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McGraw-Hill/Irwin
10-10-11
Standard Costing, Operational Performance Measures, and the Balanced Scorecard
Chapter Ten
McGraw-Hill/Irwin
10-10-22
Standard Costs
Benchmarks formeasuring performance.
The expected levelof performance.
Based on carefullypredetermined amounts.
Used for planning laborand material requirements.Standard
Costs are
McGraw-Hill/Irwin
10-10-33
Management by Exception
DirectMaterial
Managers focus on quantities and coststhat exceed standards, a practice known as
management by exception.
Type of Product Cost
Am
ou
nt
DirectLabor
Standard
McGraw-Hill/Irwin
10-10-44
Variance Analysis Cycle
Prepare standard cost performance
report.
Conduct next period’s
operations.
Analyze variances.
Identifyquestions.
Receive explanations.
Takecorrective
actions.
Begin
McGraw-Hill/Irwin
10-10-55
Cost Variance Analysis
Standard Cost Variances
Quantity VariancePrice Variance
The difference betweenthe actual price and the
standard price
The difference betweenthe actual quantity andthe standard quantity
McGraw-Hill/Irwin
10-10-66
A General Model for Variance Analysis
Actual Quantity Actual Quantity Standard Quantity × × × Actual Price Standard Price Standard Price
Price Variance Quantity Variance
Materials price variance Materials quantity variance Labor rate variance Labor efficiency variance Variable overhead Variable overhead spending variance efficiency variance
AQ(AP - SP) SP(AQ - SQ)
AQ = Actual Quantity SP = Standard Price AP = Actual Price SQ = Standard Quantity
McGraw-Hill/Irwin
10-10-77
Size of varianceSize of variance Dollar amountDollar amount Percentage of standardPercentage of standard
Recurring variancesRecurring variances TrendsTrends ControllabilityControllability Favorable variancesFavorable variances Costs and benefits of Costs and benefits of
investigationinvestigation
Significance of Cost Variances
What clues help me to determine the
variances that I should investigate?
McGraw-Hill/Irwin
10-10-88
Advantages of Standard Costing
Management byException
PerformanceEvaluation
EmployeeMotivation
Sensible CostComparisons
Advantages
McGraw-Hill/Irwin
10-10-99
Operational Control Measures in Today’s Manufacturing Environment
Raw Material and Scrap ControlRaw Material and Scrap Control
Inventory ControlInventory Control
Machine PerformanceMachine Performance
Product QualityProduct Quality
Production and DeliveryProduction and Delivery
ProductivityProductivity
Innovation and LearningInnovation and Learning
McGraw-Hill/Irwin
10-10-1010
Wait Time
Manufacturing Cycle Time
Process Time + Inspection Time+ Move Time + Waiting Time
Order Received
ProductionStarted
Goods Shipped
Delivery Cycle Time
ManufacturingCycle
Efficiency
Process Time
Manufacturing Cycle Time=
Production and Delivery Performance Measures
McGraw-Hill/Irwin
10-10-1111
The Balanced ScorecardFinancial Perspective
How do we lookto the firm’s owners?
Innovation andLearning Perspective
How can we continuallyimprove and create value?
Internal OperationsPerspective
In which activities must we excel?
Customer PerspectiveHow do our
customers see us?
Exh.10-8
McGraw-Hill/Irwin
10-10-1212
End of Chapter 10
Let’s set the standard alittle higher.
McGraw-Hill/Irwin
10-10-1313Managing Costs/ Setting standards
Controls in cost management i) standard costs ii) Actual Controls in cost management i) standard costs ii) Actual costs iii) Cost Variance is used to control costscosts iii) Cost Variance is used to control costs
By Exception:By Exception: Only exceptional variances investigated Only exceptional variances investigated Setting standards: Setting standards: 2 ways viz Historical ;Task analysis2 ways viz Historical ;Task analysis
Historical is not relevant in new products/process changeHistorical is not relevant in new products/process change
Task Analysis: of mfg process for material /time studyTask Analysis: of mfg process for material /time study Combined Approach:Combined Approach: Using a mix of both eg where only Using a mix of both eg where only
some of the processes have changed use both as reqd.some of the processes have changed use both as reqd. Standard Costs Standard Costs The standard costs so worked out The standard costs so worked out
become a target against which actual costs are controlledbecome a target against which actual costs are controlled Eg Case of Dcdesserts.com which supplies fresh and Eg Case of Dcdesserts.com which supplies fresh and
frozen desserts: Refer Excel sheetfrozen desserts: Refer Excel sheet
McGraw-Hill/Irwin
10-10-1414Significance of Cost Variances
Thumb rule is 10% or $10,000 if exceeded should merit Thumb rule is 10% or $10,000 if exceeded should merit investigation. What can also be investigated may be investigation. What can also be investigated may be persistent trends. Multiple price and Quantity variances for persistent trends. Multiple price and Quantity variances for raw material are computed and summed upraw material are computed and summed up
Similarly Labor Rate and efficiency variances are Similarly Labor Rate and efficiency variances are computed and summed up. Similar allowances for spoilage computed and summed up. Similar allowances for spoilage /defects are also to be made. If 100 gallons of chemicals /defects are also to be made. If 100 gallons of chemicals produce 80 gallons of sellable produce then for 500 gallons produce 80 gallons of sellable produce then for 500 gallons we will require 500/.8=625 gallons we will require 500/.8=625 gallons
Whether variance requires action is determined by the Whether variance requires action is determined by the judgment of managers but factors that are considered are: judgment of managers but factors that are considered are: Size, Recurrence, Trends, Controllability, Project Size, Recurrence, Trends, Controllability, Project Monitoring and Cost & Benefit of investigationMonitoring and Cost & Benefit of investigation
Statistical Approach random causes should be sorted out Statistical Approach random causes should be sorted out SQC helpsSQC helps
McGraw-Hill/Irwin
10-10-1515Impact of Standard Costing & Controlling variances
Standard costs are used to determine efficiency of working. Eg F&B Standard costs are used to determine efficiency of working. Eg F&B deptt in a hotel earns a bonus when costs are below budgeted levels. deptt in a hotel earns a bonus when costs are below budgeted levels. The bonus may cause Manager to seek cheaper supplies and watch for The bonus may cause Manager to seek cheaper supplies and watch for theft/ waste. The cheaper supplies could be at the cost of quality which theft/ waste. The cheaper supplies could be at the cost of quality which may adversely affect patronagemay adversely affect patronage
It is usual to identify one person responsible for controlling cost variance It is usual to identify one person responsible for controlling cost variance eg eg DM Price varianceDM Price variance is responsibility of is responsibility of Purchase ManagerPurchase Manager , though he , though he is not always in controlis not always in control
DM Quantity variance DM Quantity variance Is the responsibility of Is the responsibility of Production supervisor Production supervisor (PS). (PS). Sometimes a low grade material increases costsSometimes a low grade material increases costs
DL Rate Variance DL Rate Variance The PS is responsible & knows whom to put on the The PS is responsible & knows whom to put on the job. Overskilled /underskilled people add to costjob. Overskilled /underskilled people add to cost
DL Efficiency VarianceDL Efficiency Variance PS is responsible for efficient use of employees PS is responsible for efficient use of employees through motivation towards production goals & effective work schedules.through motivation towards production goals & effective work schedules.
McGraw-Hill/Irwin
10-10-1616Interaction among variances
Sometimes the interaction between variances complicates the Sometimes the interaction between variances complicates the issue eg a brass musical instrument manufacturer sourced a issue eg a brass musical instrument manufacturer sourced a different (cheaper) brass alloy resulting in favorable material costs different (cheaper) brass alloy resulting in favorable material costs but more wastage, unfavorable labor efficiency but an overall but more wastage, unfavorable labor efficiency but an overall favorable impact on costs. The decision to buy poor grade brass favorable impact on costs. The decision to buy poor grade brass would be justified provided overall quality was not impacted as would be justified provided overall quality was not impacted as shown below:shown below:
(8500) Favorable DM variance(8500) Favorable DM variance 1000 Adverse DM quantity variance (wastage)1000 Adverse DM quantity variance (wastage) 2000 Adverse DL rate variance (skilled staff needed)2000 Adverse DL rate variance (skilled staff needed) 1500 Adverse DL efficiency rate (more time needed)1500 Adverse DL efficiency rate (more time needed) (4000) Total Net favorable variance(4000) Total Net favorable variance
McGraw-Hill/Irwin
10-10-1717Standard Costs & Product Costing
Standard costs are not only used to control variances but also Standard costs are not only used to control variances but also for product costing. Costs get added to WIP Inventory. Flow of for product costing. Costs get added to WIP Inventory. Flow of costs is given belowcosts is given below
WIP InventoryWIP Inventory FG Inventory FG Inventory -DM -DM -DL -DL -Mfg OH -Mfg OH
On SaleOn Sale
Cost of Goods Sold Income SummaryExpense Closed into Income Summary at eoy
McGraw-Hill/Irwin
10-10-1818Advantages of Standard Costing
1.1. Standard Costs provide a basis for Standard Costs provide a basis for sensible cost sensible cost comparisonscomparisons
2.2. Cost variances Cost variances enable managers to manage by enable managers to manage by exceptionexception
3.3. Provide a means for appraisal & rewarding Provide a means for appraisal & rewarding employeesemployees
4.4. Provide employees a motivation to adhere to Provide employees a motivation to adhere to standardsstandards
5.5. Results in more stable product costs rather than Results in more stable product costs rather than an actual costs systeman actual costs system
6.6. Less costly to implement than an actual cost Less costly to implement than an actual cost systemsystem
McGraw-Hill/Irwin
10-10-1919Criticisms of Standard Costing
1.1. The variances calculated under standard costing are at an aggregate The variances calculated under standard costing are at an aggregate level and come too late to be usefullevel and come too late to be useful
2.2. Traditional std. costing systems (TSCS) are also too aggregate in the Traditional std. costing systems (TSCS) are also too aggregate in the sense they are not tied to specific product lines, Flexible Mfg systems sense they are not tied to specific product lines, Flexible Mfg systems etc.etc.
3.3. TSCS focus too much on costs & efficiency of DL which is becoming TSCS focus too much on costs & efficiency of DL which is becoming unimportantunimportant
4.4. Standard costing requires a stable production. process which is Standard costing requires a stable production. process which is changed by FMSchanged by FMS
5.5. Shorter product life cycles means standards are valid only for a short Shorter product life cycles means standards are valid only for a short timetime
6.6. Traditional costing systems do not capture all costs eg cost of Traditional costing systems do not capture all costs eg cost of ordering, paying bills, inspection etc.ordering, paying bills, inspection etc.
7.7. Traditional Systems tend to focus too much on cost minimization and Traditional Systems tend to focus too much on cost minimization and not on improving quality eg choosing a cheap RM which does not not on improving quality eg choosing a cheap RM which does not meet JIT schedulesmeet JIT schedules
8.8. Automated production tends to be more consistent in meeting specs Automated production tends to be more consistent in meeting specs
McGraw-Hill/Irwin
10-10-2020Adapting Standard Costing Systems
Reduced importance of labor standards & variancesReduced importance of labor standards & variances Emphasis on Material & Overhead costs hence become Emphasis on Material & Overhead costs hence become
important in managing Cost Management Systemimportant in managing Cost Management System Cost Drivers more important are m/c hrs setup costs etc.Cost Drivers more important are m/c hrs setup costs etc. Shifting cost structures towards fixed costsShifting cost structures towards fixed costs Hi quality & 0 defects TQC programs go with JIT Hi quality & 0 defects TQC programs go with JIT NVA costs should be eliminated under CMSNVA costs should be eliminated under CMS Shorter Product Life cycles need revision of standardsShorter Product Life cycles need revision of standards Real Time Info Systems: Computer Integrated Management Real Time Info Systems: Computer Integrated Management
(CIM) systems enable collection of data in real time enabling (CIM) systems enable collection of data in real time enabling corrections quicklycorrections quickly
Non financial measures for Op. control being used eg no. of Non financial measures for Op. control being used eg no. of vendors, number of common parts etcvendors, number of common parts etc
Bench marking of processes within and outside the firmBench marking of processes within and outside the firm
McGraw-Hill/Irwin
10-10-2121Operational Performance measures in today’s environment
RM & scrap RM & scrap MinimiseMinimise Inventory Inventory JITJIT Machinery Machinery Remove bottlenecks /Theory of constraintsRemove bottlenecks /Theory of constraints Product Quality Product Quality JIT demands strict adherence to qualityJIT demands strict adherence to quality Production / delivery Manufacturing CT time /delivery CTProduction / delivery Manufacturing CT time /delivery CT
Mfg. cycle efficiency = Mfg. cycle efficiency = Processing time (PC)Processing time (PC)
PC+ insp time+ Waiting time+ move PC+ insp time+ Waiting time+ move time time
Velocity is no. of mfg.units/given time periodVelocity is no. of mfg.units/given time period Productivity: sum of goods/services produced eg no. of Productivity: sum of goods/services produced eg no. of
engines/day/employeeengines/day/employee