Revision of Standards NuLathe Co. produces a turbo engine component for jet aircraft manufac- turers. It has used a standard costing system for years with good results.

Unfortunately, NuLathe recently experienced production problems. The source for its direct materials went out of business. The new source produces similar but higher quality materials. The price per pound from the old source averaged $7.00; the price from the new source is $7.77. The use of the new materials results in a reduction in scrap that lowers the actual consumption of direct materials from 1.25 to 1.00 pounds per unit. In addition, the direct labor decreased from 24 to 22 minutes per unit because of less scrap labor and machine setup time.
The direct materials problem occurred when labor negotiations resulted in an increase of more than 14 percent in hourly direct labor costs. The average rate rose from $12.60 per hour to $14.40 per hour. Production of the main product requires a high level of skilled labor. Because of a continu- ing shortage in that skill area, NuLathe had to sign an interim wage agreement.

NuLathe began using the new direct materials on April 1 of this year, the same day the new labor agreement went into effect. The company had been using standards set at the beginning of the calendar year. The direct materials and direct labor standards for the turbo engine component are as follows:

Howard Foster, cost accounting supervisor, had been examining the following performance report that he had prepared at the close of business on April 30. Jane Keene, assistant controller, came into Howard's office. He said, "Jane, look at this performance report. Direct materials price increased 11 percent and the labor rate increased over 14 percent during April. I expected larger variances, but direct manufacturing costs decreased over 5 percent from the $13.79 we experienced during the first quarter of this year. The proper message just isn't coming through."

"This has been an unusual period," Jane said. "With the unforeseen changes, perhaps we should revise our standards based on current conditions and start over."

Howard replied, "I think we can retain the current standards but expand the variance analysis. We could calculate variances for the specific changes that have occurred to direct materials and direct labor before we calculate the normal price and quantity variances. What I really think would be useful to management right now is to determine the impact the changes in direct labor had in reducing our direct manufacturing costs per unit from $13.79 in the first quarter to $13.05 in April-a reduction of $0.74."

Comparison of Actual Per-Unit Costs

Required

1. Discuss the advantages of immediately revising the standards and of retaining the current standards and expanding the analysis of variances.

2. Prepare an analysis that reflects the impact of the new direct materials supplier and the new labor contract on reducing NuLathe Co.'s costs per unit from $13.79 in the first quarter to $13.05 in April. This analysis should be in sufficient detail to identify the changes due to the direct materials price, the direct labor rate, the effect of direct materials quality on direct materials usage, and the effect of direct mate- rials quality on direct labor usage. The analysis should show the changes in cost per unit due to the following.

a. Use of the direct materials from new suppliers. (Hint: There should be three components: change due to price; change due to the effect of materials quality on materials usage, and, change in labor usage based on materials quality. The net effect of these three factors is $1.40 per unit.)

b. The new labor contract. (Note the sum of (a) and (b) should equal $0.74 per unit.)