Question

Preparing a flexible budget and computing standard cost variances

McKnight Recliners manufactures leather recliners and uses flexible budgeting and a standard cost system. McKnight allocates overhead based on yards of direct materials. The company’s performance report includes the following selected data:

		Static Budget (1,025 recliners)	Actual Results (1,005 recliners)
Sales	(1,025 recliners * \(500 each)	\)512,500
	(1,005 recliners * \(495 each)		\)497,475
Variable Manufacturing Costs:
Direct Materials	(6,150 yds. @ \(8.50/yard)	52,275
	(6,300 yds. @ \)8.30/yard)		52,290
Direct Labor	(10,250 DLHr @ \(9.20/DLHr)	94,300
	(9,850 DLHr @ \)9.40/DLHr)		92,590
Variable Overhead	(6,150 yds. @ \(5.10/yard)	31,365
	(6,300 yds. @ \)6.50/yard)		40,950
Fixed Manufacturing Costs:
Fixed Overhead		62,730	64,730
Total Cost of Goods Sold		240,670	250,560
Gross Profit		\(271,830	\)246,915

Requirements

1. Prepare a flexible budget based on the actual number of recliners sold.

2. Compute the cost variance and the efficiency variance for direct materials and for direct labor. For manufacturing overhead, compute the variable overhead cost, variable overhead efficiency, fixed overhead cost, and fixed overhead volume variances. Round to the nearest dollar.

3. Have McKnight’s managers done a good job or a poor job controlling materials, labor, and overhead costs? Why?

4. Describe how McKnight’s managers can benefit from the standard cost system.

Short answer

1. Gross profit as per flexible budget is $265,302.
2. Variance analysis:

Direct material cost variance	$1,260(F)
Direct material efficiency variance	$2,295(U)
Direct labor cost variance	$1,970(U)
Direct labor efficiency variance	$1,840(F)
Variable overhead cost variance	$2,520(U)
Variable overhead efficiency variance	$1,377(U)
Fixed overhead cost variance	$2,000(U)
Fixed overhead volume variance	$1,224(U)

1. The manager is only able to control the cost incurred in the direct material and the labor employed in the business operations.
2. Using a standard costing system manager will be able to develop the master budget and control the various departments of the business entity by establishing the standard performance.

Step-by-step solution

Definition of Flexible Budget

The budget that gets adjusted according to the level of activity the company achieves is known as a flexible budget. This budget gets adjusted according to the business’s cost variation.

Flexible budget

Particular	Budgeted cost per unit	Amount $ (1,005 units)
Sales	$500	$502,500
Less:
Direct material $\left(\frac{6,150}{1,025}\times 1005\right)$	$8.50/yard	51,255
Direct labor $\left(\frac{10,250}{1,025}\times 1005\right)$	$9.20/ DLH	92,460
Variable overhead (6,030 yards)	$5.10/yard	30,753
Fixed manufacturing cost:
Fixed overhead		62,730
Total cost of goods sold		($237,198)
Gross profit		$265,302

Variance analysis

Direct material variance analysis:

Cost variance:

$\begin{array}{c}\mathrm{Direct}\mathrm{material}\mathrm{cost}\mathrm{variance}=\left(\mathrm{Actual}\mathrm{cost}-\mathrm{Standard}\mathrm{cost}\right)\times \mathrm{Actual}\mathrm{quantity}\\ =\left(\mathrm{\$}8.30-\mathrm{\$}8.50\right)\times 6,300\\ =\mathrm{\$}1,260\left(\mathrm{F}\right)\end{array}$

Efficiency variance:

$\begin{array}{c}\mathrm{Direct}\mathrm{material}\mathrm{efficiency}\mathrm{variance}=\left(\mathrm{Actual}\mathrm{quantity}-\mathrm{Standard}\mathrm{quantity}\right)\times \mathrm{Standard}\mathrm{cost}\\ =\left(6,300-\frac{6,150}{1,025}\times 1,005\right)\times \mathrm{\$}8.50\\ =\left(6,300-6,030\right)\times 8.50\\ =\mathrm{\$}2,295\left(\mathrm{U}\right)\end{array}$

Direct labor variance analysis:

Cost variance:

$\begin{array}{c}\mathrm{Direct}\mathrm{labor}\mathrm{cost}\mathrm{variance}=\left(\mathrm{Actual}\mathrm{rate}-\mathrm{Standard}\mathrm{rate}\right)\times \mathrm{Actual}\mathrm{hours}\\ =\left(\mathrm{\$}9.40-\mathrm{\$}9.20\right)\times 9,850\\ =\mathrm{\$}1,970\left(\mathrm{U}\right)\end{array}$

Efficiency variance:

$\begin{array}{c}\mathrm{Direct}\mathrm{labor}\mathrm{efficiency}\mathrm{variance}=\left(\mathrm{Actual}\mathrm{hours}-\mathrm{Standard}\mathrm{hours}\right)\times \mathrm{Standard}\mathrm{rate}\\ =\left(9,850-\frac{10,250}{1,025}\times 1,005\right)\times \mathrm{\$}9.20\\ =\left(9,850-10,050\right)\times \mathrm{\$}9.20\\ =\mathrm{\$}1,840\left(\mathrm{F}\right)\end{array}$

Variable overhead cost variance:

role="math" localid="1656931900353" $\begin{array}{c}\mathrm{Variable}\mathrm{overhead}\mathrm{cost}\mathrm{variance}=\left(\mathrm{Actual}\mathrm{cost}-\mathrm{Standard}\mathrm{cost}\right)\times \mathrm{Actual}\mathrm{quantity}\\ =\left(\mathrm{\$}6.50-\mathrm{\$}5.10\right)\times 6,300\\ =\mathrm{\$}2,520\left(\mathrm{U}\right)\end{array}$

Variable overhead efficiency variance:

$\begin{array}{c}\mathrm{Variable}\mathrm{overhead}\mathrm{efficiency}\mathrm{variance}=\left(\mathrm{Actual}\mathrm{quantity}-\mathrm{Standard}\mathrm{quantity}\right)\times \mathrm{Standard}\mathrm{cost}\\ =\left(6,300-\frac{6,150\times 1,005}{1,025}\right)\times \mathrm{\$}5.10\\ =\left(6,300-6,030\right)\times 5.10\\ =1377\left(\mathrm{U}\right)\end{array}$

Fixed overhead cost variance:

Particular	Amount $
Actual fixed overhead	$64,730
Less: Budgeted fixed overhead	(62,730)
Fixed overhead cost variance (U)	$2,000

Fixed overhead volume variance:

Particular	Amount $
Budgeted fixed overhead	$62,730
Less: Allocated fixed overhead $\left(\frac{\mathrm{\$}62,730}{1,025}\times 1,005\right)$	(61,506)
Fixed overhead volume variance (U)	$1,224

Manager performance analysis

1. Direct material cost variance: Direct material cost variance is positive reflecting that manager is able to control its direct material cost.
2. Direct material efficiency variance and variable overhead efficiency variance: Both of these variances are unfavorable reflecting that the manager is not able to control the usage of the direct material.
3. Direct labor cost variance: It is unfavorable reflecting that the business entity is not able to maintain the labor cost within the standard limits.
4. Direct labor efficiency variance: It is favorable reflecting that the business entity is able to maintain the labor hours within the standard limit.
5. Variable overhead cost variance: It is unfavorable reflecting that the manager is not able to maintain the variable overhead of the business entity within the prescribed standards.
6. Fixed overhead cost variance: The manager is not able to control its fixed cost because the fixed overhead cost variance is unfavorable.
7. Fixed overhead volume variance: The fixed overhead volume variance is unfavorable reflecting that the business entity was not able to produce the goods according to the budgeted units.

Benefits of standard cost system

The standard cost system will help the manager in the following ways:

1. It helps in the preparation of the master budget.
2. It helps in the establishment of the standard performance level.
3. It helps in determining the sales price.
4. It helps in defining the standards that will be used to measure the performance.