Butler Products
Case Study for DBA 8230

May 8, 2012

Background
The Butler family of products produces a wide variety of items. One of the manufacturing companies makes products in three finishing departments (A, B, and C), which have identical assembly operations but package the products differently for different lines of business.
Each finishing line packages units as either single or multiple units per package. For allocating overhead, volume is defined in terms machine hours. Each department can package 1,140 single units per hour.
Department A has the oldest equipment, which is in the last year of its depreciable life. Department N’s equipment is about half depreciated. Department C’s equipment is in the second year of its life.
The budget prepared for each department in 2010 included the following costs, volumes, and overhead rates (given in millions of dollars):

| A | B | C | Expected number of units | 73M | 73M | 55M | Fixed overhead | | | | General expense | $1.5M | $2.0M | $1.25M | Rent | $1.5M | $2.0M | $1.75M | Depreciation | $0.5M | $2.0M | $5.0M | Total fixed overhead | $3.5M | $6.0M | $8.0M | Variable overhead | $150/machine hour | $131/machine hour | $150/machine hour | Machine rate | 1,140 units/hour | 1,140 units/hour | 1,140 units/hour | Direct materials | $0.50/unit | $.052/unit | $.55/unit | Direct labor | $.015/unit | $.015/unit | $0.135/unit |

The general expense portion of the overhead is set by each department at the beginning of the year for training, capital items under $2,500, and other department needs. The rent charged to each department is determined by the age and the structure of the building in which the department operates. In general, machines that are shut down because of volume decreases are not removed, so rent charges do not decrease with volume.
The company currently determines unit manufacturing cost (UMC) charges on a department basis, with one UMC for all types of products finished in that department. Under- or over-absorbed overhead is aggregated over the entire division and distributed to the departments based on normal volume.
The packaging machines in each department require different amounts of maintenance (variable overhead). In department A, the maintenance is higher because of older drive and logic systems. In department C, it is higher due to start-up costs that should decrease with time.
Direct materials costs depend on the products each department has been designated to run and the age of the equipment. They are outside the control of the department.
In 2010, Butler sales softened and not all of the capacity in departments A, B, and C is needed in 2011. Some capacity will be eliminated in one of the departments.
The UMC’s for 2010 were as follows: | A | B | C | Actual units packaged | 67 M | 73 M | 49 M | Direct labor per unit | $0.15 | $0.15 | $0.135 | Direct materials per unit | $0.50 | $0.52 | $0.55 | Actual overhead charge | $12.7M | $14.7M | $14.3M | Actual machine hours | 58,772 | 64,035 | 42,982 |
Source: G Butler, E Rubiano, S Tedesco, and B Watkins.
Analysis
Managing Inventory
A standard cost is the predetermined cost of manufacturing a single unit or a number of product units during a specific period in the immediate future. It is the planned cost of a product under current and / or anticipated operating conditions. A standard is a "benchmark" or "norm" for measuring performance.
In our daily lives, we operate in a management by exception mode most of the time. Consider what happens when you sit down in the driver's seat of your car. You put the key in the ignition, your turn the key, and your car starts. Your standard that the car will start is met; you do not have to open the car hood and check the battery, the connecting cables, the fuel lines, and so on. If you turn the key and the car does not start, then you have a discrepancy (variance). Your standards are not met, and you need to investigate why. Note that even if the car is started after a second try, it would be wise to investigate anyway. The fact that the standard was not met should be viewed as an opportunity to uncover the cause of the problem rather than as simply an annoyance. If the underlying cause is not discovered and corrected, the problem may recur and become much worse.
This basic approach to identifying and solving problems is exploited in the variance analysis cycle. The cycle begins with the preparation of standard cost performance reports in the accounting department. These reports highlight the variances, which are the differences between actual results and what should have occurred according to the standards. The variances raise questions. Why did this variance occur? Why is this variance larger than it was last period? The significant variances are investigated to discover their root causes. Corrective actions are taken, and then next period's operations are carried out. The cycle then begins again with the preparation of a new standard cost performance for the latest period. The emphasis should be on flagging problems for attention, finding their root causes, and then taking corrective actions. The goal is to improve operations - not to find blame.
Specific to our case, factory overhead volume variance represents the difference between the budget allowance and the standard expenses charged to work in process. The volume variance indicates the cost of capacity available but not utilized or not utilized efficiently and is considered the responsibility of the executive and departmental management. In this case, for allocating overhead, volume is defined in terms machine hours. * All numbers are in $M | Department A | Department B | Department C | Actual factory overhead | | $12.7 | | $14.7 | | $14.3 | Budgeted allowance based on actual hours worked: | | | | | | | Fixed expenses budgeted | $3.5 | | $6.0 | | $8.0 | | Variable expenses: actual machine hours × variable standard overhead rate | $8.8 | | $8.4 | | $6.4 | | | | $12.3 | | $14.4 | | $14.4 | Overhead spending variance | | ($0.4) | | ($0.3) | | $0.1 | | | | | | | | Actual hours × Standard overhead rate | | $11.6 | | $14.4 | | $13.6 | Standard hours allowed for expected output × Standard overhead rate | | $11.6 | | $14.4 | | $13.6 | Overhead efficiency variance | | ($0) | | $0 | | $0 |

Conclusion
This was an interesting case. In the original read, it appeared to be simplistic; however, the second read through revealed several items missed in the first read. I would reduce demand in Department A; they have the largest unfavorable variance in overhead spending.

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[ 1 ]. Zimmerman, J.L. (200). Accounting for Decision Making and Control. New York, NY: McGraw-Hill/Irwin.
[ 2 ]. Zimmerman, J.L. (200). Accounting for Decision Making and Control. New York, NY: McGraw-Hill/Irwin.
[ 3 ]. Johnsen, D. and Sopariwala, P. "Standards Costing is Alive and Well at Parker Brass," Management Accounting Quarterly, Winter 2000, pp. 12-20.