Sunair Boat Builders, Inc.

Executive Summary

Many companies have discovered the importance of cost control as a means of survival in fiercely competitive markets in the early 2000. By implementing an organized, companywide process for controlling costs, a firm can reverse its sinking earnings trend and recover its market position.

Standard costs are established and revised each period during the budgeting process. Standard costs are continually reviewed and periodically revised if significant changes occur in production methods or in the prices paid for material, labor, and overhead. The level of production output plays an important role in determining cost standards. For instance, grossly underutilized production facilities often experience varying degrees of cost inefficiency. Conversely, the stress and demands imposed on production facilities operating at full capacity can cause cost overruns. Thus, standards should correspond to what costs should be under normal operating conditions for a particular company. Establishing realistic cost standards requires input from many different sources- often including people from outside of the business organization.

Materials variances may be caused by the quality and price of materials purchased and by the efficiency with which these materials are used. Labor variances stem from workers’ productivity, pay scales of workers placed on the job, and the quality of the materials with which they work. Overhead variances result both from actual spending and from differences between actual and normal levels of production.

Case Context

Bill Schmidt, Sun Air’s accountant, expressed his disappointment about deviations from the production volume and costs from the set of standards in the molding department. He noticed the apparent variances of the actual costs of production of 430 hulls against the standard costs of production for the normal planned volume of 450 hulls while reviewing the most recent month’s production results. He predicted that there will be unfavorable variances again so he wanted to discuss the matter with the other members of the management team.

Problem Definition

The management of Sun Air Boat Builders, Inc. needs to determine how well the molding department is doing and identify the steps on how to improve its performance in terms of the standards set by the company’s accountant and the production department supervisor.

Framework of Analysis

1. Determine the molding department’s:

a. materials price and usage variances

b. labor rate and efficiency variances

c. production volume and spending overhead variances

2. Identify probable causes of such variances.

3. Describe the relationships that exist among those variances.

Analysis

STANDARD COSTS

Cost Per Hull Cost of 450 Hulls

Materials

Glass Cloth

120 sqft @ $2.00 $240 $108,000

Glass Mix

40 lbs @ $3.75 $150 $67,500

Total Direct Materials Cost $390 $175,500

Direct Labor

Mixing

0.5 hr @ $20.25 $10.12 $4,554

Molding

1.0 hr @ $20.25 $20.25 $9,112.50

Total Direct Labor Costs $30.37 $136,663.50

Indirect Costs

$24.30 $10,935

Total Costs to Mold Hulls $444.67 $200,101.50

ACTUAL COSTS

Cost Per Hull Cost of 450 Hulls

Materials

Purchased

Glass Cloth

60,000 sq.ft. @ $1.80 $216 $108,000

Glass Mix

20,000 lbs @ $4.09 $150 $81,800

Total Costs of Purchased Materials $366 $189,800

Used

Glass Cloth

54,000 sq.ft. @ $1.80 $216 $97,200

Glass Mix

19,000 lbs. @ $4.09 $150 $81,800

Total Costs of Used Materials $366 $179,000

Direct Labor

Mixing

210 hrs @ $21.37 $10.69 $4,487.70

Molding

480 hrs @ $20.25 $20.25 $9,720.00

Total Direct Labor Costs $30.94 $14,207.70

Indirect Costs

$11,140

Total Costs to Mold Hulls $475.23 $204,347.70

Materials Price Variance

AQP = Actual Quantity Purchased

AP = Actual Price

SP = Standard Price

MPV = Materials Price Variance

Glass Cloth

AP x AQP = $1.80 x 60,000 sq.ft. = $ 108,000

SP x AQP = $2.00 x 60,000 sq.ft. = $ 120,000

MPV $ 12,000 Favorable

Glass Mix

AP x AQP = $4.09 x 20,000 = $ 81,800

SP x AQP = $3.75 x 20,000 = $ 75,000

MPV $ 6,800 Unfavorable

Materials Usage Variance

SP = Standard Price

AQU = Actual Quantity Used

SQ = Standard Quantity

MUV = Materials Usage Variance

Glass Cloth

SP x AQU = $2.00 x 54,000sq.ft = $108,000

SP x SQ = $2.00 x 51,600sq.ft. = $103,200

Materials Usage Variance = $ 4,800 Unfavorable

Glass Mix

SP x AQU = $3.75 x 19,000lbs = $ 71,250

SP x SQ = $3.75 x 17,200lbs = $ 64,500

MUV = $ 6,750 Unfavorable

Labor Rate and Efficiency Variance

AR = Actual Rate

SR = Standard Rate

AH = Actual Hours

SH = Standard Hours

LRV = Labor Rate Variance

LEV = Labor Efficiency Variance

Labor Rate Variance

Direct Labor

Mixing

AR x AH = $21.37 x 210hrs = $4,487.70

SR x SH = $20.25 x 210hrs = $4,252.50

LRV = $ 235.20 Unfavorable

Molding

AR x AH = $20.25 x 480hrs = $9,720

SR x AH = $20.25 x 480hrs = $9,720

LRV = 0

Labor Efficiency Variance

Direct Labor

Mixing

SR x AH = $20.25 x 210hrs = $4,252.50

SR x SH = $20.25 x 215hrs = $4,353.75

LEV = $ 101.25 Favorable

Molding

SR x AH = $20.25 x 480hrs = $9,720

SR x SH = $20.25 x 430hrs = $8,707.50

LEV = $1,012.50

OverHead Cost Variance

Production Volume Variance = Absorbed – Budgeted

= $10,449 – $10,740

= $ 291.60 Unfavorable

Spending Variance = Budgeted – Actual

= $10,740 – $11,140

= $400 Unfavorable

**Absorption Rate = $24.30/hull

x 430

= $10,449

**Flexible Budget = $9.72 x 430 + $6,561

= $4,179.60 + $6,561

= $10,740.60

The price variance is favorable in the glass cloth but unfavorable in the glass mix. These variances may be attributed to a number of reasons. It could be that the purchased glass cloth is of low quality or there could have been other available cheaper substitutes. The favorable variance could also be a result of the purchasing department’s ability to buy materials from the company’s suppliers at discounted prices One particular factor the purchasing department should be cautious about though is the quality of materials that they were able to purchase at lower than standard costs.

The unfavorable variance in the glass mix could have been caused either by unexpected fluctuations in its market price or failure of the purchasing department to avail cash discounts from suppliers.

Although the purchasing department is usually responsible for attaining the standard prices for materials used in production, in other circumstances, however, the price variance is also the responsibility of the production department when there are last minute changes in the production requirements or when they request for particular brand names.

The materials usage variances for the glass cloth and glass mix are both unfavorable. The process of mixing and molding fiberglass hulls requires expertise and extra care on the part of the production people as minor errors in the adjustments could cause one unit to be discarded. The quality of the materials also plays a vital part. It was mentioned in the case that the molders tended to have cautious outlook toward mixing too little or cooking too long because no one wanted to end up throwing away a partial hull because there was too little glass mix. Thus, it can be deduced that the usage variance was not because of improper use of materials. Again, the emphasis would still be on the quality of the purchased materials.

On the other hand, the tendency of the workers to have cautious outlook toward mixing could be the cause why the labor rate variance for the mixing process is unfavorable. This process could have also required higher-skilled and higher-paid workers, hence causing the labor rate variance.

Notice, however, that although the company incurred a labor rate that is higher than what is specified in the standards, the higher-skilled and higher-paid workers were efficient. This is evident in the favorable direct labor efficiency variance for the mixing process. Note also that although the company achieved the standard labor rate for molding, efficiency suffered as can be seen in the labor efficiency variance of $1,012.50 for producing 430 hulls.

The overhead variances for production volume and spending are also both unfavorable. The production volume variance occurred because the actual production differed from the capacity level or volume used to calculate the standard the standard fixed overhead rate. In this case, Sun Air was able to produce 430 hulls only as compared to the standard normal volume of operations of 450 hulls.

The budget or spending variance is controllable by management. The unfavorable variance of $400 could be because of errors on the part of management in estimating how the fixed and variable overhead costs should be segregated.

Conclusion/Decision/Implementation:

The most recent month’s production results of the molding department of SunAir Boat Builders, Inc. revealed unfavorable direct and overhead cost variances. It is important to know what caused these variances especially if the values are significant because these variances do not give much meaning unless the reasons why they occurred are properly identified.

To be able to improve the performance of the molding department in terms of the standards set by the company’s management, the following steps are suggested:

Periodic reports on how actual prices compare with actual prices should be generated as frequently as deemed necessary to at least minimize or if possible completely eliminate price variances. This will provide better control for managers in preparing and allocating budget for production.

Quality of raw materials (glass cloth and glass mix) should be given more emphasis than cheaper prices in making purchase decisions.

The supervisor should closely monitor production processes to ensure proper handling of materials.

To be able to keep the whole production on schedule, management should make it a point to assign workers to jobs that match their current skills and level of expertise. Efficient allocation of materials and labor resources saves overhead costs.

The company will also benefit if management will also update their standards regularly based on industry standards and on current and historical data