Portland Company's Ironton Plant produces precast ingots for industrial use. Carlos Santiago, who

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.

"What's going on in that lab?" asked Derek Warren, chief administrator for Cottonwood Hospital, as

"What's going on in that lab?" asked Derek Warren, chief administrator for Cottonwood Hospital, as he studied the prior month’s reports. "Every month the lab teeters between a profit and a loss. Are we going to have to increase our lab fees again?"

"We can't," replied Lois Ankers, the controller. "We're getting lots of complaints about the last increase, particularly from the insurance companies and governmental health units. They're now paying only about 80% of what we bill. I'm beginning to think the problem is on the cost side."

To determine if lab costs are in line with other hospitals, Mr. Warren has asked you to evaluate the costs for the past month. Ms. Ankers has provided you with the following information:

a.	Two basic types of tests are performed in the lab—smears and blood tests. During the past month, 3,100 smears and 800 blood tests were performed in the lab.
b.	Small glass plates are used in both types of tests. During the past month, the hospital purchased 15,500 plates at a cost of $59,520. This cost is net of a 4% purchase discount. A total of 2,100 of these plates were unused at the end of the month; no plates were on hand at the beginning of the month.
c.	During the past month, 2,100 hours of labor time were used in performing smears and blood tests. The cost of this labor time was $22,785.
d.	The lab’s variable overhead cost last month totaled $16,170.

Cottonwood Hospital has never used standard costs. By searching industry literature, however, you have determined the following nationwide averages for hospital labs:

Plates:	Three plates are required per lab test. These plates cost $4 each and are disposed of after the test is completed.
Labor:	Each smear should require 0.4 hours to complete, and each blood test should require 0.8 hours to complete. The average cost of this lab time is $11.3 per hour.
Overhead:	Overhead cost is based on direct labor-hours. The average rate of variable overhead is $7.2 per hour.

Required:

1.

Compute the materials price variance for the plates purchased last month, and compute a materials quantity variance for the plates used last month. (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	$	F
Materials quantity variance	$	U

2.	For labor cost in the lab:

a.

Compute a labor rate variance and a labor efficiency variance. (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

b.	In most hospitals, three-fourths of the workers in the lab are certified technicians and one-fourth are assistants. In an effort to reduce costs, Cottonwood Hospital employs only one-half certified technicians and one-half assistants. Would you recommend that this policy be continued?
	No

3a.

Compute the variable overhead 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.)

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

3b.	Is there any relation between the variable overhead efficiency variance and the labor efficiency variance?
	Yes

Explanation: 1.

The standard quantity of plates allowed for tests performed during the month would be:

Smears	3,100
Blood tests	800
Total	3,900
Plates per test	×3
Standard quantity allowed	11,700

The variance analysis for plates would be:

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)
11,700 plates × $4 per plate			13,400 plates × $4 per plate
= $46,800			= $53,600			$59,520
	Materials quantity
	variance = $6,800 U
		15,500 plates ×
		$4 per plate
			= $62,000
				Materials price variance = $2,480 F

Note that all of the price variance is due to the hospital’s 4% quantity discount. Also note that the $6,800 quantity variance for the month is equal to nearly 15% of the standard cost allowed for plates. This variance may be the result of using too many assistants in the lab.

2.
a.

The standard hours allowed for tests performed during the month would be:

Smears: .4 hour per test × 3,100 tests	1,240
Blood tests: .8 hour per test × 800 tests	640
Total standard hours allowed	1,880

The variance analysis of labor would be:

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)
1,880 hours × $11.3 per hour			2,100 hours × $11.3 per hour
= $21,244			= $23,730			= $22,785
	Labor efficiency variance = $2,486 U			Labor rate variance = $945 F
		Spending Variance = $1,541 U

2.
b.

The policy probably should not be continued. Although the hospital is saving $0.45 per hour by employing more assistants relative to the number of senior technicians than other hospitals, this savings is more than offset by other factors. Too much time is being taken in performing lab tests, as indicated by the large unfavorable labor efficiency variance. And, it seems likely that most (or all) of the hospital's unfavorable quantity variance for plates is traceable to inadequate supervision of assistants in the lab.

3a.

The variable overhead variances follow:

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)
1,880 hours × $7.20 per hour			2,100 hours × $7.20 per hour
= $13,536			= $15,120			$16,170
	Variable overhead efficiency variance = $1,584 U			Variable overhead rate variance = $1,050 U
		Spending variance = $2,634 U

3b.

Yes, the two variances are related. Both are computed by comparing actual labor time to the standard hours allowed for the output of the period. Thus, if there is an unfavorable labor efficiency variance, there will also be an unfavorable variable overhead efficiency variance.