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Price Variance and Standard Cost Systems

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Standard cost systems can have motivational effects; some are desirable, some are not.
Consider the following situation:

The materials purchasing manager is paid a salary plus a bonus based on the net favorable materials price variance. Generally, this bonus amounts to 30 - 40% of the manager's total compensation. Due to the bankruptcy of a company in a related field, there is an opportunity to buy a key raw material. The standards for this material call for grade 2A, usually purchased for $56 per ton. Because of the bankruptcy, the company can obtain a higher grade, 4A, for $62 per ton. While the quality of the final product will be the same regardless of the grade of material used, there will be substantial savings in material yield and labor productivity if 4A is used. These savings are expected to be two to three times the additional cost of $6 per ton.

Required:
A. How would an unfavorable price variance on a particular purchase affect the overall price variance for the year?
B. Would the use of the materials price variance as a basis for the manager's bonus lead to a desirable or undesirable behavioral outcome? Explain; being sure to note whether the manager would likely pursue acquisition

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Required:
A. How would an unfavorable price variance on a particular purchase affect the overall price variance for the year?

Brief discussion on variance

A variance is the difference between standard and the actual. With regard to the costing one can find variance in both price and quantity. A price standard is the amount that should be paid for some input--direct material, direct labor, or overhead. A quantity standard relates to how much of the input should be used--direct material, direct labor, overhead. This is then compared with the actual to find out either favorable or unfavorable variance. It helps in management by exception--depending ...

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Operating system using standard absorption cost: Anderson Ltd.

Anderson Ltd. manufactures gearboxes for use in cars. At the start of the year, the management of Anderson Ltd. estimated that its costs would be:
Direct labor 8% sales value
Direct material 50% sales value
Variable production overhead 8% sales value
Fixed production overhead 12% sales value
Administration overhead 5% sales value

This was based on the following:
80 employees
2000 hours worked by each employee
40 000 gearboxes manufactured in the year as budgeted production
£200 unit selling price.

You have recently been employed by the company to establish a standard costing system. At the end of the year you were able to extract the following information:
- Labor costs £4.40/hour
- 32 000 units sold
- £210/unit selling price
- 160 000 hours were worked
- Variable production overheads were £640 000
- fixed production overheads were £810 000
- Administration costs were £350 000
- Raw material prices were 10% higher than expected
- Total expenditure on raw material was £3.696 M
- There were no opening or closing stocks of raw materials.

QUESTION- You are required to prepare an operating statement for the year, using a standard absorption costing system.

Direct Labor=
Direct Materials=
Variable overhead=
Fixed overhead=
Admin. overhead=
Total=

Selling price=
Standard profit (per unit) =
Budgeted profit=
Sales price variance=
Sales quantity variance=

Cost Variances
Labor Variances
Standard hours =
Standard cost/hour =
Rate variance =
Standard time =
Actual time =
Time variance =
Efficiency variance =

Material Variances
Material price =
Material usage standard =
actual =
Material usage variance =

Variable overheads
Standard cost £/hour =
Expenditure variance =
Standard cost =
Actual cost =
Efficiency variance (time Ã? cost) =

Fixed overheads
Expenditure variance =
Volume variance =

Admin overhead (treat as fixed)
Expenditure variance =
Volume variance =

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