Harlow Additives: favourable material variances that hide a quality problem
Harlow Additives blends two chemicals, Alfa and Beta, into a fuel additive. The current standard for a batch producing 4,500 litres of saleable additive specifies 5,000 litres of input: 3,000 litres of Alfa at £2.40 per litre and 2,000 litres of Beta at £3.60 per litre. In October, 4,500 litres of saleable additive were produced from 3,300 litres of Alfa purchased at £2.55 and 1,700 litres of Beta purchased at £3.40. The purchasing manager's annual bonus is 40% weighted to the material price variance. Alfa's usual supplier declared a two-week force majeure in October, and Beta was available only from a single approved source at the price shown. Blending records show the off-specification rate rose from 1.2% to 3.8% in October, and two customers have rejected consignments for 'gritty' product. The operations director argues that the favourable variances prove the blending team beat the standard; the finance director wants the variances presented to the board as evidence of cost control.
1. Calculate the material price, mix and yield variances for October and reconcile them to the total material variance against standard.
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Standard cost of a batch = (3,000 × £2.40) + (2,000 × £3.60) = £7,200 + £7,200 = £14,400 for 4,500 litres, i.e. £3.20 per litre of output. Actual input 5,000 litres produced 4,500 litres, the standard yield, so total input equals standard input for actual output.
Price variances Alfa: (£2.40 − £2.55) × 3,300 = £495 A Beta: (£3.60 − £3.40) × 1,700 = £340 F Net price variance = £155 A
Mix variance (actual quantities compared with actual total input in standard proportions: Alfa 60%, Beta 40%) Alfa: (3,300 − 3,000) × £2.40 = £720 A Beta: (1,700 − 2,000) × £3.60 = £1,080 F Net mix variance = £360 F - substituting 300 litres of cheap Alfa for Beta.
Yield variance Standard yield from 5,000 litres = 4,500 litres; actual yield 4,500 litres: (4,500 − 4,500) × £3.20 = £0
Reconciliation Standard cost of actual output £14,400; actual cost = (3,300 × £2.55 = £8,415) + (1,700 × £3.40 = £5,780) = £14,195. Total variance £205 F = £360 F mix − £155 A price ✓.
Note that the yield variance is nil: the richer Alfa blend produced no extra output, so the mix 'gain' is purely a cost-substitution gain on paper.
2. Evaluate the two directors' interpretations and recommend how the purchasing manager's performance should be assessed for October.
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Both interpretations are wrong, for opposite reasons. The operations director reads £205 favourable and £0 yield as good blending. But a mix variance only measures the cost of deviating from the recipe; it says nothing about whether the product works. The off-specification rate tripling to 3.8% and two customer rejections are the yield and quality variance appearing somewhere else - after the material has already been charged at a lower cost. The team did not 'beat the standard'; it made a different, cheaper product.
The finance director's 'evidence of cost control' is worse, because it would be presented to the board as unqualified good news. The £360 favourable mix variance is a warning: the recipe has drifted, and the true cost includes rework, credit notes and lost goodwill that the material variance report does not capture.
The purchasing manager. His £340 favourable Beta variance must be read in context: Beta was available only from one approved source, so the price reduction is not a purchasing achievement at all - there was no competitive choice. His adverse £495 Alfa variance arose because the usual supplier failed, forcing higher-priced spot purchases: again, largely outside his control. Rewarding him on a price variance that is dominated by supply disruption, while the quality consequence of the substitution falls on someone else, is a design failure.
Recommendation. Assess purchasing on total material cost (price, mix and yield), purchase price adjusted for market movements on a controllable basis, and supplier performance measures (on-time delivery, conformance, continuity of supply). Any recipe substitution must be approved by technical and quality before the cheaper blend is run.