Reference no: EM13877209

Variance Analysis and Accountability In late November, the sales department of Sanchez Manu- facturing accepted a rush order for 8,000 units of one of its products. The sales department did not consult with any of the operating departments before committing to a firm December 20 delivery date. The standard direct material and direct labor costs for this product are as follows:

Direct materials: 1.5 pounds @ $10.00 per pound $15.00 Direct labor: Class III, 1.2 hours @ $18.00 per hour $21.60

Total direct manufacturing cost per unit $36.60

Unfortunately, all of the labor normally used to manufacture this product was already scheduled to manufacture 12,000 units for delivery by the end of December. In addition, the regular raw material supplier could only furnish the quantity needed for the 12,000 units originally scheduled. To meet its regular commitments as well as the rush order, Sanchez did the following:

1. In addition to 18,200 pounds of raw material from Sanchez's regular supplier (cost was $180,862.50), the purchasing department was able to obtain raw material from a new supplier at a favorable price-provided that 18,000 pounds were purchased. These alternative raw materials were supposed to be of the same quality and had a total cost of $177,750.

2. The production department was able to shift Class II labor from another product to assist in producing the 20,000 units (12,000 regular units, plus 8,000 rush-order units) of product. The standard labor rate for Class II labor is $20 per hour.

At the end of December, the production department received the following summary report regarding the production costs related to the manufacture of this product. Raw material price vari- ances are not included in this report because they are isolated at the time of purchase and charged directly to the purchasing department. When raw materials are requisitioned, they are charged to the production department at standard cost.

Cost charged to the production department:

Material-regular (18,200 pounds purchased and used)	$182,000
Material-alternate (18,000 pounds purchased/15,800 pounds used)	158,000
Class III labor: 15,200 hours worked	281,200
Class II labor: 10,300 hours worked	204,970
Total cost charged to the production department	$826,170
Standard direct manufacturing cost of completed production = 20,000 units x $36.60/unit	732,000
Unfavorable cost variance	$ 94,170

The following discussion took place between Sarah Young, cost accountant, and Carlos Sanchez, production department, regarding this report.

Young: Carlos, what happened this month with this product? Your costs for this product are usually in line with standard. If I calculated a labor variance, it would be huge! The boss wants me to do an analysis of the cost overrun. Can you help me?

Sanchez: I am not at all surprised by the cost overrun. We had all kinds of problems this month-none of which were under my control!

Young: What do you mean?

Sanchez: We scheduled production for 12,000 units, based on contract orders received. Then, without warning, Sales accepted an order for 8,000 more units to be delivered mid- month! Well, I had to transfer Class II labor from another production run to cover that order-and these individuals earn about $2 an hour more per hour. If I could have left them on the other project for which they are better suited, I would probably have had a favorable labor rate variance.

Young: By transferring the Class II labor, you are probably behind on the other project, too, right? In addition, I bet the Class II workers were slow and inef?cient because this was a new product for them.

Sanchez: Well, we are OK on the project the Class II workers were supposed to work on because we arranged with the buyer to delay delivery for 30 days. The Class II workers were really not that inef?cient once they learned the routine. What was really bad was the material the purchasing department bought for us.

Young: What do you mean about "bad" material?

Sanchez: Well, our regular supplier for this project could only provide enough material for 12,000 units. Purchasing had to ?nd another source. They did and seemed to get a good deal, but the material we received was not of the same quality. Our spoilage re- ally increased.

The problem was that sometimes we could not tell whether or not it was bad until we put the labor into it. Interestingly, both the Class II and Class III laborers had the same problems and, I would guess, the same error rate. You could really tell when we started using that substitute material!

Young: Do you have any breakdown to help me? Maybe I can show my boss what happened here.

Sanchez: Sure, I have some data. I watched it closely. You ought to charge all of the variance to the sales department; after all, they caused all of the problems with that rush order!

Sanchez was able to determine when the switch to the substitute material took place, and Young was able to determine how many direct labor-hours were worked before and after the switch to the substitute materials. Following is a summary of their findings.

	Regular  Materials	Alternative  Materials
Direct materials used (in pounds)	18,200	15,800
Production output:
Class III	7,200	4,800
Class II	4,800	3,200
Total output	12,000	8,000
Actual direct labor hours: Class III labor	8,600	6,600
Class II labor	5,900	4,400
Total direct labor hours	14,500	11,000

Required

1. Determine, by calculating a direct material efficiency (usage) variance for both the regular and the alternative materials, whether or not Carlos Sanchez was correct in his analysis of direct material usage.

2. Sarah Young has decided to prepare a detailed analysis of the total direct labor cost variance. Calculate the following components of the total direct labor variance:

a. Labor rate variance, by labor class.

b. Labor substitution variance, Class II labor (calculate this as the difference in standard wage rate per hour for Class II vs. Class III labor, times the actual number of Class II labor hours worked).

c. Labor variance from use of substandard material, by labor class.

d. Labor efficiency variance associated with use of regular materials, by labor class.

3. Sanchez stated that the variances arising from the rush order should be charged to the sales department.

a. Identify which of the variances calculated in Requirements 1 and 2 above, if any, could be associated with the rush order. For each variance identified, provide a brief explanation of why it is related to the rush order.

b. Discuss whether or not Sanchez is justified in stating that the variances related to the rush order should be charged to the sales department.