Calculate the planning and operational variances

Question:

Milbao

Milbao manufactures and sells electronic games. Each year it budgets for its profits, including detailed budgets for sales, materials and labour. Departmental managers are allowed to revise their budgets if they believe there have been planning errors.

The managing director has become concerned that recent budget revisions have meant that there are favourable operational variances but less profit than expected.

Two specific situations have recently arisen, for which budget revisions were sought:

Component

A supplier of an essential component was forced into liquidation. Milbao's buyer managed to find another supplier overseas at short notice. This second supplier charged more for the components and also a delivery charge. The buyer has said that he had to agree to the price as the component was needed urgently. Two months later, another, more competitive, local supplier was found.

A budget revision is being sought for the two months where higher prices had to be paid.

Labour

During the early part of the year, Milbao experienced problems with the quality of work being produced by the game designers. The departmental manager had complained in his board report that his team were complacent and had not attempted to keep up with new developments in the industry.

It was therefore decided, after discussion of the board report, that something had to be done. The company changed its policy so as to recruit designers with excellent reputations for innovation on short- term contracts. This has had the effect of pushing up the costs involved but increasing productivity.

The design departmental manager has requested a budget revision to cover the extra costs involved following the change of policy.

Required

Discuss each request for a budget revision, putting what you see as both sides of the argument and conclude whether a budget revision should be allowed.

The standard direct material cost of a product was budgeted as \$2.50 per unit, consisting of 0.25 litres of raw material at \$10 per litre. The standard cost is recalculated once each year. Actual direct material costs during July 20X1 were \$29,100 when 11,200 units were made and 3,700 litres of direct materials were used.

The management of Milbao has now accepted that a more realistic standard cost of direct materials, due to a change in the product specification and an unexpected fall in the market price of materials, would have been \$2.40 per unit, consisting of 0.3 litres at \$8 per litre.

Required

Calculate the planning and operational variances for direct materials in as much detail as possible, and comment on your results

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