CASE STUDY NO. 01.

04

TURBO, INC.
Background
Turbo, Inc., is a wholly owned subsidiary of National Engine Corporation, located in
Cityville, Ohio. Sales for 2005 were $29,803,000, on which Turbo earned $1,788,180 before tax.
Turbo manufactures and sells turbochargers for use on new and used cars and trucks and spare parts
for repairing these turbochargers. The plant normally employs about 40 hourly people for
inspection, machining, assembling, material handling, shipping and receiving, machine setup, and
maintenance.
Ken Bauer is on the operational audit staff of National Engine Corporation, which
purchased Turbo in 2003. National Engine's policy is to conduct a review of purchasing practices at
each newly acquired subsidiary within the first two or three years of National Engine's ownership.
Early in 2006, Ken was sent to Cityville to perform this review.
On his first day, he requested a plant tour in order to familiarize himself with the product
and its manufacture. To help him understand the product, the manager of manufacturing
engineering, Martha Johnson, gave him a general bill of material (see Exhibit 1). She explained that
different finished turbocharger models are made by creating combinations of turbine wheels, turbine
housings, compressor wheels, compressor housings, and compressor plates. Over 40,000 such
model combinations are possible, but in practice Turbo makes only about 2,300 turbocharger
models each year. In addition, it sells the parts individually to repair shops for use in repairing
turbochargers.
The plant uses a material-requirements-planning (MRP) system to convert its forecast sales
of finished turbochargers and parts into net machining and purchasing requirements. Each week the
purchasing department receives computer-generated schedules of Turbo's purchased materials
requirements projected for six months.

Organization
After learning this basic information, Ken met with the purchasing manager, Doug Mitchell,
who gave Ken a copy of his organization chart (see Exhibit 2). He explained that he had divided the
parts among the buyers so that each buyer had the same number of part numbers (p/n's) assigned to
him. Doug commented that Carl Potter was his strongest buyer with the best record on cost
reduction, delivery performance, and quality acceptance. Doug also supplied Ken with a list of 2005
purchases (see Exhibit 3).

Corporate Discounts
Ken reviewed the list of purchases against the National Engine headquarters' list of
corporate discounts. This list consists of items for which the parent company has negotiated
favorable prices due to the large volume purchased by all National Engine's subsidiaries combined.
Of Turbo's purchases, all the hardware and packing items and some production chemicals,
maintenance sup plies, and office supplies were available under the National Engine's corporate
discount program. If Turbo had purchases from the corporate suppliers, savings in 2005 would have
been $30,354.30. National Engine had also developed a Korean casting supplier whose prices were
considerably lower than going rates in the United States. Potential savings from using this vendor
could not be quantified, since each p/n would have to be quoted separately. In discussion with the
buyers, Ken discovered that they were not aware of the corporate discount program.

Sourcing
Noting that turbine wheels and compressor wheels were single-sourced (that is, Turbo had
only one supplier on these items), Ken scheduled a meeting with Art Gunn. Art explained that the
turbine wheels were very difficult to cast and that no other supplier had been able to make them
reliably. Since a turbine wheel is subjected to extreme heat when in use on the engine, quality is
critical. The compressor wheels, Art felt, could probably be cast by other vendors. But engineering
had refused to allow him to solicit quotations from any other vendors, so the turbine-wheel vendor
produced compressor wheels as well. Art did not agree with this approach but had been too busy to
pursue the matter with Doug.
In reviewing Exhibit 3, Ken noticed that Turbo's current inventory of bearing housings was
almost half of the 2005 purchases. He asked Art to explain this situation. Art showed Ken the
financial statements of Castco, one of the vendors for this part. Clearly, Castco was in financial
difficulty. Art felt that Castco was a valuable vendor that worked hard to accommodate its
customers, so he ordered extra bearing housings to help keep them afloat. Turbo does not have a
formal policy regarding purchases beyond current production requirements. Art had not obtained
approval from Doug before ordering these extra parts because the part is used in all turbocharger
models, so he saw no obsolescence exposure.

Tooling
Ken was concerned about the large amount of money spent for tooling, so he scheduled a
meeting with John Harris. John explained that the major part of the expense ($1,932,816 of the
$3,017,983 for tooling and repairs) was for patterns and dies made for Turbo by the casting vendors.
Upon receiving the drawings and specifications for a new part number, the casting vendor makes
the equipment required to produce the casting. Turbo pays the casting vendor for making this
equipment, and therefore owns the equipment, although it stays at the vendor's location for use in
producing additional castings.
First, a wooden pattern is made in the exact shape of the part. Then this pattern is used to
make dies for casting the part. With usage, the patterns and the dies wear out. Thus, patterns and the
dies must be made both for new parts and for production parts whose volume has been high enough
to wear out the original equipment.
John had not inspected any of Turbo's equipment at vendor locations. Although in many
cases he felt that Turbo was charged too much or too often for patterns and dies, he was too busy to
question the vendors, so he accepted their charges. Recently, John had heard rumors that some of
the casting vendors were using Turbo's equipment to produce castings for sale to other companies.
At this stage, Ken returned to headquarters to write up the first sections of his audit before
revisiting Cityville to complete the review.

Required
1. What operational deficiency(s) explain that buyers were not aware of the corporate discount
program?
2. In what ways could that deficiency(s) have been discovered?
3. If National Engine elects to pay for casting molds for its vendors what protective actions
should be taken?
4. Art Gunn had ordered an unusually large amount of bearing housings from Castco to help
the firm (Castco) weather financial difficulties. What issues are present in this action?
5. Write the first sections of the audit report as you think Ken should write them. (optional)
 Exhibit 1
General Bill of Material

Part Qty. in Each Turbocharger No. of Different P/N's*

Wheel and shaft 1 4
Turbine wheel 1 4
Shaft 1 1
Compressor wheel 1 12
Turbine housing 1 12
Compressor housing 1 12
Bearing housing 1 1
Bearing 1 1
Compressor plate 1 6
Nuts 16 3
Washers 16 3
Seal rings 4 15
O-rings 2 4
Grease 2 1
Plastic packing cap-housings 2 1
Plastic packing cap-oil ports 2 1
Box 1 1
Shrink wrap 10 1
Silica pack 1 1

*For example, there are 12 different sizes of compressor wheels. Each turbocharger uses one
compressor wheel. Wheels are combined with other components to make different finished
turbochargers.
 Exhibit 2
Purchasing Department's Organization

Doug Mitchell
Purchasing Manager

Marty Smith
Purchasing
Secretary

Arthur Gunn Bruce Norman Carl Potter John Harris

Buyer Buyer Buyer Buyer
Turbine wheels Compressor housings Seal rings Tooling and repairs
Compressor wheels Bearings Boxes Production chemicals
Turbine housings Compressor plates Plastic bags Maintenance supplies
Bearing housing Nuts Office supplies
Shafts Washers
Rings
Grease
Plastic cap-housings
Plastic cap-oil ports
Shrink wrap
Silica packs
 Exhibit 3
Purchases in 20X5

Part P/N's UP AUC Dollars TP Buyer NS UI

Turbine wheels 4 158,902 4.53 719,826.06 IIC ARG 1 13,497
Compressor wheels 12 177,816 3.27 581,458.32 AC ARG 1 12,217
Turbine housing 12 135,614 9.18 1244,936.52 IC ARG 2 15,301
Compressor housing 12 143,806 7.46 1,072,792.76 AC BCN 2 9,983
Bearing housing 1 265,803 6.24 1,658,610.72 AC MG 2 132,750
Shafts 1 160,700 2.97 477,279.00 SBS ARG 3 12,591
Bearing 1 203,642 1.58 321,754.36 AC BCN 2 17,670
Compressor plates 1 147,819 2.03 300,072.57 AC BCN 2 13,318
Nuts 5 4,302,817 .004 17,211.27 H BCN 4 350,602
Washers 2 4,032,008 .001 4,032.01 H BCN 4 326,007
Seal rings 15 1,020,015 .002 2,040.03 H CFP 4 86,001
O rings 4 516,473 .14 72,306.22 H BCN 4 40,039
Grease 1 240,000 .01 2,400.00 C BCN 2 21,327
Plastic caps: housings 1 255,000 .05 12,750.00 P BCN 1 23,250
Plastic caps: oil ports 1 247,000 .03 7,410.00 P BCN 1 21,583
Boxes 10 380,550 .54 205,497.00 P CFP 2 30,712
Shrink wrap 1 1,300,000 .05 65,000.00 P BCN 2 98,333
Silica pack 1 125,802 .30 37,740.60 P BCN 2 12,483
Plastic bags 5 9,035,000 .02 180,700.00 P CFP 2 654,916
Tooling & repair N/A N/A N/A 3,017,983.15 N/A JMH N/A N/A
Production chemicals N/A N/A N/A 402,016.15 N/A JMH N/A N/A
Maintenance supplies N/A N/A N/A 153,249.36 N/A JMH N/A N/A
Office supplies N/A N/A N/A 97,004.14 N/A JMH N/A N/A

Total 10,654,070.24

LEGEND:
P/N is part numbers.
UP is units purchased in 20X5.
AUC is average unit cost.
TP is type of part.
NS is number of supplier.
UI is units in inventory in 12/31/X5.
IIC is iron investment casting.
AC is aluminum casting.
SBS is steel bar stock H is hardware.
C is chemical.
P is packing.