Standard hour

The standard hour in performance measurement

The standard hour is a useful concept in performance measurement and is relevant to items C2(e) and (f) in the Study Guide for MA1.

Definition
A standard hour is the amount of work achievable, at the expected level of efficiency, in an hour.

Illustration
X Co manufactures three products (A, B and C) in one of its production cost centres. It is expected that 10 units of product A can be manufactured per direct labour hour, 25 units of product B and 20 units of product C.

The standard hour for product A is, therefore, 10 units, product B is 25 units and product C is 20 units.

The standard hour is especially useful as a common measure for combining heterogeneous (dissimilar) products so that manufacturing performance for a cost centre (or production unit) as a whole can be assessed.

Example
Budgeted production of the three products (A, B and C) in period 1 is:

  • Product A - 12,400 units
  • Product B - 10,000 units
  • Product C - 18,500 units

The total budgeted direct labour hours for period 1 in the cost centre, based on the standard hour data above, is:

  • Product A - 1,240 hours (12,400 units ÷ 10 units per hour)
  • Product B - 400 hours (10,000 units ÷ 25 units per hour)
  • Product C - 925 hours (18,500 units ÷ 20 units per hour)

Total hours: 2,565

It can be seen that the budgeted production of the three different products can be combined into an overall labour activity measure and this also can be applied to the actual production volumes, using the same data about the standard hour of each product. This enables the effect of changes in the production mix to be measured.

Example
In period 1, the actual production output of the three products was:

  • Product A - 13,300 units
  • Product B - 9,600 units
  • Product C - 18,000 units

A total of 2,430 direct labour hours were worked in period 1.

Taking these actual results into account and the data concerning the standard hour of each product, the total expected direct labour hours for the actual production output in period 1 can be calculated as follows:

  • Product A - 1,330 hours  (13,300 units ÷ 10 units per hour)
  • Product B - 384 hours  (9,600 units ÷ 25 units per hour)
  • Product C - 900 hours  (18,000 units ÷ 20 units per hour)

Total hours: 2,614

Using the above data about the budgeted direct labour hours, the actual direct labour hours and the expected direct labour hours to manufacture the actual output, a series of ratios can be calculated to measure the performance of the cost centre as a whole in period 1 and to understand the causes. The ratios are:

  • Production volume ratio
  • Capacity utilisation ratio
  • Efficiency ratio

Production volume ratio

The production volume ratio measures how the actual production output for a period, measured in direct labour hours, compares with that budgeted for a production cost centre. It is calculated as:

(Expected direct labour hours of actual output ÷ budgeted direct labour hours) × 100%.

A ratio of > 100% will indicate above budget production volume and vice versa.

The production volume ratio can be further analysed by:

  • The number of hours worked compared with budget (measured by the capacity utilisation ratio).
  • The efficiency with which the output is produced (measured by the efficiency ratio).

Capacity utilisation ratio

The capacity utilisation ratio measures whether the total direct labour hours worked in a production cost centre in a period was greater or less than what was budgeted. It is calculated as:

(Actual direct labour hours worked ÷ budgeted direct labour hours) × 100%.

A ratio of > 100% will indicate that more direct labour hours were worked than budget and vice versa.

Efficiency ratio

The efficiency ratio measures whether the production output for a period in a production cost centre took more or less direct labour time than expected. It is calculated as:

(Expected direct labour hours of actual output ÷ actual direct labour hours worked) × 100%.

A ratio of > 100% will indicate greater labour efficiency than budgeted and vice versa.

Example
Continuing to use the above data concerning the total budgeted, actual and expected direct labour hours in period 1 for the production cost centre, the three ratios can be calculated as follows:

Production volume ratio:
2,614 expected direct labour hours of actual output
÷ 2,565 budgeted direct labour hours
× 100%
= 101.9%

Capacity utilisation ratio:
2,430 actual direct labour hours worked
÷ 2,565 budgeted direct labour hours
× 100%
= 94.7%

Efficiency ratio:
2,614 expected direct labour hours of actual output
÷ 2,430 actual direct labour hours worked
× 100%
= 107.6%

Analysis

It can be seen, from the above ratios, that the actual output in the production cost centre in the period, measured in expected direct labour hours, was 1.9% higher than budget (it may be noted that the total number of product units manufactured was the same as budget, but the units of one product are not comparable, in terms of production effort, with another).

The over-budget production activity occurred despite the fact that utilisation of capacity was only 94.7% of the budgeted utilisation. This was because direct labour efficiency was 7.6% better than expected – ie fewer hours than expected were required to produce the actual output.

The relationship between the three ratios can be demonstrated as follows:

Production volume 101.9% = [(capacity utilisation 94.7 × efficiency 107.6) ÷ 100] or, alternatively, [(capacity utilisation 0.947 x efficiency 1.076) x 100]

Written by a member of the MA1 examining team