tools-for-enterprise-performance-evaluation

# Or you can perform the noted algebraic calculations

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Unformatted text preview: you can perform the noted algebraic calculations for the price and quantity variances; adding them together gives you the total variance. In performing the math operations, be very careful to note that unfavorable variances (negative numbers) offset favorable (positive numbers) variances. But, don’t get lost in the math and forget the importance of the analysis. Management’s goal is to pinpoint problem areas. A total variance could be zero, resulting from the purchasing department having negotiated favorable pricing that was wiped out by waste in material usage. A good manager would want to take corrective action, but would be unaware of the problem based on an overall budget versus actual comparison. The moral of the story is to always look into the details for improvement opportunities. 4.2 An Illustration of Direct Material Variance Calculations Blue Rail Manufacturing produces high quality handrails, gates, banisters, corral systems, and similar welded steel products. The primary raw material is 40 foot long pieces of heavy gauge steel pipe. This pipe is custom cut and welded into rails like that shown in the accompanying picture. In addition, the final stages of production require some grinding and sanding operations, along with a final spray coating of paint (welding rods, grinding disks, and paint are relatively inexpensive and are classified as indirect material components within factory overhead). Blue Rail measures their output in “sections.” Each section consists of one post and four rails. The sections are 10’ in length and the posts average 4’ each. Some overage and waste is expected due to the need for an extra post at the end of a set of sections, taller than normal posts, faulty welds, bad pipe cuts, and defective pipe. The company has adopted an achievable standard of 1.25 pieces of raw pipe (50’) per section of rail. During August, Blue Rail produced 3,400 sections of railing. It was anticipated that pipe would cost \$80 per 40’ piece. Standard material cost for this level of output is computed as follows: Output -- Number of rail sections Standard quantity of input per rail section -- 40’ long pieces of pipe * Standard quantity of input (pipes) to achieve output (rail sections) Standard price per unit of input (pipe) Standard cost of direct materials 3,400 1.25 4,250 X \$80 \$ 340,000 X The production manager was very disappointed to receive the monthly performance report that revealed actual material cost of \$369,000. A closer examination of the actual cost of materials revealed the following: Download free ebooks at bookboon.com 25 Variance Analysis Tools for Enterprise Performance Evaluation Actual quantity of input (pipes) to achieve output (rail sections) Actual price per unit of input (pipe) Actual cost of direct materials 4,100 X \$90 \$ 369,000 The total direct material variance was unfavorable \$29,000 (\$340,000 vs. \$369,000). However, this unfavorable outcome was driven by higher prices for raw material, not waste. It seems that steel prices escal...
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