Portland Company’s Ironton Plant produces precast ingots for industrial use. Carlos Santiago

Portland Company’s Ironton Plant produces precast ingots for industrial use. Carlos Santiago, who was recently appointed general manager of the Ironton Plant, has just been handed the plant’s contribution format income statement for October. The statement is shown below:

	Budgeted		Actual
Sales (3,000 ingots)	$	250,000	$	250,000
Variable expenses:
Variable cost of goods sold*		53,430		67,000
Variable selling expenses		26,000		26,000
Total variable expenses		79,430		93,000
Contribution margin		170,570		157,000
Fixed expenses:
Manufacturing overhead		67,000		67,000
Selling and administrative		92,000		92,000
Total fixed expenses		159,000		159,000
Net operating income (loss)	$	11,570	$	(2,000)

*Contains direct materials, direct labor, and variable manufacturing overhead.

Mr. Santiago was shocked to see the loss for the month, particularly because sales were exactly as budgeted. He stated, “I sure hope the plant has a standard cost system in operation. If it doesn’t, I won’t have the slightest idea of where to start looking for the problem.”

The plant does use a standard cost system, with the following standard variable cost per ingot:

	Standard Quantity or Hours	Standard Price or Rate		Standard Cost
Direct materials	4.2 pounds	$	2.80 per pound	$	11.76
Direct labor	0.5 hours	$	8.30 per hour		4.15
Variable manufacturing overhead	0.5 hours*	$	3.80 per hour		1.90
Total standard variable cost				$	17.81

*Based on machine-hours.

During October the plant produced 3,000 ingots and incurred the following costs:

a.	Purchased 17,600 pounds of materials at a cost of $3.25 per pound. There were no raw materials in inventory at the beginning of the month.
b.	Used 12,400 pounds of materials in production. (Finished goods and work in process inventories are insignificant and can be ignored.)
c.	Worked 2,100 direct labor-hours at a cost of $8.00 per hour.
d.	Incurred a total variable manufacturing overhead cost of $7,560 for the month. A total of 1,800 machine-hours was recorded.

It is the company’s policy to close all variances to cost of goods sold on a monthly basis.

Required:

1.	Compute the following variances for October:

a.

Direct materials price and quantity variances. (Input all amounts as positive values. Leave no cells blank – be certain to enter “0” wherever required. Indicate the effect of each variance by selecting “F” for favorable, “U” for unfavorable, and “None” for no effect (i.e., zero variance). Omit the “$” sign in your response.)

Materials price variance	$	U
Materials quantity variance	$	F

b.

Direct labor rate and efficiency variances. (Input all amounts as positive values. Leave no cells blank – be certain to enter “0” wherever required. Indicate the effect of each variance by selecting “F” for favorable, “U” for unfavorable, and “None” for no effect (i.e., zero variance). Omit the “$” sign in your response.)

Labor rate variance	$	F
Labor efficiency variance	$	U

c.

Variable overhead rate and efficiency variances. (Input all amounts as positive values. Do not round your intermediate calculations. Leave no cells blank – be certain to enter “0” wherever required. Indicate the effect of each variance by selecting “F” for favorable, “U” for unfavorable, and “None” for no effect (i.e., zero variance). Omit the “$” sign in your response.)

Variable overhead rate variance	$	U
Variable overhead efficiency variance	$	U

2a.

Summarize the variances that you computed in (1) above by showing the net overall favorable or unfavorable variance for October. (Input the amount as a positive value. Leave no cells blank – be certain to enter “0” wherever required. Indicate the effect of each variance by selecting “F” for favorable, “U” for unfavorable, and “None” for no effect (i.e., zero variance). Omit the “$” sign in your response.)

Net variance

$

U

3.	Pick out the two most significant variances that you computed in (1) above. (You may select more than one answer. Single click the box with the question mark to produce a check mark for a correct answer and double click the box with the question mark to empty the box for a wrong answer.)
	Materials price variance Labor efficiency variance Variable overhead efficiency variance Labor rate variance Variable overhead rate variance Materials quantity variance

Explanation:
1.
a.

Standard Quantity Allowed for Actual Output, at Standard Price			Actual Quantity of Input, at Standard Price			Actual Quantity of Input, at Actual Price
(SQ × SP)			(AQ × SP)			(AQ × AP)
12,600 pounds* × $2.80 per pound			12,400 pounds × $2.80 per pound			17,600 pounds × $3.25 per pound
= $35,280			= $34,720			= $57,200
	Materials quantity
	variance = $560 F
		17,600 pounds ×
		$2.80 per pound
			= $49,280
				Materials price variance = $7,920 U

*3,000 ingots × 4.2 pounds per ingot = 12,600 pounds

1.
b.

Standard Hours Allowed for Actual Output, at Standard Rate			Actual Hours of Input, at Standard Rate			Actual Hours of Input, at Actual Rate
(SH × SR)			(AH × SR)			(AH × AR)
1,500 hours* × $8.30 per hour			2,100 hours × $8.30 per hour			2,100 hours × $8.00 per hour
= $12,450			= $17,430			= $16,800
	Labor efficiency variance = $4,980 U			Labor rate variance = $630 F
		Spending Variance = $4,350 U

*3,000 ingots × 0.5 hour per ingot = 1,500 hours

1.
c.

Standard Hours Allowed for Actual Output, at Standard Rate			Actual Hours of Input, at Standard Rate			Actual Hours of Input, at Actual Rate
(SH × SR)			(AH × SR)			(AH × AR)
1,500 hours* × $3.80 per hour			1,800 hours × $3.80 per hour
= $5,700			= $6,840			$7,560
	Variable overhead efficiency variance = $1,140 U			Variable overhead rate variance = $720 U
		Spending variance = $1,860 U

*3,000 ingots × 0.5 hours per ingot = 1,500 hours

2.
Summary of variances:

Material quantity variance	$	560	F
Material price variance		7,920	U
Labor efficiency variance		4,980	U
Labor rate variance		630	F
Variable overhead efficiency variance		1,140	U
Variable overhead rate variance		720	U
Net variance	$	13,570	U

The net unfavorable variance of $13,570   for the month caused the plant’s variable cost of goods sold to increase from the budgeted level of $53,430 to $67,000  :

Budgeted cost of goods sold at $17.81 per ingot	$	53,430
Add the net unfavorable variance (as above)		13,570
Actual cost of goods sold	$	67,000

This $13,570 net unfavorable variance also accounts for the difference between the budgeted net operating income and the actual net loss for the month.

Budgeted net operating income	$	11,570
Deduct the net unfavorable variance added to cost of goods sold for the month		13,570
Net operating loss	$	(2,000	)

3.

The two most significant variances are the materials price variance and the labor efficiency variance. Possible causes of the variances include:

Materials price variance:	Outdated standards, uneconomical quantity purchased, higher quality materials, high-cost method of transport.
Labor efficiency variance:	Poorly trained workers, poor quality materials, faulty equipment, work interruptions, inaccurate standards, insufficient demand.