Tempro, inc, uses a standard cost accounting system. Variances for the year ended December 31, 2005 were as follows:
Material Price Variance Unfavorable
Material usage variance favorable
labor rate variance favorable
labor efficiency variance unfavorable
Managers at Tempro are considering the following changes in operations for the next year ending December 31, 2006
1. An across the board pay increase of 5% will be given to all personnel.
2. the purchasing department will be allowed to purchase lower grades of material
3. several key production workers will be transferred into managerial positions. These workers will be replaced either by new hires or by production personnel who will be transferred from another department.
4. additional inspectors will be hired to ensure quality production. The cost of these inspectors will be considered administrative and general expense.
Required: Assuming that product standards are not changed from the previous year, what impact, if any, would you expect each of the changes to have on the company's variances? Consider each decision separately, and identify the variance that would be affected by the decision and whether the change would increase or decrease the prior-year variance. Explain your answer.
Solution is provided below. It covers full explanation to conceptual matters and effect of various changes on Direct material and Direct labor variances supported by numerical examples in the table format.
Part I: Favorable and unfavorable variance -Introduction and concept:
(A) Standard costs: Standard costing is a technique of cost control. It suggests what the reasonable cost should be under given set of condition. Standard cost is a norm of measuring performance. In a manufacturing or service
(B) Variance Analysis: Standards are set for each element of cost. Price and quantity standards are expressed in the terms of rate and units. As with the direct labor, they are expressed as rate and hours. Standard rate per unit or per hour is a predetermined rate. Standard cost is compared with actual cost in relation to the actual output and variance is calculated. Variance is the difference between actual costs and standard costs for each element of costs.
© Favorable variance and Unfavorable variance: Variance is classified in to various categories like favorable and unfavorable variance, Controllable and uncontrollable variance etc.
(1) Favorable variance: When actual cost is less than standard cost the variance is favorable.
(2) When actual cost is more than standard cost variance is unfavorable.
In variance ...
Changes in costs and the effects on variance for Tempro Inc is examined.