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1. Determination of resources for the project:
A project analysis has been done on the operations of “Smiths Nuts and Bolts” company that produces nuts and bolts. The company runs their operation in small to medium scale. The major resources of the company are raw material, labour and overhead. The company uses two types of metal for manufacturing the nuts and bolts. Skilled labor is required for proper manufacturing of these nuts and bolts. Besides, overhead resources are also required for running the manufacturing process successfully.
Resource Quantity description:
The company plans to produce budgeted units of 20,000 nuts and bolts per month. A total of 20gm metal is used for producing each nut and bolt. Out of this 20 gm, 12 gm of metal -1 and 8gm of metal-2 are used to produce each nut and bolt. Therefore to produce 20,000 units per month a standard quantity of 240,000 gm (20000*12) of metal-1 and 160000 gm (20000*8) of metal-2 will be required. Besides, skilled labor is also required for the production of nuts and bolt. The standard labor hour that is required to produce each nut and bolt is 2hour/per unit. Therefore to produce 20000 units in a month the monthly standard requirement of labor hour will be 40,000(20000*2) skilled labor hours.
Prioritization of resources:
The three major resources that are used in the manufacturing process are raw material, labor, and overhead resources. The company under discussion is a small company and operates with limited capital resources. Therefore resource prioritization is necessary for useful allocation of limited capital. Raw material should be given the top most priority of all the resources as the quality raw material is essential for the production of these tiny but strong nuts and bolts. Second priority goes to labor resources as highly skilled labor is required for the manufacturing of those nuts and bolts. The third priority goes to variable overhead resources.
Percentage share of the different variable cost factors out of total manufacturing cost
Total manufacturing cost
Percentage share of a cost out of total manufacturing cost
Variable factory overhead($)
The above table demonstrates that total raw material cost accounts for 46% of total manufacturing cost, direct labor accounts for only 4% of the total material cost and variable factory overhead accounts for 2% of the total manufacturing cost. The percentage share of the different variable cost factors out of total manufacturing cost demonstrates the relative importance and priority of the different resources that are included in the project.
Smiths Nuts and Bolts
Flexible budget /Expense Analysis
Budget for the month of February-2017
Cost per unit(standard or budgeted)
Variable factory overhead($)
Total Variable Cost
fixed factory overhead($)
Total Cost of manufacturing($)
The above budget demonstrates the actual cost that has been incurred and the budgeted standard cost that should be incurred to fulfill the monthly target of producing 20,000 units. The budget has been prepared for the month of February-2017 to focus on the cost aspect of the manufacturing process. To produce the budgeted units of 20,000 units, 12gm per unit of metal-1 is required. Therefore the total monthly requirement of metal-1 is 240000gm (20000*12).The budgeted purchase cost metal-1 is $3/gm. Therefore to fulfill the monthly budgeted requirement of metal-1(Direct material-1) the budgeted cost that has to be incurred is $720000.
To produce the budgeted units of 20,000 units, 8gm per unit of metal-2 is required. Therefore the total monthly requirement of metal-2 is 160000gm (20000*8).The budgeted purchase cost metal-2 is $5/gm. Therefore to fulfill the monthly budgeted requirement of metal-2(Direct material-2) the budgeted cost that has to be incurred is $800000.The standard labor hour that should be required to manufacture a unit is 2hours/per unit. Therefore the total labor hours that will be required to produce the budgeted 20000 units will be 40000 labor hours. The standard labor cost is a $3per hour. Therefore the budgeted labor cost for producing 20,000 units should be $120000(40,000*3). The budgeted variable factory overhead cost per unit is $4. Therefore the total budgeted variable factory overhead cost will be $80,000(20000*4). The company also incurs a budgeted fixed cost of $1600000.Thus the total budgeted manufacturing cost amounts to $3320000.
This budget also demonstrates the actual cost that has been incurred while fulfilling the target production of 20,000 units. The actual cost that has been incurred for acquiring the required direct material-1(240000gm) is $800,000. The actual cost that has been incurred for acquiring the required direct material-2(160000gm) is $850,000.Thus for both the direct materials the company is facing negative raw material variance.
The actual cost that has been incurred for hiring the required labor hours (40000 labor hours) is $150,000. Thus the company is also facing negative or unfavorable direct labor variance.
The actual cost that has been incurred for acquiring the required direct factory material to fulfill the budgeted target of 20,000 units is $ 100,000.Thus the company is also facing unfavorable variable factory overhead variance. However, the actually fixed factory overhead that has been incurred for fulfilling the budgeted target of 20,000 units is $1550000 which is less than the planned or budgeted expense of $1600000. The budget also demonstrates that the company is facing an overall negative variance of ($130000) with respect to the manufacturing process.
2. Cost management plan for all direct and indirect resources on the basis of budget
This company is a small company and is operating with limited resources. The above budget analysis reveals that the company is facing unfavorable variance with respect to the variable cost factors. The company has failed to keep their variable cost expenses within the budgeted limit. Therefore it is essential for the company to introduce proper cost management measures to maintain their profit margin.
As a cost management measure, the company has decided to focus on the variances. The company is facing a negative raw material variance. This indicates that the company has either failed to acquire the required raw material (400,000gm) at the budgeted cost of rs $8/hr or the company has failed to utilize the acquired raw material in an economic manner and the per unit usage of raw material may have exceeded the budgeted specification of 20gm per unit (De Jong, Annema & Van Wee, 2013). The company has to find out the actual reason of negative raw material variance and has to apply controlling measures accordingly(Teng, Huang & Lin, 2010).
The company is facing a negative labor variance. This indicates that the company has either failed to acquire the required amount of labor resources (40000 labor hours) at a cost that is more than the budgeted cost of $3/hr or the company has hired unskilled labors and as a result the production per unit has demanded more than the budgeted standard of 2 hr per unit. The company has to find out the actual reason of negative labor variance and has to apply controlling measures accordingly (Shen & Zhang, 2010).
The company is facing a negative variable overhead variance. This indicates that the company has either failed to acquire the variable overheads at a budgeted rate of $4/unit or the company has made an inefficient use of overheads that made the company to purchase a larger quantity of raw material that is greater than the budgeted requirement. The company has to investigate the source of inefficiency; that is whether it is an inefficient purchase or an inefficient usage that generates the negative variance and measures to be taken accordingly (Ahsan & Gunawan, 2010).
3. Variance analysis as key performance indicator
A variance analysis is a difference between the budgeted cost and the actual cost. And a negative variance indicates that the actual cost is greater than the budgeted cost and therefore cost controlling measures are required (Doloi, 2011). The magnitude of the negative value indicates the degree of inefficiency and the commensurate stringent measures to be taken to deal with that inefficiency (Memon et al.2011). The variance analysis reveals that the company is facing a negative material variance, negative labor variance as well as negative variable overhead variance. Not only that the company is also facing an overall unfavorable variance with respect to the manufacturing process. This indicates inefficient handling of the manufacturing process by the company (Chou, 2011). A closer look over material variance indicates that Material -1 has acquired at a cost of $3.3/gm instead of the budgeted cost of $3/gm and Material -2 has acquired at a cost of $5.3/gm instead of the budgeted cost of $/gm. A closer look over labor variance indicates that the actual usage of labor hour was 2.5hr/per unit instead of the budgeted rate of 2hr/per unit. A closer look over variable overhead variance indicates that the variable overhead has been acquired at a rate of $5/unit instead of the budgeted rate of $4/unit (Bierman & Smidt, 2012).
Moreover maximum inefficiency lies in purchase and usage of raw materials as indicated by the magnitude of the variance. Therefore as a cost-controlling measure the company should first focus on reduction of inefficiency in the purchase and usage of raw material as the degree of inefficiency is highest in raw material management as indicated by the maximum negative value of the raw material variance. The labor variance is at the second position in terms of degree of inefficiency as indicated by the magnitude of the negative labor variance and variable overhead variance lies at the third position in terms of degree of inefficiency (Wysocki, 2011).
Adjustments to be made to stay to keep all the costs within the budgeted limit
The following adjustments are to be made to keep the costs within the budgeted limit.
1.The company has to find out economic sources of raw material so that the required raw materials can be purchased at the budgeted or standardized rate of cost per unit without compromising the quality
2.The company has to bring the required efficiency so that the budgeted units can be produced at standardized rate of resource per unit so that the company is not forced to purchase additional units of raw material
3.The company has to give proper effort so that the required labor can be hired at the standardized cost per hour. Besides the company also has to bring the required efficiency so that the budgeted units can be produced at the standardized hour per unit and the company is not forced to buy additional labor hours to fulfill the budgeted target (Schwalbe, 2015).
4.Lastly, measures should be applied by the company for acquiring variable overheads at the budgeted cost per unit
4. Sample financial report covering all expenditure
In the above analysis, the performance in variable cost handling has been analyzed with the help of budget preparation and variance analysis. The variance analysis reveals inefficiency in material, labor, and overhead management and indicates that a production manager has done a very poor job so far as cost controlling is concerned (Meredith & Mantel Jr, 2011). The analysis also reveals that there is an urgent need of applying measures for material management as the magnitude of unfavorable material variance is highest. Thus budget preparation and variance analysis not only works as a performance indicator but it also helps in the future planning of production and sales (Kerzner, 2013).
However while doing the variance analysis it has been assumed that the company is only producing the targeted units or budgeted units and then the actual cost of production has been compared with the budgeted cost of production for the target units. But if a company produces more than the budgeted units then it will be difficult to identify production inefficiency through variance analysis as then the variable cost will be higher for a higher number of units that are greater than the budgeted units.
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