Ellison Furnace Corporation (EFC) is a manufacturer of industrial furnaces and heat-treating equipment, founded in 1915 and headquartered in Minneapolis, Minnesota. The company's business consists of two primary segments: original equipment and parts. Over the years, engineering innovations in the original equipment business have made the company's name, as EFC's furnaces have been used widely from car part manufacturing to the destruction of chemical and biological weapons. But the lower-profile parts business has long been the more profitable arm of the business; historically, EFC has found that once customers install equipment, they tend to prefer using the original manufacturer as the ongoing service and parts provider.

In early 2020, EFC managers began to worry that the steady profitability of the parts division was under threat. A new competitor entered the market and in June successfully won a contract from a long-time EFC customer for replaceable casings. These casings are purchased by a number of customers and useful in many manufacturing processes, so management was particularly concerned about the loss. Because of the lost contract, EFC management asked the plant accountant to compile financial information for July as soon as the month was over. As sales were not seasonal, the static sales and production budget for the plant for July was just one-twelfth of the annual budget.

On August 4, 2020, the plant accountant forwarded the report shown in Exhibit 1. The accountant also provided the following information:

• The original budget applied per-unit standard costs of $6 for direct materials and $16 total for direct labor, with each unit requiring two hours of direct labor.
• Due to a recent change in tariff rates, materials prices in July were 5% less than originally budgeted.
• Actual direct labor costs per hour were $8.20 in July due to a new bonus compensation program implemented earlier in the year.
• Beginning and ending inventory was the same.

Questions:

1. Form a flexible budget showing what revenues and costs should have been for production of 14,000 units, assuming that the selling price per unit, the variable costs per unit, and the total fixed costs were expected to remain the same as in the budget shown in Exhibit 1 shown at bottom.

2. Use the 14,000 unit flexible budget to analyze how much of the difference between the planned level of profit shown at the bottom of the Budget column in Exhibit 1 and the actual level of profit shown at the bottom of the Actual column is explained by each of the following components. For each part, include both the dollar amount and a verbal explanation of what it means:

1. expected effect of operating at a different actual volume of output (14,000 casings) than the originally planned volume of output (18,000 casings)
2. effect of an average selling price different than originally planned.
3. effect of actual costs different than your flexible budget to produce 14,000 casings.

3. The case provides information that allows us to examine two of the flexible-budget cost variances in more detail, namely the Direct Labor and Direct Material flexible-budget variances.

1. For each of these two variable cost variances, compute price and quantity variances.
2. In each of the two cases, how do the price and quantity variances relate to the flexible budget variance?

(Hint #1: You will find some of the information you need to compute price and quantity variances for these two items stated explicitly in the case. However, other information will need to be inferred. For example, when total cost = price x quantity, you can infer quantity if you know total cost and price or you can infer price if you know total cost and quantity. As a specific example, you can infer the actual quantity of labor hours used, by dividing the actual labor cost of $246,000 by the actual labor cost per hour of $8.20. As another example, you can infer the actual quantity of materials used, by dividing the actual materials cost of $85,400 by the actual material cost per unit of $5.70 (where $5.70 = 95% x standard material cost of $6.00/unit).)

(Hint #2: Don't confuse the roles of output quantities (for example 18,000 casings of output or 14,000 casings of output) with input quantities (for example, the amount of material it takes to produce 18,000 casings or the amount of material to produce 14,000 casings). To see the distinction between the roles of output quantities versus input quantities more clearly, you may find the following helpful. First, note that you can use the numbers in the case to determine the budgeted and actual hours of direct labor time. For example, the $288,000 budget for direct labor to produce 18,000 casings represents 2 hours per casing x $8.00 per hour x 18,000 casings = $288,000. You will form a budget for direct labor to produce 14,000 casings. Second, you may find it helpful to make a more concrete assumption about the materials used to produce casings. For example, assume that the materials required to produce each casing consist of 6 pounds of materials at an expected price of $1.00 per pound (consistent with the standard $6.00 of material per casing described in the case). Then assume that the actual cost of materials is 5% less than expected (consistent with the statement in the case) or $.95 per pound.)

Exhibit 1:

	Actual	Budget	Variance
Units	14,000	18,000	4,000
Sales	$686,000	$864,000	$178,000	U
Variable manufacturing costs:
Direct material	$85,400	$108,000	$22,600	F
Direct labor	246,000	288,000	42,000	F
Indirect labor	44,400	57,600	13,200	F
Idle time	14,200	14,400	200	F
Cleanup time	10,000	10,800	800	F
Miscellaneous supplies	4,000	5,200	1,200	F
Total variable manufacturing cost	$404,000	$484,000	$80,000	F
Variable shipping costs	$28,000	$28,800	$800	F
Total variable costs	$432,000	$512,800	$80,800	F
Contribution margin	$254,000	$351,200	$97,200	U
Fixed manufacturing costs:
Supervision	$58,800	$57,600	$1,200	U
Rent	20,000	20,000	-
Depreciation	60,000	60,000	-
Other	10,400	10,400	-
Total fixed manufacturing costs	$149,200	$148,000	$1,200	U
SG&A costs	112,000	112,000	-
Operating income (loss)	($7,200)	$91,200	($98,400)	U