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How Standard Costs Are Used by Managers to Help Control Costs

How Standard Costs Are Used by Managers to Help Control Costs

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Published by Aarti Soni

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Published by: Aarti Soni on Oct 07, 2012
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DISPOSAL OF VARIANCE IN STANDARD COSTING:-how standard costs are used by managers to help control costs.Company in highly competitive industries likeFederal Express,Southwest airlines,Dell Computer,Shell Oil,andToyotamust be able to provide high quality goods and services at low cost. If they do not, they willperish. Stated in the starkest terms, managers must obtain inputs such as raw materials and electricityat the lowest possible prices and must use them as effectively as possible - while maintaining orincreasing the quality of the output. If inputs are purchased at prices that are too high or more inputsare used than is really necessary, higher costs will result.How do managers control the prices that are paid for inputs and the quantities that are used?They couldexamine every transaction inStandard Costing and Variance Analysis:After studying this chapter you should be able to:Explain how direct materials standard and direct labor standards are set.Compute the direct materials price and quantity variances and explain their significance.Compute the direct labor rate and efficiency variance and explain their significance.Compute the manufacturing overhead spending and efficiency variance.In this section of the website we studymanagement control and performance measures. Quite often,these terms carry with them negative connotations - we may have a tendency to think ofperformancemeasurementas something to be feared. And indeed, performance measurements can be used in verynegative ways - to cast blame and to punish. However, that is not the way they should be used.Performance measurement serves a vital function in both personal life and in organizations.Performance measurement can provide feedback concerning what works and what does not work, andit can help motivate people to sustain their efforts.In this section we see how various measures are used to control operations and to evaluateperformance. Even though we are starting with the lowest levels in the organization, keep in mind thatperformance measures should be derived from the organization's overall strategy. For example, acompany like Sony that bases its strategy on rapid introduction of innovative consumer products shoulduse different performance measures than a company like Federal Express where on-time delivery,customer convenience, and low cost are key competitive advantages. Sony may want to keep close trackof the percentage of revenues from products introduced within the last year; whereas Federal Express
may want to closely monitor the percentage of packages delivered on time. Later in this section whenwe discuss the balance scorecard, we will have more to say concerning the role of strategy in theselection of performance measures. But first we will see detail, but this obviously would be an inefficientuse of management time. For many companies, the answer to this control problem lies at least partiallyin standard costing system.Definition and Explanation of Standard Cost and Management by Exception:A standard costis the predetermined cost of manufacturing a single unit or a number of product unitsduring a specific period in the immediate future. It is the planned cost of a product under current and /or anticipated operating conditions.A standard is a"benchmark"or "norm" for measuring performance. Standards are found everywhere your doctor, for example, evaluates your weight using standards that have been set for individuals of your age, height and gender. the food we eat in restaurants must be prepared under specified standardsof cleanliness. The buildings we live in must conform to standards set in building codes.Standards arealso widely used in managerial accounting where they relate to the quantity and cost of inputs used in manufacturing goods and producing services.Engineersandaccountantsassistmanagersto set quantityand cost standards for each major input such as raw materials and direct labour time. Quantity standards specify how much of an input should be used tomake a productor provide a service. Cost orprice standards specify how much should be paid for each unit of input. Actual quantities and actualcosts are then compared with these standards. In case of significant deviations managers Investigate the discrepancies. The purpose is to find the problem and eliminate it so that it does not recur. This processis called management by exception.  In our daily lives, we operate in a management by exception mode most of the time. Consider whathappens when you sit down in the driver's seat of your car. You put the key in the ignition, your turn thekey, and your car starts. Your exception (standard) that the car will start is met; you do not have to openthe car hood and check the battery, the connecting cables, the fuel lines, and so on. If you turn the keyand the car does not start, then you have a discrepancy (variance). Your exceptions are not met, and youneed to investigate why. Note that even if the car is started after a second try, it would be wise toinvestigate anyway. The fact that exception was not met should be viewed as an opportunity to uncoverthe cause of the problem rather than as simply an annoyance. If the underlying cause is not discoveredand corrected, the problem may recur and become much worse.This basic approach to identifying and solving problems is exploited in the variance analysis cycle, Thecycle begins with the preparation of standard cost performance reports in the accounting department.These reports highlight the variances, which are the differences between actual results and what shouldhave occurred according to the standards. The variances raise questions. Why did this variance occur?Why is this variance larger than it was last period? The significant variances are investigated to discovertheir root causes. Corrective actions are taken. And then next period's operations are carried out. Thecycle then begins again with the preparation of a new standard cost performance for the latest period.
The emphasis should be on flagging problems for attention, finding their root causes, and then takingcorrective actions. The goal is to improve operations - not to find blame.VARIANCE ANALYSIS CYCLEIdentify Questions
Receive Explanations
Take Corrective Actions
 Analyze VariancesConduct Next Period'sOperations
← ←
Prepare Standard Cost Performance Report
← ←
 BEGINWho Uses Standard Costs?Manufacturing, service, food, and not-for-profit organizations all make use of standards to some extent.Auto service centers likeFirestone andSears, for example, often set specific labor time standards for thecompletion of certain work tasks, such as installing a carburetor or doing a valve job, and then measureactual performance against these standards. Fast-food outlets such asMcDonald'shave exactingstandards for the quantity of meat going a sandwich, as well as standards for the cost of the meat.Hospitals have standards costs (for food, laundry, and other items) for each occupied bed every day, aswell as standard time allowances for certain routine activities, such as laboratory tests. In short, you arelikely to run into standard costs in virtually any line of business that you enter.Manufacturing companies often have highly developedstandard costing systemsin which standardsrelating todirect materials,direct laborand overhead are developed in detail for each separate product. These standards are listed on astandard cost cardthat provides themanagerwith a great deal of  information concerning the inputs that are required to produce a unit and their costs.In Business| Standard Costing at Parker BrassThe Brass Products Division at Parker HannifinCorporation, Known as Parker Brass, is a world-classmanufacturer of tube and brass fittings, valves, hose, and hose fittings. Management at the companyuses variances from its standard costing system to target problem areas for improvement. If aproduction variance exceeds 5% of sales, the responsible manager is required the variance and topropose a plan of action to correct the detected problem. In the past, variances were reported at the

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