Sol Electronics, a fast-growing electronic device producer, uses a standard costing system, with standards set at the beginning of each year. In the second quarter of 2015, Sol faced two challenges: it had to negotiate and sign a new short-term labour agreement with its workers' union, and it also had to pay a higher rate to its suppliers for direct materials. The new labour contract raised the cost of direct manufacturing labour relative to the company's 2015 standards. Similarly, the new rate for direct materials exceeded the company's 2015 standards. However the materials were of better quality than expected, so Sol's management was confident that there would be less waste and less rework in the manufacturing process. They also speculated that the per-unit direct manufacturing labour cost might decline as a result of the materials' improved quality.

At the end of the second quarter, Sol's CFO, Terence Shaw, reviewed the following results:

Shaw was relieved to see that the anticipated savings in material waste and rework seemed to have materialized. But, he was concerned that the union would press hard for higher wages, given that actual unit costs came in below standard unit costs and operating income continued to climb.
Required
1. Prepare a detailed variance analysis of the second-quarter results relative to the static budget. Show how much of the improvement in operating income arose due to changes in sales volume and how much arose for other reasons. Calculate variances that isolate the effects of price and usage changes in direct materials and direct manufacturing labour.
2. Use the results of requirement 1 to prepare a rebuttal to the union's anticipated demands in light of the second-quarter results.
3. Terence Shaw thinks that the company can negotiate better if it changes the standards. Without performing any calculations, discuss the pros and cons of immediately changing the standards.

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Variable Costs Variable Costs per Unit First-Quarter 2015 Actual Results Standard Direct materials 2.2 kg at S12.54 2.3 kg at S13.34 S5.70/kg 0.5 hrs at $12/hr $5.80/kg Direct manufacturing 0.52 hrs 6.00 10.00 $28.54 at $12/hr 6.24 10.00 S29.58 labour Other variable costs Static Budget for Each Quarter Based on 2015 First-Quarter 2015 Results Units Selling price per unit Sales Variable costs: 4,000 $ 70 S280,000 4,400 $ 72 $316,800 Direct materials Direct manufacturing labour Other variable costs 50,160 24,000 40,000 114,160 165,840 68,000 S97,840 58,696 27,456 44,000 130,152 186,648 66,000 $120,648 Total variable costs Contribution margin Fixed costs Operating income