What factors might have contributed to the CFO’s decision to adopt a standard costing system?
Grace Chedore, product manager at Little People Lovables, has recently decided to change raw materials suppliers and began purchasing a new and high-quality fabric to use in the production of the company’s initial product, a brightly coloured children’s quilt.
As a co-op student hired for the summer, Grace has asked you to answer the questions that are presented at the end of the case. She wants to assess the decision she made regarding the material, and is curious to know if initial analysis show this to be a good decision for the company.
Format of Report
The report should be no longer than four (4) written pages, double spaced, with an additional three (3) pages of appendices permitted. Appendices may be done in Excel.
The report is to be typewritten. Reports are to be submitted to the appropriate Dropbox on D2L. No reports will be accepted after the due date.
The format of the report should follow the following structure:
(1) Cover page, identifying the case, date, your name and student number.
(2) Introduction: This should be one paragraph introducing the report, and outlining the major highlights of what is to be addressed the report (no executive summary is required in this case).
(3) Issue Identification: This should be one-two paragraphs outlining the situation that the company is facing.
(4) Analysis of situation: This should comprise most of your written report. Your calculations should appear in the appendices, not in the body of the report. You should summarize your analysis – do not make recommendations at this time! Simply present your findings.
(5) Recommendations: This should summarize your analysis, and make a clear recommendation on what course of action is best.
(6) Conclusion: This paragraph should summarize the major issues and recommendations. The conclusion should provide closure to a report.
NOTE: In this case, you are also asked to provide an analysis of the business reasons for moving to a standard costing system, and the decision to change materials. This can appear before or after the analysis section.
Your complete calculations should appear in your appendices. Appendices should have appropriate titles, and be referenced in the document.
Little People Lovables
Little People Lovables (LPL) started in a small community in central New Brunswick when a group of local residents decided to form a weekly sewing group. Although the initial motivation for the group was social in nature, they soon discovered that many of the members were unusually talented and creative. It was not long before they were producing handmade items that were place on consignment at several of the local retail stores. After three years of continued increases in market demand, several of the more entrepreneurial members decided to investigate the feasibility of starting their own company. When a small, well-maintained manufacturing facility located in a nearby town was advertised for sale, the group of entrepreneurs, along with Elaine Marshall, the former plant manager, decided to start their own business and purchase the manufacturing plant. Under Elaine’s leadership, the group developed an initial business plan that called for the new company to focus on producing and selling products targeted for children. Thus, the founders decided to name the new company Little People Lovables.
Based on their experience with the items that were made and sold by the local sewing group, the founders decided that their initial product would be a brightly coloured quilt that would be marketed for children under the age of five, and that could be customized to accommodate a variety of customer interests and specifications. Daniel Roberts, the company’s Chief Financial Officer, who had been hired to assist with the financial arrangements of the business start-up, decided to adopt a standard costing system as part of the company’s planning and control system. He determined that the standard cost of the new quilt was $74, based on the following data:
Direct materials (6 square metres at $8 per square metre) $48.00
Direct labour (30 minutes at $16 per hour) 8.00
Manufacturing overhead 18.00
Total standard manufacturing cost per quilt $74.00
Although the company’s longer-term monthly production volume was expected to be approximately 24,000 quilts, the CFO decided to establish the initial standard manufacturing cost per quilt based on the more conservative and realistic assumption that the normal monthly production volume would be 18,000 quilts during the company’s first year of operations. The projected normal monthly production volume was based on an average monthly sales forecast of 18,000 quilts, as the CFO had determined that during the company’s start-up period it would not have sufficient cash to allow it to maintain any significant level of finished goods inventory. Daniel did not believe this would be a problem, due to the short production time for the quilts. Therefore, he felt it was reasonable to assume that monthly sales and production would be approximately the same, and for both work-in-process and finished-goods inventories to be quite small. Due to the importance of the high quality of raw materials used to make the quilts, he did anticipate the need to maintain some minimum level of raw materials inventory.
During the first several months of business, the company’s actual results were very similar to the company’s forecast. The selling price of $100 per quilt, which had been set by Grace Chedore, the company’s product manager, after considerable and careful market research, seemed to be appropriate and monthly sales and production had been pretty much as expected. Although she was delighted at the company’s early success, Grace was always looking for opportunities to grow the business and improve its profitability. In mid-April of the first year, she became aware of a new supplier that sold a unique, high-quality fabric, that she believed would improve the texture and appearance of the quilt in addition to extending its useful life. She felt that the use of the new material could result in increased sales and greater customer loyalty, both of which were important to a new company trying to establish itself in the market. The only problem was that the new material was slightly more expensive than the material the company was presently using, and Grace did not believe the company would be able to raise its $100 selling price. Nevertheless, she decided to switch suppliers and begin using the new material for the May production. So, she placed her initial order for the new material to be received at the end of April. By then, she expected there to be little, if any, existing raw material remaining in inventory. She was confident that she had made the right decision.
The following events occurred during the month of May:
a) As ordered, 220,000 square metres of the new quilt material at a price of $8.25 per square metre were received.
b) The company produced and sold 20,000 quilts at a price of $100 per quilt.
c) The company used 110,000 square metres of material and incurred 9,000 hours of direct labour at an average cost of $16.90 per hour. The higher average per-hour labour cost was due to bonuses paid to workers for exceeding normal production volumes.
d) The company’s monthly budgeted manufacturing overhead was $324,000, or $18 per quilt, at normal production volume. Of this amount, $171,000 was considered to be fixed, and the remainder expected to vary with production volume.
e) The company’s actual manufacturing overhead for the month was $330,000, of which $170,000 was fixed.
1. What factors might have contributed to the CFO’s decision to adopt a standard costing system?
2. Determine the price variance for the material purchased, and the quantity variance for the materials used in production, for May.
3. Determine the price (rate) variance and quantity (efficiency) variance for direct labour for May.
4. Determine the manufacturing overhead variances for May.
5. Identify the business reasons that might have led the company’s product manager to change to the new and more expensive raw materials.
6. Based on the information pertaining to the company’s operations for May, does the purchasing decision made by the company’s product manager appear to be a good one? Explain.