Dunmore Furniture: Production Budget, Material Variances and Budget Behaviour
Dunmore Furniture makes oak tables and chairs. For the next quarter the sales budget is 2,400 tables at £180 each and 4,800 chairs at £70 each. Opening finished goods inventory is 300 tables and 500 chairs; the target closing inventory is 400 tables and 600 chairs. Each table uses 2.5 kg of oak; each chair uses 1.2 kg. Opening oak inventory is 1,800 kg and the target closing inventory is 2,200 kg. Oak is budgeted at £6 per kg.
The quarter has now ended. Dunmore produced 2,450 tables and 4,650 chairs. It used 12,800 kg of oak, costing £80,640. The production manager claims the adverse material result is entirely the purchasing officer's fault for paying above the standard price. The purchasing officer says she bought a better grade because the standard oak was causing excessive waste. Budgets at Dunmore are set centrally by the finance director with little departmental input.
1. Prepare the production budget and the oak purchases budget for the quarter, showing quantities and budgeted material cost. Show workings.
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Production budget: Tables = sales 2,400 + closing 400 − opening 300 = 2,500 units. Chairs = sales 4,800 + closing 600 − opening 500 = 4,900 units.
Oak usage budget: Tables: 2,500 × 2.5 = 6,250 kg. Chairs: 4,900 × 1.2 = 5,880 kg. Total usage = 12,130 kg.
Purchases budget: Purchases = usage 12,130 + closing 2,200 − opening 1,800 = 12,530 kg. Budgeted material cost = 12,530 × £6 = £75,180.
2. Calculate the material price and usage variances for the quarter and reconcile them to the total material cost variance. Standard usage is based on the budgeted quantities per unit.
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Standard usage for actual production: Tables: 2,450 × 2.5 = 6,125 kg. Chairs: 4,650 × 1.2 = 5,580 kg. Total standard usage = 11,705 kg. Actual usage = 12,800 kg.
Usage variance = (11,705 − 12,800) × £6 = 1,095 kg adverse × £6 = £6,570 adverse.
Actual price per kg = £80,640 / 12,800 = £6.30. Price variance = (£6.00 − £6.30) × 12,800 = £3,840 adverse.
Total material cost variance = £6,570 adverse + £3,840 adverse = £10,410 adverse.
Check: standard cost of actual production = 11,705 × £6 = £70,230. Actual cost = £80,640. Difference = £10,410 adverse.
3. Evaluate the purchasing officer's explanation and discuss how Dunmore's top-down budgeting process may have contributed to the variances. Recommend improvements.
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The purchasing officer may be right that a better grade reduced waste, but the total material cost variance is still £10,410 adverse. The price variance is £3,840 adverse, while the usage variance is £6,570 adverse. The usage variance is 1,095 kg, or about 9.4% above standard, which is too large to ignore. Possible causes include inferior standard oak, poor cutting, machine calibration, operator training, inaccurate standards, or the supplier change. Responsibility is shared: purchasing controls price and quality, production controls usage, and both affect total material cost.
A top-down process with little departmental input can create unrealistic standards, weak ownership and finger-pointing. The purchasing officer may not have known the production consequences of buying cheaper oak; production may not have been consulted on the standard. Recommendations: use participative budgeting, set material standards jointly with purchasing and production, investigate the usage variance before blaming individuals, report total material cost as well as price and usage sub-variances, and introduce rolling forecasts so that standards can be updated when suppliers or processes change.