We have the standard unit data for Wolverine Company of Michigan, and we are going to determine following with the data –
- Direct materials price variance (based on materials used)
- Direct materials usage variance
- Direct labor variance
- Direct labor efficiency variance
And the data for the company is –
|Normal volume per month is 40,000 direct labor hours. Wolverine’s January 2014 budget was based on normal|
|Volume. During January, Wolverine produced 7,800 units with records indicating the data following:|
|Actual:||The Wolverine Company Standards:|
|Direct materials purchased||25,000 lbs. @ $3.60||Direct Materials (2 lbs. @ $3.50 per lb.)||$7.00|
|Direct materials used||23,100 lbs.||Direct Labor (4 hours @ $6.50 per hour)||$26.00|
|Direct labor||40,100 hours @ $6.30||STANDARD COST PER UNIT||$33.00|
With addition to the values of the variances, we will define each variance category and how data for it is commonly collected, try to provide a narrative about how the value was computed and explain its use in evaluating operational results. And finally provide a narrative about which two categories require management’s priority attention and support the view.
Case Study of Wolverine Company of Michigan
Direct materials price variance (based on materials used) –
We calculate “Direct material price variance” to determine if the procurement is cost effective or price adverse. If the Actual price is lower than standard price then it is favorable, otherwise not. We need actual quantity purchased and the actual price of purchase along with the standard price to calculate direct material price variance (AccountingSimplified, n.d.).
From the data we have we know the company has actually quantity purchased 25,000 lb. at price $3.60 when the standard price was expected to be $3.50 per lb.
But, the company estimated to produce 7800 units, and with the rate 2lb per unit estimated material was (7800*2) = 15600 lb. and the quantity actually use is 23,100 lbs.
Direct Material Price Variance: = Actual Quantity x Actual Price – Actual Quantity x Standard Price
= Actual Cost – Standard Cost of Actual Quantity
Applying the above state formula –
Direct Material price Variance = (25000*3.60) – (25000* 3.5) = 90000 -87500 = 2500
We can conclude that the “Direct Material price Variance is $2500 and this is unfavorable because actual price is higher than budgeted price and it impacts profit negatively.
So when we consider the impact on operational result, because the company had to pay more than it estimated, they estimated to pay $3.50 per lb. but they had to pay $3.60 per lb. Most probably because shortage of material, they had to spend additional money, and that will reduce their potential profit.
Direct materials usage variance –
We determine “direct material usage variance” when actual quantity and standard quantity vary. We can determine, if the material usage is efficient or adverse, based on if we have overpaid or underpaid than estimate (AccountingSimplified, n.d.).
In this case, in the month of January the company’s standard production is 7,800 units, and per Direct material 1 unit requires 2 lb. of materials, hence 7800 units would have required (7800*2) = 15,600 lbs. , this is the standard quantity. And the Actual Quantity used in this case was 23,100 lb.
Direct Material Usage Variance = Actual Quantity x Standard Price – Standard Quantity x Standard Price
= Standard Cost of Actual Quantity – Standard Cost of Standard Quantity
= (Actual Quantity – Standard Quantity) x Standard Price
Applying this to our situation –
Direct Material usage Variance = (23100 – 15600) * 3.50 = 26250
So the Direct Material usage variance is $26,250, and this is unfavorable, since actual price of direct material is more than estimated price for direct material, it will impact the profitability negatively. It is evident because they estimated to produce 7800 units with 2lbs per unit estimate, but they actually used 23,100 lbs.
Direct labor variance –
Direct labor variance is used to calculate if the company has spent more or less than estimated on direct labor.
In hour case, the actual hours worked is 40,100 hrs. With actual rate $6.30 per hr., although the standard per hour rate was $6.50
So here is the equation –
Direct labor variance = (Actual hour * Actual Rate) – (Actual Hours * Standard Rate)
= (40100 * 6.30) – (40100 * 6.50) = 252630 – 260650 = -8020
Clearly the direct labor variance is $(8020), hence it is favorable. The company estimated for $6.50 hourly rate but they had to pay $6.30. The negative number means in direct labor company had to spend less money than estimated, so this will have a positive impact on profit.
Direct labor efficiency variance
The purpose of calculating the direct labor efficiency variance is to measure the performance of production department in utilizing the abilities of the workers. It helps us understand if we used more or less direct labor hours than expected. And we can determine if it is favorable or unfavorable based on the negative or positive outcome respectively (accountingexplained, n.d.).
Direct labor efficiency variance = (Actual hours* standard rate) – (standard hours * standard rate)
Direct labor efficiency variance = (40100 * 6.50) – (40000 * 6.50) = 260650 – 260000 = 650
Direct labor efficiency variance is positive for the company, which is $650 and this is unfavorable. The company had estimated for 40,000 hours but in actual they needed 40,100 hours. So this means they had to work extra, and this should negatively impact profit.
In this case which two categories require management’s attention as a priority?
This company has purchased and used direct material way more than estimated. For example they estimated to use 15,600 lb to produce 7,800 units, but they purchased 25,000 lbs material and they used 23,100 lbs. It is probable that the material has a poor quality or the wastage of material is high or may be labors are not trained to use the material.
Although the company paid slightly higher price for the material, they anticipated to pay $3.50 per lb but ended up paying $3.60 per lb, but this might be temporary or next time they can estimate better.
The direct labor hours are also higher than estimated, they estimated for 40,000 hrs but ended up working 40,100 hrs. This along with high usage of material gives me the idea that labors are either not trained to use the material or the quality of material is not good. So based on my result of direct materials price variance and direct materials usage variance, my recommendation to the company would be to pay close attention on quantity of actual direct material purchased and quantity of direct material used. These two categories are causing the company to lose more potential profit.
Retrieved on 3/11/2018. Retrieved from http://accounting-simplified.com/management/variance-analysis/material/price.html
Retrieved on 3/11/2018. Retrieved from http://accounting-simplified.com/management/variance-analysis/material/usage.html
Boyd, K(n.d). HOW TO CALCULATE DIRECT LABOR VARIANCES. Retrieved from http://www.dummies.com/business/operations-management/how-to-calculate-direct-labor-variances/
Retrieved on 3/11/2018. Retrieved from https://accountingexplained.com/managerial/standard-costing/dl-efficiency-variance