Halstead Furniture: variances that pull in opposite directions
Halstead Furniture makes a single product. The standard cost card shows 5 kg of material at £4.00 per kg and 2.5 labour hours at £12.00 per hour per unit. Budgeted output was 2,000 units; actual output was 1,900 units. Actual results were: materials purchased and used 9,000 kg at a total cost of £37,800; labour 4,650 hours at a total cost of £57,660. The purchasing manager switched to a higher-grade supplier after production complained about excessive waste on the standard material. The labour rate rose because a 3.3% company-wide pay settlement was agreed centrally during the year, and the production manager also reorganised the shop floor. The production manager's bonus depends on the total material and labour cost variances reported each month.
1. Calculate the four variances and reconcile actual cost with the standard cost of actual output.
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Actual price = £37,800 ÷ 9,000 kg = £4.20 per kg. Actual rate = £57,660 ÷ 4,650 hrs = £12.40 per hour. Standard quantities for 1,900 units: material 9,500 kg; labour 4,750 hrs.
| Variance | Working | £ |
|---|---|---|
| Material price | (4.00 − 4.20) × 9,000 | 1,800 A |
| Material usage | (9,500 − 9,000) × £4.00 | 2,000 F |
| Labour rate | (12.00 − 12.40) × 4,650 | 1,860 A |
| Labour efficiency | (4,750 − 4,650) × £12.00 | 1,200 F |
Reconciliation
- Standard cost of actual output: (9,500 × £4) + (4,750 × £12) = 38,000 + 57,000 = £95,000
- Material price (A) (1,800); material usage (F) 2,000; labour rate (A) (1,860); labour efficiency (F) 1,200
- Net adverse £460 → actual cost £95,460 = £37,800 + £57,660 ✓
Note that the material variances net to £200 favourable and the labour variances to £660 adverse. Reported individually, the picture looks much worse than it is.
2. Assess whether the purchasing manager's decision was correct, and how the variances should be reported.
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The decision paid for itself. The higher-grade material cost an extra £0.20 per kg (£1,800 adverse on 9,000 kg) but cut usage from a standard 9,500 kg to 9,000 kg - a 10% saving worth £2,000. Net effect on material cost: £200 favourable.
The danger is in reporting the two variances separately. Judged on the £1,800 adverse price variance, purchasing looks to have failed; judged on the £2,000 favourable usage variance, production looks to have succeeded - but the usage saving was caused by the purchasing decision, and the price rise was its cost. Responsibility has been misassigned.
Recommendations:
- Report a total material variance (and cost per good unit produced) alongside the price and usage split, so trade-offs are visible.
- Assess purchasing on total material cost and quality, not price alone.
- Quantify the counterfactual: reverting to the cheap supplier would restore £1,800 of price saving but lose £2,000 of usage saving, leaving the firm £200 worse off.
- Watch for non-financial effects the variances cannot capture - higher-grade material may reduce customer returns and rework, which strengthens the case further; conversely, if the supplier is unreliable, delivery failures will not appear in any variance.
3. Comment on responsibility for the labour variances and the behavioural risk of the bonus scheme.
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Splitting controllable from uncontrollable:
- The 3.3% pay settlement (12.00 → 12.40) is centrally negotiated. The whole £1,860 rate variance arises from it (4,650 × £0.40) and is outside the production manager's control. It should be isolated as a planning/rate variance and excluded from his report.
- The efficiency variance (£1,200 favourable) probably reflects the shop-floor reorganisation and is genuinely controllable - 2.45 hours used per unit against a 2.5 standard.
Behavioural risks of the current scheme:
- Penalising the uncontrollable. The manager is charged £660 net adverse for a pay award he did not negotiate. This is demotivating and teaches him that effort is not rewarded.
- Gaming the numbers. Because the bonus depends on material and labour variances, he has an incentive to press for cheaper material (which caused the original waste problem) or to understate quality problems, rather than to minimise total cost per good unit.
- Narrow focus. Cost variances say nothing about quality, delivery, scrap of finished goods, or customer complaints; a manager optimising them may damage all four.
Better design: base reward on controllable variances against a flexed budget, report the total material variance as well as its split, and add non-financial measures such as units returned, rework hours and on-time delivery.