Guaranteed Minimum Wages and Cost Behavior Patterns (Prepared by the author and adapted for use in a CPA examination) The Lavin Company had a contract with a labor union that guaranteed a minimum wage of $500 payable monthly to direct laborers with at least 12 years’ service. One hundred workers currently qualified for such coverage. All direct-labor employees are paid $5 per hour.

The budget for 19_1 was based on the usage of 400,000 hours of direct labor, a total of $2,000,000. Of this amount, $600,000 (100 workers $500 X 12 months) was regarded as fixed.

Data on performance for the first three months of 19_1 follow:

JANUARY FEBRUARY MARCH Direct-labor hours actually worked 22,000 32,000 42,000 Standard direct-labor hours allowed* 22,000 32,000 42,000 Direct-labor costs budgeted $127,000 $162,000 $197,000 Direct-labor costs incurred 110,000 160,000 210,000 Variance (U = unfavorable;
F = favorable) 17,000 F 2,000 F 13,000 U * Note that perfect efficiency is being assumed.
Zs The factory manager was perplexed by the results, which showed favorable variances when production was low and unfavorable variances when production was high. He felt that his control over labor costs was consistently good.
7. Why did the variances arise? Use amounts and diagrams, as necessary, to explain.
Assume that only 5,000 standard and actual hours were utilized in a given month and that all the most senior workers were used. Does this direct-labor budget provide a basis for evaluating direct-labor performance? What variances would arise under the approach used in 1? What variances would arise under the approach you recommend?
Suppose that 5,500 actual hours were used, but that only 5,000 standard hours were allowed for the work accomplished. What variances would arise under the approach used in 1? Under the approach you recommend?