Accounting: What the Numbers Mean 9th Edition by Wayne W McManus, Daniel F Viele, David H Marshall

Exercise 106

Direct material variances—the price versus usage trade-off Williamson, Inc., manufactures quality replacement parts for the auto industry. The company uses a standard costing system and isolates variances as soon as possible. The purchasing manager is responsible for controlling the direct material price variances for hundreds of raw material items that are used in the company’s various production processes. Recent experience indicates that, in the aggregate, direct material price variances have been favorable. However, several problems have occurred. Direct material usage variances have become consistently unfavorable for many items, and the company’s total budget variance for direct materials has been unfavorable during each of the past six months. Direct laborers have complained about the quality of certain raw material items, and major customers have canceled purchase orders. In the meantime, the company’s raw materials inventory has increased by nearly 240%.

Required:

a. Give a probable explanation of why these results have occurred. (Hint: What might the purchasing manager be doing that is dysfunctional for the company as a whole?)

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b. How could the performance reporting system be improved to encourage more appropriate behavior on the part of the purchasing manager?

Step 1 of 3

a) The purchasing manager is possibly taking advantage of various large-volume quantity discounts provided by suppliers of inferior-grade raw materials input-items. More items should be purchased than are required for current period production. Since quantities of raw material inventory are increasing at a rapid pace, the carrying cost for W Inc. will shortly get out of control. Besides, these lower quality of raw material inputs has directed to constantly unfavorable usage variances, lost purchase orders (lost sales), and objectionable working conditions (i.e. situation of unfavorable labor efficiency variances).