McGraw-Hill/Irwin

10-1
Standard Costing,
Operational Performance
Measures, and the
Balanced Scorecard
Chapter Ten

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10-2
Standard Costs
Benchmarks for
measuring performance.
The expected level
of performance.
Based on carefully
predetermined amounts.
Used for planning labor
and material requirements.
Standard
Costs are
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10-3
Management by Exception
Direct
Material
Managers focus on quantities and costs
that exceed standards, a practice known as
management by exception.
Type of Product Cost
A
m
o
u
n
t

Direct
Labor
Standard
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10-4
Variance Analysis Cycle
Prepare standard
cost performance
report.
Conduct next
periods
operations.



Analyze
variances.



Identify
questions.



Receive
explanations.
Take
corrective
actions.
Begin
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10-5
Cost Variance Analysis
Standard Cost Variances
Quantity Variance Price Variance
The difference between
the actual price and the
standard price
The difference between
the actual quantity and
the standard quantity
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10-6
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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wSize of variance
Dollar amount
Percentage of standard
wRecurring variances
wTrends
wControllability
wFavorable variances
wCosts and benefits of
investigation
Significance of Cost Variances
What clues help me
to determine the
variances that I should
investigate?
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10-8
Advantages of Standard Costing
Management by
Exception
Performance
Evaluation
Employee
Motivation
Sensible Cost
Comparisons
Advantages
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10-9
Operational Control Measures in
Todays Manufacturing Environment
Raw Material and Scrap Control
g Inventory Control
@ Machine Performance
j Product Quality
) Production and Delivery
g Productivity
_ Innovation and Learning

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Wait Time
Manufacturing Cycle Time
Process Time + Inspection Time
+ Move Time + Waiting Time
Order
Received
ProductionS
tarted
Goods
Shipped
Delivery Cycle Time
Manufacturing
Cycle
Efficiency
Process Time
Manufacturing Cycle Time
=
Production and Delivery
Performance Measures
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10-11
The Balanced Scorecard
Financial Perspective
How do we look
to the firms owners?
Innovation and
Learning Perspective
How can we continually
improve and create value?
Internal Operations
Perspective
In which activities
must we excel?
Customer Perspective
How do our
customers see us?
Exh.
10-8
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End of Chapter 10
Lets set the
standard a
little higher.
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10-13
Managing Costs/ Setting standards
wControls in cost management i) standard costs ii) Actual
costs iii) Cost Variance is used to control costs
wBy Exception: Only exceptional variances investigated
wSetting standards: 2 ways viz Historical ;Task analysis
Historical is not relevant in new products/process change
Task Analysis: of mfg process for material /time study
wCombined Approach: Using a mix of both eg where only
some of the processes have changed use both as reqd.
wStandard Costs The standard costs so worked out
become a target against which actual costs are controlled
wEg Case of Dcdesserts.com which supplies fresh and
frozen desserts: Refer Excel sheet



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Significance of Cost Variances
wThumb rule is 10% or $10,000 if exceeded should merit
investigation. What can also be investigated may be
persistent trends. Multiple price and Quantity variances
for raw material are computed and summed up
wSimilarly Labor Rate and efficiency variances are
computed and summed up. Similar allowances for
spoilage /defects are also to be made. If 100 gallons of
chemicals produce 80 gallons of sellable produce then
for 500 gallons we will require 500/.8=625 gallons
wWhether variance requires action is determined by the
judgment of managers but factors that are considered
are: Size, Recurrence, Trends, Controllability, Project
Monitoring and Cost & Benefit of investigation
wStatistical Approach random causes should be sorted out
SQC helps

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Impact of Standard Costing & Controlling variances
w 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. 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 may
adversely affect patronage
w It is usual to identify one person responsible for controlling cost variance
eg DM Price variance is responsibility of Purchase Manager , though he
is not always in control
w DM Quantity variance Is the responsibility of Production supervisor
(PS). Sometimes a low grade material increases costs
w DL Rate Variance The PS is responsible & knows whom to put on the
job. Overskilled /underskilled people add to cost
w DL Efficiency Variance PS is responsible for efficient use of employees
through motivation towards production goals & effective work schedules.



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Interaction among variances
w Sometimes the interaction between variances complicates the
issue eg a brass musical instrument manufacturer sourced a
different (cheaper) brass alloy resulting in favorable material costs
but more wastage, unfavorable labor efficiency but an overall
favorable impact on costs. The decision to buy poor grade brass
would be justified provided overall quality was not impacted as
shown below:
w (8500) Favorable DM variance
w 1000 Adverse DM quantity variance (wastage)
w 2000 Adverse DL rate variance (skilled staff needed)
w 1500 Adverse DL efficiency rate (more time needed)
w (4000) Total Net favorable variance

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Standard Costs & Product Costing
w Standard costs are not only used to control variances but also
for product costing. Costs get added to WIP Inventory. Flow of
costs is given below
w WIP Inventory FG Inventory
w -DM
w -DL
w -Mfg OH
On Sale
Cost of Goods Sold
Income Summary
Expense Closed into
Income Summary at eoy
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Advantages of Standard Costing
1. Standard Costs provide a basis for sensible cost
comparisons
2. Cost variances enable managers to manage by
exception
3. Provide a means for appraisal & rewarding
employees
4. Provide employees a motivation to adhere to
standards
5. Results in more stable product costs rather than
an actual costs system
6. Less costly to implement than an actual cost
system


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Criticisms of Standard Costing
1. The variances calculated under standard costing are at an aggregate
level and come too late to be useful
2. Traditional std. costing systems (TSCS) are also too aggregate in the
sense they are not tied to specific product lines, Flexible Mfg systems
etc.
3. TSCS focus too much on costs & efficiency of DL which is becoming
unimportant
4. Standard costing requires a stable production. process which is
changed by FMS
5. Shorter product life cycles means standards are valid only for a short
time
6. Traditional costing systems do not capture all costs eg cost of
ordering, paying bills, inspection etc.
7. Traditional Systems tend to focus too much on cost minimization and
not on improving quality eg choosing a cheap RM which does not
meet JIT schedules
8. Automated production tends to be more consistent in meeting specs


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Adapting Standard Costing Systems
wReduced importance of labor standards & variances
wEmphasis on Material & Overhead costs hence become
important in managing Cost Management System
wCost Drivers more important are m/c hrs setup costs etc.
wShifting cost structures towards fixed costs
wHi quality & 0 defects TQC programs go with JIT
wNVA costs should be eliminated under CMS
wShorter Product Life cycles need revision of standards
wReal Time Info Systems: Computer Integrated
Management (CIM) systems enable collection of data in
real time enabling corrections quickly
wNon financial measures for Op. control being used eg no.
of vendors, number of common parts etc
wBench marking of processes within and outside the firm




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Operational Performance measures in todays environment
w RM & scrap Minimise
w Inventory JIT
w Machinery Remove bottlenecks /Theory of constraints
w Product Quality J IT demands strict adherence to quality
w Production / delivery Manufacturing CT time /delivery CT
Mfg. cycle efficiency = Processing time (PC)
PC+ insp time+ Waiting time+ move time
Velocity is no. of mfg.units/given time period
w Productivity: sum of goods/services produced eg no. of
engines/day/employee