Sol Electronics, a fast-growing electronic device producer, uses a standard costing system, with standards set at the beginning of each year. In the second quarter of 2011, Sol faced two challenges: It had to negotiate and sign a new short-term labor agreement with its workers union, and it also had to pay a higher rate to its suppliers for direct materials. The new labor contract raised the cost of direct manufacturing labor relative to the companys 2011 standards. Similarly, the new rate for direct materials exceeded the companys 2011 standards. However, the materials were of better quality than expected, so Sols management was confident that there would be less waste and less rework in the manufacturing process. Management also speculated that the per-unit direct manufacturing labor cost might decline as a result of the materials improved quality. At the end of the second quarter, Sols CFO, Terence Shaw reviewed the following results: Variable Costs Per Unit Per Unit Variable Cost Standard First Quarter 2011 Actual Results Second Quarter 2011 Actual Results Direct materials 2.2 lb. at $5.70 per lb. $12.54 2.3 lb. at $5.80 per lb. $13.34 2.0 lb. at $6.00 per lb. $12.00 Direct manufacturing labor 0.5 hrs. at $ 12 per hrs. $ 6.00 0.52 hrs. at $ 12 per hrs. $ 6.24 0.45 hrs. at $ 14 per hrs. $ 6.30 Other variable costs $10.00 $10.00 $ 9.85 $28.54 $29.58 $28.15 Static Budget for Each Quarter Based on 2011 First Quarter 2011 Results Second Quarter 2011 Results Units 4,000 4,400 4,800 Selling price $ 70 $ 72 $ 71.50 Sales $280,000 $316,800 $343,200 Variable costs Direct materials 50,160 58,696 57,600 Direct manufacturing labor 24,000 27,456 30,240 40,000 114,160 Other variable costs Total variable costs Contribution margin Fixed costs Operating income 165,840 68,000 $ 97,840 44,000 130,152 186,648 66,000 $120,648 47,280 135,120 208,080 68,400 $139,680 Shaw was relieved to see that the anticipated savings in material waste and rework seemed to have materialized. But, he was concerned that the union would press hard for higher wages given that actual unit costs came in below standard unit costs and operating income continued to climb. 1. Prepare a detailed variance analysis of the second quarter results relative to the static budget. Show how much of the improvement in operating income arose due to changes in sales volume and how much arose for other reasons. Calculative variances that isolate the effects of price and usage changes in direct materials and direct manufacturing labor. Make sure you break down your variance analysis into Level 1, 2, 3 and make sure you identify and disaggregate all variances to the extent possible.