Standard Costing, Operational Performance Measures Free Essays

CHAPTER 10 STANDARD COSTING, OPERATIONAL PERFORMANCE MEASURES 1. MANAGING COSTS 1. Standard-cost systems are used to help managers control the cost of operations. We will write a custom essay sample on Standard Costing, Operational Performance Measures or any similar topic only for you Order Now The system has three components: standard costs (i. e. , predetermined costs), actual costs, and the difference between the two figures (termed a variance). 2. A standard cost for each product cost category (materials, labor, and overhead) is calculated on a per-unit basis. ? This calculation considers the planned quantity of each input factor allowed (pounds, hours, etc. and the planned price for each input factor (price per pound, rate per hour, etc. ). The total planned cost is a mini, per-unit budgeted amount. †¢ After the actual costs are known, a report is generated that shows actual costs, planned costs, and related variances. A manager can examine the variance column quickly to ascertain which exceptions require attention. ? Following up on significant variances is called management by exception. Managers focus their efforts where they are most needed in the limited time available. 2. SETTING STANDARDS . Managers set standards by analyzing historical data. However, past data must be adjusted for expected changes in technology, the production process, inflation, and other similar factors. ? Managers also use task analysis to focus on how much a product should cost. †¢ Knowledgeable people such as engineers, purchasing agents, production supervisors, and accountants should be brought into the standard-setting process. Cross-functional teams are very useful here. 4. Two types of standards may be used: perfection standards and practical standards. Perfection (ideal) standards assume that production takes place in the ideal world: employees always work at peak performance, materials are never defective, and machines never break down. ? Although some managers feel that ideal standards give employees a goal to shoot for, many behavioral scientists believe that setting unattainable goals has a demotivating effect, as employees simply give up trying to reach the standard. ? Practical (attainable) standards are set high enough to encourage efficient an d effective operations but not so high as to seem impossible. Behavioral scientists feel that practical standards have a more positive effect on the productivity of employees. ? Unlike variances computed with perfection standards, variances calculated when practical standards are employed tend to be more meaningful as they represent deviations from a realistic goal. †¢ Service firms also use standards. For example, McDonald’s restaurants are noted for using standards, not only for quantities of material (amount of beef per burger) but also for the time allowed to serve customers at the drive-in window or counter. . VARIANCE ANALYSIS 5. Variance analysis involves calculating the actual amount of input used and comparing it to the budgeted amount of input that should have been used (i. e. , the standard cost allowed for actual output). The variance is then analyzed into its component parts. 6. Standards are established for: ? The amount of material required to produce a fi nished product (the standard material quantity). ? The anticipated delivered cost of materials (the standard material price). The number of hours normally needed to manufacture one unit of product (the standard direct-labor quantity). ? The estimated hourly cost of compensation (the standard labor rate). †¢ The following model can be used to calculate variances for direct materials (DM) and direct labor (DL): DM Price = (AQ Purchased x AP) – (AQ Purchased x SP) DM Quantity = (AQ Used x SP) – (SQ Used* x SP) DL Rate = (AQ x AP) – (AQ x SP) DL Efficiency = (AQ x SP) – (SQ* x SP) * Standard quantity for the actual production level Notice that the price and rate variances use a similar approach, and the quantity and efficiency variances use a similar approach, with efficiency being another way to say â€Å"quantity of hours† allowed. †¢ Unfavorable variances arise when the actual cost per unit of input (e. g. , gallons, hours, etc. ) exceeds standard cost and when actual quantities used (e. g. , gallons, hours, etc. ) exceed standard quantities. The opposite situation gives rise to favorable variances. 4. VARIANCE INVESTIGATION 1. A manager does not have time to examine each variance; therefore, he or she must consider selected factors in deciding when an investigation should take place. The factors include one or more of the following: ? Size of the variance (in absolute and/or relative terms, such as $5,000 or 10% of standard cost) ? Frequency of occurrence ? An otherwise small variance may require investigation if it consistently occurs, as it may indicate an ongoing problem or an outdated standard. ? Trends ? Controllability (there is little point to investigate items over which managers have no control). Favorable variances ? A manager should investigate both favorable and unfavorable variances. A favorable variance with advertising expense, for instance, could lead to the conclusion that an insufficient amount is being spent on promotion, which could lead to a loss of customers. ? Costs and benefits (the decision to investigate involves a cost-benefit analysis, as a number of investigative costs are incu rred). Some companies use a statistical approach to variance investigation by preparing a statistical control chart. These charts help to pinpoint random and nonrandom variances, with a statistically determined critical value being compared to a variance to determine whether an investigation is warranted. 5. BEHAVIORAL IMPACT OF STANDARD COSTING 1. Variances may be used to evaluate personnel, often with regard to salary increases, bonuses, and promotions. ? Such incentives can have positive and negative effects, as a bonus plan may prompt a manager to pursue actions that are not in the best interests of the organization. ? An example of detrimental behavior: A purchasing manager may purchase cheap material to create a favorable price variance. That material could be of poor quality, which might result in excess usage and problems with the finished product. 6. CONTROLLABILITY OF VARIANCES 2. It is rare that one person controls any event; however, it is often possible to identify the manager who is most able to influence a particular variance. These managers are often the following: ? Direct-material price variance—Purchasing manager ? Direct-material quantity variance—Production supervisor and/or production engineers ? Direct-labor rate variance—Production supervisor ? Direct-labor efficiency variance—Production supervisor . Variances often interact, making investigation and controllability difficult. For example, a labor efficiency variance may be caused by problems not only with labor but by problems with machinery and/or material. ? Managers sometimes trade-off variances, purposely incurring an unfavorable variance that is more than offset by favorable variances. 7. STANDARD COSTS AND PRODUCT COSTING 4. In a standard-cost system, costs flow through the same accounts in the general ledger as shown earlier in the text; however, they flow through at standard cost. In other words, Work-in-Process Inventory, Finished-Goods Inventory, and Cost of Goods Sold are carried at standard cost. 8. ADVANTAGES OF STANDARD COSTS 2. A standard-cost system has several advantages, as follows: ? Managers have a sensible comparison method at their disposal, one that looks at budgeted costs vs. actual costs at the actual level of output. ? Managers can practice management by exception. ? Variances provide a benchmark for performance evaluation and employee rewards. ? Standard costs provide a stable product cost. Actual costs may fluctuate erratically, whereas standard costs are changed only periodically. 9. CRITICISMS OF STANDARD COSTING IN TODAY’S MANUFACTURING ENVIRONMENT 3. Criticisms of standard costing in advanced manufacturing settings include: ? Variances are too aggregated and arrive too late to be useful. Variances should focus on activities, specific product lines, or production batches. ? Variances focus too much on the cost and efficiency of labor, which is becoming a relatively unimportant factor of production. Standard costs rely on a stable production environment, and flexible manufacturing systems have reduced this stability, with frequent switching among a variety of products on the same manufacturing line. ? Standards focus too much on cost minimization and not enough on product quality, customer service, and other contemporary issues. 10. OPERATIONAL CONTROL MEASURES 5. Many companies now focus on an increased number of performance measures, many of which are nonfin ancial in nature. Examples often include: ? Customer-acceptance measures such as customer complaints, warranty claims, and product returns. Delivery cycle time, or the average time between the receipt of a customer order and the delivery of goods. ? Manufacturing cycle time, or the total production time per unit. ? Manufacturing cycle efficiency, or processing time divided by the sum of processing time, inspection time, waiting time, and move time. †¢ To judge how well or poorly a company is performing, many firms use benchmarking, which involves comparing existing performance levels against those of either other organizations or other units within the same organization. †¢ How to cite Standard Costing, Operational Performance Measures, Essay examples