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Exam Problem # 5

Cost Variance Analysis


In order to do this problem, you will probably have to read pages 328-330 (General
Approach) and 605-606 (Nature of Production-Volume Variance).
High in the Appalachian Mountains, Clive Petersen has been making ceramic bathroom
fixtures (sinks, toilets, and bathtubs) since 1960. Petersen Pottery has grown from a twoman operation to the present group of 20 master potters located in two large old
warehouses, converted from World War II storage depots.
The manufacturing process for ceramic sanitary ware consists of two processes
green molding and glazing each of which involves a four-day kiln cycle. Raw clay is
first packed into plaster of Paris molds where it is allowed to dry before it is baked in a
kiln to harden. In the second stage, the fixture is coated with a glaze mixture to give it its
color and characteristic smooth finish. The fixture is then baked again (fired) to harden
and fix the glaze to the clay. The finished product is then shipped to various wholesale
outlets around the East Central States region.
The need for better cost control and for better control over production scheduling to meet
the increases in demand led Clive Petersen to adopt a standard cost system. With help
from his most experienced master potters and his new cost accountant, Clive arrived at
the following cost standards for a toilet, one of Petersens high volume products:
Materials
Raw clay
Glazing mix
Direct labor
Molding
Glazing
Allocated overhead
Total cost per toilet

25 lbs. @ $0.95 per lb.


5 lbs. @ $0.75 per lb.

$23.75
3.75

1 hr. @ $15.00 per hr.


.5 hr. @ $15.00 per hr.
$5.00 per toilet

15.00
7.50
5.00
$55.00

Normal volume per month for overhead allocation purposes was assumed to be 1,200
toilets. The budgeted overhead cost function was $3,672 plus $1.94 per toilet.
After six months of operations using the new cost system, Petersen was disturbed over
the lack of attention paid to the standards. He felt that the potters were just too set in
their ways to pay any attention to the new system. As a result, although the standards
existed, they were seldom met. In reviewing the June production results, actual
production was 1,145 toilets with the following actual costs:

Materials used
Clay
Glaze
Direct labor
Molding
Glazing
Overhead associated with toilets:
Variable
Fixed

28,900 lbs. @ $0.92 per lb.


6,000 lbs. @ $0.78 per lb.
1,200 hrs. @ $15.25 per hr.
600 hrs. @ $15.00 per hr.
$2,300
$3,800

Petersen met with his most experienced master potter, Jim Sedgefield, to discuss the
variances from the standards. Clive explained the problem, Well, Jim, it looks like we
will have unfavorable variances again this month as well as more missed shipping dates.
Sedgefield was not impressed, Well, Clive, I never have understood this system at all.
Why dont you ask that fast-talking accountant to explain the variances? She seems to
know what these numbers mean. All I know is that we seemed to spend all month
struggling with that new brand of clay you purchased because it was cheaper.
Required
1. Compute the following variances for the month:
a. material price variances for clay and glaze
b. material usage variances for clay and glaze
c. direct labor price variances for molding and glazing
d. direct labor usage variances for molding and glazing
e. variable overhead budget variance
f. fixed overhead budget variance
g. production-volume variance
2. What conclusions can be drawn from these variances regarding cost performance for
the month?
3. What suggestions do you have for Mr. Petersen regarding his new standard cost
system?
4. Choosing your own source(s), provide a general and brief explanation of some pros
and cons of standard costs and cost variances.