Essay: Costing, Variance Analysis, And Financial Analysis Of A Local Business.

A newly established brewing company in Sydney, Cool Brew Ltd, produces its main product, Cool Bay Draught, in 300 milliliter bottles. There are two production departments: Mixing and Bottling. The manufacturing costs for each
department during March 2013 were tabulated below.

Mixing Bottling
Direct materials $ 113 000 $ 17 000
Direct labour 15 000 6 000
Manufacturing overhead 32 000 9 000
In March 2013, Cool Brew Ltd produced 48 000 litres of Cool Bay Draught that was bottled into 160 000 bottles.
There were no beginning and ending work-in-process inventories.

(a) Calculate the cost per bottle for Cool Bay Draught;
(b) Prepare the journal entries to record the production costs for March 2013, assuming that the costs of Mixing and Bottling Departments are charged to their respective work-inprocess inventory accounts.

During October 2013, Kent Ltd’s material purchases amounted to 6 000 kilograms at a price of $7.40/kg.Actual costs incurred in the production of 2 000 units were as follows.
Direct material $ 31 080 $7.40/kg
Direct labour 118 035 $18.30/hour
The standards for one unit of Kent Ltd’s product are as follows.
Direct material Direct labour
Quantity: 2 kg/unit Quantity: 3.5 hours/unit
Price: $7.20/kg Rate: $18/hour

Calculate the following variances and indicate whether each variance is favourable or unfavourable:
(a) Direct material price variance;
(b) Direct material usage variances;
(c) Direct labour rate variance; 
(d) Direct labour efficiency variance. 

Sam, the manager of a local ice cream shop called Super Scooper, is disappointed at the lossmaking financial performance of his newly created fresh fruit juice counter.Sam has prepared following financial analysis for the year just ended.
Sales $ 67 500
Less: Cost of fruit (30 000)
Gross profit 37 500
Less: Operating expenses
Wages of counter staff $ 18 000
Consumables (e.g. cups and straws) 6 000
Utilities (allocated) 4 350
Depreciation of counter equipment and furnishings 3 750
Depreciation of building (allocated) 6 000
Super Scooper manager’s salary (allocated) 4 500
Total operating expenses (42 600)
Loss on fresh fruit juice counter $ (5 100)

(a) Evaluate Sam’s financial analysis for the year just ended; 
(b) Provide a correct profit and loss analysis to financially assess whether the fresh fruit juice counter should be continued. 

ABC Ltd has provided the following data relating to its two most popular models of an electronic product.
Standard Deluxe
$/unit $/unit
Selling price 70 120
Direct material 15 22
Direct labour 10 30
Manufacturing overhead @ $30/machine hour 30 60
Monthly demand (units) 40 000 24 000

The fixed manufacturing overhead component included in the above unit costs is $20 permachine hour.On the very first day of June, a major piece of manufacturing equipment was damaged. It would take two weeks for replacement parts to arrive from Switzerland. Consequently, there would be only 60 000 machine hours available in June to manufacture the two models of the electronic product.

(a) Given the limited machine hours available in June, conduct an appropriate financial analysis. 
(b) Based on the above financial analysis, determine how many units of each product should be produced in that month to maximise ABC Ltd’s profitability.

Costing Example - Cool Brew Ltd

Problem 1 deals with costing. It includes calculating the cost per bottle and further journalizing the transactions relating to production costs in the work in process inventory account. The calculation of correct cost per unit produced is an important factor in the accounting, as the selling price and profit margin are largely dependent on the cost of unit

In the given case, Cool Brew Ltd has started producing breweries named “Cool Bay Draught” by packaging them in bottles containing 300 milliliters. The company consists of two departments named, mixing and bottling and has respective costs. During the period the company produced 48000 litres of product and bottled them.

The first requirement is to calculate the cost per bottle of Cool Bay Drought. For calculation of cost per bottle, the total cost of both the departments is computed, which is $192,000 ($160,000 for mixing department + $32,000 for bottling department). The bifurcation of said cost is as below:

Hence, the cost per bottle is total cost divided by number of bottles produced, which comes at $1.20

Total cost / number of bottles

= 192000 / 160000

= $1.20

Hence, the cost of producing one bottle is $1.20.The second requirement asks us to journalize the transactions. The journal entries are as below:

Problem 2 – Variance analysis

Variance analysis is the investigation of the differences between actual and budgeted values. This analysis is important in controlling and maintaining the costs. As it helps in evaluating and understanding the reasons of differences between actual and budgeted data and hence helps the management in taking decisions for eliminating and controlling the irrelevant costs.

In the given case, the data has been given regarding actual and budgeted production of the output and the question demands for calculation of variances.

The first variance is Direct Material Price Variance which reflects the variation between the actual rate and standard rate.

Direct material price variance             =          (Standard price - Actual price) x Actual quantity     

                                                            =          (7.20 - 7.40) x 4200   

                                                            =          -$840   Unfavorable

Since, the actual price is more than the standard price, hence the direct material price variance is unfavorable, which means that the company has procured the material at a higher cost than budgeted.Another variance is Direct Material Usage Variance which shows the variation between the actual quantity used for producing one unit of product versus the budgeted quantity required for production of one unit of product.

Direct material usage variances          =          (Standard quantity - Actual quantity) x Standard price         

                                                            =          (4000 - 4200) x 7.20  

                                                            =          -$1,440   Unfavorable

From above, we found that the company has budgeted to consume 4000 kgs of material for producing 2000 units whereas in actual the company has consumed 4200 kgs of material for producing the 2000 units. Hence, the above variance is also unfavorable for the company.The other variance is Direct Labor Rate variance which reflects the variation between the actual rate paid to labor and the budgeted rate.

Direct labor rate variance        =          (Standard rate - Actual rate) x Actual hours worked

                                                =          (18 - 18.30) x 6450    

                                                =          -$1,935            Unfavourable

From above, we found that the company has budgeted to pay $18 per hour whereas in actual the company has paid $18.30 per hour. Since, the company has paid more than the budgeted, hence the said variance is unfavorable.The last variance is Direct Labor Efficiency variance which reflects the variation between hours taken by labor for producing one unit of product versus budgeted hours for producing one unit of material.

Direct labor efficiency variance          =          (Standard hours - Actual hours) x Standard rate       

                                                            =          (7000 - 6450) x 18     

                                                            =          $9,900 Favorable

In the above variance, the actual hours taken is lower than the budgeted hours and hence the variance is favorable.

Financial Analysis

Proper financial analysis is an key aspect for analysis the correct profitability and decision making as regard to project continuity. In the given case, Sam has an ice cream shop and has started selling fresh fruit juice as well. However, the Sam has found that the fruit juice business is an loss making business as he included the fixed and sunk cost to its profitability. The evaluation of Sam’s financial analysis is as below:

The above profit and loss shows that the company has a GP margin of 55.56%. Gross profit ratio appears to be very high. However, indirect expenses are causing this profit to turn into losses. We noticed there are some allocated costs which are not relevant for decision making.The above profit and loss includes some relevant and sunk costs as well. The correct profit & loss account is as under:

As per above revised calculation, there is profit of $9750. Therefore, business of fresh fruit juice counter should be continued.

Analysis with constraint financial resources

Every business runs for profit and profit maximization is the main aim for any business to run. Hence, the costing gives emphasizes on maximizing the profit by deciding which and how much units should be produced when the resources are limited. In such a case, the product having higher profit should be produced more as compared to one which has low profit margin.

The financial analysis when the machine hours are limited.

If machine hours are limited, product with higher CM per machine hour should be produced first. Company should first allocate machine hours first towards Standard.Number of units to be produced to maximize the ABC Ltd’s profitability.

Since maximum demand for Standard is 40,000 units, machine hours should be allocated to these 40,000 units.