Budgeted profit and actual profit for May
Fixed Overhead variance
Fixed overhead variance= Budgeted overheads- Actual overhead
That is: (2.5*1300 units)-3100= 150(F)
Analysis of Standards
The set of standards developed by Smithton Inc. is in reference to the processes of production undertaken by the organization.
The first standard regards the direct materials. Here, the company sets material usage standards such that the production of each unit of output requires 2kgs of direct materials. It also sets the standard price per kilo of direct material at £3.00. The actual performance of the organization proves that in general, the standards set underestimate the ability of the organization to efficiently apply the use of materials in production.
The second set of standards regards direct labor. The organization budgets that the production of each unit of the product requires the application of 30 minutes of labor. In addition, each hour of labor applied costs £10.00. Looking at the actual performance, the standard price is more accurately determined while there is gross overestimation of the amount of time which goes in the production of a unit of product.
The third standard concerns fixed overheads. Estimations here are done in regard of the amount of fixed overheads attributable to a unit of output. A comparison of the budgeted and actual amounts shows that, the standard set was underestimated.
Analysis of variances
Sales revenue variance
There is an adverse sales revenue variance. This variance occurs in cases where the level of sales revenue achieved differs from the set level. It could be as a result of differences in volumes of sales as explained by the sales volume variance or as a result of a difference in price budgeted and the actual price in the market.
Some factors likely to contribute to the adverse sales variance include ineffective marketing techniques, the emergence of unfavorable conditions in the market. The price at which the products were sold could be as a result of an economic recession or very tough competition in the market (College Accounting Coach, 2010, par 4).
Material Variance
The month of May registered a favorable material variance. However, a breakdown shows that material price variance was adverse while material usage variance was favorable.
Some possible causes of adverse material price variance include unexpected change in price of materials, application of an alternative grade of the material, engaging a different supplier who may be charging higher than the previous supplier. In addition, this could be as a result of exchange rate depreciation in cases where the materials are imported as well as carelessness on the part of the purchasing officers.
The favorable material usage variance could be as a result of several factors. First, the production unit could have devised better ways to control the amount of waste produced in the production process. This could result from improvement of the conditions of the relevant machines and better training of operators leading to better utilization of the materials. Secondly, there could have been a change in the design of the product with the new design requiring less material to produce in comparison to the earlier.
In addition, it is possible that fewer materials were used in production due to the fact that fewer products were produced as a result of low demand in the market. On the other hand, the variance could result from loosened quality control processes which permit less use of materials but at the expense of production of lower quality products (Standard Costs And Variance Analysis, 2010, par5-7).
Direct Labor Variance
The total labor variance is favorable. A breakdown shows that the labor efficiency variance is favorable while the labor rate variance is adverse. There are several possible causes of a favorable labor efficiency variance. First is an improvement in the techniques applied by workers in production.
This could result in increased levels of efficiency among laborers. It could also be due to improved motivation levels among works in addition to a reduction in the idle or downtime during the month. A better grade of workers could also have been employed to undertake the production process (Standard Costs and Variance Analysis, 2010).
On the other hand, an adverse labor rate variance could be as a result of the application of higher remuneration package than expected. This could be due to the implementation of a mandatory national pay rise which the organization would have to abide. Secondly, a higher grade of workers requiring higher pay may have been employed in the production process.
Again, the variance could be as a result of application of bonus payments which differ from what is planned for. Finally, it could be as a result of making more payments for overtime or premium rates than had been projected (Introduction to variance, 2010, par9).
Fixed Overhead variance
The month of may saw a favorable fixed overheads variance. This could have resulted from unexpected increases in rent, and other fixed overheads including standing charges.
Strategic Implications
In light of the information on variances described above, the most significant strategic decision would have to be aimed at correcting the large adverse sales variance. It would require substantial expenditure in marketing to ensure that targets are met. Most other decisions would require the development of more ambitious budgets in order to improve profitability even further given that the organization is able to achieve several favorable variances.
It is however clear that most emphasis should be on reducing the adverse sales variance to improve the organization’s performance. This could be through a review of the marketing techniques applied with a view towards improving them and the application of better methods to project prices more accurately.
Reference
College Accounting Coach, 2010. Archive about ‘Standard Costing & Variance Analysis’. [Online] Web.
Introduction to variance, 2010. Tutor2u. [Online] Web.
Standard Costs and Variance Analysis, 2010. Loscostos. [Online] Web.