7-34 Material cost variances, use of variances for performance evaluation. Katha

Question

7-34 Material cost variances, use of variances for performance evaluation. Katharine Stanley is the owner of Better Bikes, a company that produces high quality cross-country bicycles. Better Bikes participates in a supply chain that consists of suppliers, manufacturers, distributors, and elite bicycle shops. For several years Better Bikes has purchased titanium from suppliers in the supply chain. Better 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, Better Bikes hired Michael Scott, 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.

Better Bikes established the following standards based upon the company

Explanation / Answer

Direct materials price variance (MPV) formula: [Materials Price Variance = (Actual quantity purchased × Actual price) - (Actual quantity purchased × Standard price)] ie MPV= ($159600) - (8400Lb*$22) = $(25,200) = $25,200 F .....Ans(a1) Materials efficieny variance (MQV) Formula: [Materials Efficiency variance = (Actual quantity used × Standard price) - (Standard quantity allowed × Standard Price)] ie MQV = (7900Lb*$22) - (8Lb*800No*$22) = $33,000 U....Ans (a2) 2. Though MPV is Favorable, the UnFav MQV nullifies the benefit & results in a Total Unfav Var of (25200-33000) = -$7800. Excessive usage of materials that is usually a reason of unfavorable direct materials quantity variance may be due to inferior quality of materials, untrained workers, poor supervision etc. Generally speaking production managers are held responsible for this variance. However purchasing department may also be held responsible for purchasing materials of inferior quality to economize on prices. Where purchasing department purchases low grade direct materials at low prices to show a favorable materials price variance, the materials quantity variance is usually unfavorable due to inferior quality of direct materials. Other Var which could be affected are Labour

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