391,300 377,500 $ 13,800 U $ 10,700 U $34,000 U

* We could determine the variable overhead efficiency variance and spending variance if we assume that variable overhead is related to direct labor. Because those variances will be in the same direction

and in the ratio of standard labor cost to standard variable overhead cost, we could calculate the variable overhead efficiency variance as $1,850 unfavorable (half of the unfavorable labor efficiency variance because variable overhead of $339,750 is half of direct labor of $679,500), leaving an unfavorable spending variance of $11,950. Again, these calculations are justified only if variable overhead is related to direct labor. We reconcile the numbers as follows. Budgeted variable costs for 90,000 units are $1,307,250 ($288,000 + $679,500 + $339,750), so the flexible budget allowance for 100,000 units is $1,452,500 ($1,307,250/90,000 x 100,000). Flexible budget for 100,000 units $1,452,500 Add budgeted fixed costs 850,000 Total budget for 100,000 units 2,302,500 Plus price/rate variances from text ($16,000 + $15,100) 31,100 Total allowable cost 2,333,600 Actual total cost 2,367,600 Controllable unfavorable variances, as above $ 34,000 Note to the Instructor: Students are likely to find this problem quite difficult because they are not likely to see, at first, that they can compute the total standard cost for variable costs. They will also spend some time determining that the rate variances are computed correctly. They are likely to notice immediately, however, the manager's error in including fixed costs in his calculation of the "adjusted budgeted costs." 11-43 Design Change Variances (25-30 minutes)

Note to the Instructor: This assignment is not simple, although the principle is straightforward. The idea is to show students various ways to calculate and interpret variances. The suggestion that variances be split makes good sense, and companies do often calculate design change variances if they do not revise standards. 1. Material use variance

Budget for Actual Use Original Standard Cost 13,700 x $3.00 2,000 x $18 $41,100 $36,000 $5,100 U Use variance Direct labor efficiency variance Budget for Actual Hours 1,180 x $10 $11,800 Variable overhead efficiency variance Budget for Actual Hours 1,180 x $7 $8,260 Original Standard Cost 2,000 x $6 $12,000 $200 F Use variance Original Standard Cost 2,000 x $4.20 $8,400

$140 F Use variance 2. We first calculate the variances using the standard for the redesigned tool. Material use variance Budget for Actual Use same as above $41,100 $900 F Use variance Direct labor efficiency variance Budget for Actual Hours Standard Cost same as above 2,000 x $5.50 $11,800 $11,000 $800 U Efficiency variance Variable overhead efficiency variance Budget for Actual Hours Standard Cost same as above 2,000 x $3.85 $8,260 $7,700 $560 U Efficiency variance The summary of variances resulting from design changes is the difference between the variances computed above and those computed in requirement 1. Efficiency Variances Based on Old Standard New Standard Change Material use variance DLH efficiency variance VOH efficiency variance Totals $5,100 200 140 $4,760 U F F U $900 800 560 $460 F U U U $6,000 1,000 700 $4,300 U F F U From Design Standard Cost 2,000 x $21 $42,000

It appears that the manager's performance was worse with respect to direct labor and variable overhead using the new standard and better with respect to materials. Note, however, that the variances identified as "from design change" are really a mixture of results from operating with two designs, not necessarily the result of the design change. 11-44 Analysis of Income Statement (40-50 minutes)

This is a difficult problem and you might wish to give out some hints prior to assigning it. Telling students that they must determine total standard direct labor hours will help them get on the track. 1. $8,800 unfavorable Actual direct labor cost Total variance Standard direct labor cost $144,800 4,000 U 140,800

Divided by 22,000 units = standard cost per unit Divided by 0.80 standard hours per unit = standard rate Total standard hours (22,000 x .80) Total actual hours (22,000 x .85) Variance in hours, unfavorable Multiplied by $8 standard rate = $8,800U

$6.40 $8.00 17,600 18,700 1,100

2. $4,800 favorable, $8,800 efficiency variance minus $4,000 total variance 3. $4 $12.00 $6.40 1.60 8.00 $ 4.00

Total standard unit cost ($240,000/20,000) Direct labor Variable overhead ($2 x 0.80) Standard material cost 4. $38,200 Standard variable cost (22,000 x $1.60) Variances Actual variable overhead cost 5. 6. 7. 8. 9. $2,200 unfavorable $800 unfavorable $77,000 2 pounds 41,000 pounds,

$35,200 3,000 U $38,200

1,100 unfavorable labor hours x $2 per hour $3,000 total variance - $2,200 unfavorable efficiency variance $75,000 budgeted plus $2,000 unfavorable budget variance $4 standard cost/2 pounds per unit

the $6,000 favorable materials variance is all use since materials were bought at the standard price. Standard use (22,000 x 2) 44,000 Variance in pounds ($6,000/2) 3,000 Actual use 41,000 Forecasting Income (30-40 minutes)

11-45 1.

$7.21 Materials, 0.45 x $4.20 Direct labor, 0.35 x $10 Variable overhead, 0.35 x $5.20 Total standard variable cost $1.89 3.50 1.82 $7.21 $2,300,000 829,150 1,470,850 $ 4,536 U 25,200 U 13,104 U $588,000 493,500

2. Sales (115,000 x $20) Standard cost of sales (115,000 x $7.21) Standard gross margin (115,000 x $12.79) Variances (see below) Material use Direct labor efficiency Variable overhead efficiency Actual gross margin Fixed costs: Manufacturing ($560,000 x 1.05) S&A ($470,000 x 1.05)

42,840 U 1,428,010 1,081,500

Profit

346,510

Variances: Material use: standard = 120,000 x .45 = 54,000 Excess use at 2% Standard price Material use variance

1,080 $4.20 $4,536

Direct labor efficiency: standard = 120,000 x .35 = 42,000 Excess use at 6% 2,520 Standard rate $ 10 Labor efficiency variance $25,200 Variable overhead efficiency 11-46 Selecting a Vendor 2,520 x $5.20 = $13,104 (15 minutes)

The point of this assignment, of course, is to show that various factors besides price are important in selecting a vendor. Spartan is clearly superior on all dimensions except price, so the question is whether the division is better off saving roughly $377,000. Note the divisions at the ends of the calculations to incorporate the defect rates. Spartan, 1,000,000 x $4.40 x 99%/99% Capital, 1,000,000 x $3.90 x 98%/95% Difference favoring Capital $4,400,000 4,023,158 $ 376,842

The answer is not automatically to select Spartan. If the division is not a JIT operation and can manage with less service, it might well buy from Capital. For instance, technical support might be a trivial matter, the division might be sufficiently flexible to live with erratic deliveries, and defectives might appear quickly and not be made into product before being discovered. Under these circumstances, it might pay to deal with Capital. Spartan nonetheless does better on every dimension save price, and could be the lower-total-cost vendor. 11-47 Analyzing Results (35 minutes)

1. (a) and (b) Actual Results* $3.99 x 450,000 $1,795,500

Budgeted contribution margin is $4.09, $8.00 - $3.91. Actual Volume at Budgeted Margin $4.09 x 450,000 $1,840,500 Budgeted Results $4.09 x 400,000 $1,636,000 $204,500 F sales volume variance

$45,000 U sales price variance

$159,500 F total marketing variances * Actual selling price of $7.90 ($3,555,000/450,000) minus $3.91 standard variable cost. (c) Material price variance, only milk chocolate has a variance. Purchases equal use. Ounces Bought (Standard Price - Actual Price*) Variance Cookie mix 4,650,000 x ($.02 - $.02) $ 0

Milk chocolate 133,000U Almonds Total

2,660,000 480,000

x x

($.15 ($.50

$.20) - $.50) 0 $133,000U

*Actual total cost/actual total quantity, $93,000/4,650,000 = $0.02, $532,000/2,660,000 = $0.20, $240,000/480,000 = $0.50 (d) Material quantity variance Standard Price Standard Use - Actual Use Variance Cookie mix .02 x 10 x 450,000 - 4,650,000 $ 3,000U Milk chocolate .15 x 5 x 450,000 - 2,660,000 61,500U Almonds .50 x 1 x 450,000 480,000 15,000U Total variance $79,500U (e) Labor efficiency variance Standard Minutes - Actual Minutes 1 minute x 450,000 - 450,000 2 minutes x 450,000 - 800,000 Variance $ 0 30,000F $ 30,000F

Standard Rate per Minute* Mixing, $0.24 Baking, $0.30 Total variance

x x

* $14.40/60 = $0.24, $18.00/60 = $0.30 (f) and (g) Variable overhead variances Budgeted Variable Overhead Standard Variable for 1,250,000 minutes Overhead 1,250,000 x $0.54* 450,000 x $1.62 $750,000 $675,000 $729,000 $75,000 U $54,000 F budget variance efficiency variance $21,000 U total variance * $32.40 hourly rate divided by 60 Summary of Variances (a) (b) (c) (d) (e) (f) (g) Sales price variance Sales volume variance Material price variance Material quantity variance Labor efficiency variance Variable overhead efficiency variance Variable overhead spending variance Total variances $ 45,000U 204,500F 133,000U 79,500U 30,000F 54,000F 75,000U $ 44,000U Actual Variable Overhead

2. A problem might be that direct labor hours is not an appropriate base for Aunt Molly's Old Fashioned Cookies because it might not be the activity that drives variable overhead. A possible indication of this disconnect is shown in the variance analysis. The labor efficiency variance is favorable, while the variable overhead spending variance is unfavorable. Another problem is that baking requires considerably more electricity than mixing, which could distort product costs. 3. Activity-based costing might alleviate the problems described in part 2 above and, therefore, is an alternative that Aunt Molly's should consider. Since direct labor does not seem to have a direct cause-andeffect relationship with variable overhead, the company should try to identify the activity or activities that drive variable overhead. If

the same proportion of these activities is used in all of Aunt Molly's products, then ABC will probably not be beneficial; however, if the products require a different mix of these activities, then ABC could well be beneficial.