Standard costing variances and a special order where the material's opportunity cost decides the answer
Multiform Products makes a single component. The standard cost card per unit is: direct material 3 kg at Rs 250 per kg; direct labour 2 hours at Rs 180 per hour; variable overhead 2 hours at Rs 60 per hour. Budgeted fixed production overhead is Rs 1,200,000 per month at a budgeted output of 10,000 units and is absorbed at Rs 120 per unit. In March 2024 output was 1,900 units. Actual material purchased and used was 5,890 kg at a total cost of Rs 1,501,950. Actual direct labour was 3,700 hours costing Rs 684,500. There were no opening or closing inventories of material or work in progress, and no idle time. Operatives are paid only for hours actually worked. An overseas customer has offered a one-off order of 250 units at Rs 1,450 per unit. The order needs 800 kg of material X, already in stock at its original cost of Rs 250 per kg; its current replacement price is Rs 270 per kg. The order also requires a special jig costing Rs 30,000 that has no other use.
1. Calculate the material price and usage variances and the labour rate and efficiency variances, stating whether each is favourable or adverse.
Read the worked answer
Standard quantity for 1,900 units = 1,900 x 3 = 5,700 kg. Standard hours = 1,900 x 2 = 3,800 hours. Actual price = 1,501,950 / 5,890 = Rs 255 per kg. Actual rate = 684,500 / 3,700 = Rs 185 per hour.
| Variance | Working | Result |
|---|---|---|
| Material price | (250 − 255) x 5,890 | Rs 29,450 A |
| Material usage | (5,700 − 5,890) x 250 | Rs 47,500 A |
| Labour rate | (180 − 185) x 3,700 | Rs 18,500 A |
| Labour efficiency | (3,800 − 3,700) x 180 | Rs 18,000 F |
Reasoning notes
- The price variance is calculated on the quantity actually purchased and used (5,890 kg) since there is no inventory movement.
- The usage variance is always valued at standard price, so it measures waste only and does not double-count the price effect.
- The efficiency variance is valued at the standard rate, and the 100 hours saved at Rs 180 each equals Rs 18,000 F.
- Total material variance = 29,450 A + 47,500 A = 76,950 A; the actual material cost of 1,501,950 exceeds the standard 1,425,000 by exactly that amount.
2. The production manager argues that the adverse usage variance arises because the purchasing department bought substandard material at a low price. Evaluate this claim using your variances and suggest two other plausible causes.
Read the worked answer
The claim is not supported. The price variance is adverse at Rs 29,450 - Multiform paid Rs 5 per kg more than standard, not less. Purchasing did not chase a cheap price. If the manager is right that the material was substandard, then quality was sacrificed at a premium, which is worse, not better.
The two material variances are interrelated, so they must be read together: an adverse price variance combined with an adverse usage variance means the firm paid more and got less out of it. That pattern points to a supplier quality or specification problem, or to a purchasing decision taken without consulting production - but not to 'cheap material'.
Other plausible causes to investigate
- Machine settings, tool wear or calibration drift on the line, producing more off-cuts and rejects than the standard allows.
- Operator skill or training - new or temporary staff, or a change in shift patterns, causing extra waste; the favourable labour efficiency variance (100 hours saved) is consistent with operatives working faster, and speed often raises scrap.
- Poor stock control - damaged or deteriorated stock, or short weights from the supplier, both of which would show up as usage rather than price.
The responsible approach is to calculate the cost of investigating (a sample check of deliveries and a machine audit) against the Rs 76,950 adverse total before assigning blame.
3. Advise whether the special order should be accepted. State clearly the assumption you make about material X and show how the alternative assumption changes the decision.
Read the worked answer
Use relevant (incremental) costs only; existing fixed overheads and the Rs 30,000 jig cost need care.
Revenue: 250 x 1,450 = Rs 362,500
| Relevant cost | Rs |
|---|---|
| Material X, 800 kg – at original cost 250 (no other use) | 200,000 |
| Direct labour 500 hrs x 180 (paid per hour worked) | 90,000 |
| Variable overhead 250 x 120 | 30,000 |
| Special jig (incremental fixed cost) | 30,000 |
| Total | 350,000 |
Assumption A – material X has no alternative use. It is already in stock and would otherwise sit idle, so its opportunity cost is nil and it is charged at original cost. Contribution = 362,500 − 350,000 = +Rs 12,500 → accept.
Assumption B – material X is used in normal production and would have to be replaced. The relevant cost is the replacement cost: 800 x 270 = Rs 216,000, and total cost becomes Rs 366,000. Contribution = 362,500 − 366,000 = −Rs 3,500 → reject.
So the decision genuinely turns on the stock position. Recommendation: accept only if the stores ledger confirms X is surplus and slow-moving; otherwise decline. Before committing, also consider qualitative factors - whether the Rs 1,450 price will be quoted back at regular customers, whether the export market can absorb later orders at full price, and whether the 500 labour hours could earn more on normal work.