Question

Machine Parts Co. produces custom-made machine parts. Machine Parts Co. recently implemented an activity-based management (ABM) system with the objective of reducing costs. Machine Parts Co. has begun analyzing each activity to determine ways to increase its efficiency. Setting up equipment was among the first group of activities to be carefully studied. The study revealed that setup hours was a good driver for the activity. During the last year, the company incurred fixed setup costs of $560,000 (salaries of 10 employees). The fixed costs provide a capacity of 35,000 hours (3,500 per employee at practical capacity). The setup activity was viewed as necessary, and the value-added standard was set at 3,500 hours. Actual setup hours used in the most recent period were 36,200.

Part A Calculate the volume variance and note whether it is favorable or unfavorable. How would you describe your answer to the manager of this company? What does it mean?

Part B Calculate the unused capacity variance and note whether it is favorable or unfavorable. How would you describe your answer to the manager of this company? What does it mean?

Answer 1

Fixed Setup cost                560000 Fixed costs                         35000 hours(3500 per employee)                                              (10 employees *3500 per employee) Value added standard         3500 hours Actual setup hours            36,200 1-Computation of volume variances: 1st of all we have to calculate Fixed activity rate: Formula : SP = Set up cost / Fixed cost        560000 / 35000        16 per setup hour Working notes: Computation of Volume Variance : Formula : Volume variance : SP*SQ – SP*AQ                           16*3500 -16*35000                           56000-560000                          504000(unfavorable) A volume variance is the difference between the actual quantity sold or consumed and the budgeted amount expected to be sold or consumed, multiplied by the standard price per unit.A volume variance is less likely to arise when a company sets attainable standards, where usage quantities are expected to include a reasonable amount of scrap or inefficiency.If the standards upon which the volume variance is calculated are in error or wildly optimistic, employees will have a tendency to ignore negative volume variance results. Consequently, it is best to use standards that are reasonably attainable. 2- Computation of unused capacity Variance   : Formula : unused capacity Variance : SP*AQ – SP*AV                                     16*35000 – 16*36200                                    560000 – 579200                                    19200(Unfavorable) The unused capacity variance is a measure of the potential to reduce the spending on an activity and thus reduce the non value added costs.In this case since the resources is acquired one person at a time there is not sufficient unused capacity to reduce the number of employees one by one.The unfavorable unused capacity variance does signal that the activity demand is being reduced.