Question

“It certainly is nice to see that small variance on the income statement after all the trouble we have had lately in controlling the manufacturing costs,” said Maznah Hashim, Vice President of Hikmah Enterprise. “The RM12,250 overall manufacturing variance reported last period is well below the 3 per cent limit we have set for variances. We need to congratulate everybody on the job well done.” Hikmah enterprise produces and sells a single product. The standard cost card for the product follows: Standard Cost Card – Per unit Direct materials, 4 meters at RM 3.50 per meter RM14.00 Direct labour, 1.5 direct labour hours at RM 12.00 per DLH RM18.00 Variable overhead, 1.5 direct labour hours at RM 2.00 per DLH RM3.00 The following additional information is available for the year just completed: a. The company manufactured 20,000 units of product during the year. b. A total of 78,000 meters of material was purchased during the year at a cost of RM 3.75 per yard. All of this material was used to manufacture the 20,000 units. There was no beginning or ending inventories for the year. c. The company worked 32,500 direct labour-hours during the year at a cost of RM 11.80 per hour. d. Overhead is applied to products on the basis of standard direct labour hours. Data relating to manufacturing overhead costs are as follows: Budgeted direct labour hours (DLH) 25,000 DLH Actual variable overhead costs RM 68,250 Required: a. Compute the following variances i. Direct materials price and quantity variance for the year (4 marks) ii. Direct labour rate and efficiency variances for the year (3 marks) iii. The variable overhead rate and efficiency variances for the year (3 marks) Indicate whether each variance is favourable or unfavourable. Show all relevant computations. b. Discuss the possible causes for each of the variances that you calculated under requirement (a) Also, consider possible interactions between variances. (6 marks) c. Explain FOUR factors that should be considered in determining whether or not to investigate a variance. (4 marks) Answer the b part only

Answer 1

The direct material price variance is adverse or Negative or unfavorable the following may be the reasons for the same.

1. The Rise in market prices as a whole. Where we could not get the materials at the budgeted prices.

2. If the material purchased is of higher quality than what is required to produce results in excess prices

3. The inefficiency of procurement staff to negotiate.

The Direct Material Quantity Variance -Favourable

The favorable value represents the production departments efficiency in Handling the product and its usage in production at the optimum levels. Not using the adequate quantity also results in quality-related issues of the final product and it depends on the items.

Labour Rate Variance -Favorable

1. The employment of more un-skilled or semi-skilled labor (this may adversely impact labor efficiency variance)

2. Decrease in the overall wage rates in the market due to an increase in the supply of labor which may be caused, for example, due to the influx of immigrants as a result of the relaxation of immigration policy

3. The inappropriately high setting of the standard cost of direct labor which may, in the hindsight, be attributed to inaccurate planning

Labour Efficiency variance -Unfavourable

1. The hiring of unskilled labor

2. The learning curve is lower than the standard

3. This may also include labor idle time variance i.e non-productive hours due to machine repairs etc

Variable overhead efficiency variance -Unfavourable

1. Use of a cheaper raw material which is difficult to work with this can be linked with an adverse material usage variance and a favorable material price variance

2. production inefficiency caused by the employment of lower-skilled labor (this shall be evident in an adverse direct labor efficiency variance and probably a favorable labor rate variance)

3. Decline in the productivity of manufacturing equipment due to for example technical problems or wear and tear

4. Planning error (e.g. over calculating the impact of learning curve effect on the manufacturing efficiency)

VOH Rate variance -Unfavourable

1. Account misclassification. The variable overhead category includes a number of accounts, some of which may have been incorrectly classified and so do not appear as part of variable overhead (or vice versa).

2. Outsourcing. Some activities that had been sourced in-house have now been shifted to a supplier or vice versa.

3. Supplier pricing. Suppliers have changed their prices, which have not yet been reflected in updated standards

The linking between the variances are already mentioned in some of the points.

If the direct labor is inefficient at producing a good output, there will be an unfavorable labor efficiency variance. That inefficiency will likely cause additional variable manufacturing overhead—resulting in an unfavorable variable manufacturing overhead efficiency variance. If these inefficiencies are significant, it is possible that the company may not be able to produce enough good output to absorb the planned fixed manufacturing overhead—resulting in an unfavorable fixed manufacturing overhead volume variance.