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Question:

A consulting firm produces a service that requires the use of labor and materials. Each unit of service requires a standard labor time of 30 minutes (0.5 hours).  The average pay rate for a labor hour is £20. The consulting firm considers all materials that are required for the service as variable overheads (OH), the cost of which is directly associated with the labor hours worked. It has been estimated that variable OH rate is £10 per service hour.

The budgeted and actual costs, revenue and units for the month November are given in the table below:

 

Original Budget

Actual

Units of Service

1,500

1,600

Sales Revenue

£120,000

£124,400

Labor hours

750

860

Labor cost

£15,000

£20,210

Variable OH costs

£7,500

£8,170

Fixed Cost

£68,000

£68,000

Total Cost

£90,500

£96,380

Operating Profit

£29,500

£28,020

 
1. Calculate the flexed budget and the key variances between budgeted and actual results.

2. Reconcile the original budget and present the relationship between the budgeted and the actual profit for the month November

3. Discuss the calculated variances, and provide suggestions for better cost management.

 

 

Answers:

1. Flexible Budget:-

Particulars

Budgeted data for 1,500 units(I)

Flexible budget for 1,600 units(II)

Actual data for 1,600 units(III)

 

Sales revenue(Note 1)

120,000

128,000

124,400

Units

1,500

1,600

1,600

Selling price per unit(Note 2)

80

80

77.75

Labour hours

750

800

860

Labour hours per unit(Note 3)

0.5

0.5

0.5375

Labour cost(Note 4)

15,000

16,000

20,210

Labour cost per hour(Note 5)

20

20

23.5

Variable overhead cost(Note 6)

7,500

8,000

8,170

Variable rate per hour(Note 7)

10

10

9.5

Fixed cost

68,000

68,000

68,000

 

 

 

 

Profit(Note 8)

29,500

36,000

28,020


Note: 1-Sales revenue

For (I)-1,500*80

For (II)-1,600*80

For (III)-1,600*77.75

Note: 2-Selling price per unit

For (I)-120,000/1,500

For (II)-128,000/1,600

For (III)-124,400/1,600

Note: 3-Labour hours per unit

For (I)-750/1,500

For (III)-800/1,600

For (III)-860/1,600

Note: 4-Labour cost

For (I)-750*20

For (II)-800*20

For (III)-860*23.5

Note: 5-Labour cost per hour

For (I)-15,000/750

For (II)-16,000/800

For (III)-20,210/860

Note: 6-Variable overhead cost

For (I)-750*10

For (II)-800*10

For (III)-860*9.5

Note: 7-Variable rate per hour

For (I)-7,500/750

For (II)-8,000/800

For (III)-8,170/860

Note: 8-Profit

For (I)-120,000-15,000-7,500-68,000=29,500

For (II)-128,000-16,000-8,000-68,000=36,000

For (III)-124,400-20,210-8,170-68,000=28,020

Key variances between budgeted and actual:-

  1. Sales price variance-128,000-124,400=3,600(adverse)
  2. Direct labour total variance-16,000-20,210=4,210(adverse)
  • Variable overhead total variance-8,000-8,170=170(adverse)

2. According to the flexible budget, the profit for 1,600 units should have been 36,000. But in actual, the profit is 28,020. The difference has arisen because of variances in sales revenue as well as labour cost as well as variable cost. The difference in budgeted profit can be calculated as under:

There is difference in profit is of 7,980. There is as shortfall in profit. The shortfall is caused because of adverse variances. All the three variances calculated are adverse. Due to which the profit is adverse. The calculation is shown below:

7,980=3,600+4,210+170.

3. The variances calculated are sales price variance, direct labour total variance and variable overhead total variance. All the three variances are adverse. Variable expenses and labour expenses are incurred in excess of what should have been actually incurred. The selling price is less compared to the budgeted selling price. Units are same. Therefore, the sales price variance is adverse. Now to achieve the targeted sales revenue, company should try to sell units in an area which can provide the targeted selling price per unit. To increase the selling price is a tough decision to make as it can affect the sales units. Therefore, improving sales value variance is a difficult task.

Another two adverse variances are direct labour total variance and variable overhead total variance. The cost incurred is more than what should have been actually spent as per budgeted data for standard production. Labour cost per hour is 20 while actual labour cost per hour 23.5. To make the variance positive, the labourers should be given incentives and motivation to produce more units in one hour so that per unit labour cost can be decreased.

The most relevant variance to the business is variable overhead cost variance. Because, it depends upon the variable cost incurred by the company. Variable expenses incurred can be reduced to some extent by the organisation. Labour and sales variance can’t be controlled as compared to variable overhead. Variable overhead can be controlled by the company. Company should analyse day to day expenses carefully so that it can cut off expenses somewhere. Maintenance expenses, supplies, material expenses should be controlled to cut off variable expenses.

 

References:-

ANON, N.D., “variance analysis”, Accessed on 4th February 2015, <https://accounting-simplified.com/management/variance-analysis/>

ANON, N.D., “variance analysis”, Accessed on 4th February 2015, <https://classes.bus.oregonstate.edu/spring-07/ba422/Management%20Accounting%20Chapter%205.htm>

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