Flexed Budget Variances at Pennick Chemicals
Pennick Chemicals budgeted to produce and sell 8,000 tonnes of solvent at a standard price of $210/tonne, using 2.5 kg of raw input per tonne at a standard cost of $14/kg, and 0.4 direct labour hours per tonne at $22/hour. Fixed overhead was budgeted at $96,000. Actual results: 8,600 tonnes produced and sold for $1,780,000 revenue; 22,000 kg of input purchased and used at $13.60/kg; 3,300 labour hours at $23.10/hour; fixed overhead $99,500. The production director reports 'a favourable material price variance, so purchasing is doing well' and is surprised that total profit is below budget.
1. Flex the budget and calculate the material, labour and fixed overhead variances, then explain why a favourable price variance may not be good news here.
Read the worked answer
Flexed budget (8,600 t): revenue 8,600 × $210 = $1,806,000; material 8,600 × 2.5 = 21,500 kg × $14 = $301,000; labour 8,600 × 0.4 = 3,440 hrs × $22 = $75,680; fixed OH $96,000.
Material:
- Price = (13.60 − 14.00) × 22,000 = $8,800 F
- Usage = (22,000 − 21,500) × $14 = $7,000 A
- Net = $1,800 F
Labour:
- Rate = (23.10 − 22.00) × 3,300 = $3,630 A
- Efficiency = (3,300 − 3,440) × $22 = $3,080 F
- Net = $550 A
Fixed overhead: expenditure = 99,500 − 96,000 = $3,500 A (no volume variance under marginal-style flexing).
Why F price variance is suspect: the cheaper material may be lower quality, causing the $7,000 adverse usage (2.3% over standard). The net material position is only $1,800 F while quality problems could also drive rework and reputational cost. The purchasing manager is likely buying substandard input to hit a price target - a classic dysfunctional behaviour. Investigate supplier quality and scrap rates before praising purchasing.
2. Reconcile budgeted profit to actual profit using the variances, and identify the two variances most deserving management attention.
Read the worked answer
Budgeted profit (8,000 t):
- Revenue 8,000 × 210 = 1,680,000
- Material 8,000 × 2.5 × 14 = 280,000
- Labour 8,000 × 0.4 × 22 = 70,400
- Fixed OH 96,000
- Budgeted profit = $1,233,600
Actual profit: 1,780,000 − (22,000 × 13.60 = 299,200) − (3,300 × 23.10 = 76,230) − 99,500 = $1,305,070
Reconciliation:
- Budgeted profit 1,233,600
- Sales volume contribution: 600 extra t × (210 − 35 − 8.80) = 600 × 166.20 = +99,720 F
- Selling price: actual $206.98 vs $210 → (3.02 × 8,600) = −25,977 A
- Material price +8,800 F; usage −7,000 A
- Labour rate −3,630 A; efficiency +3,080 F
- Fixed OH −3,500 A
- Total ≈ 1,305,093 (small rounding) ✓
Attention: (1) the selling price variance of ~$26,000 A - the largest single adverse item, dwarfing all cost variances and suggesting discounting; (2) the material usage/quality link - the $7,000 A usage plus price F pattern signals a quality trade-off. The director's focus on the price variance misses the bigger revenue leakage.