Topic: Management Accounting Problem

Testa Limited manufactures small cars and is located in Sydney. More than 80 percent of the cost of the company's cars consists of materials and components, which are purchased from Australian suppliers. About three years ago, Testa introduced a comprehensive supplier evaluation system to monitor the performance of its suppliers. Each supplier was given a three-year contract that guaranteed large orders as long as it performed according to Testa's strict requirements. Each supplier's performance was measured by considering its adherence to delivery schedules (Testa works on a JIT system), the accuracy of orders delivered, a number of components rejected on delivery, and its achievements in reducing its production costs (and, therefore, its material and component prices) over the contract period. Performance in all of these areas will determine whether Testa renews the supplier's contract, or offers the contract to another supplier. The suppliers are aware that; there are many alternative component suppliers who would be eager to enter into a long-term contract with Testa.

After holding discussions with the purchasing manager, as part of the review process, the financial controller has conducted a study to determine the full cost of dealing with suppliers. While the company uses a series of non-financial performance measures to measure most aspects of supplier performance, the financial controller believes that the calculation of the total cost of ownership will provide an additional perspective to viewing supplier performance. For the most recent year, the following supplier-related activities and costs have been identified:

ACTIVITY TOTAL COST NUMBER OF ACTIVITIES Order components from supplier $1 800 000 6 000 orders Receive order $9 000 000 10 000 deliveries Return reject components to supplier $38 500 55 returns Receive late deliveries $260 000 130 late deliveries Production downtime due to late delivery $2 400 000 800 hours Production downtime due to defective material $3 600 000 3 000 hours Process invoice and pay supplier $1 050 000 3 000 invoices Dispute invoice amount $40 000 50 disputes Quality audit of supplier $500 000 10 audits Testa obtains its exhaust systems from two suppliers: Hot Exhausts and Chrome Manufacturers. Last year, Testa purchased 3 000 units from Hot Exhausts at $100 per unit, and 4 000 units from Chrome Manufacturers at $90 per unit. Both suppliers provide an identical component. The analysis revealed that last year the following activities related to the two suppliers: ACTIVITY HOT EXHAUSTS CHROME MANUFACTURERS Order components from supplier 90 orders 130 orders Receive order 90 deliveries 150 deliveries Return reject components to supplier 15 returns 16 returns Receive late deliveries 6 late deliveries 28 late deliveries Production downtime due to late delivery 45 hours 59 hours Production downtime due to defective material 20 hours 29 hours Process invoice and pay supplier 12 invoices 130 invoices Dispute invoice amount 3 disputes 3 disputes Quality audit of supplier 1 audit 2 audits Required