Chapter 9, Problem 32P

Petrillo Company produces engine parts for large motors. The company uses a standard cost system for production costing and control. The standard cost sheet for one of its higher volume products (a valve) is as follows:

During the year, Petrillo had the following activity related to valve production:

1. a. Production of valves totaled 20,600 units.
2. b. A total of 135,400 pounds of direct materials was purchased at $5.36 per pound.
3. c. There were 10,000 pounds of direct materials in beginning inventory (carried at $5.40 per pound). There was no ending inventory.
4. d. The company used 36,500 direct labor hours at a total cost of $656,270.
5. e. Actual fixed overhead totaled $110,000.
6. f. Actual variable overhead totaled $168,000.

Petrillo produces all of its valves in a single plant. Normal activity is 20,000 units per year. Standard overhead rates are computed based on normal activity measured in standard direct labor hours.

Required:

1. 1. Compute the direct materials price and usage variances.
2. 2. Compute the direct labor rate and efficiency variances.
3. 3. Compute overhead variances using a two-variance analysis.
4. 4. Compute overhead variances using a four-variance analysis.
5. 5. Assume that the purchasing agent for the valve plant purchased a lower-quality direct material from a new supplier. Would you recommend that the company continue to use this cheaper direct material? If so, what standards would likely need revision to reflect this decision? Assume that the end product’s quality is not significantly affected.
6. 6. Prepare all possible journal entries (assuming a four-variance analysis of overhead variances).

To determine

Compute the direct materials price variance and the direct materials usage variance.

Explanation of Solution

Direct material price variance: The variation in between actual price and estimated price paid for materials multiplied by the actual quantity is called material price variance. It is used to determine difference in price paid for material the price that was supposed to be paid for material.

The following formula is used to calculate direct material price variance:

$\text{Direct materials price variance}=\left[\begin{array}{l}\left(\begin{array}{l}\text{Actual}\text{Price}-\\ \text{Standard Price}\end{array}\right)\\ \times \text{Actual Quantity}\end{array}\right]$

Direct material usage (efficiency) variance: It is a measure that determines the variation in between actual and standard quantity of input multiplied by the standard unit price is called material usage variance.

The following formula is used to calculate direct material usage variance:

$\text{Direct materials usage variance}=\left[\begin{array}{l}\left(\begin{array}{l}\text{Actual}\text{Quantity}-\\ \text{Standard Quantity}\end{array}\right)\\ \times \text{Standard Price}\end{array}\right]$

Compute the direct materials price variance:

$\begin{array}{c}\text{Direct materials price variance}=\left[\begin{array}{l}\left(\begin{array}{l}\text{Actual}\text{Price}-\\ \text{Standard Price}\end{array}\right)\\ \times \text{Actual Quantity}\end{array}\right]\\ =\left[\begin{array}{l}\left(\begin{array}{l}\text{\$5}\text{.36 per pound}\\ -\text{\$5}\text{.40 per pound}\end{array}\right)\\ \times \text{135,400 pounds}\end{array}\right]\\ =\left[\text{\$}\text{.04}\times \text{135,400}\right]\\ =\$5,416F\end{array}$

Compute the direct materials usage variance:

$\begin{array}{c}\text{Direct materials usage variance}=\left[\begin{array}{l}\left(\begin{array}{l}\text{Actual}\text{Quantity}-\\ \text{Standard Quantity}\end{array}\right)\\ \times \text{Standard Price}\end{array}\right]\\ =\left[\begin{array}{l}\left(\text{145,400 pounds}-\text{144,200}\right)\\ \times \$5.40\end{array}\right]\\ =\left[1,200\times \$5.40\right]\\ =\$6,480\text{ U}\end{array}$

Working note 1: Calculate the standard quantity:

$\begin{array}{c}\text{Standard quantity = }\left(\begin{array}{l}\text{Direct materials per lbs}\\ \times \text{Number of units produced}\end{array}\right)\\ =\left(7\text{lbs}\times 20,600\text{ units}\right)\\ =144,200\end{array}$

Working note 2: Calculate the actual quantity:

$\begin{array}{c}\text{Actual quantity = }\left(\begin{array}{l}\text{Total pounds of direct materials found}\\ +\text{Beginning inventory of direct materials}\end{array}\right)\\ =\left(135,400+10,000\right)\\ =145,400\end{array}$

Conclusion

Therefore, the direct materials price variance and the usage variance is $5,416 F and $6,480 U respectively.

To determine

Calculate the direct labor rate variance and labor efficiency variance.

Explanation of Solution

Direct Labor Rate Variance: The direct labor rate variance is a measure to determine the variation in the estimated cost of the direct labor and the actual cost of the direct labor and is multiplied by the actual hours is called direct labor rate variance.

The following formula is used to calculate the direct labor rate variance:

$\text{Direct labor rate variance}=\left[\begin{array}{l}\left(\begin{array}{l}\text{Actual}\text{Rate}-\\ \text{Standard Rate}\end{array}\right)\\ \times \text{Actual Hours}\end{array}\right]$

Direct labor efficiency variance is a measure that determines the difference between the estimated labor hours and the actual labor hours used and is multiplied by the standard rate per hour is called material usage variance.

The following formula is used to calculate direct labor efficiency variance:

$\text{Direct labor efficiency variance}=\left[\begin{array}{l}\left(\begin{array}{l}\text{Actual}\text{Hours}-\\ \text{Standard Hours}\end{array}\right)\\ \times \text{Standard Rate Per Hour}\end{array}\right]$

Calculate the direct labor rate variance:

$\begin{array}{c}\text{Direct labor rate variance}=\left[\begin{array}{l}\left(\begin{array}{l}\text{Actual}\text{Rate}-\\ \text{Standard Rate}\end{array}\right)\\ \times \text{Actual Hours}\end{array}\right]\\ =\left[\begin{array}{l}\left(\text{\$17}\text{.98}-\$18.00\right)\\ \times 36,500\text{Hours}\end{array}\right]\\ =\left[\$.02\times 36,500\text{Hours}\right]\\ =\$730\text{ F}\end{array}$

Calculate the labor efficiency variance:

$\begin{array}{c}\text{Direct labor efficiency variance}=\left[\begin{array}{l}\left(\begin{array}{l}\text{Actual}\text{Hours}-\\ \text{Standard Hours}\end{array}\right)\\ \times \text{Standard Rate Per Hour}\end{array}\right]\\ =\left[\begin{array}{l}\left(\text{36,500 hours}-36,050\text{ hours}\right)\\ \times \$18.00\text{ Per Hour}\end{array}\right]\\ =\left[450\times \$18.00\text{ Per Hour}\right]\\ =\$8,100\text{ U}\end{array}$

Working note 3: Calculate the standard hours:

$\begin{array}{c}\text{Standard hours = }\left(\begin{array}{l}\text{Direct labor per hour}\\ \times \text{Number of units produced}\end{array}\right)\\ =\left(1.75\times 20,600\text{ units}\right)\\ =36,050\end{array}$

Conclusion

Therefore, the direct labor rat variance and the efficiency variance are $730 F and $8,100 U respectively.

To determine

Calculate the overhead variances using two variance analysis.

Explanation of Solution

Calculate the overhead variances using two variance analysis:

Budget variance:

$\begin{array}{c}\text{Budgeted variance =}\left[\begin{array}{l}\text{ Actual overhead}-\\ \text{Budgeted overhead}\end{array}\right]\\ \text{=}\left[\text{\$}278,000-\$249,200\right]\\ =\$28,800\text{ U}\end{array}$

Working note 4: Calculate the actual overhead:

$\begin{array}{c}\text{Actual overhead =}\left[\begin{array}{l}\text{ Actual fixed overhead +}\\ \text{ Actual variable overhead}\end{array}\right]\\ \text{=}\left[\text{\$}110,000+\$168,000\right]\\ =\$278,000\end{array}$

Working note 5: Calculate the budgeted overhead:

Step 1: Calculate the budgeted fixed overhead.

$\begin{array}{c}\text{Budgeted fixed overhead =}\left[\begin{array}{l}\text{ Standard fixed overhead rate}\times \\ \text{ Standard hours}\end{array}\right]\\ \text{=}\left[\text{\$3}\times \left(1.75\times 20,000\right)\right]\\ =\$3\times 35,000\\ =\$105,000\end{array}$

Step 2: Calculate the budgeted variable overhead.

$\begin{array}{c}\text{Budgeted variable overhead =}\left[\begin{array}{l}\text{ Standard fixed overhead rate}\times \\ \text{ Standard hours}\end{array}\right]\\ \text{=}\left[\text{\$4}\times \left(1.75\times 20,600\right)\right]\\ =\$4\times 36,050\\ =\$144,200\end{array}$

Step 3: Calculate the total budgeted overhead.

$\begin{array}{c}\text{Total budgeted overhead =}\left[\begin{array}{l}\text{ Budgeted fixed overhead }\\ \text{+ Budgeted variable overhead}\end{array}\right]\\ \text{=}\left[\$105,000+\$144,200\right]\\ =\$4\times 36,050\\ =\$249,200\end{array}$

Volume variance:

Step 1: Compute the applied fixed overhead.

$\begin{array}{c}\text{Applied fixed overhead =}\left[\begin{array}{l}\text{ Standard fixed overhead rate}\times \\ \text{ Standard hours}\end{array}\right]\\ \text{=}\left[\text{\$7}\times 36,050\text{ hours}\right]\\ =\$252,350\end{array}$

Step 2: Compute the volume variance.

$\begin{array}{c}\text{Volume variance = }\left(\begin{array}{l}\text{Budgeted fixed overhead}\\ -\text{Applied fixed overhead}\end{array}\right)\\ \text{= }\left(\$249,200-\$252,350\right)\\ =\$3,150\text{ F}\end{array}$

Working note 5: Calculate the standard hours:

$\begin{array}{c}\text{Standard hour =}\left(\begin{array}{l}\text{Number of units produced}\\ \times \text{Direct labor hour per unit}\end{array}\right)\\ =\left(\text{20,600}\times 1.75\text{hours per unit}\right)\\ =36,050\text{ hours}\end{array}$

Conclusion

Therefore, the budgeted and volume variance are $28,800 U and $3,150 F respectively.

To determine

Calculate the overhead variances using a four-variance analysis.

Explanation of Solution

Overhead Variance: The overhead variance is the difference arising between the real overhead consumed in the production of a product, and the estimated overhead determined in the production of that product.

Calculate the overhead variances using a four-variance analysis:

Step 1: Compute the budgeted variable overhead cost.

$\begin{array}{c}\text{Budgeted variable overhead cost =}\left[\begin{array}{l}\text{ Standard variable overhead rate}\\ \times \text{Actual direct labor hours}\end{array}\right]\\ \text{ =}\left[\text{\$4}\text{.00}\times 36,500\right]\\ =\$146,000\end{array}$

Step 2: Compute the variable overhead spending variance.

$\begin{array}{c}\text{Variable overhead spending variance = }\left[\begin{array}{c}\text{Actual variable overhead costs}-\\ \text{Budgeted variable overhead costs}\end{array}\right]\\ \text{= }\left[\text{\$168,000}-\$\text{146,000}\right]\\ =\$22,000\text{U}\end{array}$

Compute the variable overhead efficiency variance:

Step 1: Compute the applied variable overhead.

$\begin{array}{c}\text{Applied variable overhead =}\left[\begin{array}{l}\text{ Standard variable overhead rate}\\ \times \text{Standard hours}\end{array}\right]\\ \text{=}\left[\text{\$4}\text{.00}\times 36,050\right]\\ =\$144,200\end{array}$

Step 2: Compute the variable overhead efficiency variance.

$\begin{array}{c}\text{Efficiency variance = }\left(\begin{array}{l}\text{Budgeted variable overhead}\\ -\text{Applied variable overhead}\end{array}\right)\\ \text{= }\left(\$146,000-\$\text{144,200}\right)\\ =\$1,800\text{ U}\end{array}$

Working note 6: Calculate the direct labor hour per unit:

$\begin{array}{c}\text{Direct labor hour per unit =}\left(\frac{\text{ Actual direct labor hours}}{\text{Units prodcued}}\right)\\ \text{=}\left(\frac{\text{ 36,500 hours}}{\text{20,000 units}}\right)\\ =1.825\text{ hours per unit }\end{array}$

Working note 7: Calculate the actual direct labor hours:

$\begin{array}{c}\text{Standard direct labor hour =}\left(\begin{array}{l}\text{Units produced}\\ \times \text{Direct labor hour per unit}\end{array}\right)\\ =\left(\text{20,000}\times 1.825\text{hours per unit}\right)\\ =36,500\text{hours}\end{array}$

Conclusion

Therefore, the variable overhead spending and efficiency variance are $22,000 U and $1,800 U respectively.

To determine

Explain whether the company continues to purchases cheaper direct materials if so indicate the standard need revision to reflect this decision.

Explanation of Solution

The company would not continue to purchase low –quality materials because it affects the company. The budgeted cost of direct materials at the 20,600 units’ production level is $778,680$\left(\text{\$5}\text{.40×7×20,600}\right)$ , and the actual cost was $779,744$\left(\text{\$725,744+\$54,000}\right)$ . As seen from the detailed analysis, this cost overrun was caused by a large, unfavorable usage variance, probably attributable to the lower quality of direct materials. Also, the unfavorable direct labor efficiency variance may be caused by the inferior direct materials. If the favorable price variance had been greater than the unfavorable usage variances, then continued purchase of the cheaper direct materials would have been recommended, with a revision in the usage standards.

To determine

Prepare journal entries (four-variance analysis of overhead variances).

Explanation of Solution

Journalizing: It is the process of recording the transactions of an organization in a chronological order. Based on these journal entries recorded, the amounts are posted to the relevant ledger accounts.

Accounting rules for journal entries:

• To increase balance of the account: Debit assets, expenses, losses and credit all liabilities, capital, revenue and gains.
• To decrease balance of the account: Credit assets, expenses, losses and debit all liabilities, capital, revenue and gains.

Prepare journal entries (four-variance analysis of overhead variances):

Date	Accounts title and explanation	Debit ($)	Credit ($)
	Direct Materials	731,160
	Direct Materials Price variance		5,416
	Accounts Payable		725,744
	(To record the purchase of direct materials)
	Work in Process	778,680
	Direct Materials Usage Variance	6,480
	Direct Materials		785,160
	(To record the usage of direct materials)
	Work in Process	648,900
	Direct Labor Efficiency Variance	8,100
	Direct Labor Rate Variance		730
	Wages Payable		656,270
	(To record the use of direct labor)
	Cost of Goods Sold	13,850
	Direct Labor Rate Variance	730
	Direct Materials Usage Variance		6,480
	Direct Labor Efficiency Variance		8,100
	(To record the use of direct material and labor variances)
	Direct Materials Price variance	5,416
	Cost of Goods Sold		5,416
	(To close the direct materials price variance)
	Variable Overhead Control	168,000
	Miscellaneous Accounts		168,000
	(To record incurrence of actual overhead)
	Fixed Overhead Control	110,000
	Miscellaneous Accounts		110,000
	(To record incurrence of actual overhead)
	Work in Process	144,200
	Variable Overhead Control		144,200
	(To close the overhead variances)
	Work in Process	108,150
	Fixed Overhead Control		108,150
	(To close the overhead variances)
	Variable Overhead Spending Variance	22,000
	Variable Overhead Efficiency Variance	1,800
	Fixed Overhead Spending Variance	5,000
	Fixed Overhead Volume Variance		3,150
	Fixed Overhead Control		1,850
	Variable Overhead Control		23,800
	(To close the overhead variances)
	Cost of Goods Sold	28,800
	Variable Overhead Efficiency Variance		1,800
	Fixed Overhead Spending Variance		5,000
	Variable Overhead Spending Variance		22,000
	(To close the overhead variances)
	Fixed Overhead Volume Variance	3,150
	Cost of Goods Sold		3,150
	(To close the cost of goods sold)

Table (1)