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# Causes of Material Price Variance

 ✅ Paper Type: Free Essay ✅ Subject: Economics ✅ Wordcount: 2899 words ✅ Published: 29th Jun 2017

(A) Question data:

Direct Materials (All materials purchased were used.)

Standard quantity: 450 rolls of telephone wire

Standard cost \$4.00 per pound.

Total actual cost: \$9,600.

Standard cost allowed for units produced was \$9,000.

Materials efficiency variance: \$80 unfavorable.

Direct Manufacturing Labor

Standard cost is 3 hours per roll at \$8.00 per hour.

Actual cost per hour: \$8.25.

Labor efficiency variance: \$400 unfavorable.

## Solution:

Standard cost per roll = \$9,000/450 rolls

= \$20.00 per roll

Standard number of pound per roll = \$20.00 per roll/ \$4.00 per pound = 5.0 pounds per roll

Total Standard number of pound = 5.0 pounds per roll 450 rolls = 2,250 pounds

Actual pounds = (\$80 unfavorable/ \$4.00 per pound) + 2,250 pounds = 2,270 pounds

Materials price variance = (AP AQ) – ( SP AQ)

= \$9,600 – (\$4 2,270 pounds)

= \$520 unfavorable

Total standard labor cost of actual hours = 3 hours per roll450 rolls\$8.00per hour +\$400

unfavorable

= \$11,200

Actual hours = \$11,200/\$8.00 per hour = 1,400 hours

Total actual costs = 1,400 hours \$8.25 per hour = \$11,550

Labor price variance = Total actual costs – Total standard labor cost of actual hours

= \$11,550 – \$11,200 = \$350 unfavorable

## Possible causes for unfavorable direct material price variance:

• Lungren’s purchasing manager negotiated the direct materials prices unsuccessfully as expected in the budget.
• The purchasing manager changed to a higher-price supplier.
• Lungren’s purchasing manager bought smaller quantities than planed that resulted in a less discount than expected.
• Direct material prices rose unexpectedly due to industry undersupply, unexpected inflationary pressures, or an unexpected change in specification by production.
• Budgeted purchase prices of direct materials were set too low without thorough analysis of market condition, or could be outdated.
• The purchasing manager received unfavorable prices because he was willing to accept unfavorable terms on factor other than prices (such as higher quality material)
• Production requires a rush order (in which case the production manager may be responsible for unfavorable direct material variance).

## Possible causes for unfavorable direct labor price variance:

• A higher skilled worker with a higher labor pay rate is assigned to a job that requires a worker with a lower skill rate.
• Overtime production requirement.
• Inefficient mix of employees than that anticipated when the standards were set.

## The favorable direct material efficiency variance may be due to following reasons:

• Fewer materials than the standard quantity was used in the production process.
• More efficient worker and supervisor practices.
• Higher quality of materials purchased.
• The purchase of more efficient machinery during period.

## The unfavorable direct labor efficiency variance may be due to following reasons:

• Personnel manager hired underskilled workers.
• Production scheduler inefficiently scheduled work, leading to more manufacturing labor time than planned being used
• Maintenance department did not properly maintain machines.
• Insufficient demand or machine breakdowns, resulting in idle time.
• Budgeted time standards were set too tight without comprehensive analysis of the operating conditions and the workers’ skill.
• Workers were poorly trained, supervised, and motivated.

## Question data:

Deluxe Standard

Sales units 50,000 400,000

Sales price per unit \$650.00 \$475.00

Direct material and labor costs per unit \$180.00 \$130.00

Manufacturing support costs per unit \$80.00 \$120.00

Assignment basis for support costs: direct labor dollars

ABC information for 2009:

## Activity Cost Driver Cost Total Deluxe Standard

Setups of setups \$ 500,000 500 400 100

Machine-related of machine hours \$44,000,000 600,000 300,000 300,000

Packing of shipments \$ 5,000,000 250,000 50,000 200,000

## Solution:

1. Currently estimated deluxe-entry door total cost per unit = \$180.00 + \$80.00 = \$260.00

Currently estimated standard-entry door total cost per unit = \$130.00 + \$120.00 = \$250.00

2. Currently estimated deluxe-entry door profit per unit = \$650.00 – \$260.00 = \$390.00

Currently estimated standard -entry door profit per unit = \$475.00 – \$250.00 = \$225.00

Since assignment basis for support costs has been direct labor dollars while the deluxe door is manufactured using the new robotic systems, it appears that less direct material labor is required to manufacture each unit in deluxe product line.

Purchasing an expensive robotics system probably leads to the high machine related costs. The deluxe line uses 6 machine hours per unit (300,000 MH/ 50,000 units), while the standard line uses 0.75 machine hours per unit (300,000 MH/ 400,000 units); hence, total machining hours for the deluxe doors are the same as for the standard doors.

Setups activity = \$500,000/500 setups = \$1,000/ setups

Machine-related = \$44,000,000/600,000 machine hours = \$73.33/machine hours

Packing = \$5,000,000/ 250,000 shipments = \$20/ shipments

d2. The revised manufacturing overhead cost per unit for each type of entry door:

Deluxe-entry door = [(400 \$1,000) + (300,000 \$73.33) + (50,000 \$20)]/ 50,000 units

= \$467.98 per unit

Standard-entry door = [(100 \$1,000) + (300,000 \$73.33) + (200,000 \$20)]/ 400,000 units

= \$65.25 per unit

d3. The revised total cost per unit for each type of entry door:

Deluxe-entry door = \$180.00 + \$467.98 = \$647.98

Standard-entry door = \$130.00 + \$65.25 = \$195.25

e. No, the deluxe door is not as profitable as the original data estimated because the deluxe door requires a disproportionate share of the overhead activities (the robotic system); hence, more of the overhead costs are assigned to the deluxe door when using an ABC system.

Revised deluxe-entry door profit per unit = \$650.00 – \$647.98 = \$2.02

Revised standard -entry door profit per unit = \$475.00 – \$195.25= \$279.75

As such, for deluxe-entry door, currently estimated profit per unit is \$390.00 while revised profit per unit is \$2.02

For standard-entry door, currently estimated profit per unit is \$225.00 while revised profit per unit is \$279.75

The sales mix strategy need to consider the current and future market demands for the two types of entry doors. Other considerations comprise the capacity-related restriction of the robotics system, other equipment, and the facilities. The fact that the customers may be willing to pay more for the deluxe doors should be taken into consideration when assessing the profitability of each product line. Costs do not drive a sale mix strategy.

## Data Input:

Physical Units

Direct Materials

Conversion Costs

Direct labor

Beginning work in process (units):

20,000

\$12,000

\$4,000

\$20,000

Units started (units):

40,000

Units completed (units):

50,000

Ending work in process (units):

8,000

Spoilage (units):

2,000

\$60,000

Degree of completion of beginning work in process

100%

50%

Degree of completion of ending work in process

100%

60%

Degree of completion of normal spoilage

100%

100%

Factory overhead = 50% * Direct Labor Cost

All spoilage is normal

## Production Cost Report UsingWeighted Average method:

Conversion cost = Factory Overhead Cost + Direct Labor Cost = 50% Direct Labor + Direct Labor

= 1.5 Direct Labor.

## Conversion Costs

Units to be accounted for:

## Â

Beginning WIP inventory

20,000

Units started this period

40,000

## 60,000

Good units completed and transferred out during current period

50,000

50,000

50,000

Normal spoilage

2,000

2,000

2,000

In ending WIP inventory

8,000

8,000

4,800

## Conversion Costs

Costs to be accounted for:

## Â

Costs in beginning WIP inventory

\$ 16,000

\$ 12,000

\$ 4,000

90,000

60,000

30,000

## \$ 34,000

Costs incurred to date

\$ 72,000

\$ 34,000

Divided by equivalent units of work done to date

60,000

56,800

## \$ 0.60

Assignment of costs:

Goods units completed and transferred out

\$ 89,930

\$ 60,000

\$ 29,930

Normal spoilage

\$ 3,597

\$ 2,400

\$ 1,197

Total costs of good units completed and transferred out

\$ 93,527

\$ 62,400

\$ 31,127

Costs of ending WIP inventory

12,473

9,600

2,873

## Question 3(B)

Spoilage is unacceptable units of production that are disposed or are sold at decreased prices. Both partially completed or fully completed units of output can be spoiled.

Rework units are defective production outputs that are afterward repaired and sold as good finished products. Defective units of product detected during production or immediately after production but before units are shipped to customers, can sometimes be reworked and sold as good products.

Scrap is material leftover when manufacturing a product. It has lower sales value than sales value of the product. Scrap may be either sold, disposed, or reused in another job or processing run.

The problems associated with these items include: 1. The company pays for the total raw material not just the part converted into salable goods. 2. The cost of disposing of these unsalable or leftover items, both the disposal costs and the costs as well as difficulties related to looking for a landfill site or other disposal site. 3. These discarded of or unused items can make environmentalists unpleasant, and angry. 4. Developing high-value added products that can be produced from these various items.

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The methods your company can use to reduce these items comprise: 1. calculating the costs of these problems. An accurate measurement of the total costs should certainly give an enticement to the firm to look into possible actions. 2. Finding methods of redesigning the production, redesigning the production process to diminish these costs. 3. Investing in more sophisticated capital equipment that can be designed to minimize these costs.

Question 4(A) Methods which may be used to allocate support costs within organizations containing multiple support departments:

The direct method, which is the most widely used allocation method, allocates each support department’s costs directly to the operating departments, ignoring services provided to other support departments. As such, no interaction between Support Departments before allocation.

## Procedure:Â

Ignore services among support departments.

Allocate support department costs only to operating departments.

Advantages:Â Â  Simple to compute, control, and understand.

If the operating departments are not vigilant, support departments could overserve each other and pass the costs to the operating departments in the form of higher cost allocations.

Allocations are inaccurate estimates of operating departments’ costs when support departments use other support departments.

Incentives exist for support departments to make excessive use of other support departments.

Step-Down Method, also widely used, allocates support costs to other support departments and to operating departments that partially recognizes the mutual services provided among all support departments. One-way interaction between Support Departments before allocation.

## Procedure:

Start with one support department and allocate all of its costs to the remaining support and operating departments.

Continue one-by-one through each support department allocating all direct costs of that department and costs allocated to it. Once a support department’s costs have been allocated, no subsequent support department costs are allocated back to it.Â

A popular way of choosing the order of allocation is to begin with the support department that renders the highest percentage of its total services to other support department. The sequence continues with the department that renders the next-highest percentage, and so on, ending with the support department that renders the lowest percentage.

Simple to compute and understand.

Takes some of the interdependence of support departments into concern.

Resulting allocations are inaccurate estimates of opportunity costs.

Allocation less than opportunity cost for first department.

Allocation more than opportunity cost for last department.

The reciprocal method allocates support department costs to operating departments by fully recognizing the mutual services provided among all support departments. Full two-way interaction between Support Departments prior to allocation.

## Procedure:

Write equations defining variable cost relationships among divisions.

Solve system of simultaneous equations with linear algebra.

Allocate the complete reciprocal costs of Each Support Department to all Other Departments.

Most accurate method (best approximates opportunity costs, due to recognizing all the interactions and is thus the most accurate.)

Especially clear from looking at the repeated iterations calculations.

Highlights the complete reciprocated costs of support departments and how these costs differ from budgeted or actual costs of the departments and how these costs differ from budgeted or actual costs of the departments.

Harder to establish and calculate solution.

Hard to clarify outcomes to unsophisticated managers.

Obstructs managers in “managing” cost allocations for financial reporting and/or taxes.

## The cause of Jonathan’s reported decrease in earnings:

Since costs allocation is based on actual sales, administrative cost of store is calculated as follows: Administrative cost of store = total administrative cost (actual sales of store / total sales). As such, when the actual sales of Jonathan’ store has grown while most of other stores have had low sales, actual sales of his store takes a large proportion of total sales. As a result, more of administrative corporate costs are assigned to his store. The increase in costs may greater than the increase in sales revenue; hence, although his store has generated steady growth in sales, earnings have been declined.

## Alternative 1: Employing Budgeted performance.

Depending on real situation of each store, the firm can provide budgeted sales for each store. When actual performance are used for cost allocation, the firm will not know the rates to be used until the end of budgeted period, whereas when budgeted sales are the allocation base, the firm will know with certainty their allocated costs in advance. Regardless of actual sales, the corporate administrative costs allocations are the same with its budgeted cost.

## Alternative 2: Applying the techniques of Activity-based costing (ABC) which is an effective way to generate accurate cost – allocation bases.

The company can allocate cost based on activity based costing to reflect more exactly the company’s resources. Procedure of ABC approach is as follows: The first step was to define activities. Once administrative costs were captured by activity, the next step was to drive activity costs to goods or services using activity drivers.

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