This report recommends that no bonuses be awarded to the production department. Responsibility accounting assigns costs, revenues, and profits to those managers who have direct responsibility (Hansen, Mowen, & Guan, 2009). Responsibility accounting forms the basis of assigning responsibility, establishing performance measurements, evaluating performance, and awarding rewards. The production manager is responsible for the costs incurred in the production department. The standard cost and quantities establish the performance measurements. The production manager performance can be evaluated against the standard costs and the variances computed. The variance analysis forms the basis of awarding the bonuses.
The variance analysis shows that the production manager performed dismally. The production manager is responsible for output, material variance, labor variance variable overhead variance, and fixed overhead variance.
Direct Material usage variance: The production manager used 2.7 meters per leather jacket instead of 2.5 meters per leather jacket. The result is a $66,000 adverse material usage variance. However, the production manager had zero material variance in material usage for the Nylon jackets. The production manager adverse material usage variance in the leather jackets could not possibly be offset with a favorable material usage variance in the nylon jackets. This results in an overall adverse material usage variance of $66,000. While the production manager may blame the adverse material usage variance on the incompetence of the workers, they were in charge of hiring.
Direct Material price variance: the leather jackets material should have cost $20 per meter but did cost $21 per meter leading to an adverse material price variance of $16,500. The production manager could argue that the adverse material variance was due to the use of high quality materials. However, this would not be corroborated because the sales manager says that customer returns rose from below 1% to 8% because of inferior quality among other reasons. The production manager can also blame a hike of prices by suppliers, but it is possible that he could have entered into contracts with suppliers that could have locked into a price. The production manager may have ignored the benefit of hedging possibly because they believed that they might be able to get better market prices. The combined effect of direct material usage variance and the direct material price variance leads to an overall material variance of $82,500.
Direct labor rate variance: direct labor should have cost $20 per hour but did cost $17.60 per hour resulting in a favorable labor rate variance of $99,000. The use of inexperienced workers saved the company $99,000 in wages.
Direct labor efficiency variance: a leather jacket should have taken two hours but did take two and a half hours resulting in an adverse labor efficiency variance of $165,000. The adverse labor variance shows that the workers took 25% more time to make the leather jacket than the standard time of two hours. While the workers were cheaper, the large adverse labor efficiency more than offsets the favorable direct rate labor rate variance of $99,000 resulting in an adverse labor variance of $66,000. In addition, the workers inexperience led to the adverse material usage variance of $66,000. When you factor in the adverse material usage variance and the adverse labor variance, the total variance attributable to workers incompetence shoots to an adverse variance of $132,000.
Variable overhead variance: the leather jackets should have consumed $6.00 in variable overhead but did consume $7.00 leading to an adverse variable overhead variance of $16,500. This point to poor cost control by the production manager or errors in forecasting (Lucey, 2003).
Fixed overhead volume variance: the production manager produced 110,000 units surpassing the budgeted production by 10,000 units. This leads to a favorable fixed volume variance of $90,000. The increase in output is primarily driven by a hike in demand. In particular, a rise in demand of the leather jackets from the budgeted 5,000 units to 16,500 that more than offset the decline in the demand of the nylon jackets from the budgeted 95,000 units to 93,500 units.
Fixed overhead spend variance: the production manager actually spends $1,000,000 against a budgeted expenditure of $900,000 resulting in an adverse fixed overhead spend variance of $100,000. The adverse fixed overhead spend variance shows that the production manager is poor at controlling fixed overhead costs.
Using responsibility accounting the production manager is responsible for the adverse variances in direct material of $66,000, direct material price of $16,500, direct labor efficiency of $165,000, variable overhead variance of $16,500, and fixed overhead spend variance of $100,000. On the other hand, the production manager is responsible for the favorable variances in direct labor rate variance of $99,000 and fixed overhead volume variance of $90,000. Overall, the favorable variances cannot offset the adverse variances resulting in net adverse variance. On basis of the variance analysis, the production manager should not be awarded a bonus.
In future, the production can avoid adverse variances by entering into contracts, hiring highly skilled workers or training them quickly, controlling costs better, and better planning. Better planning will require the manager to gather more quality information that will improve the reliability and accuracy of the budgeted estimates. If the production manger improves in the said areas, it is likely that their actual performance will be within an acceptable range of the standard costs and quantities and therefore make the production department eligible to be awarded a bonus.
References
Hansen, D., Mowen, M., & Guan, L. (2009). Cost management. Mason, Ohio: South-Western.
Lucey, T. (2003). Management accounting. London: Continuum.
