Summary The management of Cotter Company, Inc. realized that its sales were subject to seasonal variations.

However, they projected that for the year as a whole the sales volume would equal the production volume, using a stand costing system. They have hired our HKS consulting firm, to analyze their production cost variances to provide their managers with useful insight in controlling the various organizational elements that affect the performance of the production function. Analysis 1. There are several assumptions that can be made for the $27,000 loss in January compared to the $20,000 profit that was expected. The first thing to consider is that January is the first month that Cotter Company, Inc. started its operations. When starting a new business it can be expected that they will have a large amount of unfavorable variances in the beginning. In the long run, we believe the company will become more stable and will gain a larger sales market as the business is promoted and expanding. This variance also could come from the fact they used standard costs and did not calculate the seasonal variances that they have already realized are part of their business. Therefore, they could have a loss in January, but make up for this loss in a more favorable month for their product. 2. Cotter Company has asked to find the point where they earn exactly zero profit, which is also known as the break-even point. We found their break-even point to be 155,556 units. We are to assume the selling price of their product is $1 per unit. The annual budget shows that their prime costs are 40% of their sales and variable production overhead is equal to 25% of prime costs. Therefore, the variable production overhead is rate is 10% of the sales, and the variable selling and general expenses rate is 5%. To figure out the fixed production overhead and fixed selling and general expenses for the month of January we divided their yearly amounts by 12 months, which gives us $50,000 for fixed production overhead and $20,000 for fixed selling and general expenses. If we assume that X is the production volume, the equation would look like: X - 0.4X - 0.1X - 0.05X - 50,000 - 20,000 = 0 X = 155,556 As a result, Cotter needs to sell 155,556 units in order to break even. 3. Based on the information given for budgeted and actual data, we found that Cotters January production volume was 150,000 units. It is stated that the annual production volume is equal to the annual sales volume in units. To find the sales volume in units, we took the sales volume and divided it by the selling price ($2,400,000 / $1), which equals 2,400,000 units. We then divided this by twelve months to find the standard monthly sales volume (2,400,000 / 12), which equals 200,000 units. We then had to find the overhead rate by using this equation:|
OH rate = Total fixed overhead cost per period + (Variable overhead cost per unit * Standard volume)

Standard volume

Using the information given and calculated previously, we found an overhead rate of .35.
($600,000 / 12) + [($240,000 / 2,400,000) * 200,000] = $50,000 + $20,000 = $70,000 = .35 200,000 200,000 200,000

Next, we used the budgeted and absorbed cost equations along with the volume variance to find the actual production volume. To solve for actual volume (x), we found that the volume variance equals absorbed costs minus budgeted costs for the month: (12,500) = .35x (50,000 + .1x) x = 150,000 units 4. We found that Cotter has an ending inventory of 10,000 units. Assuming that January was Cotters first month of operation there is no beginning inventory. During the month, their production volume was 150,000 units. January sales equaled $140,000, which divided by the selling price of $1 means that they sold 140,000 units. The ending finished good inventory can be calculated by: 150,000 140,000 = 10,000 units 5. We found Cotter Companys actual production overhead costs for January to be $52,500. We calculated this by using our actual units produced multiplied by our overhead rate: 150,000 X .35 = $52,500 This shows us that for the month of January their actual overhead costs was less than what they had budgeted. 6. For Cotter Company, their prime costs were direct materials and direct labor. The direct material cost variance can be split up into two components; the material usage variance and material price variance. The material usage variance looks at the difference between the actual quantity of material used and the standard quantity of material. The material price variance then looks at the difference between the standard price used and the actual price the materials cost. The direct labor variance is calculated like the direct materials variance and is split into an efficiency variance and a rate variance. The efficiency variance is the difference between the standard input time and the actual input time. The rate variance is the difference in the standard hourly rates and the actual hourly rate. We used each of these formulas in calculating the variances: (Further detail can be seen in Exhibits one and two) Direct Materials Variances:
Usage: Price: 110,000 X $.10 = 11,000 (F) $.01 X 390,000 = 3,900 (F)

Direct Labor Variance:

Efficiency: 833 X $9/hour = 7,497 (F) Rate: (2.36) X 2,500 = (5,900) (U)

Exhibits: 1. Direct Materials:

Direct Materials Unit Price Physical Quantity Standard $ 0.10 500,000* Actual $ 0.09 390,000 Difference $ 0.01 110,000 Total Cost $ 50,000 $ 35,100 $ 14,900

*200,000units x $2.5/lb 2. Direct Labor:

Time Standard $9/hour Actual $11.36/hour Difference $2.36/hour Direct Labor Labor Hours Total Cost 3,333 $ 30,000 2,500 $ 28,400 833 $ 1,600