Orca Ltd is a medium-size enterprise that specializes in making hand-crafted sofa cover. The company has been relatively successful over the years and their product is now well known and recognised as being of good quality. Part of the companys success is due to the good relations it has with the material suppliers and staff in the production line. Orca Ltds management, however, anticipate 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 sofa cover but securing this material would involve signing a long-term contract with a new supplier. Orca Ltds management believe that it would be prudent to delay signing the contract until an analysis can be made of how switching to a new material (and supplier) would affect the production process and operating profit. The prospective supplier was therefore asked to supply Orca Ltd the materials they needed for production during the most recent quarter.

The managing director of Orca 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		150.00
	Less: Direct materials: 2.5 metres @ 2.00 per metre		5.00
	Direct labour: 5 hours @ 12.00 per hour		60.00
	Variable overhead: 2.00 per direct labour-hour		10.00
	Contribution		75.00

		Budget (based on old supplier)		Actual (based on new supplier)
Output (production and sales)		20,000 units		22,000 units
Sales revenue		3,000,000		3,190,000
Less:
Direct materials		100,000		85,800
Direct labour		1,200,000		1,584,000
Variable overheads		200,000		250,800
Fixed overheads		80,000		82,000
Operating profit		1,420,000		1,187,400

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 sofa cover was introduced following the recommendation of Orca Ltds 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.
• Orca Ltd uses a standard variable costing system for internal reporting purposes.

Required:

1. Prepare a flexed budget that takes into account the change in output and sales during the quarter, based on the material from the new supplier.

2. 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. Prepare a statement reconciling the budgeted and actual operating profits for the quarter. The statement should clearly show the variances that you have calculated in part b).

4. Drawing on your answers in a) c) and any other financial or non-financial consideration that you think is relevant in this case, advise Orca Ltd whether or not it should sign a long-term contract with the new supplier.