Variance Analysis For Control Companies That Manufacture

15 58 Four Variance Analysisable Control Company Which Manufactures E

Able Control Company, which manufactures electrical switches, uses a standard cost system and carries all inventories 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, for a total standard overhead cost per unit of $100.00. In October, the company produced 56,000 switches out of a scheduled 60,000. The company worked 275,000 direct labor hours at a total cost of $2,550,000. Variable Overhead costs amounted to $2,340,000, and Fixed Overhead costs were $3,750,000. The production manager suggests updating the factory overhead costing method due to recent automation and a shift in labor needs, arguing that traditional overhead costs may no longer be appropriate.

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The analysis of variances in manufacturing overhead costs is critical for evaluating a company's operational efficiency, cost control, and accuracy of standard costing systems. In the case of Able Control Company, which specializes in manufacturing electrical switches, an examination of specific variances—namely, fixed and variable overhead variances—provides valuable insights into the impact of operational changes, such as automation, on cost performance and cost management strategies.

1. Calculation of Variances

a. Fixed Overhead Spending Variance

The fixed overhead spending variance measures the difference between actual fixed overhead costs incurred and the budgeted fixed overhead based on standard rates. The standard fixed overhead rate per unit is $60.00, calculated as 5 hours at $12.00/hour. The expected fixed overhead for actual production (56,000 units) is:

\[ \text{Standard Fixed Overhead} = 56,000 \times 60 = \$3,360,000 \]

However, actual fixed overhead costs are reported as $3,750,000. The fixed overhead spending variance is therefore:

\[ \text{Spending Variance} = \text{Actual Fixed Overhead} - \text{Budgeted Fixed Overhead} \]

\[ = \$3,750,000 - \$3,360,000 = \$390,000 \text{ Unfavorable} \]

This indicates the company spent $390,000 more on fixed overhead than anticipated, which could suggest inefficient spending, increased costs due to poor budgeting, or other extraneous factors such as inflation increases or unexpected expenses.

b. Production-Volume Variance

The production volume variance assesses the impact of producing fewer units than planned, affecting fixed overhead absorption. The standard fixed overhead rate per unit is $60. For actual production of 56,000 units, the standard fixed overhead allocated is $3,360,000. The original scheduled production was 60,000 units, which would have absorbed:

\[ 60,000 \times 60 = \$3,600,000 \]

The variance due to production volume is:

\[ (\text{Standard Fixed Overhead for actual units} - \text{Standard Fixed Overhead at scheduled production}) \]

\[ = \$3,360,000 - \$3,600,000 = -\$240,000 \]

The negative sign indicates a favorable variance of $240,000 because less fixed overhead was absorbed due to lower production, suggesting under-utilization of fixed resources or overestimation in standard costing.

c. Variable Overhead Spending Variance

This variance measures the difference between actual variable overhead costs and what should have been incurred at standard rates. The standard variable overhead rate per unit is $40.00 (based on 5 hours at $8.00/hour). For the actual production of 56,000 units, the standard variable overhead cost should be:

\[ 56,000 \times 40 = \$2,240,000 \]

Actual variable overhead costs are $2,340,000. The variable overhead spending variance is:

\[ \$2,340,000 - \$2,240,000 = \$100,000 \text{ Unfavorable} \]

This indicates that actual variable overhead expenses were $100,000 higher than expected, potentially due to increased utility rates, inefficiencies, or unanticipated costs.

d. Variable Overhead Efficiency Variance

This variance compares actual labor hours used versus standard hours allowed for actual production. Standard hours for 56,000 units:

\[ 56,000 \times 5 = 280,000 \text{ hours} \]

The company used 275,000 hours; thus, the efficiency variance is:

\[ (Standard Hours - Actual Hours) \times Standard Rate \]

\[ = (280,000 - 275,000) \times \$8 = 5,000 \times \$8 = \$40,000 \text{ Favorable} \]

A favorable efficiency variance suggests that the company used fewer labor hours per unit than planned, possibly due to process efficiencies or increased automation.

2. Implications and Recommendations

The variance analysis reveals both positive and negative aspects of Able Control Company's cost performance. The favorable efficiency variance indicates successful operational efficiencies, likely driven by automation and process improvements. Conversely, unfavorable variances in fixed overhead spending and variable overhead costs highlight areas for scrutiny and possible cost management improvements.

The increase in fixed overhead costs by $390,000 suggests that the company's current budgeting may not reflect recent cost structures, especially given automation that has likely altered the nature of fixed costs. Under-investment in updated cost accounting methods could lead to inaccurate product costing and misinformed managerial decisions. Therefore, the company's suggestion to update or revise overhead allocation methods is justified. Realigning standard costs with current operational realities ensures better cost control and pricing strategies.

To improve operations, Able Control should consider implementing activity-based costing (ABC) to more accurately assign overhead to products based on activities that drive costs. This approach would provide more precise cost information, especially in an automated environment where traditional labor-based rates no longer accurately reflect resource consumption. Additionally, reviewing and renegotiating supplier contracts and utility agreements may reduce actual variable overhead costs. Enhanced training and machinery maintenance could also sustain efficiency gains and prevent potential cost escalations.

Furthermore, management should revisit their standard costing system to incorporate the impact of automation, possibly shifting from labor hours to machine hours or other relevant activity measures. This transition would improve the accuracy of cost variances and support more strategic decision-making. Lastly, maintaining flexible overhead budgets that account for technological changes can help avoid significant variances in fixed costs, providing early signals for cost control measures and investments.

In conclusion, thorough variance analysis reveals operational efficiencies and cost control issues at Able Control Company. Emphasizing updated costing methods, operational efficiency, and strategic cost management will enable the company to sustain competitiveness and profitability in a rapidly changing industrial environment.

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