Project Assignment
Toddler Treasures, Inc., had its origin in a small community in central Iowa when a group of local residents decided to form a weekly sewing circle. Although the initial motivation for getting the group together was social in nature, they soon discovered that many of the members were unusually talented and creative. Consequently, it was not long before they were producing handmade items that were placed on consignment for sale at several of the local retail shops. 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 but well-maintained manufacturing facility located in a nearby town was advertised for sale, the group of entrepreneurs, along with Sharon Robinson, the former plant manager, decided to start their own small business and purchase the manufacturing plant. Under Sharon's leadership, the group developed an initial business plan that called for the new company to focus on producing the selling products targeted for children. Thus, the founders decided to name their new company Toddler Treasures, Inc.
Based on their experience with the items that were made and sold by the local sewing circle, the founders decided that their initial product would be a brightly colored blanket that would be marketed for children under the age of five, and that could be customized to different market segments to accommodate a variety of customer interests and specifications. David Reed, 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 comprehensive planning and control system. Thus, he determined the standard cost of the company's blanket to be
$74.00 as follows:
Direct material (6 square yards at $8 per square yard) $48.00
Direct labor (30 minutes at $16 per hour) $8.00
Manufacturing overhead $18.00
Total standard manufacturing cost per blanket $74.00
Although the company's longer-term monthly production volume was expected to be approximately 24,000 blankets, the CFO decided to establish the initial standard manufacturing cost per blanket based on the more conservative and realistic assumption that the normal monthly production volume would be 18,000 blankets during the company's first year of operation. The projected normal monthly production volume was based on an average monthly sales forecast of 18,000 blankets, as the CFO had determined that during the company's start-up period it would not have sufficient cash to allow it to maintain very much finished goods inventory. David did not believe this would be a problem, however, due to the short production time for the blankets. Thus, he felt it was reasonable to expect monthly sales and production to be approximately the same and for both work-in-process and finished-goods inventory to be negligible. Due to the importance of the high quality of the raw material used to make the blankets, 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 $100.00 per blanket, which had been set by Gloria Cateneze, the company's product manager, after considerable and careful market analysis, 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, Gloria 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 company's product in addition to extending it useful life. She felt that 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 Gloria did not believe the company would be able to raise is $100.00 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. Although she was confident she had made the right decision, she would just have to wait and see.
As it turned out, the following things occurred pertaining to the company's operations during May:
• As ordered, 220,000 square yards of the new blanket material at a price of $8.25 per square yard were received.
• The company produced and sold 20,000 blankets at a price of $100.00 per blanket.
• The company used 110,000 square yards of material and incurred 9,000 hours of direct labor at an average cost of $16.90 per hour. The higher average per-hour labor cost was due to bonuses paid to the workers for exceeding normal production volumes.
• The company's monthly budgeted manufacturing overhead was $324,000, or $18.00 per blanket, at normal production volume. Of this amount, $171,000 was considered to be fixed and the remainder was expected to vary with production volume.
• The company's actual manufacturing overhead for the month was $330,000, of which $170,000 was fixed.
Required:
1. What factors might have contributed to the company's CFO's decision to adopt a standard costing system?
2. Determine the price variance for the blanket material purchased and the efficiency variance for the blanket material used.
3. Determine the price and efficiency variances for direct labor.
4. Identify the business reasons that might have led the company's product manager to change to the new and more expensive blanket material.
5. Based on the information pertaining to the results of the company's operations for May, does the purchasing decision made by the company's product manager appear to be a good one? Explain.