Heritage Furniture Co. uses a standard cost system. One of the company\'s most p
ID: 2449344 • Letter: H
Question
Heritage Furniture Co. uses a standard cost system. One of the company's most popular products is an oak entertainment center that looks like an old ice box but houses a television, stereo, or other electronic components. The per-unit standard costs of the entertainment center, assuming a "normal" volume of 1,000 units per month, are as follows: During October, 800 entertainment centers were scheduled and produced at the following actual unit costs: Compute the following cost variances for the month of October: Materials price variance Materials quantity variance Labor rate variance Labor efficiency variance As a manager, would you investigate these variances? Explain.Explanation / Answer
Direct material price variance is calculated to determine the efficiency of purchasing department in obtaining direct material at low cost. A positive value of direct material price variance is favorable which means that direct material was purchased for lesser amount than the standard price. A negative value of direct material price variance is unfavorable because more than estimated price per unit is paid.
However, a favorable direct material price variance is not always good; it should be analyzed together with direct material quantity variance. It is quite possible that the purchasing department may purchase low quality raw material to generate a favorable direct material price variance. Such a favorable material price variance will be offset by an unfavorable direct material quantity variance due to wastage of low quality direct material.
Direct material quantity variance is calculated to determine the efficiency of production department in converting raw material to finished goods. In order to improve efficiency, wastage of raw material must be reduced. A negative value of direct material quantity variance is unfavorable and it implies that more quantity of direct material has been used in the production process than actually needed. A positive value of direct material quantity variance is favorable implying that raw material was efficiently converted to finished goods.
Direct labor rate variance determines the performance of human resource department in negotiating lower wage rates with employees and labor unions. A positive value of direct labor rate variance is achieved when standard direct labor rate exceeds actual direct labor rate. Thus positive values of direct labor rate variance are favorable and negative values are unfavorable.
However, a positive value of direct labor rate variance may not always be good. When low skilled workers are recruited at lower wage rate, the direct labor rate variance will be favorable however, such workers will be inefficient and will generate a poor direct labor efficiency variance. Direct labor rate variance must be analyzed in combination with direct labor efficiency variance.
The purpose of calculating the direct labor efficiency variance is to measure the performance of production department in utilizing the abilities of the workers. A positive value of direct labor efficiency variance is obtained when the standard direct labor hours allowed exceeds the actual direct labor hours used. Thus a positive value is favorable. Negative value of direct labor efficiency variance implies that more direct labor hours have been used than actually needed.
It is necessary to analyze direct labor efficiency variance along with direct labor rate variance. It is quite possible that unfavorable direct labor efficiency variance is simply the result of recruiting low skilled workers. In which case direct labor rate variance will become favorable at the expense of direct labor efficiency.
Price Quantity Standard Actual Variance Analysis Standard Actual Variance Analysis Direct Materials 143 132 -11 Favorable 104 143 39 Unfavorable Labor rate per hour Labor efficiency Standard Actual Variance Analysis Standard Actual Variance Analysis Direct Labor 44 42.9 -1.1 Favorable 32 44 12 Unfavorable