Papaya Partners Case Study

Photo by Dylan Gillis on Unsplash

In this paper, the calculation and analysis will be done to recommend the course of action that the management of Papaya Partners should take. The approach to the problem will be explained, the relevant calculations and analysis will be performed, and a recommendation will be formulated. The variances computed will be assessed and the operational results will be evaluated. After that, the person in charge to identify the root causes of the variances will be introduced and well-thought-out causes for each variance will be proposed.

Variance analysis may be defined as an examination of the discrepancy between planned and actual figures. The total of all deviations represents the overall over- or under-performance for a certain reporting period. Companies evaluate their favorability for each item by comparing real costs to industry standard costs (Corporate Finance Institute, 2022).

Case Study: Papaya Partners

In the Papaya Partners case study, we were requested to determine and analyze the factors that contributed to the total variation from the budget as well as suggest actions that management might take to reduce variances. We will examine the Standard cost per unit (carton), Actual cost per unit, Direct materials price variations, Direct materials use variances, Direct labor rate variance, and Direct labor efficiency variance in detail.

Calculation

Standard cost per unit (carton)

A standard cost is defined as a predetermined cost, a projected future cost, an expected cost, a budgeted unit cost, a forecast cost, or the “should be” cost. Standard expenditures are frequently included in a manufacturer’s yearly profit strategy and operational budget (Accounting Coach, n.d.). To calculate this, divide the entire budgeted cost by the number of cartons. Therefore:

1. Budgeted carton (units) = Budgeted sales ($500,000)/Sales price per carton ($25) = 20,000 units
2. Budgeted pounds of fruit = budgeted carton (20,000 units) * 10 pounds/unit = 200,000 pounds
3. Budgeted pounds of fruit (per pound) = Budgeted pounds of fruit (200,000 pounds) / budgeted carton (200,000) / 10 pounds/carton = $1 per pound
4. Budgeted pounds of packaging = 20,000 (from data provided)
5. Budgeted pounds of packaging (per pound) = cost for packaging per carton ($10,000) / Budgeted pounds of packaging (20,000) = $0.5 per pound
6. Budgeted hours = 0.5 hours/carton * budgeted carton (20,000) = 10,000 hours
7. Budgeted labor cost per hour = labor costs per carton ($90,000)/budgeted hours (10,000 hours) = $9 per hour

Standard cost per unit (carton)

1. Fruit = (budgeted pounds of fruit $1/pound)*10 pounds per carton = $10
2. Packaging = Budgeted pounds of packaging (per pound) = $0.5
3. Labor = Budgeted labor cost per hour ($9) / 2 hours per carton = $4.5
4. Total standard cost per unit (carton) = $10 + $0.5 + $4.5 = $15

Actual cost per unit

Actual cost is the actual expenditure paid to acquire an asset, which includes the supplier-invoiced charge as well as the expenditures to transport, set up, and test the equipment.

This is the cost of an asset when it is first recognized as a fixed asset in financial accounts (Accounting Tools, 2022). from the data provided we know that the actual cartons sold are 20,000 units. Therefore the calculation would be:

1. Actual pounds of fruit = Actual cartons * 10 pounds per carton = 200,000 pounds
2. Actual pounds of fruit (pound) = Cost of fruit per carton ($244,200)/actual pounds of fruit (200,000 pounds) = $1.22 per pound
3. Actual pounds of packaging = 11,000 pounds (from data provided)
4. Actual pounds of packaging (pound) = Cost of packaging ($11,000) / actual pounds of packaging (11,000 pounds) = $1 per pound
5. Actual hours = Labor cost per carton ($150,000)/10 pounds per carton = 15,000 hours
6. Actual labor cost per hour = Labor cost per carton ($150,000)/actual hours (15,000 hours) = $10 per hour

Actual Cost per Carton

1. Fruit = Actual pounds of fruit ($1.22/pound) *10 pounds per carton = $12.21
2. Packaging = $0.55 per carton (from data provided)
3. Labor = Actual labor cost per hour ($10)*0.75 hours per carton = $7.5
4. Total actual cost per carton = $12.21 + $0.55 + $7.5 = $20.26

Direct materials price variances

Direct materials price variances are the difference between actual costs for materials purchased and budgeted costs based on the standards (Heisinger & Hoyle, n.d.). To calculate this, we need to deduct the standard direct material price from the actual direct material price and then multiply it by the amount of material used.

Direct materials price variance = (Actual rate — standard rate) * material used

1. Cost of fruit = ($1.22 — $1)*200,000 = $44,200 (unfavorable)
2. Cost of packaging = ($1 — $0.5)*11,000 = $5,500 (unfavorable)

This unfavorable material price variation would have resulted in higher prices for both papayas and packaging.

Direct materials usage variances

Direct materials usage variances are the discrepancy between the actual amount of materials used in production and the budgeted materials that should have been utilized in production based on the standards referred to as quantity (Heisinger & Hoyle, n.d.). Because all fruits are the same, we will disregard this and simply look at the package. Subtracting the actual quantity from the standard quantity and multiplying by the standard packing price.

Direct materials usage variance = (materials used — standard) * standard rate

1. Cost of fruit = (200,000 — (10*20,000))*$1 = $0 (No variances)
2. Cost of packaging = (11,000 — (1*20,000)*$0.5) = (4,500) (favorable)

No variances in the cost of fruit for materials usage variance since the amount used is the same as the standard (budgeted). The cost of packaging has favorable variance due to less packing in the actual product.

Direct labor rate variance

Next, we’ll look at direct labor rate variation, this is sometimes known as “the discrepancy between actual direct labor expenses and anticipated expenditures based on standards (Heisinger & Hoyle, n.d.).

1. Direct labor rate variance = (actual rate ($10) — standard rate($9))*actual hours (15,000 hours) = $15,000 (unfavorable)

Direct labor efficiency variance

1. Direct labor efficiency variance = (actual hours (15,000 hours) — standard (10,000 hours))*standard rate ($9) = $45,000 (unfavorable)

Total variance = $44,200 + $ 5,500 + ($-4500) + $15,000 + $45,000 = $105,200

Person In Charge To Identify The Root Causes of The Variances

For direct material price variances, I would consult with the Production Manager to determine whether any papayas were paid at a higher price as a result of increased supplier prices passed on owing to rising demand or by selecting a higher quality material. I also would collaborate with the production manager to determine why there is a material consumption disparity in packaging. One explanation might be operational repairs and improvements, or packaging design that lowered the amount of packing material needed. For the unfavorable labor rate and labor efficiency variations, I would consult with Human Resources and Production management to determine if there has been a move to more experienced staff, any overtime hikes, or new labor contracts have been implemented.

Recommendation

I would advise management to conduct a genuine root cause analysis because a single issue, such as quality, can affect several deviations. A higher-quality product would cost more, but it would also have a smaller material utilization variation. Higher quality direct material might potentially improve labor processes, resulting in decreased labor efficiency variance.

Conclusion

To summarize, the labor expenses for this company have ended up being far more than expected, which is a serious concern for the company’s profitability. The direct material variance might be due to seasonal differences, waste, damage, rotting fruits, and so on. It would be beneficial for the organization to address these concerns.

References

Accounting Coach. (n.d.). What is a standard cost? AccountingCoach.com. Retrieved July 21, 2022, from https://www.accountingcoach.com/blog/what-is-a-standard-cost

Accounting Tools. (2022, April 18). Actual cost definition — AccountingTools. AccountingTools. Retrieved July 21, 2022, from https://www.accountingtools.com/articles/actual-cost

Corporate Finance Institute. (2022, January 31). Variance analysis. Retrieved July 20, 2022, from https://corporatefinanceinstitute.com/resources/knowledge/accounting/variance-analysis/

Heisinger, K., & Hoyle, J. B. (n.d.). Accounting for Managers. https://2012books.lardbucket.org/books/accounting-for-managers/index.html

Note:
This article is written based on University of The People Managerial Accounting (BUS 5110) written assignment by Fristy Tania in June 2022