FINAL AUTHENTIC ASSESSMENT

A CASE STUDY ANALYSIS AND

ESSAY REPORT

Presented to

Ms. Janine Abu, CPA

Subject Teacher

In Partial Fulfilment

Of the Final Requirements for the Course Subject

Cost Accounting & Control

By

Dheine Louise L. Maderazo

May 24, 2019

PROBLEM: Case 10-79 Fixed Overhead Spending and Volume Variance, Capacity
Management

Lorale Company, a producer of recreational vehicles, recently decided to begin producing a

major subassembly for jet skis. The subassembly would be used by Lorale’s jet ski plants and
also would be sold to other producers. The decision was made to lease two large buildings in
two different locations: Little Rock, Arkansas, and Athens, Georgia. The company agreed to a
11-year, renewable lease contract. The plants were of the same size, and each had 10
production lines. New equipment was purchased for each line and workers were hired to
operate the equipment. The company also hired production line supervisors for each plant. A
supervisor is capable of directing up to two production lines per shift. Two shifts are run for each
plant. The practical production capacity of each plant is 300,000 subassemblies per year. Two
standard direct labor hours are allowed for each subassembly. The costs for leasing, equipment
depreciation, and supervision for a single plant are as follows (the costs are assumed to be the
same for each plant):

Supervision (10 supervisors @ $50,000) $ 500,000

Building lease (annual payment) 800,000

Equipment depreciation (annual) 1,100,000

Total fixed overhead costs* $2,400,000

After beginning operations, Lorale discovered that demand for the product in the region covered
by the Little Rock plant was less than anticipated. At the end of the first year, only 240,000 units
were sold. The Athens plant sold 300,000 units as expected. The actual fixed overhead costs at
the end of the first year were $2,500,000 (for each plant).

Required:

1. Calculate a fixed overhead rate based on standard direct labor hours

Standard Fixed Overhead Rate (SFOR) = Budgeted Fixed Overhead

Standard Hours Allowed
Standard Fixed Overhead Rate (SFOR) = $ 2,400,000_____
2 hours x 300,000 units

Standard Fixed Overhead Rate (SFOR) = $ 2,400,000_____

600,000 hours

Standard Fixed Overhead Rate (SFOR) = $ 4 per hour

2. Calculate the fixed overhead spending and volume variances for the Little Rock and Athens
plants. What is the most likely cause of the spending variance? Why are the volume variances
different for the two plants?

Little Rock Plants

a. Fixed Overhead Spending Variance = Actual Fixed Overhead – Budgeted Fixed Overhead

Fixed Overhead Spending Variance =$2,500,000 - $2,400,000

Fixed Overhead Spending Variance = $ 100,000 Unfavorable

b. Fixed Overhead Volume Variance = Budgeted Fixed Overhead – (Standard Hours Allowed –
Standard Fixed Overhead Rate)

Fixed Overhead Spending Variance = $2,400,000 – (480,000 hours x $4)

Fixed Overhead Spending Variance = $2,400,000 – 1,920,000

Fixed Overhead Spending Variance = $ 480,000 Unfavorable

Athens Plant

a. Fixed Overhead Spending Variance = Actual Fixed Overhead – Budgeted Fixed Overhead

Fixed Overhead Spending Variance =$2,500,000 - $2,400,000

Fixed Overhead Spending Variance = $ 100,000 Unfavorable

b. Fixed Overhead Volume Variance = Budgeted Fixed Overhead – (Standard Hours Allowed –
Standard Fixed Overhead Rate)

Fixed Overhead Spending Variance = $2,400,000 – (600,000 hours x $4)

 Fixed Overhead Spending Variance = $2,400,000 – 2,400,000

Fixed Overhead Spending Variance = 0

When analyzing a variance, we determine whether it is favorable or not, by looking at

which of the actual and the budgeted is higher. In the given situation, since the actual fixed
overhead is greater than the budgeted fixed overhead, which means that the costs incurred
during the actual production exceeded those that were expected and budgeted. With this, it will
be considered as an unfavorable variance because once we have set a standard, or an
expected overhead, we want to stay in line with that and not go beyond it. Lorale Company had
a $100,000 unfavorable variance. Based on the problem, the total fixed over head cost was
composed of the salaries for the supervisor, the building lease expense and the depreciation. If
we are going to think of it, it would be very unrealistic if the cause of this unfavorable variance is
the building lease and depreciation because these expenses don’t change a lot and gradually.
However, the salaries for the supervisors can be easily changed, which makes it to most likely
cause this variance.

The volume variance for the two plants differ because the production of the Little Rock
plants was not able to maximize its capacity, which is why the output produced was less than
what was expected. It can be seen in the computed applied overhead (SH x SFOR) wherein
Little Rock plant had $1,920,000. Comparing it to the applied overhead of the Athens plant,
which is $2,400,000—same as the budgeted overhead, we can clearly say that this is what
made them different. The production of Athens plant was able to maximize the capacity and use
the costs efficiently, unlike the production of the Little Rock plant.

3. Suppose that from now on, the sales for the Little Rock plant are expected to be no more
than 240,000 units. What actions would you take to manage the capacity cost (fixed overhead
costs)?

Given this sale, the production of the Little Rock plant would have 120,000 hours less
than the expected capacity and this is permanent. This is equivalent to two lines, which in fact,
in order to manage and adjust the capacity cost, can be shut down. To adjust these costs, it will
be difficult to change the building lease because you cannot directly lessen the payments for the
building. With this, we can only adjust in terms of the supervision and depreciation expense.
Since one line in the production requires one supervisor, if we will be eliminating the two lines,
we will be able to cut down $100,000, which is the salary of the two supervisors for the said
lines. For the equipment, since it gives out depreciation expense, cannot only be reduced by not
using it, but you can sell it so that you would be able to gain from it, while also reducing the
depreciation expense that the company incurs. However, when the company sells the
equipment, it will be a one-time gain or the company will only be benefitting from it for one time
only, so, instead of selling the equipment, the company can lease it, so that the equipment is
still owned by the company but it does not only generate expenses but also profit or gain.

4. Calculate the fixed overhead cost per subassembly for each plant. Do they differ? Should
they differ? Explain. Do ABC concepts help in analyzing this issue?

Each subassembly use two hours, which means that, given the total fixed overhead rate
of $4, multiplied with the number of hours used per subassembly, which is 2 hours, will result to
$8—the fixed overhead cost per unit. The two different kinds of plants did not differ in the fixed
overhead cost per unit since they used the same figures for the calculation of the fixed overhead
rate. However, if instead of the practical capacity, the actual capacity is used to determine the
fixed overhead rate, they would differ and this will result to a $5 fixed overhead rate for Little
Rock plant, which would result to a $10 fixed overhead cost per unit. The concept of ABC would
help in analyzing this issue in a way that it determines whether the subassemblies should be
charged of the capacity which is not used or not. And in this case, using the ABC concepts, it
stated that the products should only be charged to the costs incurred for it while the unused
capacity will be reported separately.

Essay: Role of Cost Management and Control in Preserving Resources

Solving figures, counting and guarding money and preparing financial reports—these are
the common activities that most people know about accountants, which is true. However, our
job as accountants does not stop there because these may be very important, but a much more
significant job comes after. Our lives may be filled with lots of numbers and figures that we
encounter every day, but what we give back to our co-workers, to the management, to the
people, and the world, is not plain old numbers themselves, but a much more meaningful one—
an interpretation of what these figures mean, and how these will be helpful in thinking of and
planning about the next course of action that needs to be done in the company. We play a vital
role in helping the management conduct decisions regarding what will be better for the
company; especially cost accountants.
 Being in the corporate world could be a lot more difficult than what most people imagine
since it can get really dirty in terms of its systems—corruptions and fraud can be very persistent
in this type of world. Aside from this, since corporations provide most of what people buy and
consume nowadays, companies should be very careful as well because it can create an impact
on the world, specifically on the environment, which will somehow go back to us people and
also affect us. This is how corporations and the environment are related, and this is where cost
accounting and control will be very beneficial.

Production is what most companies do, and what’s scary is that this is also the cause of
the rising environmental issues today such as climate change-- the materials being used in
production, from plastics which is polluting the environment, to the oil and the smoke that come
from factories, which in the long run, results to the birth of numerous environmental issues that
results into worse case scenarios such as climate change. But since it is the life of the
businesses, it would be impossible to stop it. However, with the help of cost accountants, cases
like these would be lessened. Part of our job as accountants who specialize in costing and
control is clearly what the name of the specialization itself tells us, and that is control. How?
Here’s why. In cost accounting, the accountants are much more focused on the internal
operations of the business, mainly, production. It accounts to all the costs that were incurred
during the production, from the most important materials down to the smallest part. It is our task
to assess if the production of a certain product needs revisions because maybe it needs
improvement in terms of quality or if materials needed to be changed not only for the betterment
of the company (like reducing the expenses) but also for the part of the customers, by giving
them what they deserve and even more than that, and for the environment, to be prevented
from becoming worse. Some might think that we, accountants don’t have anything to do with all
of these, but that’s where they are wrong. Since we are very much aware of all the costs
incurred for the production of the products, we are also the ones who know which materials can
be removed and lessened, in order to prevent producing non-eco friendly products. With the
help of our assessments and analysis, we will be able to know which materials can be replaced
and what alternatives would suit the product most—these alternatives would be those that will
not cause huge problems to our environment. Plus, if after our analysis of the production, we
would also find out whether there are a lot of wastes being produced, and do our best to decide
how it will be lessened.

With all of these in mind, if continued, although they may not be direct solutions that will
immediately resolve environmental issues and achieve sustainability among companies or
businesses, I think these will be of huge help. The simple knowledge about what’s happening in
the environment, which is clearly caused by such productions and knowing how to be a part of
the solution by preventing these problems as accountants, is a major contribution towards long-
term sustainable practices in the corporate world. Good thing is that this is currently happening,
with the replacement of plastic straws with metal, bamboo and other alternatives as an example.