Hexagon ltd commenced production of the Gen3 earlier this year. The actual results for the first production run of 250 units of the Gen3 included the following information:

• Labour: 200 hours were worked, costing a total of £2,000

Produce a report that includes the following:

Report to: Jack Charlesworth, CEO, Hexagon Ltd

Subject: Analysis of Labour and Materials Variances for Gen3 Production

Introduction

This report provides a detailed analysis of the labour and materials variances arising from the first production run of 250 units of the Gen3 component. The analysis incorporates new information regarding market price changes, regulatory impacts on material usage, and the learning curve effect on labour efficiency. The report also assesses the validity of the initial responses to these variances.

1. Calculations of Planning and Operational Variances

A. Materials Variances

i. Original Variances

• Original Standard Cost:
  • Standard Quantity: 250 units × 4 kg/unit = 1,000 kg
  • Standard Price: £5/kg
  • Total Standard Cost: 1,000 kg × £5/kg = £5,000
• Actual Cost:
  • Actual Quantity: 1,250 kg
  • Actual Price: £7,500 / 1,250 kg = £6/kg
  • Total Actual Cost: £7,500
• Total Materials Variance:
  • Total Variance: £7,500 - £5,000 = £2,500 Adverse

ii. Price Variance Split

• Planning Price Variance:
  • Revised Standard Price: £6.50/kg (due to market price increase)
  • Calculation: (Revised Standard Price - Original Standard Price) × Actual Quantity
  • Variance: (£6.50 - £5.00) × 1,250 kg = £1,875 Adverse
• Operational Price Variance:
  • Calculation: (Actual Price - Revised Standard Price) × Actual Quantity
  • Variance: (£6.00 - £6.50) × 1,250 kg = £625 Favourable

iii. Usage Variance Split

• Planning Usage Variance:
  • Revised Standard Quantity: 250 units × 5.5 kg/unit = 1,375 kg (due to regulatory change)
  • Calculation: (Revised Standard Quantity - Original Standard Quantity) × Original Standard Price
  • Variance: (1,375 kg - 1,000 kg) × £5/kg = £1,875 Adverse
• Operational Usage Variance:
  • Calculation: (Actual Quantity - Revised Standard Quantity) × Revised Standard Price
  • Variance: (1,250 kg - 1,375 kg) × £6.50/kg = £812.50 Favourable

iv. Summary of Materials Variances

B. Labour Variances

i. Original Variances

• Original Standard Hours:
  • Standard Hours per Unit: 5 hours/unit (initial assumption)
  • Total Standard Hours: 5 hours/unit × 250 units = 1,250 hours
• Actual Hours: 200 hours
• Standard Labour Cost: 1,250 hours × £10/hour = £12,500
• Actual Labour Cost: 200 hours × £10/hour = £2,000
• Total Labour Variance: £2,000 - £12,500 = £10,500 Favourable

ii. Adjusted for Learning Curve (80%)

• Learning Curve Calculation:
  • Learning Curve Formula: Y = aX^b
    • a= Time for first unit = 5 hours
    • X= Cumulative units = 250
    • b= log 0.8/log 2 =  − 0.3219
  • Cumulative Average Time per Unit: 5 × 250^−0.3219 = 0.845 hours/unit
• Revised Standard Hours:
  • Total Revised Standard Hours: 0.845 hours/unit × 250 units = 211.25 hours
• Revised Standard Labour Cost: 211.25 hours × £10/hour = £2,112.50
• Planning Variance:
  • Calculation: (Revised Standard Cost - Original Standard Cost)
  • Variance: £2,112.50 - £12,500 = £10,387.50 Favourable
• Operational Variance:
  • Calculation: Actual Cost - Revised Standard Cost
  • Variance: £2,000 - £2,112.50 = £112.50 Favourable

iii. Summary of Labour Variances

2. Commentary on Calculations and Managerial Responses

A. Materials Variances Analysis

• Price Variance:
  • The planning price variance of £1,875 adverse is due to an uncontrollable market price increase from £5 to £6.50 per kg.
  • The operational price variance of £625 favourable indicates that the purchasing manager negotiated a price (£6/kg) below the revised market rate (£6.50/kg).
• Usage Variance:
  • The planning usage variance of £1,875 adverse arises from new regulations increasing material usage from 4 kg to 5.5 kg per unit.
  • The operational usage variance of £812.50 favourable suggests efficient material usage by production, using less material (1,250 kg) than the revised standard (1,375 kg).

Evaluation of Jack's Response:

• Criticism of Purchasing Manager:
  • Unjustified, as the adverse price variance was due to market conditions beyond control.
  • The purchasing manager actually achieved a price below the revised standard.
• Criticism of Material Usage:
  • Partially justified concerning initial overuse, but the production team used 125 kg less than the revised standard, indicating efficiency.

B. Labour Variances Analysis

• Planning Variance:
  • The substantial favourable planning variance (£10,387.50) is due to the initial standard being set without considering the 80% learning curve.
• Operational Variance:
  • The modest favourable operational variance (£112.50) shows that the production staff slightly exceeded the revised efficiency expectations.

Evaluation of Jack's Response:

• Praise for Production Staff:
  • Overstated, as the majority of the favourable variance is due to incorrect initial standards, not exceptional performance.
  • The actual performance was only marginally better than the revised standard.

Conclusion

The initial managerial responses to the variances were based on incomplete information and incorrect standards. The majority of the adverse materials variances were due to external factors (market price increase and regulatory changes), and the purchasing and production teams performed efficiently under the new conditions. Similarly, the substantial favourable labour variance was primarily due to the learning curve effect not being considered in the original standard, with actual performance only slightly exceeding revised expectations.

Recommendations

• Standards Revision:
  • Update standard costs to reflect current market prices, regulatory requirements, and learning curve effects.
• Performance Evaluation:
  • Assess managerial and staff performance against revised standards to provide fair evaluations.
• Communication:
  • Ensure that all departments are informed of changes that affect standards to align expectations and performance metrics.