Maquina Company produces custom-made machine parts. Maquina recently has implemented an activity-based management (ABM) system with the objective of reducing costs. Maquina 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 $504,000 (salaries of 14 employees). The fixed costs provide a capacity of 28,000 hours (2,000 per employee at practical capacity). The setup activity was viewed as necessary, and the value-added standard was set at 2,000 hours. Actual setup hours used in the most recent period were 26,200.
1. Calculate the volume and unused capacity variances for the setup activity. Explain what each variance means.
2. Prepare a report that presents value-added, non-value-added, and actual costs for setup. Explain why highlighting the non-value-added costs is important.
3. Assume that management is able to reduce the demand for the setup activity so that the actual hours needed drop from 26,200 to 4,000. What actions should now be taken regarding activity capacity management?
4. Another activity studied was inspection of supplier materials and components. Explain why inspecting incoming goods should be viewed as a non-value-added activity. In providing your explanation, consider the following counterargument: “Inspecting incoming goods adds value because it reduces the demand for other unnecessary activities such as rework, reordering, and warranty work.”