Comprehensive Variance Analysis [LO1, LO2, LO3]

Portland Company’s Ironton Plant produces precast ingots for industrial use. Carlos Santiago, who was recently appointed general manager of the Ironton Plant, has just been handed the plant’s contribution format income statement for October. The statement is shown below:

Budgeted Actual Sales (5,000 ingots) . . . . . . . . . . . . . . . . $250,000 $250,000 Variable expenses:
Variable cost of goods sold* . . . . . . . . 80,000 96,390 Variable selling expenses . . . . . . . . . . 20,000 20,000 Total variable expenses . . . . . . . . . . . . . 100,000 116,390 Contribution margin . . . . . . . . . . . . . . . . 150,000 133,610 Fixed expenses:
Manufacturing overhead . . . . . . . . . . . 60,000 60,000 Selling and administrative . . . . . . . . . . 75,000 75,000 Total fi xed expenses . . . . . . . . . . . . . . . . 135,000 135,000 Net operating income (loss) . . . . . . . . . . $ 15,000 $ (1,390)
*Contains direct materials, direct labor, and variable manufacturing overhead.

Mr. Santiago was shocked to see the loss for the month, particularly because sales were exactly as budgeted. He stated, “I sure hope the plant has a standard cost system in operation. If it doesn’t, I won’t have the slightest idea of where to start looking for the problem.”
The plant does use a standard cost system, with the following standard variable cost per ingot:

Standard Quantity or Hours Standard Price or Rate Standard Cost Direct materials . . . . . . . . . . . . . . . . . . . . 4.0 pounds $2.50 per pound $10.00 Direct labor . . . . . . . . . . . . . . . . . . . . . . . 0.6 hours $9.00 per hour 5.40 Variable manufacturing overhead . . . . . . 0.3 hours* $2.00 per hour 0.60 Total standard variable cost . . . . . . . . . . $16.00 During October the plant produced 5,000 ingots and incurred the following costs:

a. Purchased 25,000 pounds of materials at a cost of $2.95 per pound. There were no raw materials in inventory at the beginning of the month.

b. Used 19,800 pounds of materials in production. (Finished goods and work in process inventories are insignificant and can be ignored.)

c. Worked 3,600 direct labor-hours at a cost of $8.70 per hour.

d. Incurred a total variable manufacturing overhead cost of $4,320 for the month. A total of 1,800 machine-hours was recorded.
It is the company’s policy to close all variances to cost of goods sold on a monthly basis.
Required:
1. Compute the following variances for October:

a. Direct materials price and quantity variances.

b. Direct labor rate and efficiency variances.

c. Variable overhead rate and efficiency variances.
2. Summarize the variances that you computed in (1) above by showing the net overall favorable or unfavorable variance for October. What impact did this figure have on the company’s income s tatement?
3. Pick out the two most significant variances that you computed in (1) above. Explain to Mr. Santiago possible causes of these variances.