Standard Costing and Variance Analysis Case Study:
Case A: Effect of assumed
Case B: Factory overhead
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
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)
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
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
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