Chapter 10, Problem 63P

Basuras Waste Disposal Company has a long-term contract with several large cities to collect garbage and trash from residential customers. To facilitate the collection, Basuras places a large plastic container with each household. Because of wear and tear, growth, and other factors, Basuras places about 200,000 new containers each year (about 20% of the total households). Several years ago, Basuras decided to manufacture its own containers as a cost-saving measure. A strategically located plant involved in this type of manufacturing was acquired. To help ensure cost efficiency, a standard cost system was installed in the plant. The following standards have been established for the products variable inputs:

During the first week in January, Basuras had the following actual results:

The purchasing agent located a new source of slightly higher-quality plastic, and this material was used during the first week in January. Also, a new manufacturing process was implemented on a trial basis. The new process required a slightly higher level of skilled labor. The higher- quality material has no effect on labor utilization. However, the new manufacturing process was expected to reduce materials usage by 0.25 pound per container.

Required:

1. 1. CONCEPTUAL CONNECTION Compute the materials price and usage variances. Assume that the 0.25 pound per container reduction of materials occurred as expected and that the remaining effects are all attributable to the higher-quality material. Would you recommend that the purchasing agent continue to buy this quality, or should the usual quality be purchased? Assume that the quality of the end product is not affected significantly.
2. 2. CONCEPTUAL CONNECTION Compute the labor rate and efficiency variances. Assuming that the labor variances are attributable to the new manufacturing process, should it be continued or discontinued? In answering, consider the new process’s materials reduction effect as well. Explain.
3. 3. CONCEPTUAL CONNECTION Refer to Requirement 2. Suppose that the industrial engineer argued that the new process should not be evaluated after only one week. His reasoning was that it would take at least a week for the workers to become efficient with the new approach. Suppose that the production is the same the second week and that the actual labor hours were 9,000 and the labor cost was $99,000. Should the new process be adopted? Assume the variances are attributable to the new process. Assuming production of 6,000 units per week, what would be the projected annual savings? (Include the materials reduction effect.)

To determine

Calculate the value of material price variance and material usage variance. Identify whether the plant manger could continue to purchase this quality product or purchase the usual quality.

Explanation of Solution

Variance:

The amount obtained when actual cost is deducted from budgeted cost is known as variance. Variance is calculated to find whether the cost is over applied or under applied.

Use the following formula to calculate material price variance:

$\text{Material Price Variance}=\left[\begin{array}{c}\left(\text{Actual Price}\times \text{Actual Quantity}\right)\\ -\left(\text{Standard Price}\times \text{Actual Quantity}\right)\end{array}\right]$

Substitute $3.55 for actual price, 69,000 units for actual quantity and $3.50 for standard price in the above formula.

$\begin{array}{c}\text{Material Price Variance}=\left(\$3.55\times 69,000\right)-\left(\$3.50\times 69,000\right)\\ =\text{\$3,450}\left(\text{U}\right)\end{array}$

Therefore, the material price variance is $3,450 (U).

Use the following formula to calculate material usage variance with the help of columnar approach:

$\text{Material Usage Variance}=\left(\begin{array}{c}\left(\text{Standard Price}\times \text{Actual Quantity}\right)\\ -\left(\text{Standard Price}\times {\text{Standard Quantity}}^1\right)\end{array}\right)$

Substitute $3.50 for standard price, 69,000 units for actual quantity and 72,000 for standard quantity in the above formula.

$\begin{array}{c}\text{Material Usage Variance}=\left(\$3.50\times 69,000\right)-\left(\$3.50\times 72,000\right)\\ =\$10,500\left(\text{F}\right)\end{array}$

Therefore, the material usage variance is $10,500 (F).

The new process helps in saving the cost of $5,250$\left(0.25\times 6,000\times \$3.50\right)$. The decision for use the good quality material helps to the company in balancing the material price variance and material usage variance. The net savings by using the high quality product is $1,800$\left(\$5,250-\$3,450\right)$. Therefore, company should use the good quality material.

Working Note:

1. Calculation of standard quantity:

$\begin{array}{c}\text{Standard Quantity}=\text{Actual Quantity}\times \text{Standard Rate}\\ =6\text{,000}\times \text{\$12}\\ =\text{\$72,000}\end{array}$

To determine

Calculate the value of labor rate variance and labor efficiency variance. Identify whether the labor variances are attributable to the new manufacturing process should be continued or discontinued.

Explanation of Solution

Use the following formula to calculate labor rate variance:

$\text{Labor Rate Variance}=\left[\begin{array}{c}\left(\text{Actual Rate}\times \text{Actual Hours}\right)\\ -\left(\text{Standard Rate}\times \text{Actual Hours}\right)\end{array}\right]$

Substitute $118,800 for actual rate and actual hours, 10,800 hours for actual hours and $11 for standard rate in the above formula.

$\begin{array}{c}\text{Labor Rate Variance}=\$118,800-\left(\$11\times 10,800\text{ Hours}\right)\\ =\$0\end{array}$

Therefore, the labor rate variance is $0.

Use the following formula to calculate labor efficiency variance:

$\text{Labor Efficiency Variance}=\left(\begin{array}{c}\left(\text{Standard Rate}\times \text{Actual Hours}\right)\\ -\left(\text{Standard Rate}\times {\text{Standard Hours}}^1\right)\end{array}\right)$

Substitute $11.00 for standard rate, 10,800 hours for actual hours and 10,200 hours for standard hours in the above formula.

$\begin{array}{c}\text{Labor Efficiency Variance}=\left(\$11.00\times 10,800\text{ Hours}\right)-\left(\$11.00\times 10,200\text{ Hours}\right)\\ =\$6,600(\text{U)}\end{array}$

Therefore, the labor efficiency variance is $6,600 (U).

The new process helps in material usage in saving the cost of $5,250 and losses the cost in labor variance of $6,600, which giving a net loss of $1,350$\left(\$5,250-\$6,600\right)$. Therefore, company should discontinue the new process.

Working Note:

1. Calculation of standard hours:

$\begin{array}{c}\text{Standard Hours}=\text{Actual Output}\times \text{Standard Rate}\\ =6\text{,000}\times \text{\$1}\text{.70}\\ =10\text{,200 Hours}\end{array}$

To determine

Calculate the value of labor rate variance and labor efficiency variance. Identify whether the new process be adopted or not.

Explanation of Solution

Use the following formula to calculate labor rate variance:

$\text{Labor Rate Variance}=\left[\begin{array}{c}\left(\text{Actual Rate}\times \text{Actual Hours}\right)\\ -\left(\text{Standard Rate}\times \text{Actual Hours}\right)\end{array}\right]$

Substitute $99,000 for actual rate and actual hours, 9,000 hours for actual hours and $11 for standard rate in the above formula.

$\begin{array}{c}\text{Labor Rate Variance}=\$99,000-\left(\$11\times 9,000\text{ Hours}\right)\\ =\$0\end{array}$

Therefore, the labor rate variance is $0.

Use the following formula to calculate labor efficiency variance:

$\text{Labor Efficiency Variance}=\left(\begin{array}{c}\left(\text{Standard Rate}\times \text{Actual Hours}\right)\\ -\left(\text{Standard Rate}\times {\text{Standard Hours}}^1\right)\end{array}\right)$

Substitute $11.00 for standard rate, 9,000 hours for actual hours and 10,200 hours for standard hours in the above formula.

$\begin{array}{c}\text{Labor Efficiency Variance}=\left(\$11.00\times 9,000\text{ Hours}\right)-\left(\$11.00\times 10,200\text{ Hours}\right)\\ =\$13,200(\text{F)}\end{array}$

Therefore, the labor efficiency variance is $13,200(F).

The new process helps in material usage in saving the cost of $959,400$\left[\left(\$0.25\times 6,000\times \$3.50\right)+\left(\$13,200-\$0\right)\times 52\text{weeks}\right]$. The weekly saving of company is $5,250 $\left(\$5250+\$13,200\right)$. Therefore; according to the calculations company should continue the new process.

Working Note:

1. Calculation of standard hours:

$\begin{array}{c}\text{Standard Hours}=\text{Actual Output}\times \text{Standard Rate}\\ =6\text{,000}\times \text{\$1}\text{.70}\\ =10\text{,200 Hours}\end{array}$