Standard Costing and Variance Analysis Case Study:
- Case A: Effect of assumed standard levels
- Case B: Factory overhead variance analysis
Effect of Assumed Standard Levels:
Harden Company has experienced increased production costs. The primary area of concern identified by management is direct labor. The company is considering adopting a standard cost system to help control labor and other costs. Useful historical data are not available because detailed production records have not been maintained.
To establish labor standards, Harden Company has retained an engineering consulting firm. After a complete study of the work process, the consultants recommended a labor standard of one unit of production every 30 minutes, or 16 units per day for each worker. The consultants further advised that Harden’s wage rates were below the prevailing rate of $ per hour.
Harden’s production vice-president thought that this labor standard was too tight, and from experience with the labor force, believed that a labor standard of 40 minutes per unit or 12 units per day for each worker would be more reasonable.
The president of Harden Company believed the standard should be set at a high level to motivate the workers and to provide adequate information for control and reasonable cost comparison. After much discussion, management decided to use a dual standard. The labor standard of one unit every 30 minutes, recommended by the consulting firm, would be employed in the plant as a motivation device, while a cost standard of 40 minutes per unit would be used in reporting. Management also concluded that the workers would not be informed of the cost standard used for reporting purposes. The production vice-president conducted several sessions prior to implementation in the plant, informing the workers of the new standard cost system and answering questions. The new standards were not related to incentive pay but were introduced when wages were increased to $7 per hour.
The standard cost system was implemented on January 1, 19–. At the end of six months of operation, these statistics on labor performance were presented to executive management:
|Direct labor hours
|Variance based on labor standard (one unit each 30 minutes)
|Variance based on cost standard (one unit each 40 minutes)
*U = Unfavorable; F = Favorable
Materials quality, labor mix, and plant facilities and conditions have not changed to any great extent during the six month period.
- A discussion of the impact of different types of standards on motivations, and specifically the likely effect on motivation of adopting the labor standard recommended for Harden Company by the engineering firm.
- An evaluation of Harden Company’s decision to employ dual standards in its standard cost system.
- Standards are often classified into three types – theoretical (tight), normal (reasonable), or expected actual (loose). Standards which are too loose or too tight will generally have a negative impact on workers motivation. If too loose, workers will tend to set their goals at this low rate, thus reducing productivity below what is obtainable; if too tight, workers will realize that it is impossible to attain the standard, become frustrated, and will not attempt to meet the standard. An attainable or reasonable standard which can be achieved under normal working conditions is likely to contribute to the worker’s motivation to achieve the designated level of activity.
If executive management imposes standards, workers and plant management will tend to react negatively because they feel threatened. If workers and plant management participate in setting the standard, they can more readily identify with it and it could become one of their personal goals.
In Harden’s case, it appears that the standard was imposed on the workers by management. In addition, management used an ideal standard to measure performance. Both of these actions appear to have had a negative impact on output over the first six months.
- Harden made a poor decision to use dual standards. If the workers learn of the dual standards, the company’s entire measurement system may may become suspect and credibility will be lost. Company morale could suffer because the workers would not know for sure how the company evaluates their performance. as a result, disregard for the present and any future cost control system may develop.
Factory Overhead Variance Analysis:
Strayer Company uses a standard cost system and budgets the following sales and costs for 19–
|Total production cost at standard
The 19– budgeted sales level was the normal capacity level used in calculating the factory overhead predetermined standard cost rate per direct labor hour.
At the end of 19–, Strayer Company reported production and sales of 19,200 units. Total factory overhead incurred was exactly equal to budgeted factory overhead for the year and there was under-applied total factory overhead of $2,000 at December 31. Factory overhead is applied to the work in process inventory on the basis of standard direct labor hours allowed for units produced. Although there was a favorable labor efficiency variance, there was neither a labor rate variance nor materials variances for the year.
Require: An explanation of the under-applied factory overhead of $2,000, being as specific as the data permit and indicating the overhead variances affected. Strayer uses a three variance method to analyze the total factory overhead.
Under-applied factory overhead will arise when actual factory overhead incurred is larger than the standard amount of factory overhead applied to work in process. The standard amount of factory overhead applied to work in process is based on actual rather than on budgeted units of output.
Based on the information given, the sum of the factory overhead spending, efficiency, and idle capacity variances resulted in an unfavorable total factory overhead variance of $2,000.
The factory overhead efficiency variance must be favorable because it is computed on the same basis as the direct labor efficiency variance which was given as favorable.
Strayer would have an unfavorable idle capacity variance because the actual activity level for the year was less than the capacity level used in calculating the standard cost rate for factory overhead.
As to the factory overhead spending variance, the balance would be unfavorable because actual costs would have had to exceed the budgeted cost of the actual units produced since the budget allowance for production of 19,200 units must be less than for 20,000 units and the actual costs were exactly equal to the budget allowance for 20,000 units. The magnitude of the spending variance is indeterminate from the information given.
You may also be interested in other articles from “standard costing and variance analysis” chapter
- Standard Costs and Management By Exception
- Setting Standard Costs – Ideal Versus Practical Standards
- Direct Materials Price and Quantity Standards
- Direct Materials Price Variance
- Direct Materials Quantity Variance
- Direct Labor Rate and Efficiency Standards
- Direct Labor Rate/Price Variance
- Direct Labor Efficiency | Usage | Quantity Variance
- Manufacturing Overhead Standards
- Overall or net factory overhead variance.
- Controllable variance
- Volume variance
- Spending variance
- Idle capacity variance
- Efficiency variance
- Spending variance
- Variable efficiency variance
- Fixed efficiency variance
- Idle capacity variance
- Mix and Yield Variance – Definition and Explanation
- Materials Mix and Yield Variance
- Labor Yield Variance
- Factory Overhead Yield variance
- Variance Analysis and Management By Exception
- Managerial importance and usefulness of variance analysis
- Advantages and Disadvantages of Standard Costing System
- Standard Costing Discussion Questions and Answers
- Standard Costing and Variance Analysis Formulas
- Standard Costing and Variance Analysis Problems and Solution
- Standard Costing and Variance Analysis Case Study
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