Question

Riide, as discussed in the chapter opener, uses a costing system with standard costs for direct materials, direct labor and overhead costs. Two comments frequently are mentioned in relation to standard costing and variance analysis: “Variances are not explanations” and “Management’s goal is not to minimize variances.” Write a short memo (no more than two paragraphs) to Amber Wason and Jeff Stefanis, Riide’s co-founders, interpreting these two comments in the context of their electric bike business. After your memo, please choose one of the follow questions to comment on: Which of the two comments was most difficult for you to explain and why? How are standard costs for direct materials determined? What “trick” has helped you remember how to compute variances?

Reading:

WASHINGTON, DC-Avid bikers Amber Wason and Jeff Stefanis believe electric bicycles are the solution to urban congestion and global energy needs. However, “we didn’t see anything at an affordable price that people would want to ride,” recalls Jeff. Amber adds, “no one in the US had done it, so we decided to design and build our own. Amber and Jeff spent a year and their own money to design and develop Riide (Ride.com), a lighter and cheaper e-bike. The duo set out to make their e-bike maintenance-free. We obsessed over every detail, explains Jeff, and we developed precise standards. They set standards for materials and labor. We use only the highest quality components, says Amber, and we reject any material that does not meet our requirements. Amber and Jeff focus on variances between actual and expected costs. Materials price and quantity variances are used to control the costs of expensive raw materials. Unfavorable materials price variances can result from rising materials prices, which can lead them to consider alternative suppliers or to raise selling price. Each Riide bike is assembled by hand, so the company knows precisely how long each bike should take to assemble. If assembly takes longer than expected, Amber and Jeff investigate why and take corrective action. Riide has sold out all of its production for many months in advance. Our biggest challenge is keeping up with demand. Explains Amber. We want to accelerate production. When production accelerates, budgets quickly can become outdated. Flexible budgets, which reflect budgeted costs at different production levels, are useful in analyzing performance and controlling costs. While attention to budgeting, standard costs, and variances is important, Amber and Jeff encourage others to have passion and give back. We have a grand vision, claims Amber. We have to.

Sources: Riide website, January 2017: Pando, January 9, 2014; Urbanful, January 13,2015, DCInno, February 8, 2016 Washington Post, August 4, 2014

Answer 1

MEMORANDUM

TO: Amber Wason , Jeff Stefanis,

( Co founders of Riide)

FROM: XYZ

DATE:

SUBJECT: "Variances are not explainations", " Management goal is not to minimize variances"

Many congratulations to you on the success of your electric bicycles. You came out with a great innovative idea of manufacturing electric cycles to promote a healthy message to go green. With the increase in demand the production needs to be increased. I hereby need to highlight 2 instances. "variances are not explainations". Variances are the quantitative comparison of budgeted values and actual results. There can be areas where the variances will be favorable and areas where variances will be unfavorable. The costs incurred cannot be eliminated thus the budgets set cannot be fixed. There are high changes of negative variances if standards are set fixed. Budgets need to be changed with the change in demand so that they can actually comply with the actual outputs. Favourable variances occur when the actual costs incur within the standards set and vice versa.

Another instance which needs to be highlighted is that " Management goal is not to minimize variances". The basic aim of the management is to make profits. If we cut down maximum costs then there would definately be quality affected of the product. Basic costs need to be incurred to make the product meet the standards. Thus, the focus should be on maximizing profits and not on reducing costs. If the profit margin is higher costs can automatically be set off.

2. Here, I would like to explain how standard costs are determined.

Standard costs are also called budgeted costs which the company prepares as a benchmark for the costs to be in incurred in future.

Standards are set keeping the maximum capacity in mind at which the product can operate.

Standard cost for direct material can be calculated by standard quantity which can be the maximum output for the product multiplied by the rate assumed.

We generally prepare budgets at the 100% capacity to avoid any fluctuations because actual output will atmost reach the maximum level or below.

It helps in comparing the actual outputs to the standard and the price of the output.