Petersen Pottery Contrary Textbook Arguments Variances Are Hardly Ever

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Petersen Pottery

Teaching Commentary

OVERVIEW

This case on standard costs and variance analysis appears deceptively straightforward with a casual reading. Actually, it

is an “iceberg” case—many layers deep with most of the content lurking below the surface.

The case illustrates the calculation of standard costs in a fairly simple manufacturing setting—one product with

two linked manufacturing processes. It also involves practice in variance calculations for both prime costs and

manufacturing overhead. Beyond the calculations is the idea of tying together the variances into a coherent story about

operations for the period being studied. And beyond the “story” is the question of whether standard costing is even

appropriate for this business at all. What management controls seem appropriate, and is cost control via standards and

variances one of them?

ANSWERS TO ASSIGNMENT QUESTIONS

Question 1

PRIME COST VARIANCES

MATERIAL PRICE VARIANCES Pounds Purchased Pounds Used

MATERIAL USAGE VARIANCES

Clay Std. 28,625 lbs. 275U  $.95 = $261.25U

Act. 28,900 lbs.

LABOR USAGE VARIANCES

Molding Std. 1,145 hours 55U  $15.00 = $825U

Act. 1,200

OVERHEAD VARIANCES

(1,145 x $1.94 + 3,672) (1,145 x $5.)

ACTUAL ALLOWED ABSORBED

$6,100 $5,893 $5,725

$375U

VARIABLE COST PORTION (1,145 x $1.94)

$2,300 $2,221 $2,221

79U 0

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Question 2

The case is set up to make it fairly easy for

students to see that the “story” here is the cheap clay. A

“favorable” purchase price variance is more than offset by

unfavorable variances in material usage, labor usage, and,

The big point here is that this variance analysis

totally misses the real impact of the cheap clay—the lost

contribution margin from the fifty-five units not

produced. (1,200 versus 1,145) That is, the biggest

“variance” is the lost profit from lost production.

Regarding the Cheap Clay

1. Assume clay prices were rising along with everything

else in 1980 (CPI up 10%).

2. Standard of $.95/lb. would thus not be met. Glaze

Question 3

There is relevance here in the old adage that

“anything not worth doing is not worth doing better.”

Probably the best suggestion for Mr. Petersen

regarding his new standard cost system would be to get

rid of it! Should he try to fix the problems with it? Can it

position.

Effective management controls here might well

include measures of quality improvement, cycle time and

order lead time reduction, on-time delivery improvement,

scrap reduction, and employee learning.

THE PROBLEMS WITH STANDARD COSTS

1. As a generalization, standards hardly ever reflect an

up–to-date representation of the latest shop floor

virtually all companies are willing to accept. In fact,

there is often a belief that standards should be more

stable (once a year updates or twice at most).

2. As a corollary of (1), standards are not flexible

enough to catch the spirit of a “continuous

pretend to be really current, why should I pretend to

pay any real attention to them?”

4. The fundamental concept of standards serves to limit

an achievement motivation. The goal is to meet the

standard, not beat it. Good controllers say,

“standards that are regularly exceeded are too lax.”

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aggregated and they arrive too late (even a week late

is too late). Also, they represent deviation from what

operating managers see as “straw man” norms.

Variances are a very pale substitute for real-time,

6. Standard costs are used to value inventory for

financial statement purposes, but GAAP requires

actual cost. There is thus a very strong tendency to

set standards close to where you expect overall actual

results to be. This avoids the need for big

7. Standards sanction an inside-out look at products and

services rather than an outside-in look. The internal

focus is often used to justify the idea that standard

costs can be a major input in pricing decisions.

8. Standard costs that include an allowance for “fixed”

costs present management with a strong inducement

to “earn” or “absorb” cost by building inventory

TEACHING STRATEGY

I use this case after standard cost mechanics have already

will easily support ninety minutes of discussion in this

approach as well.

Overall, there are five levels of analysis in the

case, as follows:

1. Illustrating how a “Standard Cost” system works

control tool at Petersen Pottery

yes/no/maybe

5. The Concept of Standard Cost

Whither and Whence?