Reference no: EM132081169

Question - Flexible budgets, direct cost variances

Terrigal Pots manufactures clay pots. All pots are the same size. Each unit requires the same amount of resources. The following information is from the static budget for 2015:

Expected production and sales 32 000 units

Direct materials 48 000 kg

Direct labour 16 000 hours

Total fixed costs $75 000

Standard quantities, price and unit costs follow for direct materials and direct labour:

	Standard quantity	Standard price	Standard unit cost
Direct materials	1.5 kg	$2.5 per kg	$3.75
Direct labour	0.5 hours	$25 per hour	$12.50

During 2015, actual number of units produced and sold was 35 000 units. Actual cost of direct materials used was $141 487.50, based on 57 750 kg purchased at $2.45 per kg. Direct labour hours actually used were 21 000 hours, at the rate of $21.50 per hour. As a result, actual direct labour costs were $451 500. Actual fixed costs were $85 000. There was no beginning or ending inventory.

Required:

1. What is the key difference between a static budget and a flexible budget? Why might managers find a flexible-budget analysis more informative than a static-budget analysis?

2. How does variance analysis help in continuous improvement? Why is it important that managers do not evaluate variances in isolation?

3. Prepare a flexible-budget-based variance analysis (similar to Table 11-3 p.426 textbook) for each of the three cost categories.

4. Calculate price and efficiency variances for direct materials and direct labour.

5. Comment on the results in parts 3 and 4 and provide a possible explanation for them.