In Class #7.1 Direct materials and manufacturing labour variances, solving unknowns

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1 In Class #7.1 materials and manufacturing labour variances, solving unknowns All given items are designated by an asterisk. Manufacturing Labour Actual Costs Incurred (Actual Input Qty. Actual Price) (1,900 $21) $39,900 Actual Input Qty. Budgeted Price (1,900 $20*) $38,000 Flexible Budget (Budgeted Input Qty. Allowed for Actual Output Budgeted Price) (4,000* 0.5* $20*) $40,000 $1,900 U* $2,000 F* Price variance Efficiency variance Purchases Usage (13,000 $5.25) (13,000 $5*) (12,500 $5*) (4,000* 3* $5*) Materials $68,250* $65,000 $62,500 $60,000 $3,250 U* $2,500 U* Price variance Efficiency variance 2. Flexible budget Efficiency variance = $40,000 $2,000 = $38,000 Actual DMLH = $38,000 Budgeted price of $20/hour = 1,900 hours 3. $38,000 + Price variance, $1,900 = $39,900, the actual direct manuf. labour cost Actual rate = Actual cost Actual hours = $39,900 1,900 hours = $21/hour 4. Standard qty. of direct materials = 4,000 units 3 kg/unit = 12,000 kg 5. Flexible budget + Dir. matls. effcy. var. = $60,000 + $2,500 = $62,500 Actual quantity of dir. matls. used = $62,500 Budgeted price per kg = $62,500 $5/lb = 12,500 kg 6. Actual cost of direct materials, $68,250 Price variance, $3,250 = $65,000 Actual qty. of direct materials purchased = $65,000 Budgeted price, $5/kg = 13,000 kg 7. Actual direct materials price = $68,250 13,000 kg = $5.25 per kg

2 In Class #7.2 -materials variances, long-term agreement with supplier Required 1 Assume that Metalmoulder s standard materials input per machining system is 198 kilograms of metal. Compute the direct materials price variance and direct materials efficiency variance for each month of the January to May 2013 period. Month (1) January February March April May Total Actual Materials Usage in Dollars (2) $290, , , , ,128 Average Actual Materials Purchase Price per Kilogram of Metal (3) $ Total Actual Quantity of Materials in Kilograms (4) = (2) ( 3) 2,020 2,388 3,510 3,088 2,112 Number of Machining Systems Produced (5) Actual Materials Input in Kilograms per Machining System (6) = (4) (5) Materials Price Variance Actual Costs Incurred: Actual Input Month Actual Price (1) (2) January $290,880 February 343,872 March 530,712 April 474,317 May 304,128 Actual Input (3) 2,020 2,388 3,510 3,088 2,112 Budgeted Price per Unit of Input (4) $ Actual Input Budgeted Price (5) = (3) (4) $290, , , , ,128 Materials Price Variance (6) = (2) (5) $ ,272 U 29,645 U 0 Materials Efficiency Variance Month (1) January February March April May Actual Input Budgeted Price (2) $290, , , , ,128 Budgeted Input per Unit of Output (3) Actual Output Achieved (4) Budgeted Price per Unit of Input (5) $ Flexible Budget (Budgeted Input Allowed for Actual Output Achieved Budgeted Price) (6) = (3) (4) (5) $285, , 513, , ,632 Materials Efficiency Variance (7) = (2) (6) $ 5,760 U 1,728 U 7,776 F 11,520 F 9,504 F

3 Required 2 How does the signing of a long-term agreement with a supplier an agreement that includes a fixed-purchase-price clause-affect the interpretation of a materials price variance? The unfavourable materials price variances in March and April imply that Metalmoulder paid more than $ per kilogram above the 2,400 kilogram contract amount. Month (1) March April Total Actual Costs Incurred (2) $530, ,317 Contract Amount for 2,400 kg: 2,400 $ (3) $345, ,600 Cost for Purchases Above 2,400 kg (4) = (2) (3) $185, ,717 Quantity of Purchases Above 2,400 kg (5) 1, Actual Price per Kilogram of Purchases Above 2,400 kg (6) = (4) (5) $ The percentage price increases for the additional purchases above 2,400 kilograms are: Actual Price Standard Price % Increase March $ $ 15.8 April With a long-term agreement that has a fixed purchase-price clause for a set minimum quantity, no price variance will arise when the purchase amount is below the minimum quantity (assuming the budgeted price per unit is the contract price per unit). A price variance will occur only when the purchased amount exceeds the set minimum quantity. A price variance signals that the purchased amount exceeds this set minimum quantity (2,400 kilograms per month). It is likely that the supplier will charge a higher price (above $) for purchases above the 2,400 base. If a lower price were charged, the purchaser might apply pressure to renegotiate the contract purchase price for the base amount. If the purchasing officer is able to negotiate only a small price increase for additional purchases above the base amount, the purchasing performance may well be favourable despite the materials price variance being labelled unfavourable. Metalmoulder may see the advantage of a long-term contract in factors other than purchase price (for example, a higher quality of materials, a lower required level of inventories because of more frequent deliveries, and a guaranteed availability of materials). In general, the existence of a long-term agreement reduces the importance of materials price variances when evaluating the month-to-month performance of a purchasing officer.

4 In Class #7.3 materials rate, efficiency, mix and yield variances Required 1 Calculate the total direct materials price and efficiency variances for November Solution Exhibit 7-3A presents the total rate variance ($3,100F), the total efficiency variance ($2,760U), and the total flexible-budget variance ($340F). Total direct materials rate variance can also be computed as: materials Actual Budgeted Actual price variance Price Price Inpu ts for each input Tolman = ($0.30 $0.32) 62,000 = $1,240 F Golden Delicious = ($0.28 $0.28) 155,000 = 0 Ribston = ($0.22 $0.24) 93,000 = 1,860 F Total direct materials rate variance $3,100 F Total direct materials efficiency variance can also be computed as: materials Actual Budgeted inputs allowed Budgeted efficiency variance Inputs for actual outputs achieved Prices for each input Tolman = (62,000 45,000) $0.32 = 5,440 U Golden Delicious = (155, ,000) $0.28 = 7,000 F Ribston = (93,000 75,000) $0.24 = 4,320 U Total direct materials efficiency variance $2,760 U SOLUTION EXHIBIT 7-3A Columnar Presentation of Materials Price and Efficiency Variances for Greenwood Inc. for November 2013 Flexible Budget: Actual Costs (Budgeted Inputs Incurred Allowed for Actual (Actual Inputs Actual Input Outputs Achieved Actual Prices) Budgeted Prices Budgeted Prices) (1) (2) (3) Tolman 62,000 $0.30 = $18,600 62,000 $0.32 = $19,840 45,000 $0.32 = $14,400 Golden Delicious155,000 $0.28 = 43, ,000 $0.28 = 43, ,000 $0.28 = 50,400 Ribston 93,000 $0.22 = 20,460 93,000 $0.24 = 22,320 75,000 $0.24 = 18,000 $82,460 $85,560 $82,800 $3,100 F $2,760 U Total rate variance Total efficiency variance $340 F Total flexible-budget variance F = favourable effect on operating income; U = unfavourable effect on operating income

5 Required 2 Calculate the total direct materials mix and yield variances for November Solution Exhibit 7-3B presents the total direct materials yield and mix variances for Greenwood Inc. for November The total direct materials yield variance can also be computed as the sum of the direct materials yield variances for each input: Budgeted total Actu al total qu antity of all Budgeted materials direct qu antity of all d irect m aterials yield variance materials direct materials inputs allowed for for each input mix inputs used actual output input p ercentage achieved Budgeted price of direct materials inp u ts Tolman = (310, ,000) 0.15 $0.32 = 10, $0.32 = $ 480 U Golden Delicious = (310, ,000) 0.60 $0.28 = 10, $0.28 = 1,680 U Ribston = (310, ,000) 0.25 $0.24 = 10, $0.24 = 600 U Total direct materials yield variance $2,760 U The total direct materials mix variance can also be computed as the sum of the direct materials mix variances for each input: Bu d geted Actu al total Actu al m aterials d irect qu antity of direct materials m ix variance m aterials all d irect input mix for each input mix materials percentage inpu t percentage inpu ts u se d Budgeted price of direct materials inpu ts Tolman = ( ) 310,000 $0.32 = ,000 $0.32 = $4,960 U Golden Delicious = ( ) 310,000 x $0.28 = ,000 $0.28 = 8,680 F Ribston = ( ) 310,000 $0.24 = ,000 $0.24 = 3,720 U Total direct materials mix variance = $ 0 U Required 3 Comment on your results in requirements 1 and 2. Greenwood paid less for Tolman and Ribston apples and, so, had a favourable direct materials rate variance of $3,100. It also had an unfavourable efficiency variance of $2,760. Greenwood would need to evaluate if these were unrelated events or if the lower price resulted from the purchase of apples of poorer quality that affected efficiency. The net effect in this case from a cost standpoint was favourable the savings in price being greater than the loss in efficiency. Of course, if the apple jelly and applesauce are of poorer quality, Greenwood must also evaluate the potential effects on current and future revenues that have not been considered in the variances described in requirements 1 and 2.

6 The unfavourable efficiency variance is entirely attributable to an unfavourable yield. The actual mix does deviate from the budgeted mix but at the budgeted prices; the greater quantity of Tolman and Ribston apples used in the actual mix exactly offsets the fewer Golden Delicious apples used. Again, management should evaluate the reasons for the unfavourable yield variance. Is it due to poor quality Tolman and Ribston apples (recall from requirement 1 that these apples were acquired at a price lower than the standard price)? Is it due to the change in mix (recall that the mix used is different from the budgeted mix, even though the mix variance is $0)? Isolating the reasons can lead management to take the necessary corrective actions. SOLUTION EXHIBIT 7-3B Columnar Presentation of Materials, Yield, and Mix Variances for Greenwood Inc. for November 2013 Flexible Budget: Budgeted Total Quantity of Actual Total Quantity Actual Total Quantity All Inputs Allowed for of All Inputs Used of All Inputs Used Actual Output Achieved Actual Input Mix Budgeted Input Mix Budgeted Input Mix Budgeted Prices Budgeted Prices Budgeted Prices (1) (2) (3) Tolman 310, a $0.32 = $19,840310, d $0.32 = $14, , d $0.32 = $14,400 Golden Delicious 310, b $0.28 = 43, , e $0.28 = 52, ,000 Ribston 310, c $0.24 = 22, , f $0.24 = 18, ,000 $85,560 $85,560 $82,800 0 $2,760 U Total mix variance $2,760 U Total efficiency variance Total yield variance F = favourable effect on operating income; U = unfavourable effect on operating income a 62, ,000 b 155, ,000 c 93, ,000 d 45, ,000 e 180, ,000 f 75, ,000

7 In Class #7.4 Comprehensive variance analysis Required 1: Compute the following variances: a. Selling-price variance Actual selling price = $4,266, ,000 kg = $9.48 Budgeting selling price = $3,840, ,000 kg = $9.60 Selling-price variance = Actual selling price Budgeted selling price = ($9.48 $9.60) 450,000 kg = $54,000 U Actual units sold b. Material-price variance Price = Actual Price variance Of Input - Budgeted Price Of Input X Actual Quantity of Input Cookie mix = (111,360 / 290,000) = = ( ) x 290,000 = 0 x 290,000 = 0 Milk Chocolate = (621,005 / 161,720) = 3.84 = ( ) x 161,720 = 155,251.2 U Almonds = (285,000 / 29,688) = 9.60 = ( ) x 29,688 = 0 c. Material efficiency variance Efficiency variance = Actual Quantity Of Input Used - Budgeted Quantity of Input Allowed for Actual Output X Budgeted Price of Input Cookie mix = (290,000 [0.625 x 450,000]) x = (290, ,250) x = 3,360 U Milk Chocolate = (161,720 [ x 450,000]) x 2.88 = (161, ,625) x 2.88 = 60,754 U Almonds = (29,688 [ x 450,000]) x 9.60 = (29,688 28,125) x 9.60 = 15,005 U

8 d. Labour price variance Price = Actual Price variance Of Input - Budgeted Price Of Input X Actual Quantity of Input Mixing = (129,600 / 450,000) = = ( ) x 290,000 = 0 x 290,000 = 0 Baking = (288,000 / 800,000) = 3.84 = ( ) x 161,720 = 155,251.2 U e. Labour efficiency variance Efficiency variance = Actual Quantity Of Input Used - Budgeted Quantity of Input Allowed for Actual Output X Budgeted Price of Input Alternate solution information: The actual and budgeted unit costs are: Actual Budgeted materials Cookie mix $0.384 $0.384 Milk chocolate $3.84 $2.88 Almonds $9.60 $9.60 labour Mixing $17.28 $17.28 Baking $21.60 $21.60 The actual output achieved is 450,000 kilograms of chocolate nut supreme. $129,600 (450, minutes) = $17.28 $288,000 (800, minutes) = $21.60

9 The direct cost price and efficiency variances are: Flex. Budget Actual Costs (Budgeted Input Incurred Actual Allowed for (Actual Input Input Actual Output Actual Price Budgeted Efficiency Achieved Price) Variance Prices Variance Budgeted Price) (1) (2)=(1) (3) (3) (4)=(3) (5) (5) materials Cookie mix $ 111,360 $ 0 $111,360 a $ 3,360 U $108,000 h Milk chocolate $ 621, ,251 U 465,754 b 60,754 U 405,000 i Almonds $ 285, ,000 c 15,000 U 270,000 j $1,017,365 $155,251 U $862,114 $79,114 U $783,000 labour costs Mixing $129,600 $ 0 $129,600 d $ 0 $129,600 k Baking $288, ,000 e 36,000 F 324,000 l $417,600 $ 0 $417,600 $36,000 F $453,600 a $ ,000 kg = $111,360 b $ ,720 kg = $465,754 c $ ,688 kg = $285,000 d $17.28 (450,000 60) = $129,600 e $21.60 (800,000 60) = $288,000 h $0.384/kg 281,250* kg = $108,000 i $2.88/kg 140,625* kg = $405,000 j $9.60/kg 28,125* kg = $270,000 k $17.28 (1/60) 450,000 = $129,600 l $21.60 (2/60) 450,000 = $324,000 kg total *Cookie mix: kg mix 450,000 kg total = 281,250 kg Milk chocolate: kg choc. kg total 450,000 kg total = 140,625 kg Almonds: kg almonds kg total 450,000 kg total = 28,125 kg

10 Required 2: What explanations might exist for the variances in requirement 1? (a) Selling price variance. This may arise from a proactive decision to reduce price to expand market share or from a reaction to a price reduction by a competitor. It could also arise from unplanned price discounting by salespeople. (b) Material price variance. The $0.96 increase in the price per kilogram of milk chocolate could arise from uncontrollable market factors or from poor contract negotiations by Aunt Molly s. (c) Material efficiency variance. For all three material inputs, usage is greater than budgeted. Possible reasons include lower quality inputs, use of lower quality workers, and the mixing and baking equipment not being maintained in a fully operational mode. (d) Labour price variance. The zero variance is consistent with workers being on long-term contracts that are not renegotiated on a month-by-month basis. (e) Labour efficiency variance. The favourable efficiency variance for baking could be due to workers eliminating non-valued-added steps in production.

11 In Class #7.5 Price and efficiency variances, problems in standard-setting, benchmarking Required 1 Compute the price and efficiency variances of New Fashions for direct materials and direct manufacturing labour in June Budgeted direct materials input per shirt = 600 rolls 6,000 shirts = 0.10 roll of cloth Budgeted direct manufacturing labour-hours per shirt = 1,500 hours 6,000 shirts = 0.25 hours Budgeted direct materials cost = $30, = $50 per roll Budgeted direct manufacturing labour cost per hour = $27,000 1,500 = $18 per hour Actual output achieved = 6,732 shirts Flexible Budget Actual Costs (Budgeted Input Incurred Qty. Allowed for (Actual Input Qty. Actual Input Qty. Actual Output Actual Price) Budgeted Price Budgeted Price) (612 $50) (6, $50) Materials $30,294 $30,600 $33,660 $306 F $3,060 F Price variance Efficiency variance Manufacturing (1,530 $18) (6, $18) Labour $27,693 $27,540 $30,294 $153 U $2,754 F Price variance Efficiency variance Required 2 Describe the types of actions the employees at New Fashions may have taken to reduce the accuracy of the standards set by the independent consultant. Why would employees take those actions? Is this behaviour ethical? Actions employees may have taken include: (a) Adding steps that are not necessary in working on a shirt. (b) Taking more time on each step than is necessary. (c) Creating problem situations so that the budgeted amount of average downtime will be overstated. (d) Creating defects in shirts so that the budgeted amount of average rework will be overstated.

12 Employees may take these actions for several possible reasons. (a) They may be paid on a piece-rate basis with incentives for production levels above budget. (b) They may want to create a relaxed work atmosphere, and a less demanding standard can reduce stress. (c) They have a them vs. us mentality rather than a partnership perspective. (d) They may want to gain all the benefits that ensue from superior performance (job security, wage rate increases) without putting in the extra effort required. This behaviour is unethical if it is deliberately designed to undermine the credibility of the standards used at New Fashions. Required 3 If Jorgenson does nothing about standard costs, his behaviour will violate a number of standards of ethical conduct for practitioners of management accounting. In particular, he would violate the (a) standards of competence, by not performing professional duties in accordance with relevant standards; (b) standards of integrity, by passively subverting the attainment of the organization s objective to control costs; and (c) standards of credibility, by not communicating information fairly and not disclosing all relevant cost information. Required 4 Jorgenson should discuss the situation with Fenton and point out that the standards are lax and that this practice is unethical. If Fenton does not agree to change, Jorgenson should escalate the issue up the hierarchy in order to effect change. If organizational change is not forthcoming, Jorgenson should be prepared to resign rather than compromise his professional ethics. Required 5 Main pros of using Benchmarking Clearing House information to compute variances are: (a) Highlights to New Fashions in a direct way how it may or may not be cost-competitive. (b) Provides a reality check to many internal positions about efficiency or effectiveness. Main cons are: (a) (b) (c) New Fashions may not be comparable to companies in the database. Cost data about other companies may not be reliable. Cost of Benchmarking Clearing House reports.