Comment on the possible interactions between the variances listed in the report. Which ones are likely to have been caused by the purchase of the new production equipment? The company budgets and applies production overhead on the basis of direct-labor hours.
Eastern Auto Parts Company manufactures replacement parts for automobile repair. The company recently installed a flexible manufacturing system, which has significantly changed the production pro-cess. The installation of the new FMS was not anticipated when the current year’s budget and cost struc-ture were developed. The installation of the new equipment was hastened by several major breakdowns in the company’s old production machinery.
The new equipment was very expensive, but management expects it to cut the labor time required by a substantial amount. Management also expects the new equipment to allow a reduction in direct-material waste. On the negative side, the FMS requires a more highly skilled labor force to operate it than the company’s old equipment.
The following cost variance report was prepared for the month of July, the first full month after the equipment was installed.
EASTERN AUTO PARTS COMPANY Cost Variance Report for the Month of July
Direct material:
Actual cost ..................................................................................................598,700
Direct-material price variance ....................................................................150
U Direct-material quantity variance .......................................................3,900
FDirect labor: Standard cost .................................................................393,000
Actual cost ...................................................................................................383,800
Direct-labor rate variance...........................................................................4,800
U Direct-labor efficiency variance ......................................................14,000
FProduction
Actual cost ................................................................................................408,000
Variable-overhead spending variance ..................................................8,000
U Variable-overhead efficiency variance ...........................................10,000
F Fixed-overhead
U Fixed-overhead volume variance ..................................................(20,000)
††The sign of the volume variance is negative; applied fixed overhead exceeded budgeted fixed overhead.
Required: Comment on the possible interactions between the variances listed in the report. Which ones are likely to have been caused by the purchase of the new production equipment? The company budgets and applies production overhead on the basis of direct-labor hours.
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