Straightforward Variance Analysis: Arrow Enterprises Uses A
Straightforward Variance Analysisarrow Enterprises Uses A Standard C
Arrow Enterprises employs a standard costing system to evaluate its production performance for product no. 549. The standard cost sheet indicates specific input and cost standards for materials, labor, and factory overheads. During December, various operational activities occurred, including procurement of materials, labor hours incurred, and overhead costs. The objective is to analyze the variances related to direct materials, direct labor, and factory overheads to assess operational efficiency and cost control.
This analysis involves computing the variances—material, labor, and overhead—to compare actual costs against standard costs. Variances can be classified as price or rate variances and efficiency variances, providing insights into areas where management can improve or where costs are exceeding expectations. Accurate variance analysis is crucial for better cost management and strategic decision-making.
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Variance analysis is a vital component of managerial accounting that provides insights into the differences between actual and standard costs. It enables management to evaluate the efficiency of operations, control costs, and implement corrective actions. In this context, Arrow Enterprises’ standard costing system and operational data for December form the basis for such analysis.
Standard Cost Structure and Operational Data
According to the standard cost sheet for product no. 549, the costs per unit are as follows: direct materials at $26.00 (4 units at $6.50 each), direct labor at $68 (8 hours at $8.50), variable factory overhead at $56 (8 hours at $7.00), and fixed factory overhead at an unspecified total, with the total standard cost per unit being $170.00. For December, the company’s actual activities included acquiring 26,350 units of materials at $6.40 per unit, incurring labor hours totaling 51,400 at an average wage rate of $8.75, and incurring overhead costs totaling $508,400. The actual production was 6,500 units.
Direct Material Variances
Material cost variance analysis involves calculating the price variance and usage variance. The price variance compares the actual cost per unit of materials to the standard cost, while the usage variance compares the actual quantity used to the standard quantity allowed for actual production.
Material Price Variance (MPV):
= (Actual Price – Standard Price) × Actual Quantity Purchased
= ($6.40 – $6.50) × 26,350
= (-$0.10) × 26,350
= -$2,635
This results in a favorable variance of $2,635, indicating that materials were purchased at a lower cost than standard.
Material Usage Variance (MUV):
Standard quantity for actual production = 4 units × 6,500 units produced = 26,000 units
Actual quantity used = 26,350 units
Standard cost per unit of material = $6.50
Actual cost = 26,350 units × $6.40 = $168,640
Standard cost for actual production = 26,000 × $6.50 = $169,000
Material usage variance = (Standard quantity – Actual quantity used) × Standard price
= (26,000 – 26,350) × $6.50
= (-350) × $6.50
= -$2,275
This is an unfavorable usage variance, indicating higher material consumption than standard.
Direct Labor Variances
Labor variance analysis considers wage rate and efficiency variances. The actual hours worked and wage rate are compared to standards to evaluate efficiency and cost control.
Labor Rate Variance (LRV):
= (Actual wage rate – Standard wage rate) × Actual hours worked
= ($8.75 – $8.50) × 51,400
= $0.25 × 51,400
= $12,850
This is an unfavorable variance, showing wages were higher than planned.
Labor Efficiency Variance (LEV):
Standard hours for actual production = 8 hours × 6,500 units = 52,000 hours
Actual hours worked = 51,400 hours
Labor efficiency variance = (Standard hours – Actual hours) × Standard wage rate
= (52,000 – 51,400) × $8.50
= 600 × $8.50
= $5,100
This is a favorable variance, indicating greater efficiency in labor utilization.
Factory Overhead Variances
Overhead variances include two main components: variable overhead and fixed overhead variances.
Variable Overhead Spending Variance:
= (Actual variable overhead rate per hour – Standard rate) × Actual hours
First, determine actual variable overhead rate per hour:
Actual variable overhead total = Total overhead – Fixed overhead (budgeted)
Given fixed overhead (budgeted) = $1.8 million annually, spread evenly over the year, and total actual overhead = $508,400. Assuming all overhead is variable for simplicity (since fixed overhead rate isn't explicitly broken down), variances are influenced by actual costs and standards.
However, considering data limitations, we analyze total overhead relative to standard overhead for actual hours worked:
Standard variable overhead per hour = $7.00
Actual variable overhead incurred (approximated) = $508,400 (total overhead) – fixed overhead component
Assuming fixed overhead spread evenly, fixed overhead per hour = $1,800,000 / (annual hours). Since specific hours are not given for the fixed component, we focus on the overall overhead variance instead.
Total Overhead Variance:
Standard total overhead at actual hours: 8 hours per unit × 6,500 units = 52,000 hours
Total standard overhead at these hours: (Variable + Fixed) per hour × total hours
= ($7.00 + fixed overhead rate per hour) × 52,000 hours
Given data limitations, a simplified approach is to compare actual overhead incurred with the budgeted overhead for actual production.
Actual overhead incurred = $508,400
Budgeted overhead at standard hours = (budgeted overhead rate per hour) × 52,000 hours
If the standard rate is calculated based on total fixed overhead over the expected annual hours (not provided), overall, the variance analysis suggests an unfavorable total overhead variance due to actual overhead exceeding standard expectations, indicating inefficiencies or overruns in overhead costs.
Conclusion
Variance analysis reveals that Arrow Enterprises experienced favorable material cost variances due to lower purchase prices but unfavorable usage variances because of higher consumption. Labor variances indicate higher wages than standard costs but better efficiency in labor utilization. Overhead variances point towards cost overruns, potentially signaling inefficiencies in factory operations. These insights help management identify specific areas—material procurement, labor efficiency, or overhead control—requiring attention for cost management improvements. Accurate and ongoing variance analysis remains a vital tool for maintaining manufacturing efficiency and cost competitiveness in a dynamic business environment.
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