Question

Woodplex Ltd is a medium-size company that specializes in making a hand-made furniture cover. The company has been relatively successful over the years due to its good quality product and the good relations it has with its suppliers of materials and staff on the production line. Woodplex Ltd’s management, however, anticipates the market becoming more competitive in the near future, not least due to the weak UK economy and forecasts of slow growth. They are now seeking a way to lower the price of their product. A cheaper substitute material has been identified for the furniture cover but securing this material would involve signing a long-term contract with a new supplier. Woodplex Ltd’s management believe that it would be prudent to delay signing a long-term contract until an analysis can be made of how switching to a new material (and supplier) would affect the production process and operating profit. As a result of the above concern, the prospective supplier was therefore asked to supply Woodplex Ltd the materials they needed for production during the most recent quarter.

The managing director of Woodplex Ltd has now asked for your help on this matter. You have been provided with the following standard cost data (i.e., based on the old supplier) and budgets.

Unit selling price		300.00
Less: Direct materials: 2.5 metres @ £4.00 per metre		10.00
Direct labour: 5 hours @ £24.00 per hour		120.00
Variable overhead: £4.00 per direct labour-hour		20.00
Contribution		150.00

		Budget (based on old material/supplier)		Actual (based on new material/supplier)
Output (production and sales)		20,000 units		22,000 units
Sales revenue		£ 6,000,000		£ 6,380,000
Less:
Direct materials		200,000		171,600
Direct labour		2,400,000		3,168,000
Variable overheads		400,000		501,600
Fixed overheads		160,000		164,000
Operating profit		£ 2,840,000		£ 2,374,800

Additional information:

• Actual direct material usage totalled 57,200 metres. All materials used during the quarter were sourced from the prospective supplier.
• A total of 132,000 direct labour hours were worked during the quarter.
• During the quarter, a promotional price for the furniture cover was introduced following the recommendation of Woodplex Ltd’s marketing director. The marketing director argued that this would not only boost sales but also provide an opportunity to evaluate how customers would respond to their product when the substitute material is used.
• Woodplex Ltd uses a standard variable costing system for internal reporting purposes.
• Calculate for the quarter:
  1. Sales margin price and volume variances
  2. Direct material quantity and price variances
  3. Direct labour efficiency and rate variances
  4. Variable overhead efficiency and spending variances
  5. Fixed overheads spending variance

3. Drawing on your answers in (a) and (b) and any other financial or non-financial consideration you think would be relevant in this case, advise Woodplex Ltd whether or not it should sign a long-term contract with the new supplier.

Answer 1