Question

One of the variable production costs is the cost of steel. The standards for steel purchase prices and usage as set at the beginning of 2016 were:

Standard price of steel $25.00 per pound

Standard quantity of steel per car 100 pounds per car

Data on actual steel purchases for 2016 were:

Actual cost of steel purchased and used $28,700,000

Actual pounds of steel purchased and used 1,210,000 pounds

Recall that budgeted production for the year was 10,000 cars, while actual production was 11,000.

1. At the end of the year a cash bonus of 5% of performance above expectations is split among the members of the relevant departments. Performance above expectations is defined in terms of impact on total profits. What was the impact of the production department’s production activities on the company’s overall profits? What was the impact of the purchasing department’s activities on the company’s overall profits? Which department if any will receive a bonus? What size will that bonus pool be?

2. Are there any caveats in the performance evaluation mechanism used in question 1?

Answer 1

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Direct Material Variance
Actual Price for Actual Quantity of Input		28,700,000.00	A
Standard Price for Actual Quantity of Input	1210000*25	30,250,000.00	B
Standard Price for Standard Quantity of Input	11000*100*25	27,500,000.00	C
Price Variance (A-B)		(1,550,000.00)	Favorable
Quantity/ Yield Variance (B-C)		2,750,000.00	Unfavorable
Total Variance (A-C)		1,200,000.00	Unfavorable
Ans 1- What was the impact of the production department’s production activities on the company’s overall profits?
Production activities create Quantity/ Yield Variance. Here the variance is unfavorable. Its impacting the company's overall profit by $ 2,750,000. The company's profit is reducing by $ 2,750,000.
Ans 1- What was the impact of the purchasing department’s activities on the company’s overall profits?
Purchase activities create Price Variance. Here the variance is Favorable. It means Purchase department has saved money their operations. The company's profit has increased by $ 1,550,000.
Ans 1- Which department if any will receive a bonus? What size will that bonus pool be?
Purchase department should receive the bonus.
Bonus amount should be 5% of $ 1,550,000.
Bonus amount	77,500.00
2. Are there any caveats in the performance evaluation mechanism used in question 1?
Yes. It may have happened that Purchase department has negotiated the price due to which poor quality of materials have been supplied by the vendors. This affected the yield of Production department. So management should look into this matter
and ensure that no such thing happened.