Petersen Pottery

This case is set in rural West Virginia in 1980 in the $450 million pel' year "vitreous clay
fixtures" industry. There arc 70 firms in the indus..I1y and Petersen is somewhere in she
middle. The case deals with the needfor formal cost control systems.

Just outside of Elkins, West Virginia, high in the Appalachian Mountains, Clive Petersen had been
making ceramic bathroom fixtures (sinks, toilets, and barhmbs) since 1960. Petersen fixtures had
become known over the years for their distinctive custom features, their high quality, and their long
life. Petersen Pottery had grown from a two-man operation in 1960 to the present group M20 master
potters located in two large old warehouses, converted from World War II storage depots. By 1980
Clive's business had expanded to the point where he felt- he must institute some type of f01111a.l,
systematic controls over his costs. His banker was more and more concerned about the lack of any
kind of modem cost accounting system as the loan balances kept growing to fund Clive's expansion
asd seasonal operations.
The manufacture of ceramic "sanitary ware" consists of two processes: "green" moldmg and
glazing, each of which involves a four day kiln cycle. Raw clay is first packed into "plaster-of-paris"
molds where it is allowed to dry before it is baked in a kiln to harden. In t.he second stage, the fixture
is coaled with a glaze mixture to give it its color and characteristic smooth finish. The fixture is then
baked again (fired) to harden and fix the glaze to thc clay. The kiln time is as follows:

Green Molding Cycle .Glazing C)(~k

Drying 1 day Iday
Firing 1 day 1day
Cooling 2 days 2 days

The finished product is then shipped to various wholesale outlets around the 8aSt Central
States region. The molding and firing of ceramics, although not highly complex, requires an
experienced potter to assure the quality of the product Excessive heal or excessive rime in the kiln can
min a fixture. The mixing and application of [he glaze also requires a significant amount of skill.
However, too much time cannot be spent on the molding and glazing processes because delays can
cause bottlenecks in the whole production process.
The need for better cost control, coupled with anced 10r better control over production
scheduling to meet the increases in demand, led Clive Petersen to adopt a standard cost system. After
, extended discussion with his most experienced master pOUeC'S. Clive and his new cost accountant
arrived at the following cost standards for a toilet, one of the high volume products:

Materials
Raw Clay 25 Ib @$,95/Ib $23.75
Glazing Mix 5 lb @ $.75/Ib 3.75
Direct Labor
., Molding 1 hr @ $151hr1 15.00
Glazing .5 hr@S15lhrJ 7.50
Manufacturing Overhead Costs~ Absorbed
@ $5 per Fixture
Total per Fixture

I Petersen paid wages of about twice the average: for "stone and clay workers" because he. wanted 1)))1)' 10J) quality
products.
2 Normal volume per month for overhead allocation purposes was assumed 10 be 1,200 toilets. 1111:estimated
monthly manufacturing overhead allocation to this product was $1,94 per unit plus $3,672 of fixed cost.
20 k'etefS¢ll k'otterv

ANALYSIS OF OPERATIONS
After (\ months of operations using the new cost system Petersen was disturbed over the lack of
aucnrion paid to the standards. He fell that the potters were just too set in their ways to pay any
attention to the "confusing" new system. As one of the potters observed, "I have been making these
fixtures a lot longer than these new ideas had been around, and I don't see how a bunch of numbers that
sor.ne bot-shot accountant puts together are going to help me make any better toilets." The result was
that although the standards existed, they were seldom met.
IIIreviewing the June production results, the following actual COSts were noted in connection
with manufacturing 114S toilers: -,

Materials Purchased
Clay 30,000 Ib @ $.92/Ib
OIa7.1! 6,000 Ib @$.7811b
Materials Used
Clay 28,9001b
Glaze 5,900 Ib
Direct Labor
Molding 1,200 Itr@515.25/hr
Glazing 600 hr@SIS.OOJhr
Overhead Assigned to Toilets: $6,100 ($2,300 variable cost and $3,800 fixed cost)

The sales manager was unhappy that production was S5 units below plan. The cost
accountant WlIS unhappy about continuing unfavorable variances. Oefore proceeding with further
analysis, Petersen met with his most experienced master porter, Jim Sedgefleld, to discuss the variances
from the standards, He was seriously considering implementing a new and much faster "pressure
casting" mold system to replace the existing manual system, When Sedgeficld arrived, Clive explained
the problem: "Jim, you agreed when we set them up that the standards are reasonable and yet you
never meet them. It looks like we will have unfavorable variances again thls mouth as well as more
missed shipping dates." Sedgefield was not impressed. "Well Clive," he said, '" never have
understood this system at all. Why don't you ask that fast-talking accountant 10 explain the variances?
He seems to know what these numbers mean. All J know is, we seemed to spend all month fussing with
that new brand of clay you said was going to be chea per for us. Do you want Ole to make lOIS oftoilcls
or good toilets?"

QUESTIONS
I. Analyze tbe variances for the month using whatever
format you like.

2. What conclusions are suggested regarding cost performance for the month?

3. What suggestions do you have for lVlr.Petersen regarding his new standard cost system? •
i
)

t A Note on Computing Manufacturing

I
,
f
Cost Variances
For use with Petersen Pottery case
I
1
T. "PRIM E" COSTS
f The term "prime" cOSlSrefers to chose COSISwhich can be directly identified with one unit of product.

i
Another term for "prime" cost is "direct" cost or "variable" cost. You will often hear the tenus
"direct" material cost or "direct" labor C{ISt. Traditionally, labor has been considered a prim. cost by
most companies. "Indirect" material and "indirect" labor cost. arc considered to be part of
manufucturing overhead or "burden" rather than part of prime cost. Example of the.se fOllr cost
categories arc shown below:

Cost Category Cost Classification Example

Direct Labor Prime Cost Cost fur a worker's lime spent

assembling a product
Indirect Labor Overhead COst QY.<t for a worker's time spent
repairing manufacturing
equipment
Direct Material Prime Cost Cost of steel used in manufacturing
an automobile
indirect Material Overhead Cost Cost of supplies used in maintaining
m.nufacturing equipment

if Today, many companies treal manufacturing labor cost more as fixed than as volume
dependent, In this case.jhe only "prime" or "direct" cost is raw material.
The standard for any element of prime cost Involves IWO components: a price component and
a quantity component. The standard cost is the standard quantity to be used multiplied by the standard
price per unit of measure. For example, if an electric motor contains fOllr bushings and each bushing
should cost $.25, then the standard cost for bushings is $1.00 (standard quantity of 4 X the standard
price per unit "fS.25). Variances are usually computed for each ofthe two components. The formulas
for calcularing the variances are as follows:
Price variance (PV)~(AI' - SP) X AQ
Quantity variance (QV)" (AQ - SQ) X SP
Total variance (TV)" PV + QV

where SP = standard price

AP = actual p~ice
SQ = standard qU8ll1Jty
AQ = acmal quantity
210
-----------
Since the (otal variance is the difference between
the standard cost allowance (Sl' X SQ) and the actual cost
inclllm (AP X AQ), you should be able to veri!)' for
yourself Ihat. the price and quantity variance in the above
formulas do sum (0 tJ1C (otul variance.
We Call illustrate these calculations with the
foltowing example which assumes that both material and
Jaber cost arc volume dependent,
_____ __Qalcula"'li"'olu..
---1
Standar'!.jlg_!llli!
Material 2 pounds per unil at S 1.00 per
pound. $2.00 per unit
3 hours per unit ar $4.00 per
hour = $12.00 pel' unit
10 units. Therefore, the
standard cost allowance
is $20 f(lr material and $120
for labor.
Actual Costs
Material Used 25 pounds which were
purchased at a COSt of$.80
per pound, fur a cost 0/'520.
Labor Used 25 hours at an average
rate ofS5.00 per hour, for a
cost of$125.
__________ ...;P'-'e::!(cr=se"'n!..;f''-'o'''t=l~
- Note Oil CMCV
fluctuations should not be considered when measuring the
variance due to quantity fluctuauons=-vary only one
component at a time. However, most people atso [eel that
the price variance should be measured over tJl(: actual
quantities for which the price difference obtains, not the
standard quantities. Some people do not like this logical
inCODSistellCY. They prefer [0 vary only one component at
a time in both the price and quantity variance calculations.
They then set up a third variance (joint variance) caused
by the- joint fluctuation in both prices and quantities.
Under Ibis approach tJle fonnulas are as follows:
PV = (AP- SP) X SQ
QV =(AQ - SQ) X SP
JV = (AP - SP) X (AQ - SQ)
TV = PV +QV +JV
This can be illustrated graphically 8S follows, assuming
both price and quantity vari aiions are unfavorable:
TW(1-Variances Anproach
Actual
Price
Price
Variance
Slandar 0
Price Standard Quantity
Cost Variance

~rinle CQ~tVal;ance.~ Standard Usage Actual Usage

Material Price vari.nce: ($1.00 - $.80)
X 25 lb "$5 Favorable
Qilll~til)' varim~: (20 - 25) X
Sl.OO/lb = $5 Unfavorable
Tot!l! variance: £5F + $5U = 0
= $20 -S20
Labor ~y ..rjance: ($4 - $5) X 25
hr = $25 Unfavorable
R.Yru!.6tyVl<Tiance:(30 - 25) X
$4/hr ~ $20 Favorable
J~lvariance: S25U + $20Fa
SSU = SI20 - $125
,'lie ~\lggcSf that you cor worry about whether 10
put standard or actual first in the fonnulas or about trying
to keep track of whether n negative result is favorable or
. unfavorable. Instead, just I),ink about whether the
direction of the variance is good or had and forget about
algebraic signs,
A Coiupllcatiou- "The .lolnt" Variance. If you
look closely at mc variance fonnulas above, you will see
tbat quantity variance is computed using standard prices
while the price variance is computed using actual
quantities. This is logically inconsistent, but it makes
sense 10 most people. Most people feel that price
Three-variances Approach
Actual
Price Price Joint
Variance Variance
Stander u
Price Standard Quantity
C<J5t Variance
Standard Usage Actual Usage
U is impossible to give a commonsense interpretation 10
the joint variance when one of the two components varies
favorably and the other varies unfavorably. Furthermore,
most authors believe lhat purchasing agents should be
assessed for price variations on quantities actually
purchased but thaI production managers should be
assessed for quantity differences scaled with standard
prices (ignoring price fluctuations). For these reasons,
they favor the simpler, lWO variance approach.
The twO variance equality set up in this note (PV
+ QV ~ TV) is often violated ill practice in rcgartl to
material variances. That is, many firms prefer '0 compute
the price variance over quantities purchased and the
quantity variance over quantities used. Since purchase
aud usage quantities often differ in an)' given period, the
Petersen Pottery - Note on CMCV 211

two variances cannot be aggregated algebraicly. They parallel to the way a budget for direct material is
can, however, still be combined for cost reporting determined. If all manufact-uring overhead is either pure
purposes to get a picture of purchasing and usage "variable" or pure "fixed," a flexible budget is just a
variances together. formula of the following type:
Suppose, for example, that in our earlier illus-
Budget allowance = a +bx
tration material purchases totaled 30 pounds at.$.80 even
though only 25 pounds were used in production. The where a· fixed overhead costs for the period
material variance calculation could then be as follows: b = variable overhead costs per unit
x • units produced during the period
Prjee yariance: ($ t .()O • $.80) X 30 Ib - $6 Favorahle
Qywtjly variance: (20 - 25) X SI.OO/lb= $5 Unfavorable An example of a simplified flexible budget is
Total variance: S6F" S5U = $JF'I' $20·520 shown below:
Capacity «Now,)"
A labor price variance is often called a "labor
rate" variance and n labor quantity variance is often called Uliliwion: 1 40% ,.. 80% ... 100% ...
Vojls Produced 4,000 8000 10,000
a "labor efficiency" variance, A material quantity variance
Allowed
is often called a "material usage" variance and a material Overhead Cost D~hnvior
price variance is often called a "purchase price" variance. Depreciation $1,000 $1,000 $1,000 Pure non-variable
or "fixed"
H. OVERHEAD COSTS
Supervision 500 1,000 1,500 '~StCP"~i2
Conventional Overhead Budgets. Budgets for Supplies 400 800 1,000 Pure vtlriuble at
prime costs hinge on unit-level standard costs, Once $, I0 per unit
standard prime costs per unit are determined, the budget 2Q2 ROO 900 Semivariable ($400
+ $,OS per unit)
for any given period is JUS! the standard cost per unit ToW S2,SOO $3,600 $4,400
times the number of units produced. A simple approach
like this works because prime costs are variable costs, I 11Is assumed ~':lIvolumewouldnever fall below40"h of
capaclty or above 100%
The cost allowance or budget thus varies directly as
2 A "step"C4S1 is one whichdoesn't varydirectly",IU,
production volume varies, producnon but doc, increase in Jump-sum jumps when volume
Because mnllufuctwing overhead costs typically rises sui>sWltiaUy, An example wouldbe adding' second
do not vary directly with volume, it is a more difficult task foremanwhenvolume roseto the Icv<:llhat • secondshiftwas
to determine allowable overhead at any given level of needed.
production,
flexible Budge! Formula
Fixed Budgets. One approach to overhead
budgeting ignores the volume dependence issue entirely, Up to 80% of capacity: SI,900 + $.15 per unit
This approach is called fixed overhead budgeting. Under Above 80% utilization: $2,400 + S.15 per unit
a flxed-budget approach, management determines the
amount of overhead which should be incurred at the Overhead AbsOrption.
normal or most likely production level. This expense total Under GAAP or IRS rules, manufacturing overhead is
becomes the budget against which cost performance is considered to be part of product costs. It is therefore
measured, regardless of the level of production OUtput necessary to find some way of charging or "absorbing"
actually achieved, To the extent that manufacturing manufacturing overhead into inventory. However, the
overhead costs do vary with production, the fixed-budget simple approach of charging actual manufacturing
approach does not yield meaningful variance data when overhead each period directly to work-in-process (WIP)
actual output varies from planned output, There is no invcntory is usually not considered to be all acceptable
concepNal support for a fixed-budget approach to approach for two reasons:
manufacturing overhead, but many companies still..useit.
Fle.xible Budgets. The more conceptually sound I. Variances arc not considered to "add value" to the
approach to determining overhead standards in inventory. Thus, overhead variances are not
conventional cost accounting is called flexible budgeting. considered to be product costs, Thus, only allowable
A flexible manu-facturing overhead budget specifies overhead is to be "inventoried,"
allowable cost at each possible output level. Once. 2. Volume considerations also affect the decision of how
period is over and the actual production volume is known, much overhead to absorb in inventory. Suppose, for
the "flexed" cost allowance is determined by reference to example, that depreciation is $1,000 per period, Also
the flexible budget for that level of output. This is a direct
~2~1~2
__' -LPe~t~er~s~en~Po~tt~e~~.--Notc~nCN1C

suppose that 1 unit is produced in period 1 and 1,000 equal planned overhead at One particular volume
units are produced in period 2. It doesn't seem "fair" level--rhat level used in computing the absorption
to most accountants to say that in period one, the one rate,
unit carries a cost of $1,000 for"depreciation ($1,000
depreciation + 1 unit) and in period two, each unit
2. If actual overhead expenses equal planned expenses
per the flexible budget. Since only budgeted
only $1 ($1,000 depreciation + 1,000 unit), A unit
overhead is absorbed, any differences between
can't really be "more valuable" just because fewer
budgeted costs and actual costs will not be "cleared"
were produced that month.
from the factory overhead Tvaccount.
"Fair" allocation of depreciation to inventory seems ,
to require a concept of"n()rmal" volume. The SI,OOO At the end of any accounting period, there is usually a
depreciation expense is incurred as a "reasonable" residual balance in the factory overhead aCCOWlt resulting
cbarge on the assumption that some reasonable or from failure to meet one or both of these two conditions.
normal number of units will be produced on the This end-or-period residual ill the factory overhead T-
equipment. It is this normal volume level Overwbieh account is sometime. called the "book" overhead variance
the planned overhead should be spread, SO the because it is what shows up in the books of account. II is
argument goes. also sometimes called the total overhead variance.
Normal accounting practice is to charge this
For these two reasons, conventional practice for
variance to cost of goods sold for the month as a period
charging manufacturing overhead into inventory is to use
expense.
a "normal absorption rate." This rate is computed as
planned overhead cost et normal production volume (per
Analyzing the Total Overhead Variance
the flexible budget) divided by Ihat normal volume. In the
example above, the normal volume is 8,000 units (80% of Using the same example froln above with actual
capacity). At this level of output, budgeted overhead is production of 7,000 units, we can produce the following
513,600. the "normal absorption rate" is thus cos! table:
$3,60018,000, OT S.4S per unit. Ptexible Budge,
III single-product firms, output can be expressed AIJowuIlo;
in units of product. In multiproduct flrms, however, it is nt Actual Actu!l1
necessary 10 sCI some other measure of capacity Votume of Expenseat Spending
utilization, such as labor hours, labor dollars, or machine ~Ilem 7,000 IInits .4.ctunl VQitllllC Vatiance
hours. The choice of a volume measure in a particular
business should be based on which variable best measures Il<:p"':,atioo $1,000 $1,100 SIOOU
the level of capacity utilization for that business. Supcrvislon 1,000 1,050 SOU
Of course, the notion that ony one measure of Supplies 700 690 IOf
activity can capture the essence of capacity utilization Power 1~ 21fJ l2..U
across manufacturing departments ignores the richness Total lW.Q ~ ~
which activity-based costing tries to capture. j\.tanufs(;turing Overhead Absotbed into Inventory
Tbe accounting works as follows. A T -account 7000 X S,45 '" $3 150
is established in the books of account called "factory
overhead" or "burden" or something equivalent. Actual As showi in ihe table, the difference between
manufacturing overhead expenses arc charged (debited) to actual overhead incurred and the flexible budget at this
this '[-aocount. Overhead is absorbed into inventory by level of output is called the overhead "spending," variance.
crediting the "factory overhead" account and debiting the It measures cost control perfonnance wider the
work-In-process inventory in an amount equal to the assumption that the flexible budget is a useful cost
absorption rare times the actual volume attained. In our benchmark.
example, if uctual volume was 6,000 units, 52,700 of The tOlal variance which shows lip ill the T-
overhead would be charged to W1P(6,000 X $.45). account is equal to the difference between actual overhead
This absorption process will only "clear" the (the debits) and absorbed overhead at actual volume (III.
factory overhead account if two conditions are both mel credit). In this example, the total variance is $460tJ (3610
-3150).
I. If acrual volume equals planned volume. The variance which is useful in measuring cost
Manufacturing overhead cost does not vary directly . control effectiveness (the spending variance) is equal to
with production. The absorption rate, however, is a the difference between actual overhead and allowed
pure variable rate. Thus, absorbed overhead will only overhead at actual volume. For the example, this is
 . -- ------ ---------_
S160U. In order 10 present an analysis which "balances,"
cost accountanrs need to have some name for the
difference between the total variance and the spending
variance. Using a little algebra, we can see that the
quantity for which we need a name, "the plug." is allowed
OH - absorbed Oli:
Actual Allowed Aclual
Minus + Minus Minus
1\'lo\~"d ~~ A~SOl'bcu
Spending Tolal
Vari!\~ .p '~'rll1g'" y~
$160U +S300U = $46011
Regarding the plug, We have already observed
that allowed Oli will only equal absorbed on when the
finn operates at normal volume. Why? Because
budgeted overhead does not vary directly as production
varies, hut absorbed overhead is purely variable, by
convention. The absorption rate is set to JUSt absorb into
inventory the planned overhead when the lim, actually
operates at its normal volume, The idea hero is thai the
normal absorption rate is the normal amount of
manufacturing overhead each unit should carry.
Standard (absorbed) overhead cost per unit, for
purposes of valuing inventories, is thus equal to a
proportional share of normal overhead when production
volume is at normal levels. The plug variance (allowed
Ot! • absorbed OH) results from the difference between
planned and acrual production volume. It is usually called
(he "production volume variance." The dollar amount of
this production volume variance has no particular
management significance whatsoever. The dollar amount
is just the plug required to reconcile a managerially
.significant number (the spending variance) 10 a number
which shows up in the income Statement (the total
variance). The production volume variance does result
from varia lion between planned and actual production
volume, In this sense, the name is appropriate. However,
. the amount is not managerially useful-c-the amount is just
;,a plug. 1'01' our example, the amount is $300U as shown
Going one step further, we can talk about what
comprises the "plug." It does nol include any variable
ovahead because items which are directly variable with
~''p~~dUlcli'Dn arc treated identically in the absorption rate
5 per unit) and in the flexible budget ($.15 pCI' unit).
Ihus cancel out in computing the difference between
and absorbed cost. In our illustration, for
the absorption rate of S.45 per unit includes $.15
if variable cost. and the flexible budget also includes $.15
unit of variable COSt($.]0 for supplies and $.05 for
At actual volume of 7,000 units, therefore, both
allowed OH of S3,450 and Ihe absorbed OH of S3. 150
include $1.050 of variable COSI. This $1,050 thus does
not contribute anything to the difference between S3,450
and $3,150.
The difference is the fixed-cost portion of the
absorption rate (S.3(J) times the unfavorable volume
fluctuation of 1,000 units, or $300U. The $.30 fixed cost
portion of the absorption rate is equal to the S2,400 of
planned fixed overhead al normal volume divided by the
volume measure of 8.000 units. When operating 81 the
7,000 unit level, we are allowed $2,400 of fixed
manufacturing overhead, hut we only absorb S2,100
(7,000 x $.3).
JIl. MANAGERIAL USE OF VARlANCES
It is very widely assumed in "cost accounting circles" that
variances calculated according
10 the techniques explained
here in Parts I and II represent useful management
information. We will summarize here the particular slant
on this poinl of view from four of the ''top 20" MBA
programs as reflected in textbooks written by faculty
members there,
A. Stanford Business School (Professor Charles
Horngren)
"Standard costs are the building blocks of a
budgeting and feedback system. A standard cost
is a caretully predetermined COSI that should be
attained."
"In practice, direct materials and direct labor are
often said to be controlled with tho help of
standard costs."
"Perfect standards are expressions of the
absolute minimum costs possible under the best
conceivable conditions. No provision is made
for waste, spoilage, machine breakdowns, and
the like. Those who favor this approach maintain
Ihat the resulting unfavorable variances will
constantly remind managers of the perpetual
need I'M Improvement in all phases of operations .
Perfect Siandards are not widelv used. however.
because Lhey haye an adverse effect Qn emplovee
o'l91ivaticm.'·
"Currently attainable standards ate costs that can
be achieved by a specified level of effort.
Allowances are made for normal spoilage, waste,
and nonproductlve time. There are at least two
popular interpretations of the meaning of
'currently attainable' standards. The first
interpretation has standards set just tightly
enough so that employees regard their fulfillment
as highly probable if normal effort and diligence
are exercised. That jx, variances should be
negligible. A second interpretation of currently
attainable standards is Ihat standards are set
214
tightly. That is, employees regard their
fulfillment as possible, though unlikely."
"Managers responsible for varian= should be
required to explain them. In addition, managers
Who have control over the causes of the
variances should be held accountable for
avoiding unfavorable variances or correcting the
factors causing them. Thc primary function of
variances is explanation. The main goal is to
understand what is affecting costs and revenues
so that managers can make better decisions in the
future."
"Variances do not, by themselves show why tbe
budget (standard) was 1I0t achieved. But they
raise questions, provide clues, and direct
attention."
"Because there are so many interdependences
among activities, a variance should not lead a
manager to jump to conclusions. By themselves,
such variances merely raise questions and
provide clues. They are auention directors, not
answer givers."
a Colgate - Darden Business Schoct (professors
Brandl Allen and Willia)l) Retch)
"There are three important ways in which
standard costing systems assist management:
1. The automatic built-in provision of
variances helps identify areas that need
management's attention,
2. The development of a .database of
standard costs and quantities SUPP0l'ts
pricing decisions and helps the overall
planning process.
3. The use of standard product costs
.hnplitics inventory accounting."
c. The VAnderbilt Business School (Professor
(;crmain Boer)
"A standard, as defined by the Oxford English
Dictionary, is a definite level of excellence 01'a
definite degree of quality, viewed as a prescribed
object of endeavor or a measure of what is
adequate for some purpose. A standard, as used
in management accounting, is a predetermined
cost"
"The primary purpose of standards is to measure
the difference between wbat costs are and what
costs should be tor the purpose of controlling
costs. In a more .gencral sense, the benefits of
Petersen Pottery - Note on CMCV
standards can be classified as follows:
I. Beller control over costs and thus income
through the identification of variances
between actual and standard costs.
2. More informative income statements
which call illustrate the profit impact of
variances by showing excess costs as
waste and cost savings as gains.
3. Ease and expedition of COSI accounting
since all inventories can be valued at
standard.
4. Basic data are provided for planning and
special studies.
5. Othcr benefits include:
a. The planning required to set-up
standards.
b. Coordination and cooperation is
enhanced by and within all areas.
c. Standards set total and individual
goals."
"Standards should be based 01\a scientific study
of the quantities of material and units of labor
which should be used to produce the product;
that is, they should be engineered standards, The
setting of standards is the responsibility of the
technical staff of II plant, such as industrial
engineers, design engineers, and chemists,
Unless the supervisor agrees that a standard is
fair, their reaction to variances will be defensive
rather than corrective. After 1M standard
quantities are set, they are normally submitted to
the accountants for conversion into standard
costs."
"Two types of standards have been found
acceptable for cost control purposes: (1) the
attainable standard, and (2) the perfect standard.
The former can be used for cost control and for
. the development of standard costs. The latter is
used only for cost control and may supplement
the use of attainable standards. The basic
consideration in selecting either or both types is
bow well they will serve the purposes of cost
control."
"Attainable direct materials standard. are based
on the type and quantity of material which should
be used to produce a finished product of
specified quality. Allowance is made for normal
losses in initial processing. and considering titis,
Petersen Pottery Note on CMCV
the yield in quantity of finished or semi-finished
product is determined,"
"When standard costs are used, allowances are
set for spoilage ateach operation."
"Un.der a standard cost system, a standard
percentage of total production is set as the
quantity of seconds expected to be produced."
"From practical experience, it is evident that
perfect operation. can never be attained. Thus,
perfect standards sbould be taken as the direction
in which attainable standards should move."
D. Cornell Business School (professor Ronald
HUton)
"Standards should not be determined by the
managerial accounrant alone. People generally
will be more committed to m•• lins standards if
they are allowed to participate in sening them."
"Some managers believe that perfect standards
motivate employees to achieve rhe lowest cost
possible. they claim that since the standard is
theoretically attainable, employees will have an
incentive to come as close as possible ro
achieving it.
Other managers and many behavioral
scientists disagree. 'nICY feel that perfect
standards discourage employees, since they are
so unlikely to be attained. Moreover, setting
unrealistically difficult standards may encourage
employees to sacrifice product quality to achieve
lower costs. By skimping on raw-material
qualil)' or the attention given manual production
tasks, employees may be able 10 lower the
production cost. However, this lower cost may
come at the expense of a higher rare of defective
unirs. Thus, the finn ultimately may incur higher
costs than necessary as defective products are
rcwmed by customers or scrapped upon
inspec-tion. n
"Practical standards allow for such oCCl/rrcnces
as occasional machine breakdowns and normal
amounts of raw-material waste. Attaining a
practical standard keeps employees on their toes,
wlthout demand ing miracles. Mosl bella vioral
theorjs~~believe that Drilfti2al standards
en20om2e more positive and productive
employee attitudes then do meet Slandards."
215
"Standard costs and valiance analysis are useful
in diagnosing organizational performance. These
tools help managers to discern 'the story behiod
Ihe story' - the details of operations that underlie
reported cost and profit numbers, Standard
costs, budget" and variances are also used to
evaluate the performance of individuals and
departments. The performance of individuals,
relative ro standards or budgets, often is used 10
help determine salary lucresses, bonuses, and
promotions. When standard. and variances
affccl employee reward strucmres, they can
profoundly influence behavior."
"A standard-costing systern offers six clear
advantages if used properly:
I. Standard costs provide a basis for sensible
cost comparisons. It would make no sense
to compare budgeted COSISat one (planned)
activil)' level with actual costs incurred al a
different (actual) activit)' level. Standard
COSts enable the managerial accountant TO
compute the standard allowed cost, given
actual output, whicb then serves as a
sensible benchmark to compare with the
actual COSI.
2. Computation of standard costs aud cost
variances enables managers to employ
management by exception. This approach
conserves valuable management time.
3. Variances provide a means of performance
evaluation and rewards for employees.
4. Since the variances at-eused ill performance
evaluation, they provide motivation for
employees to adhere to standards.
5. Use of standard costs in product costing
results in more stable product costs than if
actual production costs were used. Actual
costs often fluctuate erratically. whereas
standard costs arc changed only periodically,
6. A standard-costing system is usually less
expensive than an actual costing system.
IV, A FINAL THOUG({T
It is problematic today whether this point M view from
section (II-standard costs and variances are useful to
management-represents best thinking in the 1990s or
merely a 1990srecapitulation of best thinking in the
19605. Exploring this dilemma is beyond the scope of
this 0010.