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10-10-11

Standard Costing, Operational Performance Measures, and the Balanced Scorecard

Chapter Ten

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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

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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

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10-10-44

Variance Analysis Cycle

Prepare standard cost performance

report.

Conduct next period’s

operations.

Analyze variances.

Identifyquestions.

Receive explanations.

Takecorrective

actions.

Begin

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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

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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

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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?

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10-10-88

Advantages of Standard Costing

Management byException

PerformanceEvaluation

EmployeeMotivation

Sensible CostComparisons

Advantages

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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

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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

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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

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10-10-1212

End of Chapter 10

Let’s set the standard alittle higher.

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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

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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

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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.

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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

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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

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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

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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

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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