58. (Standards revision) Westlake Company produces a component for aircraft manufacturers. A standard cost system has been used for years with good results.

Unfortunately, Westlake’s original direct material source went out of business.

The new source produces a similar but higher quality material. The price per pound from the original source averaged $7; the price from the new source is $7.77. The new material reduces scrap and, thus, reduces the use of direct material from 1.25 to 1.00 pounds per unit. In addition, direct labor is reduced from 24 to 22 minutes per unit because there is less scrap labor and machine setup time.

The direct material problem was occurring at the same time that labor negotiations resulted in an increase of over 14 percent in hourly direct labor costs.

The average rate rose from $12.60 per hour to $14.40 per hour. Production of the main product requires a high level of labor skill. Because of a continuing shortage in that skill area, an interim wage agreement had to be signed.

Westlake started using the new direct material on April 1, the same date that the new labor agreement went into effect. However, the company is still using standards that were set at the beginning of the calendar year. The direct material and direct labor standards for the component are as follows:

Direct material 1.2 pounds at $6.80 per pound $ 8.16 Direct labor 20 minutes at $12.30 per DLH 4.10 Standard cost per unit $12.26 Howard Foster, cost accounting supervisor, had been examining the following April 30 performance report.

Jane Keene, assistant controller, came into Foster’s office and Foster said, “Jane, look at this performance report! Direct material price increased 11 percent and the labor rate increased over 14 percent during April. I expected greater variances, yet prime costs decreased over 5 percent from the $13.79 we experienced during the first quarter of this year. The proper message just isn’t coming through.”
“This has been an unusual period,” said Keene. “With all the unforeseen changes, perhaps we should revise our standards based on current conditions and start over.”
Foster replied, “I think we can retain the current standards but expand the variance analysis. We could calculate variances for the specific changes that have occurred to direct material and direct labor before we calculate the normal price and quantity variances. What I really think would be useful to management right now is to determine the impact the changes in direct material and direct labor had in reducing our prime costs per unit from $13.79 in the first quarter to $13.05 in April—a reduction of $0.74.”

a. Discuss the advantages of (1) immediately revising the standards and (2)
retaining the current standards and expanding the analysis of variances.

b. Prepare an analysis that reflects the impact of the new direct material and new labor contract on reducing Westlake’s prime costs per unit from $13.79 to $13.05. The analysis should show the changes in direct material and direct labor costs per unit that are caused by (1) the use of new direct materials and (2) the new labor contract. This analysis should be in sufficient detail to identify the changes due to direct material price, direct labor rate, the effect of direct material quality on direct material usage, and the effect of direct material quality on direct labor usage. (CMA adapted)

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PERFORMANCE REPORT STANDARD COST VARIANCE ANALYSIS FOR APRIL 2001 Standard Price Variance Quantity Variance Actual DM $ 8.16 ($0.97 x 1.0) $0.97 U ($6.80 x 0.2) $1.36 F $ 7.77 DL 4.10 $12.26 [$2.10 x (22/60)] 0.77 U [$12.30 x (2/60)] 0.41 U 5.28 $13.05 DM DL COMPARISON OF 2001 ACTUAL COSTS Average 1st Quarter Costs $ 8.75 5.04 $13.79 April Costs $ 7.77 5.28 $13.05 % Increase (Decrease) (11.2) 4.8 (5.4)