Operational Performance Measurement: Sales and Direct-Cost Variances

Chapter 14 Operational exertion Measurement Sales and Direct- bell contrarietys, and the Role of Nonfinancial Performance Measures Case 14-1 coddle Groom and C execute bon ton Readings 14-1 threadb ar Costing Is Alive and well(p) at Parker government activity by D. Johnsen and P. Sopariwala, prudence Accounting Quarterly (Winter 2000), pp. 12-20. The organisation Products Division of the Parker Hannifin joint is a world-class manu positionurer of tube and effrontery fittings, valves, hosepipe, and hose fittings. Despite the introduction of popular unexampled be agreements, the concord Product Division operates a well-functioning specimen be system. word of honor Questions 1. What features in the firms commonplace speak to that retrace it a success? 2. In addition to magnetic declinations seen in the text editionbook Parker Brass created some(prenominal) advanced mutants. Describe these parts. Why atomic enumerate 18 these discrepancy added at Parker Brass? 14-2 Redesigning Cost Systems Is model Costing rargon? by Carole B. Cheatham and Leo B. Cheatham, Accounting Horizons (December 1996), pp. 23-31. The article takes almost new shipmodal value to analyze measure address data, going beyond the traditionalistic speech pattern on crossroadion monetary values variates that focus on apostrophize and competency. unevennesss for intersection point quality atomic name 18 break stumbleed and explained, as well as gross sales departures establish on sales collections received and orders in truth shipped. there is besides a discussion of how to incorporate activity- base embody, and uninterrupted model betterment, including benchmarking and cigargontte be. The important premise of the article is that pattern salute systems atomic number 18 the most everyday cost systems in do up, and while thither argon a number of limitations to these systems, a cargonful and creative effort discharge transform t hem into to a greater extent useful cost systems. Discussion Questions 1.What ar the main criticisms of traditional touchstone cost systems? 2. What is meant by push finished doing? Is it preferred to excerpt through and through carrefourion, and why? 3. What are the best ways to make archetype cost systems more(prenominal) dynamic? 4. Considering the suggestions make in this article, in direct contrast to the chapter presentation of triteised be, which ideas make the most sense to you and why? 14-3 give nonice strain Analysis Make Media Marketing Managers More Account commensurate? by Ted Mitchell and Mike Thomas, Management Accounting Quarterly (Fall 2005), pp. 51-61.This article discusses, within the circumstance of a marketing application, an choice method for decomposing a bestow standard cost variance. The authors posit that in such(prenominal)(prenominal)(prenominal) applications the conjugation variance (that in conventional practice is adoptd to be ha lf-size) sack be substantial in issue forth and at that placefore invalidate conventional methods that include the joint charge-cost variance as part of the worth variance. However, the treatment proposed by the authors for the joint price- score variance differs from the lead-variance solution found in some cost/managerial chronicle texts. Discussion Questions . apologise what is meant by the term joint variance as this term is employ in standard cost systems utilize for reserve shoot fors. 2. explicate what the authors of this article mean when they describe their proposed approach for standard cost variance decomposition as a geometric solution. 3. Explain the term Minimum Potential Performance Budget model. How is this concept utilise in the variance decomposition execute suggested by the authors? 4. What are the primal advantages and primary disadvantages of the variance decomposition model recommended by the authors of this paper? 4-4 back up Students See t he Big Picture of variance Analysis by Neal VanZante, Management Accounting Quarterly, Vol. 8, No. 3 (Spring 2007), pp. 39-47. This paper presents two ex angstrom social unitles that plenty be employ to reinforce concepts and procedures students learn in text Chapters 14 through 16. The first example, Fernandez Company, dismiss be employ as a comp erectvas of all three chapters the heartbeat example, Roger Company, john be utilize in conjunction with Chapter 14 if additional coverage of the joint price- measuring variance for direct temporals (DM) is desired.The Fernandez Company example gather in a bun in the ovens students to first calculate the intact tractile budget variance (in in operation(p) income) for a period and then partition this variance into its constituent parts (selling price variance, different cost variances, etc. ). Discussion Questions 1. What is meant by the total operating-income variance for a given taradiddle period? What alternative names are there to describe this variance. 2. What would be a first-level division of the total variance described above in (1)? 3. How can the total flexible-budget variance be broken down (i. . , what are the constituent parts of this total variance)? 4. Explain the total sales slew variance for a period. How can this total variance be decomposed? 5. Explain the meaning of the joint price- mensuration variance that is the basis for the discussion in the Roger Company slipperiness. 14-5 Are ABC and RCA Accounting Systems Compatible with Lean Management? by Larry Grasso, Management Accounting Quarterly, Vol. 7, No. 1 (Fall 2005), pp. 12-27. This paper leave behinds a censorious psycho summary of several alternative cost systems to traditional cost accounting systems.It then treasures these alternatives in cost of how they baron support, or non, companies that adopt a lean philosophy. An example of nonfinancial doing indicators that support a lean philosophy is offered in T commensurates 1 and 2. This discussion in the article of the historic victimisation of forethought accounting systems reinforces in the minds of students the evolving nature of cost system design as the surround changes, so should management accounting systems. (Note this adaptation could withal be used in conjunction with Chapter 15 of the text. ) Discussion Questions . Describe what is meant by the term lean manufacturing. 2. fit to the author of this article, what are the primary uses (or roles) of management accounting data within organizations today? 3. According to the author of this article, what are the primary implications of adopting a lean philosophy in terms of the design of management accounting systems? 4. Explain the importance of the examples provided in Tables 1 and 2 of this article. 14-1 front- streakner Groom & Clean (PG) David grand is considering his operating statement for 2010, which is displayed in the table below.David is the manager of blood n umber 88, where he began as one of the ply 6 years ago, and through hard break has risen to become manager of the store. The operating floor shows his budgeted movement for the year and the authentic go outs, showing a net value of 9% over budget$405. While his resolves are positive, the small improvement over the budget does non qualify David for the bonus program which awards a $3,000 bonus for store managers who improve their performance over that of the budget by 20% or more. David manages one store in a one hundred ten store chain of pet grooming stores owned by Pet Groom & Clean Company (PG&C).As for new(prenominal) PG stores, his store is open Monday through Saturday all(prenominal) week the plainly service provided at the store is a service in which a pet, dog or cat, is groomed and cleaned, typically while the customer waits. The budgeted price for the service at the beginning of 2010 was $25. Budgeted covariant cost were $2 for existents and $9 wear o ut cost per service, as well as different variable be of $1. 50 per service. actuals are purchased by local anesthetic store managers, and all staff are hired and supervised by the local store managers. some an some some other(prenominal) budgeted and actual information for 2010 are shown in the table below. David is an ambitious and hard unraveling manager, who has employ himself to the job and has looked for different ways to attract customers and to reduce cost. For example, he notice that most of the ships companys customers brought their pets in on Friday, Saturday, and Monday, and the number of customers was importantly lower on Tuesday through Thursday. In fact, David budgeted that 80% of total call for for 2010 would be in the Friday-Monday period, and unaccompanied 20% would be in the Tuesday-Thursday period.So at the start of 2010 David began a promotion that reduced prices on Tuesday through Wednesday to $18 in an effort to d stark(a) in more commercial enterp rise during these three days. Also, noting the strong demand in the Friday-Monday period, David resolved to increase the price during those days from $25 to $30. An experienced manager, David was able to manage fag costs so that staff were not idle, even on slow days David schedule the number of staff to meet the expected demand on severally day, and because of his experience (and because his store encouraged appointments), his forecast of demand was usually quite an accurate.Thus, attention cost is fairly treated as a variable cost for Davids store. Labor costs consists of 3 staff who are budgeted to work 2,500 seconds per year at a budgeted pay rate of $12 per hour, thus the total budgeted stab costs of $ 90,000 (= 3 x $12 x 2,500). Through his careful scheduling of staff, and his effective management style, Dave was able to save labor metre so that each(prenominal) of the three employees worked solitary(prenominal) 2,250 hours in 2010.Other expenses include training ex penses each staff employee is expected to call for at least 6 hours of training at the PG&C headquarters during the year the local store is charged $250 per hour for this training. The local store manager determines the amount of training time for each staff. Other expense also includes advertising expense, which is controlled by the local managers PG&C recommends that advertising should be about 1% of total sales. Service development is the cost of instructing new wares for use in he stores and for the study of potential new ways to improve the services provided at PG&C stores. Service development is charged to each store based on the allocation rule of 10% of store sales. Accounting, insurance costs, taxes, and management bash (which includes store rent and managers pay) are stipendiary at the home office of PG&C and are allocated based upon a radiation pattern which combines store size, store sales, and the age of the store. Employee benefits accrue to staff at the rate of 20% of total pay. These benefit payments are contri saveed to a 401(k)-type retirement plan for each employee.The go away of Davids promotional price for the Tuesday-Thursday period was successful, as total sales increase from 10,000 to 10,500 and the Tuesday-Thursday sales increased from 20% to 30% of total sales. Required From David Greens perspective, develop an analysis which explains your performance for the year ended December 31, 2010. pic 14-1 threadbare be IS ALIVE AND WELL AT PARKER BRASS by David Johnsen and Parvez Sopariwala Many flock assimilate condemned standard costing, saying it is irrelevant to the current just-in-time based, fast-paced business environment. further surveys consistently show that most industrial companies in the United States and abroad1 restrained use it. Apparently, these companies retain successfully adapted their standard costing systems to their special(a) proposition business environments. In addition, many another(prenom inal) academics set about contributed ideas on how the standard costing system could be and has been do more responsive to the needs of companies operating in this new economy. 2 The Brass Products Division at Parker Hannifin Corporation (here after(prenominal), Parker Brass), a world-class manufacturer of tube and brass fittings, valves, hose and hose fittings, is one of the tandard costing success stories. It operates a well-functioning standard costing system of which we will show you some highlights. WHATS SPECIAL ABOUT THE STANDARD COSTING SYSTEM AT PARKER BRASS? Parker Brass uses its standard costing system and variance analyses as important business managewisels to can job areas so it can develop solutions for unbroken improvement. Here are some examples of these standard costing- cerebrate withalls (Disaggregated product line information. Parker Brass has been divided into Focus affair Units (FBUs) along product lines.Earnings statements are developed for each FBU, and variances are shown as a per centumage of sales. If production variances exceed 5% of sales, the FBU managers are require to provide an explanation for the variances and to put together a plan of satisfy to correct the sight problems. To succor the turn, a dress accountant has been delegate to each FBU. As a result of these steps, each unit is able to take a much more proactive approach to variance analysis. ( Timely product cost information.In the past, variances were inform but at calendar month-end, but often a particular job already would have been off the shop floor for three or more weeks. Hence, when management questioned the variances, it was withal late to review the job. Now exception reports are generated the day after a job is closed (in other words, the day after the termination part has been manufacture). Any jobs with variances greater than $1,000 are displayed on this report. These reports are distributed to the managers, planners or schedulers, and p lant accountants, which permits people to ask questions while the job is still snotty-nosed in everyones mind. Timely corrective action. Because each job is costed (in other words, transferred out of Work-in-Process and into absolute Goods) 10 days after the job has closed, there is adequate time for undeniable corrective action. For example, investigating a galactic textile standard variance tycoon reveal that certain bad finished parts were not include in the final draw and quarternel of finished parts. Such timely information would allow management to decide whether to rework these parts or to increase the size of the next job.This chassis of corrective action was not possible when variances were provided at the end of each month. (An effective control system. Summary reports are run weekly, beginning the second week of each month, to show each variance in total dollar marks as well as each variance by product line and each the great unwashed within the product line. In addition, at the end of each month, the database is updated with all variance-related information. As a result, FBU managers can review variances by part number, by job, or by high dollar script. (Employee training and empowerment.Meetings are held with the hourly employees to explain variances and earnings statements for their FBU, thereby creating a more positive atmosphere in which the FBU team can work. These meetings help employees understand that management decisions are based on the numbers discussed and that if foolish data are put into the system, then erroneous decisions whitethorn be do. For example, a shape whitethorn not be running efficiently. An wheeler dealer may clock off of the job so that his or her efficiency does not look bad. Because the works efficiency is not adversely impacted, no FIGURE 1 adorn A THE FACTS sample production in 1 hour (units) 50 stock(a) batch criterion (units) 2,000 stock(a) hours requisite for 2,000 units 40 mensurat ion time need for 1 doup (hours) 4 Standard labor rate per hour $10 substantial measurement get downd (units) 1,200 Actual modelup hours for 1 setup 4 Actual productive labor hours to make 1,200 units 24 Actual labor cost for 28 hours at $10 per hour $280 add-in B WORKINGS Setups Production Total Standard time per unit Standard setup time ( hours) 4 Standard production time (hours) 40 Standard batch size (units) 2,000 2,000 Hence, standard time per unit (hours) 0. 002 0. 020 0. 022 Standard time charged for 1,200 units Standard time per unit (hours) 0. 002 0. 020 0. 22 of units actually produced 1,200 1,200 1,200 Standard time charged (hours) 2. 40 24. 00 26. 40 PANEL C SOLUTION If SRQV is determined, the ledger accession would be Work in process (26. 40)($10) $264 SRQV (4. 00 2. 0)($10) $16 Accrued payroll $280 If SRQV is not determined, the journal door would be Work in process (26. 40)($10) $264 LEV 28. 00 (1 . 20 0)(0. 022)$10 $16 Accrued payroll $280 maintenance is done to that instrument, and the inefficiency continues. In addition, because the street girl is not charging his/her cost to a job, the cost is being include in indirect labor, and manufacturing costs increase.If the operator had reported the hours correctly, management would have questioned the problem, and the railway car would have been doctor or replaced based on how severe the problems were. WHAT NEW discrepancyS HAS PARKER BRASS DESIGNED? In addition to the aforementioned innovations that Parker Brass has made to adapt its standard costing system to its particular business environment, the company has created the following new variances (The standard-run quantity variance to explain situations where the size of a lot is slight than the optimum batch quantity. (The somatic electrical switch variance to evaluate the feasibility of alternative raw materials. ( The method variance to assess situations where differ ent machines can be used for the same job. THE STANDARD RUN QUANTITY divergencyThe standard run quantity variance (SRQV) represents the amount of setup cost that was not vulcanised because the batch size was smaller than the earlier determined optimal batch size. Because setup costs are included in the standard labor hours for a standard batch quantity is likely to create an reproachful labor efficiency variance (LEV). Unless, FIGURE 2 PANEL A THE FACTS Standard price per shell of material Ml $10 Standard price per pound of material M2 $11 Standard material quantity (Ml & M2) to make blow units (lbs. 2 Actual quantity produced (units) 2,000 Actual pounds of M2 purchased and used 43 PANEL B WORKINGS Standard quantity to produce 2,000 units Standard material quantity to make degree centigrade units (lbs. ) 2 Actual quantity produced (units) 2. 00 Hence, standard quantity to produce 2,000 units 40 PANEL C SOLUTION If MSV is determined, the journal intromissi on would be Work in process (40. 00)($10) $400 MEV (43. 00 40. 00)($11) $33 MSV (40. 00)($11 $10) $40 stuffM2 (43. 0)($11)1 $473 If MSV is not determined, the journal entry might be Work in process (40. 00)($11) $440 MEV (43. 00 40. 00)($11) $33 MaterialM2 (43. 00)($11) $473 owever, the impact of actual production inefficiencies is separated from setup-related inefficiencies, the LEV glistens the combine impact of these two causes of inefficiencies and is not sincerely useful for taking the necessary corrective action. See discover 1 for an illustration of this issue. dialog box A shows that standard batch quantity is 2,000 units, the standard production during one hour is 50 units, and, hence, 40 standard hours are needed to produce 2,000 units. In addition, it takes four standard and actual hours to set up one batch. beautify B reveals that standard hours for setup and production labor are 0. 002 and 0. 020 per unit, respectively, for a total of 0. 022 per unit.In addition, because actual quantity produced is 1,200 units, the total standard hours chargeable to these 1,200 units is 26. 40 (0. 002 + 0. 020)(1,200). Finally, panel C shows the recommended journal entry whereby an SRQV is created. This SRQV represents the unrecovered setup costs because 1,200 units were manufacture sort of of the standard batch quantity of 2,000 units. Thus, because the company expected to overstep $40 (4 hours)($10 per hour) on each setup, the setup cost relating to the 800 (2,000 1,200) units not produced, or $16 U, is considered an invidious SRQV or the cost of producing small lots. On the other hand, employ traditional standard costing, this amount of $16 U would most likely have been categorized as an LEV.Yet there really is no LEV,3 and the variance of $16 U attributed to labor efficiency is moreover the unabsorbed portion of the setup cost attributable to the 800 units that were not produced. The advantages of extracting the standa rd run quantity variance are many. First, the SRQV ordinarily would be included in the LEV and could provide a misleading impression of labors efficiency. Second, because just-in-time practices recommend smaller lots and minimal finished goods armory the SRQV is inheringly the cost of adopting JIT Third, to the extent that setup cost and the cost of carrying memorial are competing undesirables, a determination of the cost of small lots could be used in the trade-off analysis against the cost of h olding and carrying inventories.Finally, to the extent that this variance can be separated for each customer, it would reveal how much of a expiry was suffered by allowing that customer to purchase in small lots. Such information could be used in next bids. If a customers schedule demand a smaller lot, then that customers job cost could be enhanced conquerly. THE MATERIAL SUBSTITUTION VARIANCE The material substitution variance (MSV) assumes gross(a) or near perfect substitutability of raw materials and measures the loss or gain in material costs when a different raw material is substituted for the material designated in the job sheet. Substitutions may be made for many campaigns. For example, the designated material may not be available or may not be vailable in small- sufficient quantities, or the company may want to use up material it purchased for a product that it has since discontinued. The usefulness of MSV is discussed in invention 2. Panel A shows that both materials, M1 and M2, can be used to manufacture a product, and it is assumed that two pounds is the standard input per unit for both materials. Material M1 is the material designated in the job sheet, but material M2 can be substituted for M1. The standard cost of M2 ($11 per lb. ) is higher than that for M1 ($10 per lb. ), and M2 is used because M1 is presently not available and a valued customer needs a rush job. 4 Panel B reveals that the standard quantity needed to manufacture 2,000 units i s 40 lbs.For the purposes of this illustration, we assume that material price variance (MPV) is detected when material is purchased (in other words, the material account is maintained at standard cost). Hence, Panel C reveals the recommended journal entry whereby MSV is created. The MSV represents the benefit obtained by modify a more expensive material (M2) for the less expensive material (M1) and hence represents the loss through substitution. The MSV is $40 U because (1) 40 lbs. is the standard quantity of M1 and M2 needed to manufacture 2,000 units, and (2) M2 costs $1 more per lb. than M1. In addition, the material efficiency variance (MEV) is $33 U because 43 lbs. instead of the standard quantity of 40 lbs. ere used to manufacture 2,000 units. In contrast, the traditional standard costing system might ignore the substitution, and the job might be charged with the standard cost of victimisation 40 lbs. of M2. In that scenario, the job would cost $40 more and could have an imp act on customer profitability analysis even though the customer did not request the substitution. Now Parker Brass is evaluating an extension that would be to relax the simplifying self-confidence that both materials require the same standard input. See assure 3. It adopts the facts from Figure 2 except that 1. 9 lbs. of material M2 are required for 100 units instead of 2 lbs. for both materials in Figure 2.In this situation, we have two MSVs, one for the price impact called MSV-Price and the other for the efficiency impact, called MSV- ability. Panel C shows the recommended journal entry whereby two MSV variances are created. First, MSV-Price is admonitory because M2, a more expensive material, is being substituted for M1. As a result, MSV-Price is $40 U as material M2 costs $1 more per lb. than material M1. On the other hand, as you might expect, the MSV-Efficiency is favorable because only 1. 9 lbs. of M2 are required to make 100 units as compared to 2 lbs. required for M1. T hus, MSV-Efficiency is $22 F because each batch of 100 units requires 38 lbs. of M2 against 40 lbs. of M1. The net result of the MSV variances is $18 U (38 lbs. )($11) (40 lbs. ($10), suggesting that, barring any other complications, the substitution of M2 for M1 is not likely to be profitable under existing circumstances. Finally, the MEV using material M2 is $55 U, reflecting the fact that 43 lbs. of material M2 actually were used whereas only 38 lbs. of material M2 should have been used. This variance could have been caused by the fact that M2 was a new material and required initial information and other nonrecurring costs. In such a case, the standard quantity of 38 lbs. for 2,000 units may not need to be changed. On the other hand, the MEV variance may have been caused because of the inherent difficulty in working with material M2. In such a case, the standard of 38 lbs. for 2,000 units may need to be amended.In contrast, as was shown in Panel C of Figure 2, the journal entry that is likely to be made using traditional standard costing would completely ignore the impact of material substitution and would likely expatiate the cost of this particular job. The advantages of extracting the MSV are as follows. First, determining MSV lets the company doom the MSV cost to a customer whose rush job may have required using a more expensive material like M2. On the other hand, the MSV could be written off if the substitution were made to benefit the company. Also, creating an MSV and breaking it up into its price and efficiency components allows the company to evaluate whether the substitution of M2 for M1 is a profitable one.While all these calculations can also be performed off the accounting system, creating the MSV makes the process a part of the system so a history of such evaluations is available for future reference. METHOD VARIANCE A method variance occurs when more than one machine can be used to manufacture a product. 5 For example, a plant may have n ewer machines that it normally would expect to use to manufacture a product, so its standards would be based on such new machines. Yet the same plant may also keep, as backups, older and less efficient machines that also could manufacture the same product but would require more inputs in the form of machine and/or labor hours. For this example, we assume that labor hours and machine hours have a 11 relationship. 6 As FIGURE 3 PANEL A THE FACTS Standard price per pound of material M1 $10 Standard price per pound of material M2 $11 Standard material quantity of M1 to make 100 units (lbs. ) 2 Standard material quantity of M2 to make 100 units (lbs. ) 1. Actual quantity produced (units) 2,000 Actual pounds of M2 used 43 PANEL B WORKINGS Material M1 Material M2 Standard quantity to produce 2,000 units Standard material quantity for 100 units (lbs. ) 2 1. Actual quantity produced (units) 2,000 2,000 Hence, standard quantity to produce 2. 000 units 40 38 PANEL C SOLUT ION If MSV is determined, the journal entry would be Work in process (40. 00)($10) $400 MEV (43. 00 38. 00)($11) $ 55 MSV-Price (40. 0)($11 $10) $ 40 MSV-Efficiency (40. 00 38. 00)($11) $ 22 MaterialM2 (43. 00)($11) $473 If MSV is not determined, the journal entry might be Work in process (38. 0)($11) $418 MEV (43. 00 38. 00)($11) $55 MaterialM2 (43. 00)($11 ) $473 a result, the method variance becomes pertinent because the traditional LEV from operating the older machines could potentially include the following two impacts. First, an older machine may need additional labor hours to perform the same task, and the additional hours would be reflected in the LEV. Second, the LEV would include the workers efficiency or overleap thereof on the older machine.We evaluate the usefulness of the method variance in Figure 4. Panel A shows that both machines, A and B, can be used to manufacture a product. Machine A is the more efficient machine and the one used f or setting the standard time. Machine B is the backup. Panel B shows that the standard machine hours needed to produce 1,800 units are 30 on machine A and 36 on machine B, which can be compared to the 35 hours actually used to manufacture 1,800 units on machine B. Panel C of Figure 4 reveals the recommended journal entry whereby a method variance is created. This method variance represents the loss incurred by change the backup machine B for machine A.Because machine Bs standard of 36 labor hours is greater than machine As standard of 30 hours, there is an inauspicious method variance of $long hundred. On the other hand, because machine B took 35 hours to manufacture 1,800 units instead of its standard of 36 machine hours, there is a favorable LEV of $20. As you can see, while there was a loss incurred by using machine B instead of machine A, the actual usage of machine B was efficient. In contrast, assuming the traditional costing system recognizes that machine B was used, it is likely to charge the job $720 (36 hours) x ($20 per hour) instead of the $600 (30 hours) x ($20 per hour) that would have been charged if machine A had been used. Here are the advantages of extracting the method variance.First, the impact of the method variance ordinarily would be included in the LEV and would provide a misleading impression of labors productivity. Second, the method variance could be used to isolate the additional cost that was incurred during the year by operating machine M2. This could permit a trade-off amongst purchasing a new machine FIGURE 4 PANEL A THE FACTS Machine A standard time needed for one unit (minutes) 1. 0 Machine B standard time needed for one unit (minutes) 1. Labor rate per hour $20 Actual quantity produced (units) 1,800 Actual labor hours used to make 1,800 units using machine B 35 Actual labor cost $700 PANEL B WORKINGS Machine A Machine B Standard hours needed for 1. 800 units on Standard time needed for one unit (minutes) 1 . 0 1. Actual quantity produced (units) 1,800 1,800 Hence, the standard hours needed 30 36 PANEL C SOLUTION If method variance is determined, the journal entry would be Work in process (30. 00)($20) $600 Method variance (36. 00 30. 00)($20) $120 LEV (36. 00 35. 0)($20) $ 20 Accrued Payroll $700 If method variance is not determined, the journal entry might be Work in process (36. 00)($20) $720 LEV (36. 00 35. 0)($20) $ 20 Accrued Payroll $700 and continuing to maintain the older machine, especially if lactating delivery schedules are not the norm. Finally, the product cost would still be based on the standards for the more efficient new machine, and the job would not be charged a higher cost merely because a less efficient machine was used. That means a job that was spotless on the older machine would not be penalized. 7 RELEVANT, not IRRELEVANT As you can see from the Parker Brass examples, standard costing has not become irrelevant in the new rapid- paced business environment.Parker Brass not only has managed to modify its standard costing system to get hold of disaggregated and timely cost information for timely corrective action, but it has also designed additional variances to determine how setup time relating to small batches should be absorbed, whether an alternative raw material is economically feasible, and how a products cost might reflect the use of alternate production facilities. 1Studies describe on the widespread use of standard costing in the U. S. , the U. K. , Ireland, Japan, and Sweden are summarized by Horngren, Foster, and Datar on page 225 of the 9th edition of their cost accounting text published by Prentice-Hall in 1997. 2C. Cheatham, Updating Standard Cost Systems, ledger of Accountancy, December 1990, pp. 57-60 C. Cheatham, Reporting the Effects of Excess Inventories, Journal of Accountancy, November 1989, pp. 131-140 C. Cheatham and L. R.Cheatham, Redesigning Cost Systems Is Standard Costing Obsolete , Accounting Horizons, December 1996, pp. 23-31 H. Harrell, Materials variability Analysis and JIT A fresh Approach, Management Accounting, May 1992, pp. 33-38. 3The standard production hours needed for 1,200 units were 24 (1,200) x (0. 020), whereas the actual labor hours used have been intentionally set at 24. In addition, the standard and actual labor hours for one setup have been intentionally set at four. 4An alternative scenario could have the cost per pound of M2 ($9 per lb. ) being lower than that for M1 ($10 per lb. ) because M2 is used to manufacture other products as well and the company obtains quantity discounts for large purchases of M2. To a express mail extent, the rationale behind the method variance is similar to that for the material substitution variance (MSV) discussed earlier. 6That is, the machine does not work independent of the worker. Hence, the labor hours washed-out on the machine are the same as the number of hours the machine was operated. 7A similar reasoning is applied in situations wherein the routing for the manufacture of a product is amended during the year, possibly because the customer wants an additional processing step. In such a case, the resulting process variance could be charged to the customer. 14-2 Redesigning Cost Systems Is Standard Costing Obsolete? By Carole B. Cheatham and Leo B. Cheatham, Professors at Northeast Louisana University.SYNOPSIS Since the early 1980s standard cost systems (SCSs) have been under attack as not providing the information needed for advanced manufacturers. In spite of its critics, SCSs are still the system of choice in some 86 portion of U. S. manufacturing firms. This paper discusses the criticisms of SCSs that (1) the variances are obsolete, (2) there is not provision for continuous improvement, and (3) use of the variances for responsibility accounting result in inner conflict quite an than cooperation. Updates for SCSs in the form of designed variances, suggestions for dynam ic standards, and re think responsibility and reporting systems are presented. The compatibility of SCSs and its main competitor as a cost system, activity-based costing (ABC), is examined.The authors discuss when it is appropriate to use ABC or SCS or some combination of the two. Since Eli Goldratts (1983) charge that cost accounting is the number one enemy of productivity in the early 1980s, traditional cost systems have been under attack. Although Goldratt by and by softened his stand to say that cost quite than accounting was the culprit (Jayson 1987), others were quick to jump on the bandwagon to condemn the cost systems in use. rude(a) systems were proposed of which the most popular was activity-based costing (ABC). In spite of all the criticism, a 1988 survey shows 86 percentage of U. S. manufacturers using standard cost systems (Cornick et al. 988). A survey by Schiff (1993) indicates that 36 percent of companies use activity-based costing, but only 25 percent of those use it to replace their traditional cost system. It would wait that only about 9 percent (25 percent of the 36 percent) of companies are using ABC as their main system while the coarse majority use a standard cost system (SCS). This is not to say that traditional SCSs could not benefit from being updated. However, accountants in fabrication (as well as academia) seem unaware that a redesigned SCS can provide the information they need, and that updating their present system is an easier process than adopting a new system.The SCS is one vehicle of articulation among managerial, financial and operations accounting, and it is a control system while the candidates for its replacement typically are only cost accumulation systems. In this article the major criticisms of SCSs are examined along with ways that the weaknesses can be remedied or ameliorated. The criticisms relate to the use of specific variances, the lack of provision for continuous improvement, and the fact that administr ation of the system results in internal competition rather than cooperation. The appropriate use of ABC systems in conjunction with SCSs is also discussed. UPDATING THE VARIANCES IN AN SCSConcerning the variables analyzed in an SCS, most criticisms relate on the overemphasis on price and efficiency to the exclusion of quality. Other criticisms focalise on the use of the volume variance to measure utilization of content while ignoring overproduction and unnecessary buildups of inventory. In making such charges, critics emit to realize variance analysis is not locked-in to a particular set of variables. Standards are only benchmarks of what performance should be. The particular variables used can be changed as the need arises. The following discussion focuses on concerns of the new manufacturing environmentraw material ordering and inventory levels, quality, production levels, finished goods inventory levels and completion of sales orders.random variables Pertaining to nude Mater ials The set of variances in Figure 1 centers on the function of raw material ordering and inventory levels (Harrell 1992). The defenseless Material Ordering Variance gives information about the effectiveness of suppliers. It contrasts the raw materials ordered with the raw materials delivered (purchased). Any variation may be considered unfavorable because the closing is to have orders delivered as placed. Too much delivered will result in unnecessary buildups of raw material stocks. Too little delivered is unfavorable because production stops may result. The Price Variance in Figure 1 is the traditional price variance computed on materials purchased.This variance has been criticized on the grounds that over-emphasis on price leads purchasing managers to ignore quality. However, price is a sure concern that should not be overlooked. This system also uses a role Variance (presented in a following section). If low quality materials are purchased in order to gain a low price, th is will result in an unfavorable Quality Variance. Variances Pertaining to Material Inventories and Efficient Use The set of variances in Figure 2 focuses on raw material inventory levels and quantity or efficiency of material use. The Raw Materials Inventory Variance (Harrell 1992) shows either more material purchased than used (an inventory buildup) or more material used than purchased (an inventory decrease).With the JIT philosophy, purchasing more than used causes an unfavorable variance, while decreasing precedent buildups causes a favorable variance. The Efficiency Variance in Figure 2 is based on the balance mingled with the actual pounds of material used and the standard amount for total production. The traditional Efficiency or Quantity Variance is the difference between the actual pounds of material used and the standard amount for good production. The traditional variance is actually as combination of quality and efficiency factors. As can be seen in the next section, quality is better treated in a separate variance. Variances Pertaining to Production Levels and QualityThe next set of variances (Figure 3) turns from input analysis to output analysis and relates to production levels and quality. All cost factors are included in the standard cost per unit including labor and overhead. The Quality Variance is the standard cost of units produced that did not meet specifications (the difference between total units produced and good units produced). In traditional variance analysis, this variance is buried in the efficiency variances of the various inputs. Ignoring labor and overhead, suppose a company used two pounds of material per finished unit at a standard cost of $1. 00 per pound. Further assume they used 4,900 pounds in the production of 2,500 total units, of which 100 were defective.Traditional variance analysis would show an unfavorable Efficiency Variance of $100 computed on the difference between the standard cost of the 4,800 pounds that sh ould have been used to produce the 2,400 good units and the 4,900 pounds actually used. A better breakdown of the traditional variance shows a favorable Efficiency Variance of $100 and an unfavorable Quality Variance of $200. The Production Department did use only 4,800 pounds to produce 2,500 units that should have taken 5,000 pounds. The fact that some of these units were defective should come to the fore as a Quality Variance, as it does in this analysis. The Quality Variance is $200 unfavorable representing $2. 00 per unit invested in 100 defective units.This analysis also yields a Production Variance based on the difference between the standard cost of good units produced and the plan amount of production. The goal in advanced manufacturing environments is to produce exactly what is needed for sales orders (scheduled production). A variance from scheduled production either way is unfavorable because too much production results in unnecessary buildups of inventory while too li ttle results in sales orders not filled. As is the case with the Raw Material Inventory variance, the critical factor is the cost of the capital invested in excess inventories. It is desirable to highlight this cost in responsibility reports by applying a cost of capital figure. o the excess (Cheatham 1989). For simplicitys sake, the above illustrations of input analysis pertain to materials. Labor and volume-related variable overhead can be analyzed in a similar manner. Since there is no difference between labor purchased and labor used in production, the labor input variances would include the traditional Rate Variance and the updated Efficiency Variance. Other than showing a budget variance for the various elements of fixed overhead, there is no point in further analysis in terms of a Volume Variance. The updated Production Variance serves the same purpose in a far better fashion. VARIANCES PERTAINING TO SALES ANALYSISThere are various ways to analyze sales. One method is to use price, mix and volume variances. A further analysis is to break down the volume variance into market size and market share variances. The analysis in Figure 4 is presented because it articulates well with the output analysis for production. The sales variances indicate customer service as well as the cost of lost sales. The variances use budgeted contribution margin as a measure of opportunity cost. The Finished Goods Variance indicates the opportunity cost associated with orders completed but not shipped. A delay in shipment causes a loss because of subsequent delay in receiving payment.The Sales Order Variance represents the opportunity cost associated with sales orders that could not be filled during the time period for whatever reasonlack of capacity, scheduling problems, etc. The above discussion presents a concoction of variances that are not used in a traditional standard cost system. The variances can be used for control purposes alone or can be integrated into the financi al accounting records (Cheatham and Cheatham 1993). The system is not intended to be a generic solution for any companys needs. It is intended to demonstrate that, with a little creativity, it is possible to redesign SCSs to measure variables that are important to a particular company in todays manufacturing environment. UPDATING THE SCS FOR CONTINUOUS IMPROVEMENTIn a manufacturing environment in which continuous improvement is a goal of most companies, the charge has been made that SCSs do not encourage positive change. However, static standards based on unioniseing studies or historical data are not an essential part of an SCS. Standards can be adjusted to be dynamic, or changing, by any of several methods. using Prior Periods Results as Standards One way to have dynamic standards is to use brave periods results as standards. This idea has been advocated in the past as a way for small business to have the benefits of standards without the expense of engineering studies (Lawler and Livingstone 1986 Cheatham 1987).The objection can be made that last periods results may not make very good standards if last period was unrepresentative for whatever reason. If this is the case, last periods results can be modified. Another variation on using past performances as standards is the use of a base period. Comparisons can be made with the base period and all subsequent periods, if desired. Boer (1991, 40) describes a system of using a base year as a pseudo flexible budget from which unit costs are developed. He comments that the system encourages continuous improvement and never implies that a level of performance is adequate. Instead, it encourages managers to improve continuously. subdued another variation on using preceding periods results as standards is the use of best performance-to-date (BP).BP is a rigorous standard for self-reformation because it motivates workers as well as managers to exceed all past performance. development Benchmarking Although past performance costs may be used in a variety of ways to formulate dynamic standards, any such system has an inward focus. Benchmarking looks outside the firm to the performance of industry leaders or competitors. Benchmarking typically is applied to performance measures rather than standard costs. However, using the performance of industry leaders as a standard provides pauperization to become world-class in much the same fashion. The primary restraint to use of benchmarking standards is, of course, lack of information. Edward S.Finein (1990), former vice president and chief engineer of Xerox, lists the following sources of information when using benchmarking for performance measures (1) external reports and trade publications (2) superior associations (3) market research and surveys (4) industry experts (5) consultants studies (6) company visits and (7) competitive labs. In the absence seizure of hard information, an approach may be taken to estimate the performance of industry le aders. Trying to meet the supposed standards of industry leaders (or other competitors) can have results that are useful as long as the company is striving toward beneficial goals. Using Moving Costs Reductions Still another way to have dynamic standards is through use of preset cost reductions. Horngren et al. 1994) describe a system of what they call a continuous improvement standard cost or a moving cost reduction standard cost. This system reduces the standard cost by a predetermined piece each time period, such as a one percent reduction in standard cost per month computed by setting the new standard at 99 percent of the previous months standard. The question that their system raises is how to determine the amount of the cost reduction. One possibility is the use of cost improvement curves. Cost improvement curves are a new variation of the old learning curve idea. Learning curves were based on reduction of direct labor costs due to learning by the workers.With a large percen tage of product conversion being brought about by automated equipment rather than laborers, potential cost reductions relate to the experience factor for the organization as a whole which may be measured by cost improvement curves. Pattison and Teplitz (1989) calculate the new rate of learning for an organization that replaces labor with automated equipment as Ratenew = Rateold + (1 Rateold) * L * R where Rateold is the rate of learning for the old system, L is the proportion of learning attributed solely to direct labor give tongue to as a percentage, and R is the proportion of direct labor being replaced. The formula actually reduces the learning rate applicable to labor only, the assumption being that workers can learn but not machinery.An updated version of the formula is needed which encompasses factors such as managers, supervisors and engineers experience. The Japanese stress the formula 2V=2/3C, or if volume is doubled, the cost should be two-thirds of what it was origina lly. This formula equates to a 67 percent learning curve which represents a high degree of learning. However, their placement is that learning does not just happenit should be made to happen. Using Target Costs Another idea borrowed from the Japanese is the use of localise costs based on the market. Target costs are used in Japan primarily for new products that are still in the design order. The idea is to set a cost that is low enough to permit a selling price that is viable on the market.The price is the starting point for calculating costs, and the various costs are sanction out from the price. Typically, the target cost is very low. Hiromoto (1988) describes the use of target costs at the Daihatsu Motor Company. First, a product development order is issued. wherefore an allowable cost per car is calculated by taking the difference between the target selling price and the profit margin. Then each department calculates an accumulated cost based on the standard cost achievable with current technology. Finally, a target cost is set somewhere between the allowable and accumulated cost. All this takes place before the product is designed.The design stage typically takes three years. When the product is finally in production, the target cost is gradually tightened on a monthly basis. later(prenominal) the actual cost of the previous period is used to drive costs down further. Market-based target costs have a strong assembling on a basis for standard costs because they focus on the customer rather than on internal engineering capabilities. However, using target costs is easiest with new products because as much as 90 percent of product costs are set in the design stage (Berliner and Brimson 1988). The way a product is designed determines the way it has to be manufactured and sets the stage for further cost reductions.Standard costs do not have to be static. Dynamic standards can be formulated using a variety of methods including past performance, industry l eaders performance, or target costs based on predetermined reductions or the market. Market-based target costs have the most intuitive appeal because the focus is on the future and on the customer. However, they may work better for new products rather than for open products. UPDATING MANAGEMENT RESPONSIBILITY AND REPORTING Besides revamping the SCS to better reflect todays concerns in terms of variables to be measured and continuous improvement, there needs to be improved reporting of variances.Old reporting systems tended to nourish internal competition and arguments about whose department was to blame for unfavorable variances. There needs to be an attitude of cooperation among workers, managers and departments. Revised lines of responsibility used with new plant layouts are improving some of the competitive attitudes that once prevailed in manufacturing organizations. Plants that used to feature push through production with large spate of raw materials and semi-finished produc t moving from one process to another are changing to work cells or similar arrangements. The work cell arrangement features equipment that can process a product from start to finish. Workers in the work cell typically can operate all or several types of machinery.This leaner pull through approach allows a sales order to be rapidly processed within the work cell which decreases wheel around time and holds work in process and finished goods inventories to a minimum. The work cell arrangement allows a team of workers to be responsible for the consummate product and reduces the likelihood that defects will be passed along to the next department. on with the work cell arrangement many companies are decentralizing functions such as engineering and making these personnel responsible for a particular work area or product line. With the decentralization, there is more focused responsibility. Decentralization and a team approach to production eliminate many conflicts that once existed.In a ddition to the new attitudes about responsibility, there needs to be improved reporting. The variances outlined in this paper can be reported in two types of management reports. The report illustrated in Fig. 5 shows the trade-offs between price, efficiency and quality. This type of report can be done on a plant level or department level as well as a work cell level. The price variance for work cells or departments should be computed on material used rather than purchased because this gives a better picture of the trade-offs involved. Upper-level management reports should probably show both types of price variances if there are significant differences between purchases and use.The report illustrated in Fig. 6 shows the effects of variances related to inventories. Raw material excesses at cost, related to both current and past purchases, are listed along with the related cost of capital. In this case it is assumed the excess was held the entire month and the cost of capital was one p ercent. Work-in-Process excesses are measured in terms of the Production Variance. This variance measures the difference between scheduled and actual production. presumably if there were excesses from the previous month, there was an adjustment made in the scheduled production. Cost of capital figures show the effect of holding these excess inventories.In the case of Finished Goods, the crucial factor is the opportunity cost of sales orders not filled measured by the lost contribution margins. Therefore, if orders are completed but not shipped or there is an inability to fill a sales order because of lack of capacity, this is indicated by the Finished Goods Variance or the Sales Order Variance. The illustration assumes a favorable Finished Goods Variance because more sales orders were filled than units produced, indicating a decrease in previous finished goods stock. Although a reporting system such as that illustrated in Figures 5 and 6 may not eliminate all conflicts, it is certai nly