Written Assignment: Little People Lovables Case Summary

Written Assignmentlittle People Lovablescase Summarygrace Chedore Pro

Analyze and assess the decision-making process related to the change in raw materials at Little People Lovables, including calculating variances, understanding the reasons for adopting standard costing, and evaluating the impact of switching to a higher-quality but more expensive raw material.

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Introduction

The decision by Little People Lovables’ product manager, Grace Chedore, to switch to a higher-quality fabric supplier represents a significant strategic move aimed at enhancing product quality and potentially increasing market competitiveness. This paper critically examines the factors influencing this decision, the effectiveness of the standard costing system adopted by the company, and the financial performance during the month of May. By analyzing variances in materials, labor, and overhead, the report evaluates whether the decision to source more expensive raw materials has been justified, considering the company's overall operational context and strategic objectives.

Issue Identification

Little People Lovables, a startup focusing on children’s products, initially adopted a standard costing system to aid in planning and control, based on conservative estimates aligned with projected sales and production volume. The company’s product manager, Grace Chedore, identified the potential to improve product quality by switching to a premium fabric from a new supplier. Although this decision promised enhanced quality, it also introduced higher raw material costs, which prompted a thorough analysis of the associated variances during the first month of implementation—May. The core issue revolves around whether this material change positively impacts profitability and aligns with the company's strategic goals, taking into account the variances in costs and operational performance.

Analysis of Situation

The adoption of a standard costing system at Little People Lovables was driven by several factors. First, it provides a benchmark against which actual costs can be compared, facilitating performance evaluation and control. Second, it simplifies decision-making for pricing, budgeting, and cost management, especially critical for a startup with limited cash flows. Third, the standard system supports variance analysis, enabling management to identify and address cost discrepancies efficiently (Garrison et al., 2021). The choice of a standard cost per quilt of $74 was based on expected production volumes, materials, labor, and overhead, aiming to streamline cost monitoring amidst fluctuating market conditions.

During May, the company purchased 220,000 square meters of fabric at a price of $8.25 per square meter, slightly above the previous cost of $8.00, reflecting the higher-quality material. The actual purchase resulted in a material price variance that needed examination to understand whether the higher cost was justified by abilities to improve the product. Additionally, the company used 110,000 square meters for 20,000 quilts, which indicates an efficiency in material usage consistent with the standard requirement of 6 square meters per quilt.

Material Price Variance Calculation

The price variance measures the difference between the actual cost and the standard cost for materials purchased. The standard price was $8.00 per square meter, and the actual price was $8.25. The variance calculation is:

Price Variance = Actual Price - Standard Price x Actual Quantity Purchased

Price Variance = ($8.25 - $8.00) x 220,000 = $0.25 x 220,000 = $55,000 (unfavorable)

This unfavorable variance indicates the company paid more for the material than initially planned, aligning with the decision to switch to a higher-quality fabric.

Material Quantity Variance

The quantity used in production was 110,000 square meters for 20,000 quilts, which aligns with 5.5 square meters per quilt, slightly below the standard of 6 square meters, suggesting efficient material usage. The standard quantity for actual production is 20,000 quilts x 6 sq. meters = 120,000 sq. meters. The variance calculation is:

Quantity Variance = Standard Price x (Standard Quantity - Actual Quantity)

Quantity Variance = $8.00 x (120,000 - 110,000) = $8.00 x 10,000 = $80,000 (favorable)

This favorable variance reflects higher efficiency, possibly due to better material quality or improved process control.

Labor Variances

The company incurred 9,000 hours at a rate of $16.90 per hour, exceeding the standard rate of $16.00 per hour. The rate variance is calculated as:

Labor Rate Variance = Actual Hours x (Actual Rate - Standard Rate)

Labor Rate Variance = 9,000 x ($16.90 - $16.00) = 9,000 x $0.90 = $8,100 (unfavorable)

The efficiency variance considers the difference between actual hours used and standard hours expected for actual production. Standard hours for 20,000 quilts at 0.5 hours per quilt are 10,000 hours. The variance calculation is:

Labor Efficiency Variance = Standard Rate x (Standard Hours - Actual Hours)

Labor Efficiency Variance = $16.00 x (10,000 - 9,000) = $16.00 x 1,000 = $16,000 (favorable)

The favorable efficiency variance suggests better utilization of labor, potentially influenced by higher-skilled workers or process improvements.

Manufacturing Overhead Variances

The actual overhead was $330,000, with fixed overhead at $170,000, close to the budgeted $171,000. Variances include the spending and volume variances. The spending variance is the difference between actual and budgeted overhead, which is marginally adverse ($330,000 - $324,000 = $6,000 unfavorable). The volume variance would involve comparing actual hours or production volume against standards, which requires further data but generally indicates slight over-spending or under-spending.

Business Reasons for Material Change

The decision to switch to a higher-quality fabric was driven by strategic aims to improve product durability, texture, and appearance, which could enhance customer satisfaction and loyalty. A better-quality material aligns with market positioning of premium children’s products, enabling the company to justify higher perceived value and potentially command better market share. Furthermore, the new fabric may improve the product’s competitive advantage, foster positive word-of-mouth, and reduce returns or complaints due to inferior materials (Kotler & Keller, 2016). Despite a higher initial cost, this move can be justified if it leads to increased sales volume, improved brand reputation, and higher profit margins over time.

Assessment of the Purchasing Decision

Based on the analytical variances, the purchase of the higher-cost fabric appears justified, given the favorable material quantity variance and the potential for enhanced product quality. The unfavorable price variance is understandable, considering the premium nature of the fabric. The labor efficiency and overhead variances indicate effective production management, supporting the decision’s overall positive impact on operational performance. If the quality improvements translate into higher sales or customer loyalty, as anticipated, the initial cost premium can be recovered, validating the decision. However, continuous monitoring and further analysis of sales data and customer feedback are recommended to ensure that the strategic objective is achieved.

Conclusion

The decision by Little People Lovables’ product manager to switch to a more expensive, higher-quality fabric appears to be a sound strategic choice, supported by favorable efficiency variances and justifiable through potential enhancements in product appeal. The use of a standard costing system facilitated effective variance analysis, enabling the company to monitor cost performance and inform strategic decisions. Moving forward, ongoing evaluation of the quality’s impact on sales and customer satisfaction will be crucial in determining the long-term success of this material change, ensuring that additional costs are offset by increased revenue and brand strength.

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