Jay Walk Slippers, Inc., and Static Budgeting
Mr. Sonic, CEO of Jay Walk Slippers, Inc., asks Ms. Villa, accountant, the reason for obtaining an unfavorable factory overhead variance. Ms. Villa looks serious as she glances at the report on manufacturing operations for the current month of October. Actual factory overhead is bigger than the standard. Since last month, Mr. Sonic’s idea about the plant operations has always been negative. During that time, he planned to have the internet disconnected because of various complaints about employees playing online games even during regular daytime office hours and night shifts.
There are two material price increases during the month because of the recent oil increase. The plan to cut off internet connection was not pursued because management and staff agreed to minimize internet use for personal interest.
Miss Villa explains to the CEO that the variance is not a gross figure but a net difference. There might be an unfavorable production volume variance but this is offset with a favorable efficiency variance. But when unfavorable production volume is greater than the favorable efficiency variance, it results in a net unfavorable factory overhead variance. Such unfavorable volume variance exists because the planned production capacity is not fully utilized due to the unexpected price increase. Expected production for slippers has been 1,000 units, and only 900 were actually produced. However, efficiency variance is favorable because even when production expectation is not realized, there is an indication that the company is able to produce its actual target during the period.
Explaining further, she says, at standard, the company should have used 7,200 hours to produce 900 units of Jay Walk Slippers, but it has used only 7,000 hours. This is due to the manpower training that was sponsored by a foreign investor planning to buy its products at the middle of the year.
Mr. Sonic instructs her right away to analyze carefully the situation and whatever will be suggested as improvement will be implemented right away.
Miss Villa is trying to tell the CEO that the company is using static budgeting for overhead wherein no deduction for fixed overhead is made, because it cannot be adjusted even if the company produces less or more than the expected capacity. Static budgeting is also used in all its financial forecasts.