Eastern Auto Parts Company manufactures replacement pails for automobile repair. The company recently installed a flexible manufacturing system, which has significantly changed the production process. The installation of the new FMS was not anticipated when the current year’s budget and cost structure were developed. The installation of the new equipment was hastened by several major breakdowns in the company’s old production machinery.

The new equipment was very expensive, but management expects it to cut the labor time required by a substantial amount. Management also expects the new equipment to allow a reduction in direct-material waste. On the negative side, the FMS requires a more highly skilled labor force to operate it than the company’s old equipment.

The following cost variance report was prepared for the month of July, the first full month after the equipment was installed.

EASTERN AUTO PARTS COMPANY

Cost Variance Report

For the Month of July

Direct material:

Standard cost ...............$602,450

Actual cost ................ 598,700

Direct-material price variance .......... 150 U

Direct-material quantity variance ........ 3,900 F

Direct labor:

Standard cost ............... 393,000

Actual cost ................. 383,800

Direct-labor rate variance ............ 4,800 U

Direct-labor efficiency variance ........ 14,000 F

Manufacturing overhead:

Applied to work in process .......... 400,000

Actual cost ................ 408,000

Variable-overhead spending variance ......... 8,000 U

Variable-overhead efficiency variance ...... 10,000 F

Fixed-overhead budget variance ......... 30,000 U

Fixed-overhead volume variance ........ (20,000)

‘F denotes favorable variance; U denotes unfavorable variance.

The sign of the volume variance is negative; applied fixed overhead exceeded budgeted fixed overhead.

Required:

Comment on the possible interactions between the variances listed in the report. Which ones are likely to have been caused by the purchase of the new production equipment? The company budgets and applies manufacturing overhead on the basis of direct-labor hours.