Question

Magic Cakes Co. produces birthday cakes, biscuits, and a variety of quality confectionery. The company recently installed a flexible manufacturing system for the production of its range of quality confectionery. The company was experiencing serious problems in the production of confectionery products that were affecting the quality of the final products and the capacity to deliver on time to its customer. The problems were due to several major breakdowns in the companys old production machinery. The installation of the new production system was not anticipated when the current years budget and cost structure were developed.

The new system was expensive, but management expects it to cut the labour time required by a substantial amount. Management also expects the new equipment to allow a reduction in direct material waste. On the negative side, the new flexible manufacturing system requires a more highly skilled labour force to operate it than it was needed for the companys old equipment.

The following cost variance report was prepared for October, the first full month after the equipment was installed:

Required:

Explain the possible interactions between the variances listed in the report. Which ones are likely to have been caused by the purchase of the new system? Provide reasons for why you think this. Please note: The company budgets, and applies manufacturing overhead costs, on the basis of direct labour hours. (1 mark for each correct explanation, total 7 mark).

Magic Cakes Co. Cost Variance Report October 2019 Direct material: Standard cost $1 204 900 Actual cost 1 197 400 Direct material price variance 300 U Direct material quantity variance 7 800 F Direct labour: Standard cost 786 000 Actual cost 767 600 Direct labour rate variance 9 600 U Direct labour efficiency variance 28 000 F Manufacturing overhead: Applied to work in process $800 000 Actual cost $816 000 Variable overhead spending variance 16 000 U Variable overhead efficiency variance 20 000 F Fixed overhead budget variance 60 000 U Fixed overhead volume variance 40 000 F