Mile High Cycles Case Solution

1. Determine the direct cost and overhead variances. What might be causing each of the variances to occur?

Variances for the individual activities can be calculated by comparing the costs incurred actually for each activity with the standard cost estimates. For the Frame assembly, a budget based on 10,000 cycles shows that a total of 110,000 pounds of steel tubing will be used in the assembly for the production estimated cycles. This means that the management of the Mile High Cycles was expecting the consumption of steel tubing in the frame assembly to remain at 11 pounds per unit. However, the actual consumption data shows that a total of 113,400 pounds were used for the production of 10,800 cycles. Two types of variances can be used to assess the cost implications of the materials consumed i.e. Volume variance and Price variance. The word price here refers to the “price incurred” by the company for using a particular input material.

The formula for the calculation of volume variance is as follows:

Volume Variance = (Standard Quantity – Actual Quantity) * Standard Price

Standard quantity here means the quantity required to produce the actual number of outputs if a standard number of inputs is used. For example, for 10,800 cycles actually produced, a number of pounds of material tubing required according to estimates will be 118,800. However, in reality, the number of pounds consumed for the production of 10,800 cycles was 113,400. Therefore, Volume variance for material tubing can be calculated as follows:

Volume Variance = (118,800 – 113,400) * $20   = $ 162,000. (Favorable)

The positive sign of the volume variance tells us that the actual quantity of material tubing used was less than the budgeted quantity estimated by the management, which resulted in cost savings of $162,000 due to efficiency in material usage.

In the same way, price variance for material tubing can be calculated using the following formula:

Price Variance = (Standard Price – Actual Price) * Actual Quantity

The budgeted price per pound of material tubing, as shown in exhibit 1, is $30 while the actual cost per pound came out to be $31.50. Using this information, in addition to the actual number of pounds consumed, price variance for materials tubing can be computed as follows:

Price Variance = (30 – 31.50)* 113,400 =   - $170,100 (unfavorable).

The negative sign of the price variance shows that the actual price per pound was higher than the budgeted price per pound; hence, costs rose by $170,000 from the budget due to the increase in price. These values of Volume variance and price variance, when added together, will tell us whether the costs have risen due to the use of material tubing.

Volume Variance = $162,000 + (-$170,100)   = -$8,100.

The negative sign tells us those cost savings brought about by the efficient use of material tubing was not enough to cover the negative impact of a price increase. Therefore, actual costs incurred while material tubing use was higher than the budgeted cost by $8,100.

In the same way, volume and price variances of all the cost centers may be analyzed to see the overall impact of the cost variances. All of these calculations have been shown in the excel sheet department wise. These calculations show that in the “Frames” department, the total cost for the production of 10,800 cycles according to the budget estimates should have been $5,211,000; whereas, exhibit 2 shows that the total cost actually incurred in the Frames department was $5,128,338. This means that there was an overall cost saving of $82,663 in the Frames department. In the same way, the actual cost implications of all the activities in the departments may be calculated to assess their performances.