Post on 10-Apr-2018
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Accounting for Decision Making
Week 5 Lecture
(Seminar 6
Controlling the Plan )
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Main Topics: Feedback and feed forward control
systems
Fixed budget vs flexible budget Standard cost Variance analysis (i.e. sales price
variance, total overhead variance,material cost and labour costvariances)
Profit reconciliation statement
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Control Systems
FEEDBACK SYSTEMS Where actual performance is measuredagainst budget and corrective action is
taken after the event like a gas centralheating system or air conditioning.
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Control Systems
FEEDBACK SYSTEMS
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Control Systems
FEEDFORWARD SYSTEMS Where predictions are made of expected
outcomes and compared to budget rolling forecast . Action can be takenBEFORE the event occurs
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Performance Reporting System
Measure actual results with reasonable accuracy
Speed of issue and total accuracy
Identify variances (against plan) and the reasons for them
Provide non-financial information (critical success factors)as well as traditional accounting information
Distinguish between controllable and non-controllable
items (Responsibility Accounting)
Be prepared in such a way that there is no bias
Issued to everyone who needs to know.
For a performance reporting system to be effective,it must:
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Fixed BudgetA fixed budget is prepared at thebeginning of the budgeting period and is
valid for only the planned level of activity.
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Fixed BudgetFixed Budget
Units sold 12,000
Revenues @$120 $1,440,000
Variable costs
Direct materials @$60 x 12,000 720,000Direct Labor @$16 x 12,000 192,000
Production overhead * 144,000
Total variable costs 1,056,000
Contribution margin 384,000
Fixed costs 276,000
Profit $108,000
*overhead absorption rate @ $12 x 12,000
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Fixed-Budget Variance
- For planning and control, and for performanceevaluation, we are interested to study thevariances between the actual results and the
budgeted results.- A favorable variance - denoted F has theeffect of increasing profit relative to thebudgeted amount. An unfavorable variance -
denotedU
has the effect of decreasing profitrelative to the budgeted amount.
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ActualResults
Fixed-Budget
VarianceFixed
Budget
(1) (2) = (1) -(3) (3)
Units sold 10,000 2,000 U 12,000
Revenues $1,250,000 $190,000 U $1,440,000
Variable costs
Direct materials 621,600 98,400 F 720,000
Direct Labor 198,000 6,000 U 192,000
Production overhead 130,500 13,500 F 144,000
Total variable costs 950,100 105,900 F 1,056,000
Contribution margin 299,900 84,100 U 384,000Fixed costs 285,000 9,000 U 276,000
Profit $14,900 $93,100 U $108,000
$93,100 U
Fixed-budget variance
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A fixed budget is suitable for planning purposes,but it is inadequate for evaluating how costs arecontrolled.
If the actual activity during a period differs fromwhat was planned, it would be misleading tosimply compare actual costs to the fixed budget,as the actual costs are based on one level of
activity while the fixed budget costs are basedon a different level of activity.
If activity is higher than expected, variable costsshould be higher than expected; Otherwise, the
variable costs should be lower than expected.
What is wrong with a fixed budget?
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I dont think I can
answer the questionusing a fixed budget.
How much ofthe favorable cost
variance is due to loweractivity, and how much isdue to better cost control?
What is wrong with a fixed budget?
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A flexible budgetcalculates budgets revenuesand budgeted costs based on the actual
output level in the budget period.
The flexible budget is prepared at the end of aperiod after the actual output level is known.
Flexible Budget
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1.The budgeted selling price per unit is the sameone used in preparing the fixed budget.
2.The budgeted variable costs are the same perunit costs used in the fixed budget.
3.The budgeted fixed costs are the same fixedbudget amount (assuming the company is stillproducing within the relevant range).
Flexible Budget
In preparing the flexible budget:
The only difference between the fixed budget and theflexible budget is that the fixed budget is prepared forthe planned output, whereas the flexible budget is
based on the actual output.
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Flexible Budget FlexibleBudget
Units sold 10,000
Revenues @120 x 10,000 $1,200,000
Variable costs
Direct materials @60 x 10,000 600,000
Direct labor @$16 x 10,000 160,000
Production overhead @12 x 10,000 120,000
Total variable costs 880,000
Contribution margin 320,000
Fixed costs ( within the relevant range) 276,000
Profit $44,000
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Fixed versus Flexible BudgetsFixed Budgets
Used for planningpurposes.
Prepared at thebeginning of theperiod.
Based upon
projected level ofactivity.
Flexible Budgets
Used for controlpurposes.
Prepared at theend of the period.
Flexed toaccommodate
actual level ofactivity.
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ActualResults
FlexibleBudget
Variance
FlexibleBudget
SalesVolume
VarianceFixed
Budget
(1) (2)= (1) -(3) (3) (4)= (3) -(5) (5)
Units sold 10,000 0 10,000 2,000 U 12,000
Revenues $1,250,000 $50,000 F $1,200,000 $240,000 U $1,440,000
Variable costs
Direct materials 621,600 21,600 U 600,000 120,000 F 720,000
Direct Labor 198,000 38,000 U 160,000 32,000 F 192,000
Productionoverhead 130,500 10,500 U 120,000 24,000 F 144,000
Total variablecosts 950,100 70,100 U 880,000 176,000 F 1,056,000
Contributionmargin 299,900 20,100 U 320,000 64,000 U 384,000
Fixed costs 285,000 9,000 U 276,000 0 276,000
Profit $14,900 $29,100 U $44,000 $64,000 U $108,000
$93,100U
Fixed-budget variance
$29,100 UFlexible-budget variance
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ActualResults
Flexible-
BudgetVariance
FlexibleBudget
(1) (2) = (1) -(3) (3)
Units sold 10,000 0 10,000
Revenues $1,250,000 $50,000 F $1,200,000
Variable costs
Direct materials 621,600 21,600 U 600,000
Direct labor 198,000 38,000 U 160,000
Production overhead 130,500 10,500 U 120,000
Total variable costs 950,100 70,100U
880,000Contribution margin 299,900 20,100 U 320,000
Fixed costs 285,000 9,000 U 276,000
Profit $14,900 $29,100 U $44,000
Flexible-Budget Variance
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ActualResults
Flexible-
BudgetVariance
FlexibleBudget
(1) (2) = (1) -(3) (3)
Units sold 10,000 0 10,000
Revenues $1,250,000 $50,000 F $1,200,000
Variable costs
Direct materials 621,600 21,600 U 600,000
Direct labor 198,000 38,000 U 160,000
Production overhead 130,500 10,500 U 120,000
Total variable costs 950,100 70,100 U 880,000
Contribution margin 299,900 21,100 U 320,000
Fixed costs 285,000 9,000 U 276,000
Profit $14,900 $29,100 U $44,000
Flexible-Budget Variance
SALES PRICE VARIANCE:
The difference in sales value for the periodcaused by the actual selling price being different fromthe budgeted selling price
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ActualResults
Flexible-
BudgetVariance
FlexibleBudget
(1) (2) = (1) -(3) (3)
Units sold 10,000 0 10,000
Revenues $1,250,000 $50,000 F $1,200,000
Variable costs
Direct materials 621,600 21,600 U 600,000
Direct labor 198,000 38,000 U 160,000
Production overhead 130,500 10,500 U 120,000
Total variable costs 950,100 70,100 U 880,000
Contribution margin 299,900 20,100 U 320,000
Fixed costs 285,000 9,000 U 276,000
Profit $14,900 $29,100 U $44,000
Flexible-Budget Variance
TOTALOVERHEAD VARIANCE:
This compares the overhead absorbed with the actualoverhead expenditure. The resultant variance is theunder/over absorption of overheads for the period.
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The unfavourable total overhead variance could dueto one or more of the following:
Under estimation of the absorption rate (either by under
estimation of total production overhead or overestimation of the absorption base) Less actual total units of the absorption base were used
than the estimated.
Flexible-Budget Variance
Absorptionrate
xActual total units of the
absorption baseincurred during the
period
=Total production
overheadsabsorbed
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ActualResults
Flexible-
BudgetVariance
FlexibleBudget
(1) (2) = (1) -(3) (3)
Units sold 10,000 0 10,000
Revenues $1,250,000 $50,000 F $1,200,000
Variable costs
Direct materials 621,600 21,600 U 600,000
Direct labor 198,000 38,000 U 160,000
Production overhead 130,500 10,500 U 120,000
Total variable costs 950,100 70,100 U 880,000
Contribution margin 299,900 20,100 U 320,000
Fixed costs 285,000 9,000 U 276,000
Profit $14,900 $29,100 U $44,000
Flexible-Budget Variance
In the following lecture, we shall focus on theflexible-budget variances for direct materials,direct labor
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Flexible-Budget Variance
ActualResults
Flexible-Budget
VarianceFlexibleBudget
(1) (2) = (1) -(3) (3)
Variable costs
Direct materials 621,600 21,600 U 600,000
Direct labor 198,000 38,000 U 160,000
Production overhead 130,500 10,500 U 120,000
Total variable costs 950,100 70,100 U 880,000
What is wrong with the flexible-budget variance fordirect materials and direct labor?
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Flexible-Budget Variance
We have no way to tell if the unfavorable variance isdue to:
1. Inputs are purchased at prices that are too high,or
2. More input is used than is really necessary.
What is wrong with the flexible-budget variance fordirect materials and direct labor?
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I dont think I can
answer the question!
What is wrong with the flexible-budget variance for direct
materials and direct labor?
How much ofthe unfavorable variance isdue to higher input price,and how much is due to
more input us used?
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Standard Cost
Quantity Standards specify how much of an inputshould be used to make a product or provide aservice.
Price Standards specify how much should be paidfor each unit of input.
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Standard Cost
(i) (ii) (i) x (ii)
Inputs
Standard
QuantityPerOutput Unit
Standard
PricePer Input Unit
Standard
Costper Unit
Direct materials(square yard)
2.0 squareyards
$30 persquare yard $60
Direct labour
(laborhour) 0.8 labor hr
$20 per
labourhr $16Production overhead
(machine hour) 0.4 machine hr$30 per
machine hr $12
Total standard unit cost $88
Standard cost card for one unit of product:
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Setting Standard Cost The future period of time covered by the standard should
be determined Relate to prescribed working conditions and practices
and defined levels of activity and operating efficiency
The standard quantities of both direct material and labourshould be determined by scientific methods The standard prices for materials and rates of pay for
labour should be based on those anticipated in thestandard cost period
The psychological effect of setting standards should notbe too tough - they should be attainable, but with hardwork!
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Setting Direct Labour Standards
Quantity(Efficiency)Standards
( 0.8 labor hr)
Should includeallowances for breaks,
personal needs ofemployees, cleanup,
and machinedowntime.
Price(Rate)
Standards($20 / labor hr)
Should include notonly wages earned
but also fringebenefits and other
labour costs
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Standard Quantity Allowed for Actual Output
(i) (ii) (i) x (ii)
InputsStandardQuantity
ActualOutput
StandardQuantity allowed
foractual output
Direct materials 2.0 sq. yards 10,000 20,000 sq. yards
Direct labor 0.8 laborhr 10,000 8,000 labor hrs
What is the standard quantity allowed for eachvariable input for producing the actual output of10,000 units?
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Flexible-Budget Costs
(i) (ii) (i) x (ii)
Inputs
StandardQuantity allowed
foractual output
StandardPrice
Flexible-Budget
Cost
Direct materials 20,000 sq. yards $30 / sq. yards $600,000
Direct labor 8,000 laborhrs $20 / labor hr. $160,000
The flexible-budget costs for each variable input canalso be computed by multiplying the standard price bythe standard quantity allowed for actual output.
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Actual Costs
(i) (ii) (i) x (ii)
InputsActual
QuantityActualPrice
ActualCost
Direct materials 22,200 sq. yards $28 / sq. yards $621,600
Direct labor 9,000 laborhrs $22 / labor hr. $198,000
At the end of the month, the company obtained thefollowing actual costs information for their variableinputs:
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A General Model for Variance Analysis
Cost Variance
Price Variance(Rate Variance)
The difference betweenthe actual price and the
standard price
Quantity Variance(Usage Variance)
(Efficiency Variance)
The difference betweenthe actual quantity andthe standard quantity
allowed for actual output
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The component parts of the direct material and direct labourvariances:
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A General Model for Variance Analysis
Price Variance Quantity Variance
Actual Quantity Actual Quantity Standard QuantityAllowed forActual Output
Actual Price Standard Price Standard Price
AQ(AP - SP) SP(AQ - SQ)
- -
+
Flexible-Budget Variance
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Actual Quantity Actual Quantity Standard QuantityAllowed forActual Output
Actual Price Standard Price Standard Price
22,200 sq. ydsx
$28/sq. yd.
$621,600
22,200 sq. ydsx
$30/sq. yd.
$666,000
20,000 sq. ydsx
$30/sq. yd.
$600,000
$44,400 FPrice variance
$66,000 Uusage variance
$21,600 U
Materialcost varian
ce
Material Cost Variances
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Direct Materials Quantity VarianceThe unfavourable materials usage variance representsthe company actually used more quantity of directmaterials than what should have been used according tothe standard that has been set. This could due to one ormore of the following:
Personnel manager hired unskilled workers. Works were scheduled inefficiently. Poorly maintained machines.
Inferior quality of materials. Poor supervision Standard quantity was set too tight without careful analysis.
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Actual Quantity Actual Quantity Standard QuantityAllowed forActual Output
Actual Price Standard Price Standard Price
9,000 Labourhrs.x
$22/hr
$198,000
9,000 Labourhrsx
$20/hr
$180,000
8,000 Labourhrsx
$20/hr
$160,000
$18,000 URate variance
$20,000 UEfficiency variance
$38,000 UL
abourcost varian
ce
LabourCost Variance
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Labor Rate VarianceThe unfavorable direct labour rate variance representsthe company actually paid a higher average hourly labourrate than what should have been paid according to thestandard that has been set. This could due to one or
more of the following:
Poor negotiation skill with labour union. Employed more skilled workers. More overtime work at premium rates.
Tight labour market Standard rate was set too low without careful analysis.
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Labor Efficiency VarianceThe unfavorable direct labor efficiency variancerepresents the company actually used more direct labourtime than what should have been used according to thestandard that has been set. This could due to one or
more of the following:
Poorly trained or motivated workers. Poor quality materials, requiring more labour time in
processing.
Faulty equipment, causing breakdowns and workinterruptions.
Poor supervision of workers. Standard quantity was set too low without careful
analysis.
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Profit Reconciliation Statement
BUDGETEDCONTRIBUTION MARGIN $320,000
VARIANCES:
Sales price variance 50,000
Material price variance 44,400
Material usage variance (66,000) Labour rate variance (18,000)
Labour efficiency variance (20,000)
Total overhead variance (10,500)
TOTAL VARIANCES $20,100
ACTUALCONTRIBUTION MARGIN $299,900
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Glacier Peak Outfitters has the followingdirect material standard for the fiberfill in its
mountain jacket.0.1 kg. of fiberfill per jacket at $5.00 per kg.
Last month 210 kgs of fiberfill were
purchased and used to make 2,000 jackets.The material cost a total of $1,029.
Quick Check 1
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What is Glacier Peak Outfitters actual priceof fiberfill per kg?
What is the standard quantity of fiberfill thatshould have been used to produce 2,000jackets?
What is the materials price variance andusage variance?
Quick Check 1
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Hanson Inc. has the following direct laborstandard to manufacture one Zippy:
1.5 standard hours per Zippy at $6.00 perdirect laborhour
Last week 1,550 direct labor hours wereworked at a total labor cost of $9,610 tomake 1,000 Zippies.
Quick Check 2 Zippy
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What is Hansons actual rate for labour forthe week?
What is the standard hours of labour thatshould have been worked to produce 1,000Zippies?
What is the labour rate variance andefficiency variance?
Quick Check 2 Zippy
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SEMINAR 6
EXAMPLE
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Materials
12.50 kg of tubing @ 3.80 per kg 47.50
1 set of components 152.00 199.50
Labour
Frame Dept.2.00 hrs @ 6 per hr 12.00
Assembly Dept.1.25 hrs @ 10 per hr 12.50 24.50
Total Overheads8.
00
Total cost 232.00
Profit margin 58.00
Sales price 290.00
The standard cost card for producing one Crusader Mountain Bikeshows the following information:
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During the month of May, 4,000 cycles were sold and the actual resultswere as follows:
Sales (4,000 cycles) 1,192,000
Costs
54,000kg of tubing 175,500
4,000 component sets 620,000
7,600 Framing department hours 49,400
4,800 Assembly department hours 49,200
Overheads 30,500 924,600
Profit 267,400
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Material Cost Variance:
Tubing
Components
Act QtyX
Act price
175,500
620,000
Act QtyX
Std price
54,000
X3.8
205,200
4,000X
152
608,000
PRICEVARIANCE
29,700 F
12,000 U
Std QtyX
Std price
4,000 x 12.5
X3.8
190,000
4000 x 1X
152
608,000
USAGEVARIANCE
15,200 U
nil
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Labour Cost Variance:
Frame
Assembly
Act QtyX
Act price
49,400
49,200
Act QtyX
Std price
7,600
X6
45,600
4,800X
10
48,000
RateVARIANCE
3,800 U
1,200 U
Std QtyX
Std price
4,000 x 2
X6
48,000
4000 x 1.25X
10
50,000
EfficiencyVARIANCE
2,400 F
2,000 F
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7) Total overhead variance
Overheads absorbed (recovered) 32,000(4,000 x 8)
Actual overheads 30,500Overhead variance 1,500OVER ABSORPTION (FAVOURABLE)
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9) Whose Responsibility? Likely Causes?SALES PRICE (F)
MATERIAL PRICETubing (F),Components (U)
MATERIAL USAGE
Tubing (U)
LABOUR RATEFraming (U)
Assembly (U)
LABOUR EFFICIENCY
Framing (F)Assembly (F)
OVERHEADS (F)
Sales manager: Price inflation, Good market, Look at costs was
increase due to higher costs?
Buyer: Better /poor negotiation skill of the purchasing manager.
Adopted a lower-price / higher-price supplier. Purchased lower-
quality / higher quality materials etc.
Production managers: Personnel manager hired unskilled workers.
Works were scheduled inefficiently. Poorly maintained machines
etc.
HR manager : Poor negotiation skill with labour union. Employed more
skilled workers. More overtime work at premium rates etc.
Production managers: Better trained or motivated workers. Better
quality materials, requiring less labour time in processing. Less
faulty equipment, causing less breakdowns and work interruptions
etc.
All managers: The actual costs of the production overheads costing
less than the estimated. Less actual quantities of the variable
overhead items were used than the estimated. Over estimation of
the absorption rate etc.
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Seminar Question
As the Chief Executive of a manufacturing company,you are asked to make decisions on the followingmatters:
1. Your company uses a key material to make itsproduct. Each unit that you make uses 6 kilogramsof the material and you are currently paying 50p perkilo. You have the opportunity to purchase acheaper quality of this material and save 10% of the
price. However, wastage will increase so it will nowneed 6.5 kilograms to make each unit. What shouldyou do? What effect would the decision have onprofits if you made and sold 120,000 units everymonth?
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Seminar Question
2. The product you make uses 2 hours of labour foreach unit and that costs 6 per hour. You couldrecruit better trained labour at 8 per hour and it
would only take 1 hours to make each unit. Whatshould you do? What effect would the decisionhave on profits if you made and sold 120,000 unitsevery month?
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Seminar 6:Questions 1 2
Students are required to hand in
solutions to the assigned exercises at
the beginning of the tutorial sessions.
Tutorial Exercise
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End of
Week 5
Lecture
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210 kgs. 210 kgs. 200 kgs.
$4.90 per kg. $5.00 per kg. $5.00 per kg.
= $1,029 = $1,050 = $1,000
Price variance$21 favorable
Usage variance$50 unfavorable
Actual Quantity Actual Quantity Standard Quantity
Actual Price Standard Price Standard Price
Quick Check 1
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Actual Hours Actual Hours Standard Hours
Actual Rate Standard Rate Standard Rate
Quick Check 2
Rate variance$310 unfavorable
Efficiency variance$300 unfavorable
1,550 hours 1,550 hours 1,500 hours
$6.20 per hour $6.00 per hour $6.00 per hour
= $9,610 = $9,300 = $9,000
Zippy