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we study management control and performance measures. Quite often, these terms carry with them negative connotations - we may have a tendency to think ofperformance measurement as something to be feared. And indeed, performance measurements can be used in very negative ways - to cast blame and to punish. However, that is not the way they should be used. Performance measurement serves a vital function in both personal life and in organizations. Performance measurement can provide feedback concerning what works and what does not work, and it can help motivate people to sustain their efforts.
In this section we see how various measures are used to control operations and to evaluate performance. Even though we are starting with the lowest levels in the organization, keep in mind that performance measures should be derived from the organization's overall strategy. For example, a company like Sony that bases its strategy on rapid introduction of innovative consumer products should use different performance measures than a company like Federal Express where on-time delivery, customer convenience, and low cost are key competitive advantages. Sony may want to keep close track of the percentage of revenues from products introduced within the last year; whereas Federal Express may want to closely monitor the percentage of packages delivered on time.
Company in highly competitive industries like Federal Express, Southwest airlines, Dell Computer, Shell Oil, andToyota must be able to provide high quality goods and services at low cost. If they do not, they will perish. Stated in the starkest terms, managers must obtain inputs such as raw materials and electricity at the lowest possible prices and must use them as effectively as possible - while maintaining or increasing the quality of the output. If inputs are purchased at prices that are too high or more inputs are used than is really necessary, higher costs will result. They could examine every transaction in detail, but this obviously would be an inefficient use of management time. For many companies, the answer to this control problem lies at least partially in standard costing system.
Standard Costs - Management by Exception:
A standard cost is the predetermined cost of manufacturing a single unit or a number of product units during a specific period in the immediate future. It is the planned cost of a product under current and/or anticipated operating conditions.
Setting Standard Costs - Ideal Versus Practical Standards:
Setting price and quantity standards requires the combined expertise of all persons who have responsibility over input prices and over effective use of inputs. In a manufacturing firm, this might include accountants, purchasing managers, engineers, production supervisors, line mangers, and production workers. Past records of purchase prices and input usage can help in setting standards. However, the standards should be designed to encourage efficient future operations, not a repetition of past inefficient operations.
Direct Materials Standards and Variance Analysis:
Direct Materials Price and Quantity Standards:
Standard price per unit of direct materials is the price that should be paid for a single unit of materials, including allowances for quality, quantity purchased, shipping, receiving, and other such costs, net of any discounts allowed.
Direct Materials Price Variance:
Direct materials price variance is the difference between the actual purchase price and standard purchase price of materials. Direct materials price variance is calculated either at the time of purchase of direct materials or at the time when the direct materials are used.
Direct Materials Quantity Variance:
Direct materials quantity variance or Direct materials usage variance measures the difference between the quantity of materials used in production and the quantity that should have been used according to the standard that has been set. Although the variance is concerned with the physical usage of materials, it is generally stated in dollar terms to helpgauge its importance.
Direct Labor Standards and Variance Analysis:
Direct Labor Rate and Efficiency Standards:
Direct labor price and quantity standards are usually expressed in terms of a labor rate and labor hours. The standard rate per hour for direct labor includes not only wages earned but also fringe benefit and other labor costs.
Direct Labor Rate | Price Variance:
Direct Labor price variance is also termed as direct labor rate variance. This variance measures any deviation from standard in the average hourly rate paid to direct labor workers.
Direct Labor Efficiency | Usage | Quantity Variance:
The quantity variance for direct labor is generally called direct labor efficiency variance or direct labor usage variance.
Manufacturing Overhead Standards and Variance Analysis:
Manufacturing Overhead Standards:
Procedures for the establishing and using standard factory overhead rates are similar to the methods of dealing with the estimated direct and indirect factory overhead and its application to jobs and products.
Factory Overhead Variances:
Jobs or processes are charged with cost on the basis of standard hours allowed multiplied by the standard factory over head rate. The standard overhead rate or predetermined overhead rate is discussed in detail at our job order costing system page. The standard hours allowed figure is determined by multiplying the labor hours required to produce one unit (the standard labor hours per unit) times the actual number of units produced during the period. The units produced are the equivalent units of production for the departmental factory overhead cost being analyzed. At the end of the month, overhead actually incurred is compared with the expenses charged into process using the standard factory overhead rate. The difference between these figures is called the overall or net factory overhead variance.
Factory Overhead Variance Analysis:
Strayer Company uses a standard cost system and budgets the following sales and costs for 2009
Total production cost at standard
The 2009 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 2009, 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 efficiencyvariance, 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 productionof 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.
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--.
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 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.