Variance Analysis

1. Identify the sources of variance

2. Calculations of Price and Quantity Variances

3. Suggestions for favorable and unfavorable variances

Capital Budgeting

1. Determine which product lines should be automated

2. Calculations for capital budgeting

3. Description of method used

4. Justification of decision criterion

Costing

1. Select a costing method

2. Justify that decision

3. Determine standard costs of that system

Case Information

The Caldwell Copper Company manufactures several different products from raw copper. Its products include copper wire, copper pipes, and copper pots & pans. The Chief Executive Officer, Catherine Caldwell, has noticed that net operating income is down even though sales have increased. You have been hired as a consultant to help Ms. Caldwell figure out what happened and to provide suggestions for improvement. She has provided you with the following information from the companies operations. This information includes an income statement showing the financial results from 2016 and 2015 and a list of standard costs and activity rates for each product line.

Caldwell Copper Company
Income Statement
For the Year Ended 2016
	2015	2016
Sales Revenue	$1,875,000.00	$2,750,000.00
Cost of Goods Sold	1,500,000.00	2,415,000.00
Gross Profit	$375,000.00	$335,000.00
Selling and Administrative Expenses
Advertising Expense	100,000.00	120,000.00
Sales Commissions	40,000.00	56,000.00
Administrative Salaries	80,000.00	80,000.00
Finished Goods Warehouses	30,000.00	33,000.00
Net Operating Income	$125,000.00	$46,000.00

Standard	Wire	Pipes	Pots & Pans
Unit Sales (2016)	1,000,000 feet	500,000 feet	25,000 pans
Unit Sales (2015)	750,000	300,000	20,000
Selling Price Per Unit	$0.50	$3.00	$30.00
Pounds of Copper per unit	0.05	0.30	1.50
Cost of copper per pound	$3.00	$3.00	$3.00
Labor Hours per unit	0.02	0.06	1.00
Wage Rate per labor hour	$12.00	$12.00	$12.00
Machine Hours per unit	0.02	0.04	1.00
Predetermined Overhead Rate	$10 per labor hour	$10 per labor hour	$10 per labor hour
Sales Commissions per unit	$0.02	$0.05	$0.50

Ms. Caldwell would like to know why profits have been down even though sales are up. She tells you that the company increased its advertising budget by 20% in an attempt to generate more sales and that an additional finished goods warehouse was rented for $3,000 per year to store the extra inventory. Glancing at the income statement, Ms. Caldwell is unsure where the problem lies. She is aware that some of the actual expenses differed from what was budgeted and provided the following information of the actual activity and costs. She would like you to confirm where the variances occurred and make some suggestions on how to capitalize on any positive variances and correct and negative ones.

Actual Usage	2015	2016
Direct Materials (Pounds of copper)	127,500	237,500
Total cost of direct materials	$334,000	$712,500
Direct Labor (Labor Hours)	53,000	76,500
Total cost of direct labor	$636,000	$937,500

Given the issues experienced in the companys operations, Ms. Caldwell would like to consider making some changes in the production processes. Specifically, she has looked into increasing the automation, and the companys bank has extended a line of credit for that purpose in the amount of $1.5 million. Ms. Caldwell has researched the potential costs of the machines that would need to be purchased and estimated the changes in the standard costs if the automation is introduced. The machines would be entirely purchased in the current year, and each piece of equipment would have a useful life of 5 years and a salvage value equal to 5% of the purchase price. The new equipment would significantly reduce the labor requirements and also provide some increases in materials efficiency, but there would be a significant increase in machine hours. Based on current financial conditions, the discount rate for future cash flows is 17%, which accounts for the interest on the line of credit.

Costs for New Equipment	Wire	Pipes	Pots & Pans
Purchase price	$500,00	$750,000	$300,000
Useful life	5 years	5 years	5 years
Salvage Value	$25,000	$37,500	$15,000
Standard Costs per Unit	Wire	Pipes	Pots & Pans
Materials (pounds of copper)
Before automation	0.05	0.30	1.5
After automation	0.02	0.25	1.5
Labor (Hours)
Before automation	0.02	0.06	1.00
After automation	0.01	0.03	0.75
Machine Hours
Before automation	0.02	0.04	0.80
After automation	0.04	0.08	1.20

Ms. Caldwell would like to know which product lines, if any, she should automate based on the potential cost savings over current standard production costs. In order to understand your recommendation, she will need a short description of the method and a justification of the criterion used to make the decision.

Thinking about these issues and the potential changes, Ms. Caldwell is concerned that the company is not efficiently tracking its overhead costs. In addition to the activities listed previously, there are three primary departments within the company: smelting, shaping, and finishing. The smelting department prepares raw copper for further processing. The shaping department uses machines to mold and forge the copper into the desired shapes. Finally, in the finishing department workers remove scraps and remnants of the manufacturing process and package the goods. The estimated overhead usage by department is listed below along with activity levels within each department both with the automation and without. Based on the preceding activity information and the departmental information, Ms. Caldwell would like for you to suggest a new costing system for the company and to determine the new standard costs for the company based on the current total manufacturing overhead costs of $750,000. Also, given the previous issues, she would like to keep the system relatively simple and so would not like to have more than three overhead rates to keep track of.

Overhead Item	Cost
Equipment depreciation	$250,000
Machine maintenance	125,000
Factory Rent	100,000
Utilities	75,000
Janitorial services	50,000
Supervisor salaries	150,000

Departmental Information	Smelting	Shaping	Finishing
Proportion of Overhead Usage	40%	35%	25%
Without Automation
Materials	135,000	77,500	25,000
Labor Hours	20,000	35,000	20,000
Machine Hours	20,000	20,000	20,000
With Automation
Materials	120,000	57,500	25,000
Labor Hours	15,000	13,750	15,000
Machine Hours	25,000	60,000	25,000