Elveron Limited

Business Report

ACC2005

Brian Kelly Rory OCallaghan Niall McCourt Ryan Nesbitt

Table of Contents

Introduction

Issue #1

3-4

Issue #2

5-7

Appendix 1

Appendix 2

Issue #3

10 - 12

Issue #4

13 - 15

Elveron Limited - Business Report

Introduction
The issues identified and advised on in this report are based on the changes
within Elveron Limited and specifically how these changes affected the Truck division of the company. Elveron Limited is an electronic component manufacturing company based in County Wicklow. It is one of the largest manufacturers in
Europe which produces components for car manufacturers and has recently
started manufacturing components for trucks and buses. In November 2005,
the company was sold to Cooper Inc. who is a global market leader based in
the United States.
When Cooper Inc. took over, they made a number of changes to the company.
The changes they introduced included the company splitting into three divisions: the car division, the truck division and the bus division. New work practices were introduced which required the employees to work in a number of
other roles as well as their own. Additionally, local suppliers had also been replaced by suppliers based in Asia. And finally, the product development team
was disbanded.

Elveron Limited - Business Report

Issue #1

and solutions in the budgetary control

| Problems
system and performance report

There are a number of problems with the new budgetary control system now operated by
Cooper Inc that need to be identified and rectified in order to improve the running and efficiency of Elveron Limited.
From the information provided, it states that, Due to the inexperience of a new staff member
who is responsible for the stock accounting records, the purchase price for both materials X
and Y have not been recorded separately. This error has not been accounted for in the Truck
Divisions performance report and may be a contributory reason for the Material Variance of
29,795A and so the correct price for each material should be recorded in the performance
report of the Truck Division.
The Performance Review of the Truck Division incorporates a figure for the allocation of Cooper Inc. HQ costs and Central Elveron costs, which amount to adverse variances of 18,000
and 7,000 and which contribute towards the negative operating profit figure of the Truck Division of 30,250. However these costs are irrelevant to the performance of the truck division
and should not be included in its performance report.
Cooper Inc. have also adopted a new policy whereby staff are sometimes required to complete the work normally done by another grade but are paid by the rate at which they were
originally recruited. The actual labour hours worked and the actual rates of pay were as follows :

Grade 1= 3,980 hours @ 9.80 per hour

Grade 2= 3,400 hours @ 11.76 per hour
Grade 3= 3,000 hours @ 14.70 per hour

This discrepancy in calculating labour costs means that the labour variance calculation is
likely to be incorrect and is a major drawback of the budgetary control system operated by
the organisation. Labour costs should be calculated on the basis of work actually completed
to give a more accurate performance report.

Elveron Limited - Business Report

The budgetary control system is also likely to have underestimated the cost and disruption of
dividing the company in to 3 different divisions which is a possible contributory factor for the
negative divisional operating profit of the Truck Division as employees take time to settle in to
the new structure of the company. A possible solution would be to learn more about the skills
of its employees so that the most efficient allocation of labour takes place.
Although employees at the company experienced a budgetary control system before, they
were not used to it being used in such an authoritarian and constraining way. Budgets were
seen more of as guidelines and not actual goals to be achieved. As a result of this, employees were always likely to fall short of the budget requirements set out by Cooper Inc. In order
to alleviate this problem Cooper Inc. should not make as demanding budgets for its employees or to at least explain the importance of achieving budget figures and related variances.
It is also stated in the text that the European market for the industry is ahead of expectations
by 10% which may have not have been accounted for in setting the budget figures for the
Truck Division. This growth in the industry is likely to increase material and labour costs
through no fault of the company and so the budgeted labour and material costs should be
lower.
David also states that there has been no attempt to analyse or explain the variances calculated which is likely to lead to confusion and a lack of motivation amongst the workforce In
order for Cooper Inc. to operate a successful budgetary control system it must educate its
workforce on its usefulness and obtain feedback from employees.

Elveron Limited - Business Report

Issue #2

of the budgeted and actual

| Reconciliation
gross profit

Sales margin price variance

This is the actual difference between the sales margin of the product sold. This means it
shows the effect of the difference in selling prices when multiplied across the entire sales for
the quarter. The standard variable cost is used for both side to ensure any production variances do not distort the figure calculated.
When you then put in the figures it gives you an adverse variance of 8,500. This means that
as a result of the actual selling price being 10p smaller than what was budgeted, there was a
difference of 8,500 between their budgeted and actual total sales margin. This any have
come about as a result of managers believing they could sell their product for 6 but discovering due to market competition, they could only sell it for 5.90.

Sales margin volume variance

This shows the sales margin variance caused by there being a difference in the total sales
volume between what was budgeted and what was actually sold.
This shows a favourable variance of 45,750. This means that as a result of Elveron selling
15,000 more units than they predicted they made an extra 45,750 contribution or sales
margin. This could be as a result of the lower selling price increasing sales or potentially some
other external factor such as a rival firm going out of business or just a general increase in
demand.

Material Price Variance

This shows the overall difference caused by the difference in price of the materials purchased.
Its magnitude or level of consequence is determined by the amount of materials bought, in
this case Elveron bought 13,000kg of X and 6,500kg of Y.
When we do this we find a favourable variance of 12,205 meaning that at the standard
prices set out in the budget, the amount we actually bought was 12,205 less than what we
would have expected. A variance like this will have been caused by the materials being
cheaper than expected, this could occur due to a number of things including discounts for
bulk purchases or finding a cheaper supplier.
Elveron Limited - Business Report

Material Usage Variance

This shows us the cost or benefit of using less or more materials throughout the quarter.
When calculated individually for material X and Y it gives us an adverse variance for each of
them as 10,200 each. This could be related to the above favourable variance in relation to
the price of the goods purchased. If Elveron are purchasing cheaper Materials, it could lead
to increased waste as the quality may not be as good. This would mean more materials are
purchased and could be the cause of this adverse materials usage variance. Both these variances could tie in with the fact that the local suppliers have been replaced with preferred
suppliers, typically based in Asia. These will probably be cheaper, however may not be as
high quality.

Labour Rate Variance

The labour rate variance shows how the difference in budgeted wage rate and the actual
wage rate affects Elveron in terms of the actual number of labour hours used in the quarter. It
is calculated using the following formula and then applied over the three different grades of
labour to show us the total variance.
When we put the figures in we get favourable variances of 796, 816 and 900 for Grades
1,2 and 3 respectively. This gives us a total favourable variance of 2,512. This will most likely
have come about through reduced wages as a result of the takeover, however this cannot be
certain.

Labour Efficiency Variance

The labour efficiency variance represents the quantity variance for direct labour.
The standard labour hours is calculated by multiplying the total output (85,000 units) by the
time in hours. This give us an adverse 17,229 variance. The fact that this comes after a favourable variance for the labour rate shows that although they spent less per hour on labour,
the labour was less efficient.

Fixed Overhead Variance

This is one of the simplest variances to calculate and understand, it is just the difference between the budgeted overheads and the actual overheads. In this case, the fixed overheads
are 1 per component, so they are 85,000 and 70,000 respectively.
Applying the figures to the formula gives us an adverse fixed overhead variance of 15,000.
This comes as a direct result of the increased production.

Elveron Limited - Business Report

Variable Overhead Expenditure Variance

The variable overhead expenditure variance is the difference between the flexed budget and
the actual output. The flexed budget can only be used when we know actual output. It is the
variable overhead we would expect, when we know the actual output, based on the proportion of the Variable overhead to budgeted output. The variance is then the difference between
the flexed value for variable overheads (82,875) and the budgeted overheads (80,367).
These were calculated by taking away the fixed overheads from the total of fixed and variable
overheads given in the performance report. This gives us a favourable variance of 2,508.
This could result from savings in costs incurred and more economical use of services. This
may be as a result Cooper Inc.s reshuffling of the business activities.

Variable Overhead Efficiency Variance

The standard hours of output is found by dividing the budgeted expenditure (68,250) and
the actual expenditure (80,367). This gives us an adverse variance of 12,123. This may
have been caused by inefficient work being done by employees. This may be as a result of
the companys reshuffling of staff. As the reshuffle occurred quite recently, the staff members
may be simply settling into their new jobs.

Reconciliation Statement
The reconciliation statement in Appendix 1 (on the following page) shows the revenue and
cost variances in more detail than the one provided in the first quarter performance report for
the Truck Division for 2006. It is essentially a compilation of all the variances presented in a
more easily understandable format and shows an overall adverse variance of 10,277 giving
an actual gross profit of 133,223 when it was budgeted as 143,500.
Appendix 2 shows the formula used to calculate the different variances above.

Elveron Limited - Business Report

Appendix 1: Reconciliation Statement

Budgeted Gross Profit

143,500

Variances:
Sales margin price
Sales margin volume
Materials price
Materials usage
Labour rate

(A)

(F)

8,500
45,750
12,205
20,400
2,512

Labour efficiency
Fixed O/H expenditure
Variable O/H expenditure

17,229
15,000

Variable O/H efficiency

12,123
73,252

2,508
62,975

Variance

10,277A

Actual Gross Profit

133,223

Elveron Limited - Business Report

Appendix 2: List of variance formulae

Sales margin price variance

(actual selling price - standard selling price) x actual sales

volume

Sales margin volume

(Actual sales volume - Standard sales volume) x Standard

variance

contribution margin

Materials price variance

(Actual quantity purchased Actual price) (Actual quantity purchased Standard price)

Materials usage variance

(Actual quantity used Actual price) (Actual quantity

used Standard price)

Labour rate variance

(Actual hours worked Actual rate) (Actual hours

worked Standard rate)

Labour efficiency variance

(Actual hours worked Standard rate) (Standard hours

allowed Standard rate)

Fixed O/H expenditure

(Standard fixed overheads - Actual fixed overheads)

variance
Variable O/H expenditure

(Standard variable overheads for actual input volume -

variance

Actual variable overheads cost)

Variable O/H efficiency

(Standard quantity of input hours for actual production -

variance

Actual input hours) x Variable overhead rate

Elveron Limited - Business Report

Issue #3

Impact of inaccurate labour standards and

revision of variances

The third issue we investigated was about the potential impacts of using inaccurate labour
standards and how the accuracy of the revised variances can be determined.
When a variance is calculated the next step will be to find the reasons for that variance, and
do whatever is necessary to fix it. By using inaccurate labour standards for the truck division,
Elveron Limited may come to the wrong conclusions about the source of the variance and
could take unfair action against the division managers.
Standards may also become outdated if they have not been regularly revised by the company. If this does happen, the standards could represent a technology which no longer exists
or supply conditions that have changed, which is evident in this case as the local suppliers
have been replaced with suppliers based mainly in Asia. This could have a detrimental effect
to the stock levels of the company as in the information provided to us it stated that there is a
required minimum level of stock of 5000 components. If it were to drop below this, it would
be a lot easier to re-stock from local suppliers than from those based in Asia.
The most relevant effect of outdated standards in Elveron Limiteds case is that the workforce
has become more experienced due to the new work practices introduced by Cooper Inc.
when they took over the company. These new work practices require employees to complete work in a variety of different roles as well as in their own specialised areas.

FIGURE 1

Grade I
Grade II
Grade III

Actual time
(minutes)
2.80
2.40
2.12

Elveron Limited - Business Report

Budgeted time
(minutes)
3.00
2.00
1.50

Revised time
(minutes)
2.85
2.30
2.10

10

Figure 1 above illustrates how to determine the accuracy of the revised budgets. We have
assumed that in the revised labour standards the wage rate per hour remained the same and
only the time per component was different.
Using this assumption we were able to determine the calculations for the accuracy of the revised standards. From the table the actual times are worked out by dividing the total time in
hours by the actual production output. Then multiply this by 60 to get it into minutes.
From the table we can see that the revised standards are more accurate compared to the
budgeted labour standards as they are closer to the actual times. The next step is to use
these revised standards to re-calculate our labour variances.
To calculate the labour rate and efficiency variances we use the same formula as previously
outlined in issue #2 but substitute in the new figures for the actual hours worked. The new
figures for hours worked is calculated by dividing the revised time per component by 60 then
multiplying it by the total units sold which is 85,000. The calculations for the revised labour
wage rate variance are:

Grade I : (2.85/60) x 85000 = 4

(10 9.8) x 4037.5 = 807.5 F

Grade II : (2.30/60) x 85000 = 3258.33

(12 11.76) x 3258.33 = 781.99 F

Grade III : (2.10/60) x 85000 = 2975

(15 14.70) x 2975 = 892.5 F

Total labour rate variance = 807.5 + 781.99 + 892.5 = 2481.99 F

With this variance the variance of grade 1 increased from the original variance calculated and
grade 2 and 3 both decreased. This was due to the fact that grade 1 workers had worked
more hours and grades 2 and 3 had decreased the amount of hours worked.

Elveron Limited - Business Report

11

There is a similar pattern with the labour efficiency with the variance of grade 1 decreasing
and the variance for both 2 and 3 increasing. This again was due to the changing amount of
hours worked by each grade of employee. Calculations for the revised labour efficiency variance are shown below:

Grade I : (4250 4037.5) x 10 = 2125 F

Grade II : (2833 3258.33) x 12 = 5103.96 A
Grade III : (2125 2975) x 15 = 12750 A

Total efficiency variance = 2125 F + 5103.96 A + 12750 A = 15,728.96 A

Elveron Limited - Business Report

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Issue #4

and drawbacks of the proposed in| Benefits

centive schemes

Issue 4 relates to a comparison of the existing time-based scheme of paying wages and the
two new proposed incentive schemes. In order to calculate the total weekly wages in each
scheme, we must first analyse the costs for the current time-based scheme based on a
current employee, John Murphy.
John Murphy is a typical employee working at the grade II level within the production function
of the truck division. Using the information provided in appendix 3, we learn that he is
currently paid at a rate of 11.76 per hour and works a standard 40-hour week. On top of
this, during the first quarter, he worked an average of 6 hours overtime per week which was
paid at time and a half. We have assumed that John Murphy represents each average worker
in the total workforce.
FIGURE 2

Time-based scheme
()

Piece-rate with
guaranteed
minimum ()

Differential piecerate ()

1,000 components

576.24

380

340

1,300 components

576.24

468

442

1,600 components

576.24

576

720

Figure 2 above shows the schedule which compares the weekly wages earned by John Murphy under the existing time-based scheme and the two possible incentive schemes at each
weekly activity level. As you can see, we calculated the total weekly wages for John Murphy
to be 576.24 for each level of activity as it isn't dependant on how many components are
manufactured.

Elveron Limited - Business Report

13

The first incentive scheme is the piece-rate with a guaranteed minimum. Under this scheme,
grade II workers would be paid a rate of 0.36 per component but with a guaranteed
minimum of 380 per week. The calculations for each activity level are included in the table.
Also included are the calculations for the second incentive scheme which is the differential
piece-rate. This allows the workers to earn more if they manufacture within the higher levels
of components.
For both levels of activity (1,000 and 1,300 components), the workers would prefer the timebased scheme as they would be paid 576.24 weekly compared with the 380 and 468 for
the piece-rate with a guaranteed minimum, and the 340 and 442 from the differential
piece-rate scheme. They would prefer this as from their point of view; they will receive
576.24 regardless of the number of components manufactured so there is no motivation for
them to work harder or put in more effort as they are not receiving an additional benefit from
it.
For the third level of activity (1,600 components), it would be in the best interest of the
workers to prefer the differential piece-rate scheme because if they manufacture the full 1,600
components, they can earn 720 per week which is the most that can be paid out per week
of all three schemes.
Overall, the workers would prefer the time-based scheme because regardless of how much
work they put in to the manufacture of the components, they will still be paid the same
amount. However, if the workers wanted some extra motivation or wanted to increase their
weekly wages, they could opt to prefer the differential piece-rate scheme with an increase in
wages of 143.76 if they can manufacture the full 1,600 components. If they do not meet this
requirement, they will only receive the lower amounts of either 442 or 340. In conclusion,
the workers should only prefer the differential piece-rate if they believe that they can continue
to manufacture the full 1,600 components and the increase in wages will certainly be good
motivation to do so.
So that is from the workers' perspective, but incentive schemes can also benefit the
company and have its drawbacks.
Some of the benefits for Elveron Limited would be that it would motivate the workers to
constantly produce a high volume of good components which would decrease the amount of
wasted materials. Also, the company would only be spending money on wages to those who
perform well and are not wasting money on paying those who are slacking or producing less
than the requirements.
The company will be making a saving compared to the time-based scheme apart from at the
1,600 component activity level for the differential piece-rate scheme but this extra labour
expenditure is returned in a high amount of good components manufactured by the workers.
There will be a reduction in the cost of production per component because the cost of
production per units of output declines due to a decrease in the labour cost and overheads
per unit. The final benefit is a reduction of idle time. Since the payment of wages is linked with
efficiency, the idle time costs are reduced to the minimum.

Elveron Limited - Business Report

14

And finally, the drawbacks of the incentive schemes for Elveron Limited are that it could
cause conflict between the workers. If some feel that they are being treated unfairly or
differently, it will have a negative impact on the productivity of these employees. This is a
disadvantage to the company as the employees will not be productive which will decrease
the amount of good components manufactured. Another is that the company would have to
provide more supervision: as the workers won't want to speed up to manufacture more
components to increase their wage level, more supervision is required to avoid decline in the
quality of work and an increase in the wastage of direct materials. There could also be union
opposition. Labour unions may oppose the incentive schemes because it makes them less
essential and creates jealousy and greed among the workers. This could ultimately lead to
strikes or lock-outs.

Elveron Limited - Business Report

15