Question

Katharine Austen is the owner of Grand Bikes, a company that produces high quality cross-country bicycles. Grand Bikes participates in a supply chain that consists of suppliers, manufacturers, distributors, and elite bicycle shops. For several years Grand Bikes has purchased titanium from suppliers in the supply chain. Grand Bikes uses titanium for the bicycle frames because it is stronger and lighter than other metals and therefore increases the quality of the bicycle. Earlier this year, Grand Bikes hired Michael Fielding, a recent graduate from State University, as purchasing manager. Michael believed that he could reduce costs if he purchased titanium from an online marketplace at a lower price. 3 (Click the icon to view the standard and actual information.) * Data Table Requirements Grand Bikes established the following standards based upon the company's experience with their previous suppliers. The standards are as follows: Cost of titanium $ 20 per pound 8 lbs. Titanium used per bicycle 1. Compute the direct materials price and efficiency variances. 2. What factors can explain the variances identified in requirement 1? Could any other variances be affected? Was switching suppliers a good idea for Grand Bikes? Explain why or why not. Should Michael Fielding's performance evaluation be based solely on price variances? Should the production manager's evaluation be based solely on efficiency variances? Why is it important for Katharine Austen to understand the causes of a variance before she evaluates performance? 5. Other than performance evaluation, what reasons are there for calculating variances? 6. What future problems could result from Grand Bikes' decision to buy a lower quality of titanium from the online marketplace? Actual results for the first month using the online supplier of titanium are as follows: 800 Bicycles produced Titanium purchased Titanium used in production 8,400 lb. for $159,600 7,900 lb.

Answer 1

Grand Bikes Requrement 1 Actual input x Budgeted price Direct materials (purchases) = 8400 x $20 = $168000 Direct materials (usage) = 7900 x $20 = $158000 Budgeted input for actual output = Standard x Actual bicycles produced = 8 x 800 = 6400 lbs Flexible budget cost = Budgeted input for actual output x Budgeted price Direct materials = 6400 x $ 20 = $128000 Budgeted Flexible Actual costs Purchases Usage budget costs 159600 168000 158000 128000 Direct materials Price Variance = 168000 - 159600 = 8400 F Efficiency Variance = 158000 - 128000 = 30000 U Requrement 2 The price variance is due to the difference between the standard price based on the previous suppliers and the actual price paid through the on-line marketplace. The unfavorable efficiency variance could be due to several factors including inexperienced workers, lower quality product, and machine malfunctions. But the likely cause here is that the lower-priced titanium was lower quality or less refined, which led to more waste. The labor efficiency variance could be affected if the lower quality titanium caused the workers to use more time.

Requrement 3 If the net effect of the two variances is unfavorable, then switching suppliers was not a good idea However, if the net effect isfavorable, then switching suppliers was a good idea. In this example, the net effect of the two variances is unfavorable ($8,400 F + $30,000 U). The $8,400 savings in the cost of titanium was outweighed by the $30,000 extra material usage. In addition, the $30,000 U efficiency variance does not recognize the total impact of the lower quality titanium because only 7,900 pounds were used. Grand Bikes could expect the remaining 500 lbs to result in an additional unfavorable efficiency variance. Requrement 4 The purchasing manager's performance evaluation should not be based solely on the price variance. The short-run reduction in purchase costs was more than offset by higher usage rates. His evaluation should be based on the total costs of the company as a whole. In addition, the production manager's performance evaluation should not be based solely on the efficiency variances. In this case, the production manager was not responsible for the purchase of the lower-quality titanium, which led to the unfavorable efficiency scores. In general, it is important for Preston to understand that not all favorable material price variances are "good news", because of the negative effects that can arise in the production process from the purchase of inferior inputs. They can lead to unfavorable efficiency variances for both materials and labor. Preston should also that understand efficiency variances may arise for many different reasons and she needs to know these reasons before evaluating performance. Requrement 5 Variances should be used to help Grand Bikes understand what led to the current set of financial results, as well as how to perform better in the future. They are a way to facilitate the continuous improvement efforts of the company. Rather than focusing solely on the price of titanium, Michael can balance price and quality in future purchase decisions. Requrement 6 Future problems can arise in the supply chain. Michael may need to go back to the previous suppliers. But Grand Bikes' relationship with them may have been damaged and they may now be selling all their available titanium to other manufacturers. Lower quality bicycles could affect Grand Bikes' reputation with the distributors, the bike shops and customers, leading to higher warranty claims and customer dissatisfaction, and decreased sales in the future.