7/31/2019 Variance Analysis 5.16

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34 Questions

A manufacturing company, Hexicon, has provided you with the following data which relates to product RYX, for theperiod which has just ended.

Budget Actual

Number of labour hours 8,400 7,980Production units 1,200 1,100Overhead cost (all fixed) $22,260 $25,536

Overheads are absorbed at a rate per standard labour hour.

Required

(a) (i) Calculate the fixed production overhead cost variance and the following subsidiary variances.

Expenditure Efficiency Capacity

(ii) Provide a summary statement of these four variances. (8 marks)

(b) Briefly discuss the possible reasons why adverse fixed production overhead expenditure, efficiency and

capacity variances occur. (9 marks)(c) Briefly discuss two examples of inter-relationships between the fixed production overhead efficiency

variances and the material and labour variances. (3 marks)

(Total = 20 marks)

QUESTION 5.16

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142 Answers

(a) (i) Budgeted fixed overhead absorption rate =

$22,260 8,400 hours = $2.65 per labour hour

Standard labour hours per unit of component RYX =

8,400 hours 1,200 units = 7 hours per unit

Standard fixed overhead absorbed per unit =

7 hours $2.65 per hour = $18.55

$Fixed production overhead incurred 25,536Fixed production overhead absorbed (1,100 $18.55) 20,405

Fixed production overhead cost variance 5,131 (A)

Budgeted expenditure 22,260Actual expenditure 25,536Fixed production overhead expenditure variance 3,276 (A)

1,100 units should have taken ( 7 hrs) 7,700 hrsbut did take 7,980 hrs

280 hrs (A) standard rate per hour $2.65Fixed production overhead efficiency variance $742 (A)

Budgeted hours of work 8,400 hrsActual hours of work 7,980 hrs

420 hrs (A) standard rate per hour $2.65Fixed production overhead capacity variance $1,113 (A)

(ii) Reconciliation of fixed overhead variances$

Expenditure variance 3,276 (A)Efficiency variance 742 (A)Capacity variance 1,113 (A)

Cost variance 5,131 (A)

(b) Possible reasons for the occurrence of the fixed overhead expenditure, efficiency and capacity variances

Expenditure variance

This variance represents the difference between actual and budgeted fixed overhead expenditure. An overalladverse variance could arise if expenditure on one or more categories of fixed overhead was higher than

anticipated (the actual expenditure on other categories either being at the same level as, or not significantlyless than, anticipated). There may be a greater than expected rise in buildings insurance premium, for

example. Alternatively global factors, such as a rate of inflation higher than that allowed for in the budget,

will have a more general adverse effect on fixed overhead expenditure.

Efficiency variance

This variance shows the effect, at the standard absorption rate per hour, of actual hours worked being more

or less than the standard allowance for the actual output. An adverse variance will occur if actual hours are

SOLUTION

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Answers 143

greater than standard hours; possible reasons for this are the same as those for an adverse labourefficiency variance and include the following.

(1) The use of less skilled labour than that stipulated in the standard.

(2) Higher than anticipated labour turnover, resulting in more time spent on training than budgeted.

(3) The use of poor quality materials, with the result that production takes longer than budgeted.

(4) The use of poor quality materials leading to a higher scrap rate than anticipated and hence more

time spent on rectification than planned.(5) Problems with motivation and morale.

(6) The standard hours could have been set unrealistically low.

Capacity variance

This component of the volume variance does not take into account the standard hours per unit of productionbut simply compares the actual number of hours worked with the budgeted number of hours, the differencebeing multiplied by the standard absorption rate per hour to calculate the variance. An adverse variancearises if actual hours worked are less than budgeted hours (because we would expect output to be lessthan budgeted). Possible reasons for such a variance include the following.

(1) Lack of demand for the product

(2) A higher than anticipated level of downtime due to problems with plant and machinery(3) Shortage of labour

(4) Excessive time lost due to sickness or disputes

(c) Individual variances should not be looked at in isolation. One variance might be dependent upon another,and much of it might have occurred only because the other inter-dependent variance occurred too. Considerthe following examples.

(1) Using less skilled workers than anticipated when standards were set is likely to result in a

favourable labour rate variance (because the labour rate should be less) but, because the workers

are likely to be less efficient and less skilled at using materials, it could also produce adverse labour

efficiency, material usage and fixed production overhead efficiency variances.

(2) The use of materials of a higher quality than required by a standard could produce an adversematerial price variance (because the material is likely to be more expensive) but, because the

material could be easier to use, it could lead to favourable material usage, labour efficiency and

fixed production overhead efficiency variances.

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