Carly Davis, production manager, was upset and puzzled by the latest performance report, which indicated that she was $ 100,000 over budget. She and her staff had worked hard to beat the budget. Now she saw that three items—direct labor, power, and setups—were over budget. The actual costs for these three items were as follows:
Direct labor .......... $ 210,000
Power ............. 135,000
Setups ............. 140,000
Total ............ $ 485,000
Carly felt that the additional labor and power cost were due to the fact that her team produced more units than originally budgeted. Uncertainty in scheduling had led to more setups than planned. She asked Sean Carpenter, the controller, why the performance report did not take the additional production into account. Sean assured Carly that he did adjust the report for increased production and showed her the budget formulas he used to predict the costs for different levels of activity. The formulas were based on direct labor hours as follows:
Direct labor cost = $ 10X
Power cost = $ 5; 000 + $ 4X
Setup cost = $ 100; 000
Carly pointed out that power costs were unrelated to direct labor hours, but that they seemed to vary with machine hours instead. She also pointed out that setup costs were not fixed. They varied with the number of setups— which had increased due to scheduling changes. The increase in setups required her team to work overtime, adding to the costs. Each setup also took supplies that added significantly to overhead costs. Sean agreed that the formulas did not adequately take care of Carly’s concerns. He agreed to develop a new set of cost formulas based on better explanatory variables. After a few days, Sean shared the following cost formulas with Carly:
Direct labor cost = $ 10X; where X = Direct labor hours
Power cost = $ 68; 000 + 0: 9Y, where Y = Machine hours
Setup cost = $ 98; 000 + $ 400Z; where Z Number of setups
The actual measure of each activity driver is as follows:
Direct labor hours .......... 20,000
Machine hours ............ 90,000
Number of setups .......... 110
1. Prepare a performance report for direct labor, power, and setups using the direct labor- based formulas.
2. Prepare a performance report for direct labor, power, and setups using the multiple cost driver formulas that Sean developed.
3. Of the two approaches, which provides the more accurate picture of Carly’s performance? Why?