2.3 Direct Material Price Variance
= actual quantity*(standard price-actual price
= 5,600kg*[£10/kg-(£61,600kg/5,600kg)]
= 5,600kg*(£10/kg-£11/kg)
=£5,600 A(3.75%)
The rate for direct material price variances is 3.75%
2.4 Direct Labour Total Variance
= (standard hours of actual production*standard rate ph)-(actual hours*actual rate ph)
= 3,200hrs*£9-3,520hrs*£10
= £6,400 A
The rate for direct labour total variances is22.22%
2.5 Direct Labor Efficiency Variance
= standard rate ph * (standard hours of actual production – actual hours)
= £9*(3,200hrs-3,520hrs)
= £2,880A
The rate for direct labour efficiency variances is 10%
2.6 Direct Labor Rate Variance
= actual hours*(standard rate ph-actual rate ph)
= 3,520hrs*(£9-£10)
= £3,520 A
The rate for direct labour rate variances is 12.2%
2.7 Total Overhead Variance
= total standard overhead for actual production- total actual overheads
= (£18000/12+£2500+£2200+£2000)-( £1500+£2500+£2200+£2400)
= £400 A
The rate for total overhead variances is3.5%
3.0 Analysis of Variances
Considering the policy of Tricol plc, the criterion that need to analyse the variance is more than a rate of significant of 3%, as a result, it need to analyse all variances. The below are some possible reasons for variances.
3.1 Direct Materials
- Direct materials total made up of Direct material usage and Direct material price.
- Direct material usage £8000F (12.5%) improved the material usage which can saving large amount of material of about 800kg. This may cause by new machinery uses less materials or incurs less wastage, or there is higher-grade material which can save the amount for this products,
-
Direct material price £5600 A (8.75%), there isncrease from original £10 per kg to £11 per kg, 1/kg more expensive than planned as the profit is high, which may caused by new supplier, which lead to loss of discounts.
3.2 Direct Labour
- When adding labour rate and efficiency variances the result must equal to the labour total variance. Therefore, £3520(A) + £2280(A) = £6400(A).
- Direct labour rate: 3520A (12.2%) on average, the time of produce a products will require more than the original hours for 12 minutes, and£1/hour higher than planned. There may be more overtime than it was required, or wage settlement are higher than expected.
- Direct labour efficiency: £2880 A(10%) the time changes from 3200 hours to 3520 hours, using 320 more labour hours for the production. The changeable of the machine have made some adverse result for the company, as there required more hours for training operative of machines.
3.3 Total Overhead
- The total overhead is £400 A (3.5%), there is higher fixed costs, caused by introducing the new machinery. The company need to pay more money on insurance and maintenance, as well as extra administrative costs in relation to the procurement of machinery..
- These lead to £200 increased of insurance cost and administration cost, so this firm will has £400 adverse.
4.0 Recommendations for Management Action
Mangers should pay close attention on all of the variance, for the reason that the figure of each variance is calculated more than 3% of the budgeted total cost. Thus, all the variances need to be further investigated by the firm.
Specifically, there is high level of remuneration of the staffs, but the manufacture of production is low, thus, there should be inspect the Direct Labour as well as the management of staff and their work efficiency, made clear that why the company's labour wage are beyond the labour productivity. To solve the problem, the firm can provide some training classes for their staffs to improve their skill and knowledge to increase their level of work efficiency. Another way to avoid great variance is to reduce labour rate, through employ some lower grade workforce, hence to pay lower salary and make a plan for overtime.
Part B
1.0 The two technique methods
1.1 The payback period methods:
The usual investment and project appraisal assumptions have been applied, namele: year 0 means now; year 1 means at the end of 12 months from now; and so on the figures in brackets, designate an outflow.
1.2 Discounted Cash Flow
Calculate the present value at 10%:
1.3 A briefly description of the key assumption
- The impact of taxation and inflation has been ignored
- Assumed that the given market rate of return will not change and
- All the market factors are stable
- The total cost of the project will be payable at the start
- There is no change in exchange rate
- The expected revenue from the investment, this is the expected net cash flow after deduction of all relevant costs.
1.4 Summery and Recommendation
Payback period is 4years and 1.5months. In year 5 the cash inflows for the full year are £ 320,000, but only £40,000 is required to recoup the initial investment. Therefore, this is reached in 1.5 months. The company will pay back the initial outlay in less than 5years, which seems that the project is profitable.
Net present value for the project is £(64800), that is a deficit which means the cash flow are nor enough to allow more deducted and could not repay the original investment with required of 10% return.
Therefore, considerations should be taken before invest in the project.
By only consider NPV outcome, the company cannot make profit in investment. However, the company plan to develop a long-term project.
The managers should consider that the project payback is less than 5years or it can exist beyond 5 years. The cost of finance is also very important. It should consider how to finance such enough money of £1.000.000 to invest in the project. Meanwhile, the company predict the cash flow during 6 to 10 years. By calculation of net present value. In addition, there are also some non-financial factors to be considered.
2.0 Consideration of Other factors
Thee are some important factors which should be considered careful by the management.
2.1 Advantages and Disadvantages of Payback and NPV
Advantages of pay back methods
- It is considered to be simple to operate and easy to understand.
- It is to be considered that the shorter the payback period, the less risky the project.
- It shows how soon the cost of purchasing an asset will be recovered.
Disadvantages of payback methods
- It ignores cash flows after initial outflow has been met
- It ignored risk.
- No allowance is made for interest on the initial capital investment.
Advantages of NPV method
- Provides an objective basis for evaluating and selecting investment projects
- Takes account of both magnitude and timing of expected cash flows in each period of a project's life
- Focuses on cash inflows and outflows rather than on accounting profits.
Disadvantages of NPV method
- The cost of capital used to calculate the discount factor is hard to forecast
- Assumes that we live in a world of certainty, that we are sure of the cash flows and that they occur regularly and evenly.
2.2 Additional factors
-
Surplus value: is the project have only five years residual value or longer life.
-
Internal Technical factors: New facilities and high-tech equipment, will enhance the company's productivity. Or it will increase in money of training the labour and employ high-skilled workers.
-
Strategy: whether or not the investment and project are conform with the company's cooperate strategy.
-
Cash flow: whether there is enough current to invest in the project of totally £1,000,000.
-
Environment factors: changes in PEST factors such as political factors, economic factors, social factors and technical factors.
- Government policies such as restrict business activities, and increase the tax on this product.
- Or social factors like the consumer purchasing power is limited, when supply is over demand, the products may fell in price.
Conclusion
The report can help the company make the flex budget and variances, as well as use the two technique methods to analysis the investment and help the company choose the investment methods.