Preston Recliners manufactures leather recliners and uses flexible budgeting and

Question

Preston Recliners manufactures leather recliners and uses flexible budgeting and a standard cost system. Preston allocates overhead based on yards of direct materials. The company's performance report includes the following selected data:

Preston Recliners manufactures leather recliners and uses flexible budgeting and a standard cost system. Preston allocates overhead based on yards of direct materials. The company's performance report includes the following selected data:

Static Budget
(1,000 recliners) Actual Results
(980 recliners) Sales (1,000 recliners X $495) $495,000             (980 recliners X $475) $465,500 Variable manufacturing costs:      Direct materials (6,000 yds @ $8.80/yard) 52,800                                        (6,150 yds @ $8.60/yard) 52,890      Direct labor (10,000 hrs @ $9.20/hour) 92,000                               (9,600 hrs @ $9.30/hour) 89,280 Variable overhead (6,000 yds @ $5.00/yard) 30,000                                        (6,510 yds @ $6.40/yard) 39,360 Fixed manufacturing costs:      Fixed overhead 60,000 62,000 Total cost of goods sold $234,800 $243,530 Gross profit $260,200 $221,970 Requirements: 1. Prepare a flexible budget based on the actual number of recliners sold. 2. Compute the price variance and the efficiency variance for direct materials and for direct labor. For manufacturing overhead, compute the variable overhead spending, variable overhead efficiency, fixed overhead spending, and fixed overhead volume variances. 3. Have Preston's managers done a good job or a poor job controlling materials, labor, and overhead costs? Why? 4. Describe how Preston's managers can benefit from the standard costing system.

Explanation / Answer

Part A)

The flexible budget will be prepared with the use of actual units and static budget cost per unit (as and where applicable) details.

_____________________

Flexible Budget:

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Part B)

The formulas for calculating different variances are provided below:

Material Price Variance = Actual Material*(Actual Rate Per Unit - Standard Rate Per Unit)

Material Efficiency Variance = Standard Rate*(Actual Units Consumed - Standard Units for Actual Production)

________

Labor Price Variance = Actual Hours*(Actual Rate Per Hour - Standard Rate Per Hour)

Labor Efficiency Variance = Standard Rate*(Actual Hours Used - Standard Hours Used for Actual Production)

________

Variable Overhead Spending Variance = Actual Material*(Actual Variable Overhead Rate Per Unit - Standard Variable Overhead Rate Per Unit)

Variable Overhead Efficiency Variance = Standard Variable Overhead Rate Per Unit*(Actual Units Consumed - Standard Units for Actual Production)

________

Fixed Overhead Spending Variance = Actual Fixed Overhead - Budgeted Fixed Overhead

Fixed Overhead Volume Variance = Budgeted Fixed Overhead - Applied Fixed Overhead

_______________

Using the values provided in the question, we get,

Material Price Variance = 6,150*(8.60 - 8.80) = $1,230 (Favorable)

Material Efficiency Variance = 8.80*(6,150 - 6,000/1,000*980) = $2,376 (Unfavorable)

________

Labor Price Variance = 9,600*(9.30 - 9.20) = $960 (Unfavorable)

Labor Efficiency Variance = 9.20*(9,600 - 10,000/1000*980) = $1,840 (Favorable)

________

Variable Overhead Spending Variance = 6,510*(6.40 - 5) = $9,114 (Unfavorable)

Variable Overhead Efficiency Variance = 5*(6,510 - 6,000/1,000*980) = $3,150 (Unfavorable)

________

Fixed Overhead Spending Variance = $62,000 - $60,000 = $2,000 (Unfavorable)

Fixed Overhead Volume Variance = $60,000 - $60,000/1000*980 = $1,200 (Unfavorable)

_______________

Part C)

No, the Preston's managers have not done a good job of controlling costs as most of the variances calculated above are unfavorable indicating that the actual costs are higher than the expected costs. Only 2 variances are favorable (material price variance and labor efficiency variance). However, an unfavorable material efficiency variance may indicate that poor quality of material might have been procured to save material cost per unit. The benefit associated with favorable labor efficiency variance is also offset to the extent of extra spending made on labor (as indicated by unfavorable labor price variance).

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Part D)

Preston's managers can benefit from the standard costing system by using variance analysis as a tool for identifying areas where costs are exceeding and using appropriate measures to control them. This can help them in improving the performance of their respective departments and earning extra incentives for keeping things under control.

Flexible Budget (980 recliners) Sales (980*495) 485,100 Variable manufacturing costs: Direct materials (6,150*8.80) 54,120 Direct labor (9,600*9.20) 88,320 Variable overhead (6,510*5) 32,550 Fixed manufacturing costs: Fixed overhead 60,000 Total cost of goods sold 234,990 Gross Profit $250,110

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