Standard Costs and Operating

Performance Measures
VOKASI - IPB
Mata Kuliah: Akuntansi Biaya
23 November 2023
Performance Measurement

Performance
measurement or
feedback:

1. What works and

what doesn’t

2. Sustain motivation
and effort

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Scoreboard

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Standard Cost – Management by Exception

We will be decomposing spending variances into two parts:

1. A part that measures how well resources were used and
2. A part that measures how well the acquisition prices of those resources were
controlled.
A standard is a benchmark or “norm” for measuring performance. Standards are found
everywhere. Standards are also widely used in managerial accounting where they relate to
the quantity and cost (or acquisition price) of inputs used in manufacturing goods or
providing services.
• Quantity standards specify how much of an input should be used to make a product or
provide a service.
• Price standards specify how much should be paid for each unit of the input.
• Actual quantities and actual costs of inputs are compared to these standards.
• If either the quantity or the cost of inputs departs significantly from the standards,
managers investigate the discrepancy to find the cause of the problem and eliminate it.
This process is called management by exception.
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 Standard Cost – Management by Exception
The significant variances are
investigated to discover their root • The emphasis
causes should be on
highlighting
problems, finding
their root causes,
and then taking
corrective action.
then next period’s
operations are • The goal is to
carried out. improve
operations—not to
assign blame.

Why did this variance occur?

Why is this variance larger than it
was last period?
highlight the variances, which are the differences
between actual results and what should have
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occurred according to the standards
Standard Cost – Ideal vs Practical Standards
Ideal standards can be attained only under the
best circumstances. They allow for NO machine
breakdowns or other work interruptions, and
they call for a level of effort that can be attained
only by the most skilled and efficient employees
working at peak effort 100% of the time.
• Some managers feel that such standards spur
continual improvement. These managers
argue that even though employees know they
will rarely meet the standard, it is a constant
reminder of the need for ever-increasing effi
ciency and effort.
• Few organizations use ideal standards
Practical standards are standards that are “tight but
attainable.” They allow for normal machine downtime
and employee rest periods, and they can be attained
by though highly efficient, efforts by the average
worker.
• Variances from practical standards typically
signal a need for management attention because
they represent deviations that fall outside of
normal operating conditions.
• Furthermore, practical standards can serve
multiple purposes. In addition to signaling
abnormal conditions, they can also be used in
forecasting cash flows and in planning inventory.
By contrast, ideal standards cannot be used for
these purposes because they do not allow for
normal inefficiencies and result in unrealistic
forecasts
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Standard Cost – Colonial Pewter Company
• The Colonial Pewter Company was organized a year ago.
• The company’s only product is a reproduction of an 18th
century pewter bookend.
• The bookend is made largely by hand, using traditional
metalworking tools. Consequently, the manufacturing
process is labor intensive and requires a high level of skill.
• Colonial has recently expanded its workforce to take
advantage of unexpected demand for the bookends.
• The company started with a small cadre of experienced
pewter workers but has had to hire less experienced
workers as a result of the expansion.
• The president of the company, J. D. Wriston, has called a
meeting to discuss production problems.
• Attending the meeting are Tom Kuchel, the production
manager; Janet Warner, the purchasing manager; and
Terry Sherman, the corporate controller
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 J. D. Wriston (President)
Tom Kuchel (Production manager)
Standard Cost – Colonial Pewter Company Janet Warner (Purchasing manager)
Terry Sherman (Corporate controller)
J. D.: I’ve got a feeling that we aren’t getting the production we should out of our new people.
Tom: Give us a chance. Some of the new people have been with the company for less than a month.
Janet: Let me add that production seems to be wasting an awful lot of material— particularly pewter. That
stuff is very expensive.
Tom: What about the shipment of defective pewter that you bought a couple of months ago—the one with
the iron contamination? That caused us major problems.
Janet: That’s ancient history. How was I to know it was off-grade? Besides, it was a great deal.
J. D.: Calm down everybody. Let’s get the facts before we start sinking our fangs into each other.
Tom: I agree. The more facts the better.
J. D.: Okay, Terry, it’s your turn. Facts are the controller’s department.
Terry: I’m afraid I can’t provide the answers off the top of my head, but it won’t take me too long to set up
a system that can routinely answer questions relating to worker productivity, material waste, and input
prices.
J. D.: How long is “not too long”?
Terry: I will need all of your cooperation, but how about a week from today?
J. D.: That’s okay with me. What about everyone else?
Tom: Sure.
Janet: Fine with me.
J. D.: Let’s mark it on our calendars. 8
 Janet Warner (Purchasing manager)
Terry Sherman (Corporate controller)
Standard Cost – Setting DM Standards
• Terry Sherman’s first task was to prepare price and
quantity standards for the company’s only significant
raw material, pewter ingots.
• The standard price per unit for direct materials should
reflect the final, delivered cost of the materials, net of
any discounts taken.
• After consulting with purchasing manager Janet
Warner, Terry prepared the following documentation for
the standard price of a pound of pewter in ingot form:

• If everything proceeds according to these expectations,

the net cost of a pound of pewter should be $4.00. 9
 Tom Kuchel (Production manager)
Terry Sherman (Corporate controller)
Standard Cost – Setting DM Standards
• The standard quantity per unit for direct materials should reflect the amount of material required
for each unit of finished product as well as an allowance for unavoidable waste.
• After consulting with the production manager, Tom Kuchel, Terry Sherman prepared the
following documentation for the standard quantity of pewter in a pair of bookends:

These allowances should

be periodically reviewed
and reduced over time to
reflect improved
processes, better training,
and better equipment

•The
Thestandard cost of
bill of materials material
details per unit
the quantity of the
of each finished
type product
of material can be
that should beused
computed
in a
asproduct.
follows:
• “Waste and spoilage”
3.0 poundsrefers to unit
per materials thatper
x $4.00 are pound
wasted as a normal
= $12.00 part
per of the production
unit
process or that spoil before they are used.
This $12.00 refers
• “Rejects” cost will
to theappear on thecontained
direct material product’sin standard costthat
defective units card.
must be scrapped.

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Standard Cost – Setting DM Standards

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 Tom Kuchel (Production manager)
Terry Sherman (Corporate controller)
Standard Cost – Setting DL 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 wages, employment taxes, and fringe benefits.
Using wage records and in consultation with the production manager, Terry Sherman determined the standard
rate per direct labor-hour at the Colonial Pewter Company as follows:

The standard direct labor time required to complete a unit of product (called the standard hours per unit) is
perhaps the single most difficult standard to determine. The approach can be:
1. To break down each task into elemental body movements (such as reaching, pushing, and turning over).
Published tables of standard times for such movements can be used to estimate the total time required to
complete the task.
2. For an industrial engineer to do a time and motion study, actually clocking the time required for each task.
The standard time should include allowances for breaks, personal needs of employees, cleanup, and machine
downtime.
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 Tom Kuchel (Production manager)
Terry Sherman (Corporate controller)
Standard Cost – Setting DL Standards
The standard direct labor time required to complete a unit of product (called the standard hours per unit) is
perhaps the single most difficult standard to determine. The approach can be:
1. To break down each task into elemental body movements (such as reaching, pushing, and turning over).
Published tables of standard times for such movements can be used to estimate the total time required to
complete the task.
2. For an industrial engineer to do a time and motion study, actually clocking the time required for each task.
After consulting with the production manager, Terry Sherman prepared the following documentation for the
standard direct labor hours per unit:

The standard direct labor cost per unit of product can be computed as follows:
2.5 direct labor-hours per unit x $14 per direct labor-hour = $35 per unit

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Standard Cost – Standard Cost Card
At Colonial Pewter, the variable portion of the predetermined overhead rate is $3 per direct labor-hour.
Therefore, the standard variable manufacturing overhead cost per unit is computed as follows:
2.5 direct labor-hours per unit x $3 per direct labor-hour = $7.50 per unit

Standard Cost Card— Variable Manufacturing Costs

From the
job-order
costing

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A General Model for Variances Analysis
• Why are standards separated into two categories—price and quantity? Different
managers are usually responsible for buying and for using inputs.
• For example, in the case of a raw material, a purchasing manager is responsible for its
price. However, the production manager is responsible for the amount of the raw
material actually used to make products.
• The purchasing manager’s tasks are completed when the material is delivered for use in
the factory. A performance report for the purchasing manager can be prepared at that
point.
• However, the production manager’s responsibilities have just begun at that point. A
performance report for the production manager must be delayed until production is
completed and it is known how much raw material was used in the final product.
• Therefore, it is important to clearly distinguish between deviations from price standards
(the responsibility of the purchasing manager) and deviations from quantity standards
(the responsibility of the production manager).

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A General Model for Variances Analysis
Three things to note:
1. A price variance and
a quantity variance
can be computed for
each of the three
variable cost
elements—DM, DL
and VOH.
2. The price variance
and quantity variance
are computed in
exactly the same way
regardless of whether
one is dealing with
DM, DL and VOH.
3. The input is the actual quantity of direct materials, direct labor, and variable manufacturing overhead
purchased or used; the output is the good production of the period, expressed in terms of the standard
quantity (or the standard hours) allowed for the actual output.
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Standard Cost – DM Variance Analysis

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Standard Cost – DM Variance Analysis

1. Delaying the computation

of the price variance until
the materials are used
would result in less timely
variance reports.
2. Computing the price
variance when the
materials are purchased
allows materials to be
carried in the inventory
accounts at their standard
cost. This greatly simplifies
bookkeeping.

Most companies compute the materials price variance when materials are purchased rather than
when they are used in production. There are two reasons for this practice.

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Standard Cost – DM Variance Analysis
An excerpt from Colonial Pewter’s variance report is shown below along with the purchasing
manager’s explanation for the materials price variance.

Isolation of Variances. Variances should be isolated and brought to the attention of management as
quickly as possible so that problems can be promptly identified and corrected (“red flags”);
Responsibility for the Variance Who is responsible for the materials price variance? Many factors
influence the prices paid for goods
Variance analysis should not be used to assign blame. The emphasis should be positive rather than
negative otherwise can destroy morale and kill any cooperative spirit.
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Standard Cost – DM Variance Analysis

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Standard Cost – DM Variance Analysis

It is best to isolate the materials quantity variance when materials are used in production.
Materials are drawn for the number of units to be produced, according to the standard bill of materials for each
unit. Any additional materials are usually drawn with an excess materials requisition slip, which is different in
color from the normal requisition slips.

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Standard Cost – DL Variance Analysis
• In most companies, the wage rates paid to
workers are quite predictable.
• Nevertheless, rate variances can arise because
of the way labor is used. Skilled workers with
high hourly rates of pay may be given duties that
require little skill and call for lower hourly rates of
pay. Finally, overtime work at premium rates will
result in an unfavorable rate variance if the
overtime premium is charged to the direct labor
account.
• Who is responsible for controlling the labor rate
variance? Production supervisors are usually
responsible for seeing that labor rate variances
are kept under control.
• Possible causes include poorly trained or
motivated workers; poor quality materials,
requiring more labor time; faulty equipment
causing breakdowns and work interruptions;
poor supervision of workers; and inaccurate
standards.
• The managers in charge of production would
usually be responsible for control of the labor
efficiency variance.
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Standard Cost – DL Variance Analysis

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Standard Cost – DL Variance Analysis
Practices at 18 plants:
• 7 plants eliminated direct labor
variances  11% decline in
labor productivity (saving
~$2mn vs $0.2mn)

• 11 plants did not (tracking DLV)

 lower decline

VS.

• Advocates of lean production –

DLV is non value added activity

Which one you

choose? Tracking or
not tracking

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Standard Cost – VOH Variance Analysis

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Standard Cost – VOH Variance Analysis

• The interpretation of the variable overhead variances is not as clear as the direct materials and direct labor
variances. In particular, the variable overhead efficiency variance is exactly the same as the direct labor
efficiency variance except:
 In the case of the direct labor efficiency variance, this difference is multiplied by the direct labor rate.
 In the case of the variable overhead efficiency variance, this difference is multiplied by the variable
overhead rate.

• So when direct labor is used as the base for overhead, whenever the direct labor efficiency variance is
favorable, the variable overhead efficiency variance will be favorable. The other way around.

• Indeed, the variable overhead efficiency variance really doesn’t tell us anything about how efficiently
overhead resources were used. It depends solely on how efficiently direct labor was used.

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 J. D. Wriston (President)
Tom Kuchel (Production manager)
Standard Cost – Colonial Pewter Company Janet Warner (Purchasing manager)
Terry Sherman (Corporate controller)

J. D.: Terry, I think I understand the report you distributed, but just to make sure, would you mind summarizing the highlights of
what you found?
Terry: As you can see, the biggest problems are the unfavorable materials quantity variance of $2,000 and the unfavorable
labor efficiency variance of $5,600.
J. D.: Tom, you’re the production boss. What do you think is causing the unfavorable labor efficiency variance?
Tom: It has to be the new production workers. Our experienced workers shouldn’t have much problem meeting the standard of
2.5 hours per unit. We all knew that there would be some inefficiency for a while as we brought new people on board. My plan
for overcoming the problem is to pair up each of the new guys with one of our old timers and have them work together for a
while. It would slow down our older guys a bit, but I’ll bet the unfavorable variance disappears and our new workers would
learn a lot.
J. D.: Sounds good. Now, what about that $2,000 unfavorable materials quantity variance?
Terry: Tom, are the new workers generating a lot of scrap?
Tom: Yeah, I guess so.
J. D.: I think that could be part of the problem. Can you do anything about it?
Tom: I can watch the scrap closely for a few days to see where it’s being generated. If it is the new workers, I can have the old-
timers work with them on the problem when I team them up.
J. D.: Janet, the favorable materials price variance of $1,300 isn’t helping us if it is contributing to the unfavorable materials
quantity and labor efficiency variances. Let’s make sure that our raw material purchases conform to our quality standards.
Janet: Fair enough.
J. D.: Good. Let’s reconvene in a few weeks to see what has happened. Hopefully, we can get those unfavorable variances
under control.
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Standard Cost – Exercise

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 Standard Cost – Exercise

Group 1
Group 2
Group 3
Group 4

Group 5

Group 5

Group 4

Group 3

Group 2

Group 1

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Reference

Managerial Accounting 13th edition, Garrison/Noreen/Brewer

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