A PROJECT

ON

“Standard Costing And Variance Analysis”

(Submitted in partial fulfillment of the requirement of Bachelor of Business Administration (BBA) – 4th Semester Examination)

JAI NARAIN VYAS UNIVERSITY, JODHPUR

Project

Submitted to Submitted by

Mrs. Madhavi Bhatnagar Abhishek Jindal

(Project Supervisor)

(Session 2011-12)

AISHWARYA COLLEGE OF EDUCATION (A.C.E.)

A-9, K. N. Nagar, Opp. National Handloom (Pratap Nagar)

Jodhpur-342003 (Raj.)

Phone - (0291) 2670175

E-Mail – info@aishwaryacollege.in

1

CERTIFICATE

This is to certify that project has proceeded under my supervision entitled on

“Standard Costing And Variance Analysis” The work embodied in this project

is original and is of the standard expected of BBA student. They has completed all

requirements of guidelines for project and the work is fit for evaluation

(Mrs. Madhavi Bhatnagar)

Project Supervisor

Aishwarya College of Education

Jodhpur

2

UNDERTAKING

We hereby declare that total work of this project entitled “Standard Costing And

Variance Analysis” is an original work under the guidance of Mrs. Madhavi

Bhatnagar to the best of our knowledge and beliefs the facts mentioned in the Group

Assignment are true.

Abhishek Jindal

3

ACKNOWLEDGEMENT

Sometimes words fall short to show gratitude, the same happened with me during this project. The immense help and support received from Our Guide Mrs. Madhavi Bhatnagar overwhelmed me during the Project Work

My sincere gratitude to Shri Bhupendra Singh Rathore (Director) and Shri Rajeev Gujral (Head, Dept of Mgt. Studies), for providing me with an opportunity to have library research in my college.

I am highly indebted to My Guide Mrs. Madhavi Bhatnagar, Assistant Prof. Management Studies, who has provided me with the necessary information and her valuable suggestion and comments on bringing out this Project in the best possible way.

I also thank other faculty guide namely Shri M.D.Bissa, Dr.Santosh Bohra , Mrs.Madhavi Bhatnagar, Ms.Priyanka Maratha , who have sincerely supported me with the valuable insights into the completion of this Project.

My heartfelt love for My parents, whose constant support and blessings helped me throughout this Project.

4

STANDARD COSTING AND VARIANCE ANALYSIS

INTRODUCTION 6

DEFINITON 8

HOW TO CREATE STANDARD COST 11

VARIANCE ANALYSIS 13

VARIANCE CALCULATION 14

FIXED OVERHEAD VARIANCES 18

MIX AND YIELD VARIANCE 20

INVESTINGATING VARIANCE 22

PLANNING AND OPERATION VARIANCE 24

CAUSES OF VARIANCE 25

BENCHMARKING 27

McDONALDIZATION 29

ADAVANTAGE & DISADVANTAGE 32

BIBLIOGRAPHY 34

5

Introduction to Standard Costing

A standard cost is planned or forecast unit cost for a product or service, which is assumed to hold good given expected efficiency and cost levels within an organization. It represents a target cost and is useful for planning, controlling and motivating within an organization.

Variance analysis is a budgetary control process, which compares standard or budgeted costs and revenues with the actual results of an organization, in order to obtain information regarding any exceptions from budget, this information is also used to improve performance through control action e.g. correction problems.

Standard costing can be used for

Budget preparation e.g. planning

Control through exception reporting e.g. performance measurement

Stock valuation

Cost bookkeeping

Motivating staff

Under a standard costing system an organisation can value stock at standard cost, incorporating this within the ledger or cost accounts of the organization, the budget or forecasts being a memorandum kept outside the ledger accounts.

Types of Standard

Ideal Standard e.g. attained under the most favourable conditions with no allowance for any waste, scrap, idle time or downtime.

Attainable or Expected Standard e.g. what should be achieved with a reasonable level of effort given current efficiency and cost levels.

Loose Standard e.g. loosely set and easy t achieve.

6

Basic Standard e.g. first standard ever used by the organization and used as a basis or yardstick for comparing current standards or monitoring trends over time.

Historical Standards e.g. standards used historically in previous accounting periods.

7

Criticism of Standard Costing

1. Sometimes hard to define an ‘attainable standard’.

2. Uncontrollability of performance within operations e.g. discounts lost due to the reduction in the quantity ordered or seasonal price fluctuations within the period of appraisal.

3. With more automation within operations, they become less valuable as information.

4. Feedback not feed forward control e.g. out of date information.

5. Revisions to standards may be too frequent to guide performance over time.

6. Standard costing is an internal not external control measure e.g. improvement also needs to consider competition and customers.

7. Performance measurement would be inadequate as a process if the standard is wrong.

8. The reason or cause of the variance are sometimes overlooked or not investigated.

8

Standard Costing

Costing is the identification of the value of resources used for specified goods or services. One purpose of costing is to determine what resources were required to provide the goods or services. A second purpose is to provide a guide to resource usage through the use of budgets that clearly identify managers' responsibility. It is the second purpose that is considered in the following discussion.

Methods Of Costing Identified Budgets

Budget figures may be based on actual, budgeted, or standard costs. These categories are not mutually exclusive. For example, while a standard cost is a budgeted cost, a budgeted cost is not always a standard cost. An actual cost may or may not be the budgeted cost.

Allowed for forth coming activity. To establish budgeted costs, actual costs of the previous year, information from supervisors about where resources might be more efficiently used, and subjective judgments about the need to conserve resources are often considered. Standard costs are objectively determined costs that reflect Budgets based on actual costs reflect expenditures anticipated for the level of resource use. Budgeted costs are generally described as the best estimate about what should be the effective and efficient use of resources.

Standard Costs

Standard costs are costs established through identifying an objective relationship between specified inputs and expected outputs. Therefore, standard costs are generally related to carefully analyzed phenomena both in the laboratory and in the workplace. For example, in the factory of a company that produces high-quality cotton shirts for men, standard costs are used for materials and labor. To establish the standard usage of fabric for a single shirt, the cutting possibilities are analyzed in the laboratory, where attention can be given to how much fabric must be used if the shirt is cut as specified. At this point, the focus is not on how many minutes are needed by an experienced cutter to meticulously cut the fabric so as to minimize usage. Rather, there is experimentation in the ways of cutting and the time required for each way considered. Experimentation continues until the most economical combination of

9

fabric usage and cutting time is established. That combination is likely to be modified to take account of less than perfect conditions in the workplace.

The goal of the personnel responsible for setting standard costs is to provide realistic standards. Workers are to be motivated to achieve output with specified standards. If standards are unreasonable—either too tight or too loose—the level of discipline expected is seriously undermined. If standards cannot be achieved with reasonable effort, workers may become discouraged and become so indifferent that their work quality deteriorates significantly. If standards are too easy to achieve, there may be an unnecessary waste of resources.

Standard costing has applications to any type of business activity. The process described briefly above can be applied, for example, for processing documents in an insurance company or in a financial services business.

Monitoring Standard Costs

Standard costs are monitored as a basis for determining the extent to which expectations are realized. Typically, companies plan for reporting weekly or monthly. A commonly used method is to determine the difference between what the budget allowed and what was actually spent for the output achieved. This difference is called a variance. For example, assume that in the factory producing shirts, 12,000 shirts, requiring 30,500 yards of fabric, were cut in a month. The standard usage was 2.5 yards per shirt, for a total of 30,000 yards. The excess usage would indicate an unfavorable usage variance of 500 yards. Variances are generally presented as units × standard cost for the fabric. Therefore, if the standard cost for the fabric was $4.75, the variance would be reported as 500 units × $4.75 = $2,375. A policy must be established about the level of variance that is to be investigated. Some variation from expectations is allowed, and if standards are realistic, much of the variation is eliminated over the period of a year—that is, insignificant favorable variances cancel out insignificant unfavorable variances.

Variances that are determined to be significant are investigated. Careful observation and discussion with those workers involved in producing the output that led to a variance will aid in assessing what circumstances appeared to be the explanation. Wise consideration of what should be done in the future can lead to the elimination of significant variances.

10

In an objective review of observations and discussions, questions may arise as to the appropriateness of the standards established. There may need to be a reconsideration of the earlier analyses that were the basis for the standards used in the budget followed

by operational personnel.

For an organization to gain optimum value from standard costing, all employees involved must understand the motivation for such costing and understand the assessment that will be made. Imposing standard costs without communicating in an honest, candid manner will undermine much of the perceived value of such costing.

Related Developments

Developments such as continuous improvement, target costs, and push-through production have changed to some extent the usefulness of traditional standard costing. However, each of these developments has been implemented in some organizations with aspects of standard costing included. For example, continuous improvement, in a general way, introduces a review of what resources were used this year to identify where fewer resources might be used in the forthcoming year. The task of identifying fewer resources is a standard-setting task. Target costs are calculated by starting with the cost consumers are believed to be willing to pay for the completed good or service, then analyzing the cost in a backward fashion. This process can also involve the basic concept of standard costing. Push-through production, in which groups have responsibility for a number of processes, can profit from standard costing as a basis for monitoring resource usage.

One major barrier to implementation of standard costing in the twenty-first century is the speed of change in how tasks are performed and in the alternative materials available. Frequent change leads to insufficient time for the careful analyses of inputs and outputs. Decisions are based solely on judgments and observations. Such decisions may be close to those established systematically—however, they may not be.

The usefulness of the information provided from analysis of variances related to standard costs has been challenged. Attention to quality, some critics say, is inadequate in this traditional analysis. Others have proposed that quality considerations can be incorporated in standard costing assessment (see Cheatham and Cheatham, 1996).

11

How to Create a Standard CostStandard Material Price Supplier quotations and estimates

Previous Invoices/trends Internet/websites of suppliers Discounts for bulk purchases Price Seasonality Cost to Manufacture internally Differences between the quality of

different material

Standard Material Usage Time/motion studies Quality of material e.g. natural

wastage Specification of standard product

manufactured Operational wastage expected

Standard Labor Rate Market rate for grade/type of labor Internal rates form HR department Bonus schemes/piece work rates in

current use

Standard Labor Efficiency Idle time expected during operations Time/motion studies Skill/expertise of staff Learning curve Motivation of Staff Remuneration system in place

Standard Overhead Rate Overhead absorption rates obtained by dividing forecast overhead with an expected level of activity

Review overhead Understand fixed and variable

relationship with output, labor hours, machine hours or % of cost

12

Methods For Planning And Control

A fixed budget is a budget prepared on the basis of an single estimated production and sales volume. It does not mean it is never revised or charged, just Fixed at a certain level of output sold and produced. This tends to be a form of budgeting for a service organization where a high proportion of total cost if fixed, and therefore does not vary significantly, with the volume or activity of the service performed. Such a form of budgeting would be little use for control purposes, when comparing to actual results, if significant variable cost exists. A fixed budget provides detail of costs, revenues or resource requirements for a single level of activity.

Flexible budgets are prepared for many different sales and production quantities and can be used to plan more effectively for an organization e.g. useful at the planning stage for ‘what it?’ analysis. Flexible budgeting recognizes different cost behavior patterns, that may rise or fall with the volume of production or sales and is a better system for control purposes. A flexible budgeting system based upon its budget set at the beginning of the period can be flexed to correspond to the actual activity volume of results for a prepared. When a budget is flexed it would give an appropriate level of revenue and costs as a yardstick to compare like for like to actual results, at the same activity level, meaningful variances can then be reported to the managers responsible for control purposes.

Flexible Budgeting

1. Useful at the planning stage (what if analysis)2. Can be ‘Flexed’ retrospectively and compared to actual results for control

purposes

13

Variance analysis

By comparing a flexed budget, which has been prepared using standard cost information to actual results, total variances can be calculated. These reconcilable differences between the two statements can then be sub-dividend further, calculated, interpreted and used to correct problems within the organization to stay on target through control action by management or employees.

Variances Can Occur For The Following Reasons

Inaccurate data when creating standards, producing the budget or compiling actual results

A standard used which is either not realistic or perhaps out of date, Efficiency of how operations were undertaken by management or employees

during the period of assessment Random or chance

Budgetary planning involves the production of budgets or forecasts using realistic standards for cost and efficiency levels. Budgetary Control identifies areas of responsibility for management and is the process of regularly comparing actual results against budget or standards. Because the original budget would have forecast a different number of units produced or sold, when compared to actual units produced or sold, a ‘Flexed budget’ would be prepared in order to compare costs and revenues on a like with like basis.

14

Variance Calculations

Sales Price Variance

Did sell (actual) quantity sold x actual price) X

Should sell (actual quantity sold x standard price) (X)

Sales Price Variance X

Sales Volume Profit Variance

Units

Did sell (actual quantity sold) XShould sell (budget quantity sold) (X) X standard profit per unit*Sales Volume Profit Variance X

* Standard profit would be used if the organization uses absorption costing methods, when using marginal costing methods, the standard contribution volume variance, rather than standard volume profit variance would be used. The Performa above would be the same however the difference in units above would be multiplied by the standard contribution per unit rather than standard profit per unit.

There is also the calculation of the sales volume revenue variance

Units

Did sell (actual quantity sold) XShould sell (budget quantity sold) (X) X X Standard Price

Sales Volume Revenue Variance X

This would be a calculation considered in isolation from an operating statement e.g. if an organization wants to reconcile the difference between the original sales budget revenue and actual sales revenue achieved rather than profit or contribution.

15

Material Price Variance

Did spend (actual quantity purchased X actual price) XShould spend (actual quantity purchased x standard price) (X)

Material Price Variance X

This variance calculation always uses the quantity of material actually purchased never used, if there is a difference between the two within a question.

Material Usage Variance

Kg/Litres

Actual production did use XActual production should use (actual production x standard usage) (X) X X standard price

Material Usage Variance X

This variance calculation always uses the quantity of material actually used never purchased, if there is a difference between the two within a question.

Labor Rate Variance

Did spend (actual hours paid X actual rate) XShould spend (actual hours paid X standard rate) X

Labor Rate Variance X

This variance calculation always uses the actual hours paid for never hours worked, if there is a difference between the two within a question.

16

Labor Efficiency Variance

Hours

Actual production did take XActual production should take (actual production x standard hours) (X) X Standard rateLabout Efficiency Variance X

This variance calculation always uses the actual hours worked never hours paid if there is a difference between the two within a question.

Labor Idle Time Variance

Hours

Actual hours paid for XActual hours worked (X) Idle time X X standard rate

Labor Idle Time Variance X

Only applicable if there is idle time e.g. a difference between labor hours paid and worked.

Variable Overhead

Expenditure Variance

Did spend (actual hours worked X actual OH rate) XShould spend (actual hours worked x standard OH rate) (X)

Variable Overhead Expenditure Variance X

Variable overhead expenditure within a question will be assumed to be driven by labor hours worked never paid if there is a difference between the two e.g. if production stops and staff are idle then no variable overhead should be incurred.

17

Variable Overhead Efficiency Variance

Hours

Actual production did take X Actual production should take (actual production x standard hours) (X) X X standard overhead rate

Variable Overhead Efficiency Variance X

This variance calculation always uses the actual hours worked never hours paid if there is a difference between the two within a question; notice the Performa is similar to the labor efficiency variance.

Fixed Overhead Expenditure

Variance

Actual fixed overhead expenditure XBudgeted fixed overhead expenditure (X)

Fixed Overhead Expenditure Variance X

Fixed Overhead Volume Variance

Units

Did produce (actual quantity produced) XShould produce (budget quantity produced) (X) X X overhead absorption rate (O.A.R.)

Fixed Overhead Volume Variance X

This variance calculation is only applicable if the organization uses absorption costing, never when marginal costing, and is to do with the way the organization charges the profit and loss account within the production fixed overhead control account.

18

Fixed Overhead Variances Further Explained

Traditional absorption costing takes the total budgeted fixed overhead for a period and divides by a budgeted (or normal) activity level e.g. units, in order to find the overhead absorption rate. This is a simple method of charging fixed overhead and allows fixed overhead to be allocated to products, jobs or wor-in-progress.

Overhead absorption rate (OAR)= Budgeted production overhead Normal/budgeted level of activity

Production Fixed Overhead Control Account

Actual production overhead X Actual production (units) x O.A.R. = Charge to W.I.P. during the period X

At the end of the period, the overhead ‘absorbed’ or charged to production is compared to the actual production overhead incurred for the period. Any shortfall in overhead charged would be an ‘under absorption’ of production overhead (DR profit and loss accounts CR Production overhead control account). Any ‘Over charge’ to the profit and loss account during a period would be an ‘over absorption’ of production overhead (CR profit and loss account DR Production overhead control account).

The sum of the fixed overhead expenditure and volume variance would be equal to the under or over absorption, when sub-divided, explaining the two different causes as to how this occurred during a period e.g. under or over spent and/or under or over produced when compared to the original budget.

The difference between absorption costing and marginal costing organizations, is that the marginal costing organization makes no attempt to absorb or charge production into a cost unit or the profit and loss account. It treats production overhead as a period cost only and does not absorb overhead, but rather charges it entirely to the profit and loss account for each period. With marginal costing organizations only the fixed overhead expenditure never the fixed overhead volume variance would be applicable within a question.

19

Stock Valuation Under Absorption And Marginal Costing Systems

It is also important to remember that marginal costing organizations would also value stock at variable production cost only never full production cost, when contrasted to an absorption costing company.

Standard Cost Per Unit:

Direct Costs of ProductionDirect labor XDirect material XDirect variable production overhead XTotal direct variable cost or total prime cost X Marginal costing stock valuation

Indirect production overhead absorbed XFull production cost X Absorption costing stock valuation

20

Mix and Yield (or productivity) variances

A material usage variance can be subdivided into a mix and yield variance where there exists two or more ingredients that can be substituted for one another. The sun of the material mix and yield variance will total the sum of the material usage variance. The same concept can also be applied to labor and mix and yield variances, when one grade or skill of labor can be substituted for another, when making a particular product or completing a job. The labor efficiency variance in this case reanalyzed further into the mix and yield variances, exactly in the same way as the marginal usage variance.

Interpreting mix variances ‘individual valuation basis’

Actual output Did use Should use Standard price

Variance (at std mix)

Material/labor A

X kg/Hrs X kg/Hrs X £x= £x (F)

Material/labor B X kg/Hrs X kg/Hrs X £x= £x (A)X kg/Hrs X kg/Hrs £x (A)

If you use a quantity of material which is more than standard mix there would be an adverse variance

If you use a quantity of material which is less than standard mix there would e a favourable variance

Interpreting Mix Variance ‘Average Valuation Basis’

Actual output Did use Should use Standard price less avg.

price

Variance (at std mix)

Material/labor A

X kg/Hrs X kg/Hrs X £x= £x (F)

Material/labor B X kg/Hrs X kg/Hrs X £x= £x (A)X kg/Hrs X kg/Hrs £x (A)

If you use a quantity of material which is more than standard mix and the material is more expensive than the average cost, there would be an adverse variance

21

If you use a quantity of material which is more than standard mix and the material is less expensive than the average cost, there would be a favourable variance

If you use a quantity of material which is less than standard mix and the material is more expensive than the average cost, there would be a favourable variance

If you use a quantity of material which is less than standard mix and the material is less expensive than the average cost, there would be an adverse variance

Both totals of the individual and average valuation bases give the same answer, it is the analysis which makes up the total, where you would find the differences between the two methods.

Interpreting yield (or productivity) variances

Yield

Actual material used or labor time did produce XActual material used r labor time should produce XOver/(under) produced XX standard cost of one unit of output x £x

£X (A)/(F)

The sum of the material mix/labor mix and material/labor yield variances will be equal to the material usage/labor efficiency variance respectively. It is also worth nothing that there can be an interdependent relationship between a mix and yield variance e.g. a higher skill mix of labor in substitute of a lower skill mix, would cause an adverse mix variance, but may also cause at the same time a favourable yield variance, due to greater experience and therefore efficiency by that type of labor. Lastly a word of caution favourable variances, especially when dealing with mix and yield do not necessarily mean you have improved the organization e.g. more water and less favoring would improve both mix and yield when making soft drinks, but do little to improve the quality of the drink being made.

Investigating Variances

22

Statistical Methods For Interpretation

Variances can be expressed relatively rather than absolutely, the variance is normally expressed as a percentage against the standard cost. In a past exam old syllabus the examiner asked students to express material mix and yield variances, the deviations in weight rather than values, as a percentage of the standardized weight for the product being produced.

From the answer of example this would have been calculated as

Tomato ingredient – mix 3kg/31kg = 9.7%(F) Cheese ingredient – mix 3kg/37kg = 8.1%(A)Yield 1.8kg/61.8kg = 2.9%(A)

These percentages could be plotted on a graph from one period to the next, which would provide managers with the following advantages.

Graphical presentation or percentages analyses over time allows easier interpretation and clearer understanding by managers

Presenting variances over time allows trends to be identified easier

By working out percentages expressed against standard, it removes changes in monetary size of the variance caused by changing activity levels, improving trend analysis

Example of a variance chart

23

Factors To Consider Before Investigation

1. The size of it (materiality)2. The general trend of it e.g. use of control charts for this

3. The type of standard that was used

4. Interdependence with other variances

5. The likelihood of identifying the cause of it

6. The likelihood that if a cause is found then it is controllable

7. The cost and benefits of correcting the cause

8. The cost of the investigation

24

Planning and operational variances

Planning variances are caused by the budget or standard at the planning stage being wrong. The budget and standard used would therefore need revising if your operational variances are to be more realistic.

Operational variances are your normal variance calculations as learned earlier within this chapter, that is assuming all planning errors within the budget have been adjusted for or removed and your standard used is realistic.

Process of calculating planning variances

1. Calculate the planning variance and adjust the original budget within the operating statement for this, before any operational variances are calculated

2. Adjust the standard cost used in the budget from ex ante to ex post (revised) standard

3. Now that the original budget and standard cost has been adjusted, the operational variance that would be effected by the adjustment, will give a more realistic standard.

The effects is to sub-divide a variance into 2 parts

1. The planning variance which is beyond the control of staff e.g. planning errors2. The operational variances which may be within the control of staff

This allows better management information for control purposes

Planning and operational variances are not alternatives to the conventional approach; they just produce a more detailed analysis. Further analysis of variances into groups e.g. planning which are to do with poor planning or inadequate standards used compared with actual true favourable or adverse operational variances, allow managers to be appraised truly on deviations they can control not those variances which are beyond their control.

Advantages of planning variances

Highlight between variances which are controllable and uncontrollable Help motivate managers and staff

Help use more realistic standards

Give a fairer reflection of operational variances

25

However critism includes still the question of determining a ‘realistic standard’ in the first place and putting too much emphasis on ‘bad planning’ rather than ‘bad management’ and the analysis can be more time consuming and costly than the conventional approach.

26

Causes of variances

Possible causes of the individual variances are:Material price variance Different sources of supply

Unexpected general price increase

Alteration in quantity discounts

Alternation in exchange rates (imported goods)

Substitution of a different grade of material

Standard set at mid-year price so one would expect a favourable price variance for part of the year and an adverse variance for the first of the year.

Material Usage Variance Higher/lower incidence of scrap

Alternation to product design

Substitution of a different grade of material

Wages Rate Variance Unexpected national wage award

Overtime/bonus payments different from plan

Substitution of a different grade of labor

Labor Efficiency Variance Improvement in methods or working conditions

Variations in unavoidable idle time

Introduction of incentive scheme

27

Substitution of a different grade of labor

Variable Overhead Variance Unexpected price changes for overhead items

Labor efficiency variances (see above)

Fixed Overhead Expenditure Variance Changes in prices relating to fixed overhead items e.g. rent increase

Seasonal effects e.g. heat/light in winter. (This arises where the annual budget is divided into four equal quarters of thirteen equal four-weekly periods without allowances for seasonal factors. Over a whole year the seasonal effects would cancel out.)

Fixed Overhead Volume Change in production volume due to change in demand or alternatives to stockholding policy

Changes in productivity of labor or machinery

Production lost through strikes etc.

Operating Profit Variance Due To Selling Prices

Unplanned price increase

Unplanned price reduction e.g. to try and attract additional business.

28

Benchmarking

“Continuous, systematic process for evaluating the products, services and work processes of an organization that are recognized as representing best practice, for the purpose of organizational improvement.”

World-class organizations strive to obtain competitive advantage. This can be achieved by using benchmarking. This is the process of comparing your performance with that of another organization considered to be the best in its class.

Benchmarking

1. Internal: Compare an internal function to the best found elsewhere internally within the same organization.

2. ‘Best practice’ or functional: Compare an internal function to that of the best, not necessarily an organization in the same industry.

3. Competitive: Product/service features compared to that of firms/competition in the same industry.

4. Strategic: Compare yourself in terms of organizational structure and culture, mission statement and strategic choices made to the most successful market leader.

Performance Dimensions to Gain Competitive Advantage:

Quality e.g. aesthetics (imperative to organizations like Dior or Cartier), features, courtesy and friendliness of staff involved within the purchase stages within the organization, accuracy of administration.

Speed/flexibility e.g. AA/RAC 24/7, parcel force ‘overnight’ Concorde gave fast transatlantic flights

Cost e.g. if the organizational pursues cost leadership

Differentiation e.g. brand recognition for certain product features such as image, reliability or functional

29

Companies to be the very best much establish where customers perceive differences, set the very best standards to exceed, establish what the competition is doing and encourage, manage, knowledge and ideas of staff to exceed standards set.

30

The process would involve

1. Select what you want to benchmark/set objectives2. Consider benefits against the cost of doing it

3. Assign responsibilities to a team

4. Identify potential partners/known leaders

5. Breakdown of process to complete

6. Test and measure (observation, experimentation or investigation/interview)

7. Gather information

8. Gap analysis

9. Implement changes/programs/communicate

10.Monitor and control

11.Repeat regularly

Benefits of Benchmarking

Better understanding of competition and customers needs Discourages complacency/improves business awareness of managers

You learn from other organization mistakes

Don’t need to ‘re-invent the wheel’

Source of new ideas/faster awareness of innovation

Fewer complaints and warranty claims

Leaner more efficient organization in terms of waste and reworks

Customer satisfaction and brand loyalty in the long-term

Efficiency and effectiveness of functions or process improved within the organization

Sales and profitability improved

31

Drawbacks of Benchmarking

Deciding and documenting what need to be benchmarked is time consuming Getting the information to actually do it may be a problem

Confidential information could be leaked

Damn lies and ‘statistics’

Deciding who is the best in their class

Keeping employees motivated, as standards once exceeded, will normally be raised

32

McDonaldization

Modern manufacturing questions the thought of whether standard costing still plays a valuable part when considering information for control purposes.

Dynamic environments Customization/differentiation not homogenous products

Shorter product life-cycles

Automation

Higher concern for quantity rather than efficiency

George Ritver within his book ‘The McDonaldization of Society’ listed the advantages of producing standard or homogenous products, the pinnacle comparison being McDonalds, with it’s a fast food strategy of uniformity of operations and delivery on a global basis. A concept you will find within thousands of companies in the world, especially the larger corporations e.g. Audi or V/W Group incorporating hundreds of components, including the engine, within a large range of cars manufactured. Although surely you would understand such an idea better through the use of a ‘Big Mac’ right? Standardization of machinery uniforms and packaging e.g. sachets, drinking cups and paper bags. Automation of dispensers, cooking processes and staff… have a nice day! Food already pre-prepared before cooking e.g. cheese sliced, salads prepared, sauces all pre-packed any easy to open and serve. This is uniformity or standardization.

Some facts about McDonalds

Started as a hot dog stand in 1939 by 2 brother (Richard and Maurice McDonald) 30,000 outlets in 119 countries

One of the first to end waiter service

Cut their means down to a few standard and homogenous dishes for simplicity

Plates replaced with cardboard containers to save on washing up

Advantages of McDonadlization ‘standardization reduces cost and improves efficincy’

33

Control e.g. easier to create a pre-defined standard as there is such uniformity within the specification of the products produced, also easier to manage, organize, train and control workers

Efficiency e.g. combined with specialization it is the most efficiency way of working within large organizations

Predictability e.g. customer always knows what they are buying, giving reassurance and brand organizations

Calculability e.g. quantitative not qualitative information so easier to interpret

Proficiency to staff can be assessed more effectively

Such a philosophy and its advantages are similar to the classical school of management, but can have its disadvantages

Excessive specialization of tasks e.g. work dull and boring Removes initiative of workers e.g. reduces innovation and creativity

Boredom, frustration and de-motivation of workers

Diagnostic related or reference groups (DRG) ‘Can applied to a Big Mac’

Standard costing is and can be applied to service organizations such as the health service, accountancy practice or even retail. The diagnostic reference group or healthcare resource group is a system of classifying hundreds of different medical conditions with the health sector, as a basis of recognizing that similar medical illnesses require essentially similar treatment or care. There are around 800 DRGs existing within the health service.

This enables health service management to

Standardize resources e.g. beds/wards/consultancy/medication Standardize patient treatment e.g. specifications of how treatment applied

Standardize codes for insurance companies or standardize payments to the NHS or other private health providers for payment or charges made

Such standards can also be used by government to benchmark the performance and create league tables of those hospitals that complete treatments within standard times and costs and those that do not. The DRG approach also used to remunerate hospitals

34

for each standard treatment they perform.

Such a system is not without its critics, arguing that surely it is the qualitative factors in patient treatment more than the quantitative measures that are more important when it comes to patient care, and not every operation or treatment can be cured in a single best way. If payments are made to hospitals based on a standard amount or price, this could mean overzealous treatment of a patient causing overspending; this in itself could affect the level of patient care given.

Characteristics of services

Intangibility e.g. no material substance or physical existence of it when compared to a tangible good

Legal ownership e.g. no physical evidence often exists, so you can never return it if it was faulty

Instant perish ability e.g. unlike goods, services cannot be stored

Heterogeneity e.g. each time the service is performed even to the same customer it can be different each time, goods generally are homogenous

Inseparability e.g. cannot be separated from the person who provides it

It is for the above reasons, as well as the human influence in the quality and effectiveness of the service performed, when compared to manufacturing a product, that makes standard costing more difficult to apply within the service sector.

35

Advantages / Benefits of Standard Costing System:

Standard costing System has the following main advantages or benefits:

1. The use of standard costs is a key element in a management by exception approach. If costs remain within the standards, Managers can focus on other issues. When costs fall significantly outside the standards, managers are alerted that there may be problems requiring attention. This approach helps managers focus on important issues.

2. Standards that are viewed as reasonable by employees can promote economy and efficiency. They provide benchmarks that individuals can use to judge their own performance.

3. Standard costs can greatly simplify bookkeeping. Instead of recording actual costs for each job, the standard costs for materials, labor, and overhead can be charged to jobs.

4. Standard costs fit naturally in an integrated system of responsibility accounting. The standards establish what costs should be, who should be responsible for them, and what actual costs are under control.

Disadvantages / Problems / Limitations of Standard Costing System:

The use of standard costs can present a number of potential problems or disadvantages. Most of these problems result from improper use of standard costs and the management by exception principle or from using standard costs in situations in which they are not appropriate.

1. Standard cost variance reports are usually prepared on a monthly basis and often are released days or even weeks after the end of the month. As a consequence, the information in the reports may be so stale that it is almost useless. Timely, frequent reports that are approximately correct are better than infrequent reports that are very precise but out of date by the time they are released. Some companies are now reporting variances and other key operating data daily or even more frequently.

2. If managers are insensitive and use variance reports as a club, morale may suffer. Employees should receive positive reinforcement for work well done. Management by exception, by its nature, tends to focus on the negative. If variances are used as a club, subordinates may be tempted to cover up

36

unfavorable variances or take actions that are not in the best interest of the company to make sure the variances are favorable. For example, workers may put on a crash effort to increase output at the end of the month to avoid an unfavorable labor efficiency variance. In the rush to produce output quality may suffer.

3. Labor quantity standards and efficiency variances make two important assumptions. First, they assume that the production process is labor-paced; if labor works faster, output will go up. However, output in many companies is no longer determined by how fast labor works; rather, it is determined by the processing speed of machines. Second, the computations assume that labor is a variable cost. However, direct labor may be essentially fixed, then an undue emphasis on labor efficiency variances creates pressure to build excess work in process and finished goods inventories.

4. In some cases, a "favorable" variance can be as bad or worse than an "unfavorable" variance. For example, McDonald's has a standard for the amount of hamburger meat that should be in a Big Mac. A "favorable" variance would mean that less meat was used than standard specifies. The result is a substandard Big Mac and possibly a dissatisfied customer.

5. There may be a tendency with standard cost reporting systems to emphasize meeting the standards  to the exclusion of other important objectives such as maintaining and improving quality, on-time delivery, and customer satisfaction. This tendency can be reduced by using supplemental performance measures that focus on these other objectives.

6. Just meeting standards may not be sufficient; continual improvement may be necessary to survive in the current competitive environment. For this reason, some companies focus on the trends in the standard cost variances - aiming for continual improvement rather than just meeting the standards. In other companies, engineered standards are being replaced either by a rolling average of actual costs, which is expected to decline, or by very challenging target costs.

In sum, managers should exercise considerable care in their use of a standard cost system. It is particularly important that managers go out of their way to focus on the positive, rather than just on the negative, and to be aware of possible unintended consequences.

37

Nevertheless standard costs are still found in the vast majority of manufacturing companies and in many service companies, although their use is changing. For evaluating performance, standard cost variances may be supplanted in the future by a particularly interesting development known as the balanced scorecard.

BIBLIOGRAPHY1. The Internet2.

38