Standard Costing, Operational Performance Measures

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1. Standard-cost systems are used to help managers control the cost of operations. 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.


3. 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 and 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.


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 finished 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 =...
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