From the buyers standpoint fixed fee arrangements

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From the buyer’s standpoint, fixed fee arrangements provide protection against cost over- runs and/or hidden charges. The downside is that workers have an incentive to take shortcuts (in Shari’s example, the fewer hours spent on the job, the greater the profit). On the other hand, jobs billed out on an actual time basis impose risk of cost over-runs and hidden charges, although workers incentives to take shortcuts are muted. This particular problem provides a nice venue for instructors to discuss the advantages/disadvantages of fixed fee contracts. b. The tables below provide the required information to calculate the variances. Laureen’s labor: Flexible Budget “As if” budget Actual 1  50*  $50 70  $50 70  $50 $2,500 $3,500 $3,500 * The flexible budget quantity = 50 hours because there is only 1 job and Laureen planned for 50 hours to complete the job. Moreover, it is important to remember that the flexible budget quantity is based on output (and not input) which, in this case, is the number of jobs completed. A similar rationale applies for Laureen’s assistant. Assistant’s Labor: Flexible Budget “As if” budget Actual 1  100  $20 65  $20 65  $20 $2,000 $1,300 $1,300 Thus, both labor price variances are $0 (since the budgeted input price equaled the actual input price). Thus, Laureen’s labor quantity variance = $3,500 – $2,500 = $1,000 U . Balakrishnan, Sivaramakrishnan, & Sprinkle – 2e FOR INSTRUCTOR USE ONLY 8-30
For Laureen’s assistant, the labor quantity variance = $1,300 – $2,000 = $700 F . c. The total labor quantity variance is $300 U = ($1,000 U + 700 F) . There are no other costs (e.g., materials), there are no revenue variances, and the actual wage rate equals the budgeted rate. This number indeed explains the difference between Laureen’s actual profit and master budget profit for this job. The fact that the total labor quantity variance is unfavorable seems odd because the actual total number of hours worked (70 + 65 = 135) is less than the budgeted number of total labor hours to be worked (100 + 50 = 150 hours). How can we say that the firm was not as efficient even though fewer total hours were worked? The answer lies in the mix of hours. While fewer total hours were worked, a greater proportion of these hours were worked by Laureen (the more skilled and more highly compensated employee). Thus, it is not appropriate to consider the two types of labor hours as substitutes. Because of this, it is most appropriate to calculate the labor variances separately. Moreover, combining all of the variances can obscure differences between employees of differing skill or ability levels (e.g., a really productive employee and a non-productive employee). 8.55 a. To calculate the actual quantity of materials used, we use the quantity variance that compares the flexible budget to the “as if” budget. We cannot use the price variance since there are two unknowns, the actual price and quantity.

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