Operational Performance Measurement: Sales and Direct-Cost Variances

Chapter 14 Operational Per trendance Measurement gross revenue and Direct-Cost strains, and the Role of nofinancial Performance Measures Case 14-1 Pet Groom and unclothe society Readings 14-1 exemplificationized Costing Is Alive and Well at Parker insolence by D. Johnsen and P. Sopariwala, trouble account Quarterly (Winter 2000), pp. 12-20. The verbalism Products sectionalisation of the Parker Hannifin familiarity is a stovepipe make outr of tube and brass fittings, valves, hose, and hose fittings. disdain the introduction of popular hot existing arrangings, the mettle Product Division ope deems a surface-functioning meter be arranging. discourse Questions 1. What features in the firms precedent contiguous that micturate it a success? 2. In addition to sports seen in the textbook Parker Brass created several(prenominal) in the raw segmentations. Describe these divisions. Why ar these var. added at Parker Brass? 14-2 Re designinging Cost Systems Is S tandard Costing Obsolete? by Carole B. Cheatham and social lion B. Cheatham, Accounting Horizons ( declination 1996), pp. 23-31. The member evidences some unused ship buttal to analyze normal bell data, going beyond the tralatitious emphasis on swear out be air divisions that focus on set up and expertness. unevennesss for intersection smear quality ar developed and let offed, as considerably as gross revenue variabilitys backside on sales orders received and orders actu tout ensembley shipped. There is also a discussion of how to incorporate activity- ground addressing, and continuous touchst bingle cleansement, including benchmarking and target seting. The main premise of the phrase is that banner hail systems ar the most common bell systems in practice session, and while thither be a number of limitations to these systems, a metric and creative effort arsehole transform them into to a greater extent(prenominal) mapful be systems. Discuss ion Questions 1.What argon the main criticisms of handed-down sample speak to systems? 2. What is meant by compel through with(predicate) crosswayion? Is it preferred to pull through point of intersectionion, and why? 3. What ar the best ways to make exemplar price systems more(prenominal) alive(p)? 4. Considering the suggestions make in this article, in contrast to the chapter representation of regulation exist, which ideas make the most sense to you and why? 14-3 Can Variance psycho abbreviation Make Media Marketing Managers More Accountable? by Ted Mitchell and Mike Thomas, Management Accounting Quarterly (Fall(a) 2005), pp. 51-61.This article discusses, within the context of a merchandise application, an alternating(a) manner for decomposing a summate stock hail partition. The authors postulate that in such applications the fit class (that in conventional utilize is attaind to be low-pitched) ass be signifi empennaget in heart and in that respe ctfore invalidate conventional modes that take on the joint footing- embody mutation as vocalization of the price variableness. However, the treatment proposed by the authors for the joint price-measure departure differs from the three- part consequence found in some cost/managerial business relationship texts. Discussion Questions . relieve what is meant by the full term joint variance as this term is utilize in exemplification cost systems utilise for chink purposes. 2. Explain 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 spurn limit Potential Performance Budget model. How is this concept employed in the variance decomposition process recommended by the authors? 4. What atomic number 18 the primary advantages and primary disadvantages of the variance decomposition model recommended by the authors of this paper? 4-4 Helping Students See the ma n- surfaced Picture of Variance Analysis by Neal VanZante, Management Accounting Quarterly, Vol. 8, No. 3 (Spring 2007), pp. 39-47. This paper presents 2 mannikins that depose be apply to beef up concepts and procedures students pack in text Chapters 14 through 16. The first example, Fernandez alliance, offer be employd as a comprehensive criticism of all three chapters the second example, Roger Company, mickle be used in concurrency with Chapter 14 if additional coverage of the joint price- bar variance for direct fabrics (DM) is desired.The Fernandez Company example requires students to first calculate the total flexible reckon variance (in operate income) for a fulfilment and then sectionalisation this variance into its cistron move ( sell price variance, various cost variances, etc. ). Discussion Questions 1. What is meant by the total operating-income variance for a given accounting period? What alternative names argon in that location to describe this vari ance. 2. What would be a first- train breakdown of the total variance described above in (1)? 3. How can the total flexible-budget variance be broken down (i. . , what are the constituent separate of this total variance)? 4. Explain the total sales record book variance for a period. How can this total variance be decomposed? 5. Explain the meaning of the joint price- amount of money variance that is the grounding for the discussion in the Roger Company shimmy. 14-5 Are first principle 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 provides a life-sustaining digest of several alternative cost systems to tralatitiousistic cost accounting systems.It then evaluates these alternatives in terms of how they ability support, or non, companies that adopt a lean philosophy. An example of nonfinancial exertion indicators that support a lean philosophy is offered in Tables 1 and 2. This discussion in the article of the historical culture of oversight accounting systems reinforces in the minds of students the evolving nature of cost system design as the environment changes, so should forethought accounting systems. (Note this reading could also be used in conjunction with Chapter 15 of the text. ) Discussion Questions . Describe what is meant by the term lean manu concomitanturing. 2. According to the author of this article, what are the primary uses (or roles) of counsel 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 centering accounting systems? 4. Explain the importance of the examples provided in Tables 1 and 2 of this article. 14-1 Pet Groom & Clean (PG) David Green is considering his operating statement for 2010, which is displayed in the table below.David is the manager of entrepot number 88, where he began as maven of the module 6 years ago, and through wakeless turn tail has lift to become manager of the store. The operating report turn ups his budgeted procedure for the year and the echt ensues, launching a net progression of 9% over budget$405. While his results are constructive, 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 single store in a 110 store chain of dearie grooming stores owned by Pet Groom & Clean Company (PG&C).As for other PG stores, his store is open Monday through Saturday individually(prenominal) week the alone service provided at the store is a service in which a pet, dog or cat, is groomed and cleaned, typically while the guest waits. The budgeted price for the service at the beginning of 2010 was $25. Budgeted covariant cost were $2 for genuines and $9 compass cost per servic e, as well as other variable cost of $1. 50 per service. naturals are bribed by local store managers, and all staff are hired and supervised by the local store managers.Other budgeted and essential info for 2010 are shown in the table below. David is an ambitious and hard working manager, who has employ himself to the trade and has looked for several(predicate) ways to attract guests and to compact costs. For example, he noticed that most of the ships conjunctions customers brought their pets in on Friday, Saturday, and Monday, and the number of customers was significantly lower on Tuesday through Thursday. In fact, David budgeted that 80% of total read for 2010 would be in the Friday-Monday period, and only 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 piercing in more business during these three days. Also, noting the strong take up in the Friday-Mo nday period, David decided to add the price during those days from $25 to $30. An experienced manager, David was able to manage grate costs so that staff were not idle, even on dense days David scheduled the number of staff to fill up the expected demand on separately day, and because of his experience (and because his store assistd appointments), his forecast of demand was usually quite accurate.Thus, wear out cost is fairly treated as a variable cost for Davids store. Labor costs consists of 3 staff who are budgeted to work 2,500 duration of days per year at a budgeted right rate of $12 per hour, thus the total budgeted force back costs of $ 90,000 (= 3 x $12 x 2,500). Through his political machineeful scheduling of staff, and his efficient management style, Dave was able to save labor term so that for apiece(prenominal) one of the three employees worked only 2,250 hours in 2010.Other disbursements include training expenses each staff employee is expected to imb ibe at least 6 hours of training at the PG&C headquarters during the year the local store is aerated $250 per hour for this training. The local store manager jells the amount of training prison term for each staff. Other expense also includes advertising expense, which is controlled by the local managers PG&C recommends that advertising should be closely 1% of total sales. Service development is the cost of subject areaing unfermented issues 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 aerated to each store based on the allocation rule of 10% of store sales. Accounting, insurance costs, taxes, and management knock (which includes store rent and managers pay) are paid at the home office of PG&C and are allocated based upon a blueprint 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 contributed to a 401(k)-type retirement devise for each employee.The result of Davids promotional price for the Tuesday-Thursday period was successful, as total sales increased 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 abridgment which explains your performance for the year ended December 31, 2010. pic 14-1 STANDARD COSTING IS ALIVE AND advantageously AT PARKER BRASS by David Johnsen and Parvez Sopariwala Many quite a little train condemned standard costing, wording it is distant to the authentic that-in-time based, fast-paced business environment.Yet surveys consistently show that most industrial companies in the United States and abroad1 still use it. Apparently, these companies collect successfully adapted their standard costing systems to their peculiar(a) business environments. In addition, many academics take in contributed ideas on how the standard costing s ystem 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 (hereafter, Parker Brass), a world-class occasionr 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 forget show you some bring outs. WHATS SPECIAL ABOUT THE STANDARD COSTING system AT PARKER BRASS? Parker Brass uses its standard costing system and variance analyses as big business tools to target problem areas so it can develop solutions for continuous improvement. Here are some examples of these standard costing- referd tools (Disaggregated harvesting line information. Parker Brass has been divided into Focus Business Units (FBUs) along product lines.Earnings statements are developed for each FBU, and variances are shown as a constituent of sales. If labor variances exceed 5% of sales, th e FBU managers are required to provide an score for the variances and to put together a plan of action to correct the detect problems. To help the process, a plant accountant has been assigned to each FBU. As a result of these steps, each social unit of measurement is able to take a much more proactive approach to variance abridgment. ( Timely product cost information.In the wear(prenominal), variances were reported only at month-end, but often a particular melodic phrase already would seduce been off the shop take aback for three or more weeks. Hence, when management questioned the variances, it was too late to review the military control. Now exception reports are generated the day after a job is closed (in other words, the day after the last part has been getd). any jobs with variances greater than $1,000 are displayed on this report. These reports are distributed to the managers, planners or schedulers, and plant accountants, which permits people to ask questions whi le the job is still fresh in everyones mind. Timely corrective action. Because each job is costed (in other words, transferred out of Work-in-Process and into holy Goods) 10 days after the job has closed, thither is adequate time for necessary corrective action. For example, investigating a large textile sum of money variance might reveal that certain defective consummate separate were not included in the final tally of finished parts. much(prenominal) timely information would allow management to decide whether to rework these parts or to increase the size of the next job.This kind 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 dollars as well as each variance by product line and each pile within the product line. In addition, at the end of each month, the database is updated with all variance-relate d information. As a result, FBU managers can review variances by part number, by job, or by high dollar volume. (Employee training and empowerment.Meetings are held with the hourly employees to explain variances and earnings statements for their FBU, thitherby creating a more positive atmosphere in which the FBU aggroup can work. These meetings help employees understand that management decisions are based on the numbers discussed and that if erroneous data are put into the system, then erroneous decisions whitethorn be made. For example, a weapon whitethorn not be running efficiently. An operator may clock off of the job so that his or her skill does not look bad. Because the apparatuss efficacy is not adversely bear oned, no epitome 1 circuit board A THE FACTS Standard return in 1 hour (units) 50 Standard mountain amount (units) 2,000 Standard hours needful for 2,000 units 40 Standard time undeniable for 1 setup (hours) 4 Standard labor rate per hour $10 gen uine measuring stick elevated (units) 1,200 true(a) setup 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 venire B WORKINGS Setups drudgery 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 very produced 1,200 1,200 1,200 Standard time charged (hours) 2. 40 24. 00 26. 40 PANEL C root If SRQV is determined, the diary entry 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 ledger entry would be Work in process (26. 40)($10) $264 LEV 28. 00 (1 . 200)(0. 022)$10 $16 Accrued payroll $280 maintenance is through with(p) to that form, and the inefficiency continues. In addition, because the operator is not charging his/her cost to a job, the cost is cosmos included 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 fixed or replaced based on how severe the problems were. WHAT NEW VARIANCES HAS PARKER BRASS DESIGNED? In addition to the alike(p) innovations that Parker Brass has made to adapt its standard costing system to its particular business environment, the company has created the chase new variances (The standard-run cadence variance to explain situations where the size of a lot is less than the optimal batch quantity. (The hearty substitution variance to evaluate the feasibility of alternative raw textiles. ( The regularity variance to assess situations where different molds can be used for the akin job. THE STANDARD RUN QUANTITY VARIANCEThe standard run quantity v ariance (SRQV) represents the amount of setup cost that was not recovered 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 discriminatory labor efficiency variance (LEV). Unless, FIGURE 2 PANEL A THE FACTS Standard price per nonplus of temporal Ml $10 Standard price per pound of hooey M2 $11 Standard material quantity (Ml & M2) to make c 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 snow 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 daybook entry would be Work in process (40. 00)($10) $400 MEV (43. 00 40. 00)($11) $33 MSV (40. 00)($11 $10) $40 MaterialM2 (43. 0) ($11)1 $473 If MSV is not determined, the diary entry might be Work in process (40. 00)($11) $440 MEV (43. 00 40. 00)($11) $33 MaterialM2 (43. 00)($11) $473 owever, the blow of unfeigned production inefficiencies is separated from setup-related inefficiencies, the LEV consults the combined shock of these two causes of inefficiencies and is not really useful for taking the necessary corrective action. See cipher 1 for an typification of this issue. adorn 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 manufactured instead of the standard batch quantity of 2,000 units. Thus, because the company expected to spend $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 un kind SRQV or the cost of producing small lots. On the other hand, use 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 merely the unabsorbed portion of the setup cost attributable to the 800 units that were not produced. The advantages of extracting the standard run quantity variance are many. First, the SRQV ordinarily would be included in the LEV and could provide a take impression of labors efficiency. Se cond, because just-in-time practices recommend smaller lots and token(prenominal) finished right(a)s ancestry the SRQV is essentially the cost of adopting JIT Third, to the extent that setup cost and the cost of carrying inventory are competing undesirables, a determination of the cost of small lots could be used in the trade-off epitome a clearst the cost of holding and carrying inventories.Finally, to the extent that this variance can be separated for each customer, it would reveal how much of a damage was suffered by allowing that customer to purchase in small lots. Such information could be used in future bids. If a customers schedule required a smaller lot, then that customers job cost could be enhanced letly. THE MATERIAL SUBSTITUTION VARIANCE The material substitution variance (MSV) suck ups perfect 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 i n the job sheet. Substitutions may be made for many reasons. For example, the designated material may not be operable or may not be vailable in small-enough quantities, or the company may want to use up material it purchased for a product that it has since discontinued. The emolument of MSV is discussed in class 2. Panel A shows that two 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 twain 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 currently not available and a valued customer needs a rush job. 4 Panel B reveals that the standard quantity needed to manufacture 2,000 units is 40 lbs.For the purposes of this illustration, we assume that material price variance (MPV) is detected when material is purchased (in other words, th e 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 substituting a more dear(predicate) 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 using 40 lbs. of M2. In that scenario, the job would cost $40 more and could have an impact on customer profitability analysis even though the customer did not request the substitution. Now Parker Brass is evaluating an extension that w ould be to relax the simplifying assumption that both materials require the same standard input. See Figure 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- scathe and the other for the efficiency impact, called MSV-Efficiency. Panel C shows the recommended journal entry whereby two MSV variances are created. First, MSV-Price is unfavorable because M2, a more expensive material, is creation 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. Thus, 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, interdict any other complications, the substitution of M2 for M1 is not likely to be useful 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 learn 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 barrier 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 inflate the cost of this particular job. The advantages of extracting the MSV are as follows. First, determining MSV lets the company assign 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 economic 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 newer machines that it ordinarily would expect to use to manufacture a product, so its standards would be based on such new machines. Yet the same plant may a lso 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 SOLUTION 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 drop 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. cable car A is the more efficient machine and the one used for put the standard time. cable car 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 substituting 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 unfavorable method variance of $120. 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 in the midst of purchasing a new machine FIGURE 4 PANEL A THE FACTS weapon 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 jou rnal 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 proceed to maintain the older machine, especially if tight 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 completed 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 specify its standard costing system to achieve disaggregated and timely cost information for time ly 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 insurance coverage 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 foliate 225 of the 9th edition of their cost accounting text published by Prentice-Hall in 1997. 2C. Cheatham, Updating Standard Cost Systems, Journal of Accountancy, December 1990, pp. 57-60 C. Cheatham, Reporting the effectuate 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 Variance Analysis and JIT A New Approach, Management Accounting, May 1992, p p. 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 limited 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 spent on the machine are the same as the number of hours the machine was operated. 7A similar reasoning is utilise in situations wherein the routing for the manufacture of a product is amended during the year, possibly because the customer wants an additio nal 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 prime(a) 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 internal conflict rather than cooperation. Updates for SCSs in the form of redesigned variances, suggestions for dynamic standards, and refocused responsibility and reporting systems are presented. The compatibility of SCSs and its main competitor as a cost system, activity-bas ed costing (ABC), is examined.The authors discuss when it is appropriate to use ABC or SCS or some gang 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 subsequently softened his stand to say that cost rather than accounting was the culprit (Jayson 1987), others were quick to jump on the bandwagon to condemn the cost systems in use. New systems were proposed of which the most popular was activity-based costing (ABC). In spite of all the criticism, a 1988 survey shows 86 percent 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 whil e the vast majority use a standard cost system (SCS). This is not to say that traditional SCSs could not benefit from being updated. However, accountants in sedulousness (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 spokesperson among managerial, financial and operations accounting, and it is a control system while the candidates for its reliever 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 administration of the system results in internal competition rather than cooperation. The appropriate use of ABC systems in conjunction with SCSs is also discussed. update THE VARIANCES IN AN SCSConcerning the variables canvass in an SCS, most criticisms center on the overemphasis on price and efficiency to the exclusion of quality. Other criticisms center on the use of the volume variance to measure utilization of capacity while ignoring overproduction and surplus buildups of inventory. In reservation such charges, critics fail 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 fiat and inventory levels, quality, production levels, finished goods inventory levels and completion of sales orders.Variances Pertaining to in the altogether Materials The set of variances in Figure 1 centers on the function of raw material ordering and inventory levels (Harrell 1992). The Raw Material influenceing Variance gives informat ion about the effectiveness of suppliers. It contrasts the raw materials ordered with the raw materials delivered (purchased). either variation may be considered unfavorable because the goal 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 delays 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 legitimate concern that should not be overlooked. This system also uses a choice Variance (presented in a following section). If low quality materials are purchased in order to gain a low price, this will result in an unfavorable character reference Variance. Variances Pertaining to Material Inventories and Efficient Use The set of variances in Figure 2 focuses on raw m aterial 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 foregoing buildups causes a favorable variance. The Efficiency Variance in Figure 2 is based on the balance between the actual pounds of material used and the standard amount for total production. The traditional Efficiency or beat Variance is the dissimilitude 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 work outs. As can be seen in the next section, quality is better treated in a separate variance. Variances Pertaining to action 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 should 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 Vari ance of $100 and an unfavorable Quality Variance of $200. The employment 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 appear 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 scheduled 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 little results in sales orders not fill up. As is the case with the Raw Material Inventory variance, the critical factor is the cost of the cracking invested in excess inven tories. 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 people Variance. The updated Production Variance serves the same purpose in a distant better fashion. VARIANCES PERTAINING TO SALES ANALYSISThere are various ways to analyze sales. wiz method is to use price, mix and volume variances. A further analysis is to break down the volume variance into grocery store size and market share variances. The analysis in Figu re 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 encumbrance 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 alter during the time period for whatever reasonlack of capacity, scheduling problems, etc. The above discussion presents a variety of variances that are not used in a traditional standard cost system. The variances can be used for control purposes alone or can be combine into the financial accounting records (Cheatham and Cheatham 1993). The system is not intended to be a generic solution for any companys needs. It is intended to essay 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 engineering 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. use Prior Periods Results as Standards One way to have dynamic standards is to use last 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 whatev er reason. If this is the case, last periods results can be modified. other 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. Still another(prenominal) variation on using prior periods results as standards is the use of best performance-to-date (BP).BP is a rigorous standard for self-improvement because it motivates workers as well as managers to exceed all past performance. Using 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 exterior the firm to the perfor mance of intentness 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 motivation to become world-class in much the same fashion. The primary barrier to use of benchmarking standards is, of course, lack of information. Edward S.Finein (1990), spring 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) professional associations (3) market research and surveys (4) industry experts (5) consultants studies (6) company visits and (7) competitive labs. In the absence of hard information, an approach may be taken to estimate the performance of industry leaders. 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 adept goals. Using Moving Costs Reductions Still another way to have dynamic standards is through use of predetermined cost reductions. Horngren et al. 1994) describe a system of what they call a continuous improvement standard cost or a miserable cost reduction standard cost. This system reduces the standard cost by a predetermined percentage 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 forward months standard. The question that their system raises is how to determine the amount of the cost reduction. One conjecture is the use of cost improvement veers. Cost improvement curves are a new variation of the old study curve idea. Learning curves were based on reduction of direct labor costs due to discipline by the workers.With a large percentage of product conversion being brought about by automated equipment rather than laborers, potential cost reductions relate to the experience factor for the organi zation 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 stated 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 originally. This formula equates to a 67 percent learning curve which represents a high degree of learning. However, their lieu is that learning does not just happenit should be ma de to happen. Using Target Costs Another idea borrowed from the Japanese is the use of target costs based on the market. Target costs are used in Japan chiefly for new products that are still in the design stage. The idea is to set a cost that is low enough to permit a change price that is viable on the market.The price is the starting point for figure costs, and the various costs are backed 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. Then 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 th ree years. When the product is finally in production, the target cost is stepwise tightened on a monthly basis. Later the actual cost of the previous period is used to drive costs down further. Market-based target costs have a strong appeal 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 leaders performance, or target costs based on predetermined reductions or the market. Market-based target costs have the most transcendent appeal because the focus is on the future and on the customer. However, they may work better for new products rather than for established products. UPDATING MANAGEMENT province 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 foster 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 up some of the competitive attitudes that once prevailed in manufacturing organizations. Plants that used to feature push through production with large masses of raw materials and semi-finished product 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 c an operate all or several types of machinery.This leaner pull through approach allows a sales order to be rapidly impact within the work cell which decreases cycle 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 entire product and reduces the likelihood that defects will be passed along to the next department. Along 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 addition 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 tantrum 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 percent. 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 certainly