Miracle Lights, Inc.
Miracle Lights, Inc. – Variable Cost Variance
Kathy Wahl, Jerry Kennedy, and Jerry Craig
Accounting 529
Lewis Worcester
March 8, 2016
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Miracle Lights, Inc.
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Miracle Lights – Variable Cost Variance Analysis
Introduction
Budget, according to Merriam-Webster (2005), the amount of money that is
available for, required for, or assigned to a particular purpose. Budgets are a primary
means by which performance can be measured against. In business, a budget is projected
for some level of activity using a set of standard costs, which come in the form of current
commodity pricing, prevailing wage, units of work, and other factors. This concept is a
key component in cost accounting, not only are budgets, estimates if you will, set, but
post production analyses are generated to determine the actual performance against those
budgets, or cost variance.
This paper will analyze the variable cost variances Miracle Lights’ Brightlites
product line. In particular, it will focus on the price variance for raw materials purchased,
raw materials usage variance, direct labor rate variance, direct labor efficiency variance,
variable overhead spending variance, and variable overhead efficiency variance for the
week ended May 30, 2004 (see Figure 1). The paper will close focusing on the
importance of such measures to managers responsible for a set of activities.
Figure1: Miracle Lights’ Brightlites
Week ended May 30, 2004
Source: Marshall (2003), p. 561
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Raw Materials Price
Standard cost per unit
Actual cost per unit
Actual quantity used
Price variance for raw materials purchased
(6.80/lb
-7.10/lb)
x 4.87lbs
= $1.46 U
Companies typically have historical data at their disposal to accurately determine
material costs. However, even the best data can be incorrect due to market fluctuations.
Management checklist:

Were the unit costs calculated on specific bulk package rates?

Were the purchases made in such a way that maximizes those rates?

Was there a market factor that shifted the costs?

Were materials purchased on the futures market to lock in costs?

Was there a shift in accounting for inventory usage that affected costs?

Was there a change in the supply chain that impacted prices?

Was there a change in the purchase agreement with the supplier?
Typically there is a lag between the time the estimates were established and when
the materials were used. When commodity purchases are involved, time lags allow for
market shifts, which invariably provide for price fluctuations. Managers need to monitor
situations that will affect prices. It is not enough to simply monitor the prices of a
particular product, as Savastano, (2003) indicates in his article on raw material pricing, a
result of the increase in the prices of crude oil and other ingredients, numerous raw
material suppliers have announced price increases this year.
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Raw Materials Usage
Standard quantity allowed
Actual quantity used
Standard cost per unit
Raw Materials usage variance
(5lbs
– 4.87lbs)
x $6.80
= $0.88F
Coupled with raw material pricing is material usage. Companies need to
maximize efficient usage of the raw materials used in the production process.
Management checklist:

Was there a change in the supply chain?

Is the quality of the raw materials acceptable?

Have the materials be tested for quality?

Are spoilage levels consistent with expectations?
Material usage shows a favorable variance, so why worry? Logically, the
increased margins should be considered a positive. But as is indicated in Marshall (2003),
spending less for raw materials because lower-than-specified-quality materials were
purchased may give rise to an arithmetically favorable variance (actual cost was less than
standard cost) that is not desirable because of the negative impact on product quality.
Variance analysis is not restricted to unfavorable results, the mere fact that there is a
variance, may be enough to require an analysis.
Direct Labor Rate
Standard cost per unit
Actual cost per unit
Actual quantity used
Direct labor rate variance
($14/hr
- $14.35/hr)
x 2.3hrs
= $0.80U
Labor is typically the most significant cost in any company and the most difficult
to control. As a general rule, wages always trend upward. This makes labor rate
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estimates that much more difficult. Even with solid average wage rates a manager may
find that the labor costs exceeded expectations.
Management checklist:

Was there a need to include higher wage employees?

Was there a union contract change during production?

Were there any legislative actions that affected labor costs?

Were high cost contractors required to supplement the workforce?

Has the labor market changed since the estimates were generated?
There are numerous issues that can affect total labor costs. Unlike raw materials,
changes in these costs are more difficult to determine. In this case, the actual labor rate
was higher than standard. It could be a conscience decision by a manager to use high
skilled labor to generate production efficiencies. As Marshall (2003) indicates in a
similar example, even though the workers were paid more than the standard rate, the
work was performed efficiently enough to more than make up for the unfavorable rate
variance.
Direct Labor Efficiency
Standard quantity allowed
Actual quantity used
Standard cost per unit
Direct labor efficiency variance
(2.4 hrs
- 2.3 hrs)
x $14/hr
= $1.4/hr F
Indeed we find a gain of $1.40 per hour in efficiency. While Miracle Lights loses
some on the per unit rate, they gain it back by shorter production cycle times.
Management checklist:

Were the assigned employees higher skilled?
Miracle Lights, Inc.

Were the employee’s average service times higher than standard?

Were there environmental factors that caused the employee’s to be more
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efficient?
These are critical issues for managers to investigate, focusing on successes and
perpetuating them is vital to a corporation. Efficiency variance is one of those unseen
costs. Managers accept variance as a part of their responsibilities, having data to support
this knowledge helps them address it properly.
Variable Overhead Spending
Standard cost per unit
Actual cost per unit
Actual quantity used
Variable overhead spending variance
($4.5
-$4.3)
x 1.5hr
= $0.3/hr F
The third category of cost that comprises production cost is overhead. Overhead
is often overlooked, but can be a substantial percentage of the actual costs involved in the
production. As noted in a finance report by Edwards, (2003), the impact of overhead
costs on service costs must be continually reviewed and challenged. Edwards sees these
as being just as important as direct labor and material costs. Miracle Lights appears to
perform well in this category with a $0.30/hour savings over standard. However, there
are still items to review.
Management checklist:

Did administrative processes delay product distribution?

Were there production issues such as lighter demand in other product lines
that provided for more efficient processing?
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Overhead is very difficult to isolate to a specific activity since there is a good deal
of shared service and support across production. It is also very difficult to control since
the demands can come from many different directions.
Variable Overhead Efficiency
Standard quantity allowed
Actual quantity used
Standard cost per unit
Variable overhead efficiency variance
(1.5hrs
-1.5hrs)
x $4.5
=0
Production operation managers need to have clear communication lines with
managers that are responsible for the various overhead activities. When developing a
proposal, there is a lot of labor hours involved before a project gets to the production
floor. These costs do not vanish and are not free so it is essential that there is strong
oversight.
Management checklist:

Were production schedules communicated clearly to maximize efficient use of
administrative processes?

Were communications channels open throughout the cycle?

Were there technology changes that affected overhead?
Miracle Lights performed well in the overhead category both on price and on
efficiency. They were able to meet standard efficiency while realizing a cost savings.
This does not preclude them from review. As stated above, identifying the cause of these
results provide valuable information for on-going operations.
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Analysis and Conclude
Variances should not be viewed in isolation from each other. For example, an
adverse material price variance may be due to the fact that the material purchased was of
a higher standard that normal. This may mean that the usage variance for that material
will be favorable because the higher quality may result in less wastage than normal.
(Gibbins, 2000)
In the last portion of this analysis we noted that the overhead cost and efficiency
was favorable overall. Most would consider this to be a good sign and simply look to
continue this trend. But managers need to gain visibility to the other components of the
production process to see if these savings and efficiencies cause adverse impacts
elsewhere. If a company saves in per hour overhead due to a 10% reduction in
administrative staff, is this good? What if it caused production delays, inventory build-up,
back orders, and other production inefficiencies? Isolating on a single variance can be
misleading and cause managers to make incorrect decisions.
Variable cost variance analysis is a tool set and not simply a tool. It is correctly
divided between cost and efficiency since this is a typical dividing line for management
responsibility. Managers should certainly scrutinize the data directly related to their area
of responsibility, but they should also be aware of the results in the other variance to
determine any unintended results.
Finally, variable cost variance analysis should not be used as a means to place
blame. The data collected should be analyzed to the benefit of the organization and not
the detriment of an individual. In an excellent article on quality measurements, Garwood,
(2002) aptly states, measurements are to be used to stimulate corrective action, not inflict
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punishment. The question is what went wrong, not who. And remember, employees often
have a different view of "punishment" than management. This paper agrees with this
premise, but would further expand it to, what went right.
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References
Edwards, D. (2003). Finance and corporate governance strategy – approved. Retrieved January
15, 2005 from http://deliveringhealth.co.uk/bops/strat_page_sec.php3?strategy=F
Garwood, D. (2002). Caution: measurements and accountability may be
hazardous to your health! Retrieved February 16, 2005 from
http://www.rdgarwood.com/archive/hot29.asp
Gibbins, R. (2000). Variance analysis – part 1. Student accountant. Retrieved, February 13,
2005 from http://www.acca.co.uk/publications/studentaccountant/12858
Gibbins, R. (1999). Variance analysis – part 2. Student accountant. Retrieved, February 14,
2005 from http://www.acca.co.uk/publications/studentaccountant/12904
Marshall, D., McManus, W., & Viele, D. (2003). Accounting: what the numbers mean. (6th ed.).
New York: McGraw Hill Companies.
Merriam-Webster, (2005). Merriam-Webster online. Retrieved February 13, 2005 from
http://www.merriam-webster.com/cgi-bin/dictionary?book=Dictionary&va=budget
Savastano, D. (2003). The raw material report. Retrieved, February 12, 2005 from
http://www.inkworldmagazine.com/Sept032.htm