Able Control Company That Manufactures Electrical Switches

Able Control Company Which Manufactures Electrical Switches Uses A S

Able Control Company, which manufactures electrical switches, uses a standard cost system and carries all inventory at standard cost. The standard factory overhead cost per switch is based on direct labor hours: Variable overhead 5 hours at $8.00 /hour $40.00 Fixed overhead* 5 hours at $12.00 /hour $60.00. Total standard overhead cost per unit produced is $100.00. The standard is based on a practical capacity of 300,000 direct labor hours per month.

In October, the company produced 56,000 switches although 60,000 were scheduled. The company worked 275,000 direct labor hours at a total cost of $2,550,000. Variable overhead costs were $2,340,000, and fixed overhead costs were $3,750,000. The production manager suggests adopting a more current basis for allocating factory overhead, citing increased automation and reduced direct labor.

Paper For Above instruction

This paper analyzes the factory overhead variances for Able Control Company, focusing on fixed and variable overhead costs, and discusses the managerial implications of these variances. It aims to evaluate how the variances reflect on operational efficiency and cost control, and proposes strategic actions to improve cost management and production planning.

Introduction

Effective cost control and variance analysis are critical for manufacturing firms to maintain profitability and operational efficiency. Company management relies on variance analysis to identify deviations from standard costs which can inform corrective actions. The case of Able Control Company, a manufacturer of electrical switches, presents an intriguing scenario where the evolution of manufacturing technology warrants a reassessment of traditional overhead allocation methods. This paper computes pertinent variances for October, interprets their implications, and provides strategic recommendations for operational improvement.

Calculation of Variances

Fixed Overhead Spending Variance

The fixed overhead spending variance reflects the difference between actual fixed overhead costs and budgeted fixed overhead based on the actual hours worked.

• Standard fixed overhead rate per hour = $12.00
• Actual fixed overhead costs = $3,750,000
• Actual direct labor hours = 275,000

Budgeted fixed overhead = Standard rate per hour × Actual hours worked = $12.00 × 275,000 = $3,300,000

Fixed overhead spending variance = Actual fixed overhead - Budgeted fixed overhead = $3,750,000 - $3,300,000 = $450,000 unfavorable.

Production Volume Variance (Fixed Overhead)

This variance indicates the difference arising from producing fewer or more units than planned, relative to fixed overhead application capacity.

• Standard hours for actual production= 56,000 units × 5 hours = 280,000 hours
• Practical capacity = 300,000 hours

Fixed overhead applied at standard rate per hour = 280,000 × $12.00 = $3,360,000

Budgeted fixed overhead for actual production = Standard rate × Standard hours for actual output = $12.00 × 280,000 = $3,360,000

Production volume variance = Budgeted fixed overhead - Fixed overhead applied = $3,360,000 - (Standard rate × Actual hours for units produced)

Since fixed overhead is based on standard hours, the variance can be viewed as: (Practical capacity hours - Actual hours) × Rate = (300,000 - 275,000) × $12.00 = 25,000 × $12.00 = $300,000 favorable.

Variable Overhead Spending Variance

This variance measures the difference between actual variable overhead costs and the budgeted variable overhead for actual hours worked.

• Standard variable overhead rate per hour = $8.00
• Actual variable overhead costs = $2,340,000
• Actual hours worked = 275,000

Budgeted variable overhead for actual hours = $8.00 × 275,000 = $2,200,000

Variable overhead spending variance = Actual variable overhead - Budgeted variable overhead = $2,340,000 - $2,200,000 = $140,000 unfavorable.

Variable Overhead Efficiency Variance

This variance indicates whether the actual direct labor hours used were more or less than standard hours for actual production, affecting the variable overhead.

• Standard hours for actual output = 56,000 units × 5 hours = 280,000 hours
• Actual hours worked = 275,000 hours

Variable overhead efficiency variance = (Standard hours for actual output - Actual hours) × Standard rate = (280,000 - 275,000) × $8.00 = 5,000 × $8.00 = $40,000 favorable.

Discussion of Variance Implications

The fixed overhead spending variance of $450,000 unfavorable suggests that actual fixed costs exceeded expectations, possibly due to inefficiencies or overbudgeting. Conversely, the production volume variance of $300,000 favorable indicates that actual production was less than planned, leading to under-absorption of fixed overhead — a typical consequence of lower output levels.

The variable overhead spending variance of $140,000 unfavorable indicates that actual variable costs were higher than expected, which could be due to inefficiencies such as machine setup issues or wastage. Nevertheless, the variable overhead efficiency variance of $40,000 favorable suggests increased efficiency in using direct labor hours, perhaps attributable to automation that reduced labor dependence.

Managerial Implications and Recommendations

The variances collectively highlight discrepancies in cost control and production planning. The significant unfavorable fixed overhead spending variance warrants scrutiny of overhead expenses, possibly indicating overbudgeting or unexpected cost increases. The favorable efficiency variance reflects improved use of labor hours, likely a result of automation and better machine utilization.

Considering the production manager’s comment on automation and reduced labor, the traditional basis for overhead allocation, which primarily depends on direct labor hours, becomes less suitable. The company should consider shifting towards activity-based costing (ABC) methods or machine-hour-based allocations that better reflect the current manufacturing environment. This change would enable more accurate overhead application, supporting better decision-making and cost management.

Furthermore, the company should analyze the causes of excess fixed costs to identify areas for cost reduction or process improvements. Enhanced variance analysis and regular monitoring can help detect inefficiencies early, allowing corrective actions to prevent cost overruns.

Investing in automation not only improves efficiency but also necessitates revisiting standard costs and variances regularly. Adaptive cost systems that reflect technological advancements will enable the company to maintain accurate product costing, strategic pricing, and competitive advantage.

In addition, aligning production schedules with capacity and demand forecasts can help optimize resource utilization, preventing under- or over-utilization of fixed resources. Implementing continuous improvement programs such as Lean or Six Sigma may further enhance operational efficiency.

Conclusion

The analysis of Able Control Company's overhead variances reveals critical insights into its manufacturing performance. While efficiency improvements are evident, cost control issues persist, particularly concerning fixed overhead costs. To adapt to technological changes and the new manufacturing landscape, the company should consider updating its cost allocation bases, enhancing variance analysis processes, and focusing on strategic cost management. Such measures will improve operational performance, cost accuracy, and overall profitability in an increasingly automated environment.

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