Transcript T7M3
Slide 1
Standard costs have several advantages. The biggest advantage is that it helps managers put a spotlight on process problems. The use of variances helps pinpoint the process problems location. If the performance reports are timely…like daily or even hourly…problems can be identified and either reduced or fixed avoiding huge monetary losses.
In addition, standards if properly designed and implemented can provide benchmarks for employees to judge their performance. This is consistent with “responsibility accounting”, where standards establish:
§ What costs should be
§ Who should be responsible for the costs
§ If costs are within set parameters
Also, the use of standard costs can simplify general bookkeeping
Slide 2
There are several problems that can pop up when standard costs are used. First, timeliness of performance reports is key if standard costs are to benefit the organization. It does no good to have a variance two months out from when the problem began. Big problems lead to significantly reduced profits. Remember everything that happens on the factory floor winds up on the financial statements which are the ultimate performance measurement for the company.
Employee morale can be reduced if variances are used as weapons and not incentives. Employees might be tempted to disregard safety policies which can lead to adverse outcomes. How management uses performance reports is critical to whether standard costs are a good management tool or a negative one.
Standard costs are not black and white. Sometimes “favorable” variances are not favorable and likewise “unfavorable” variances may not be unfavorable. Common sense needs to be employed. For instance substandard materials may give a favorable price variance but then create unfavorable labor variances or material quantity variances. Or if a product does not hold up under performance could increase warranty costs and decrease customer appeal. All bad things for the bottom line.
Standard costs can pressure managers to build excess inventories in order to stay within certain parameters. Nothing could be worse than tying up cash in inventory as it prevents the cash to be used in other areas where it can generate larger and faster returns. Another poor assumption is that increased labor pace will increase output. If a process is heavily automated decreased man hours may not be a reasonable assumption. Even if an increase in labor pace is possible the increase in inventory as mentioned earlier may not be in the best interest of the organization.
Finally a constant focus on variances may overshadow important objectives or worse problems. Too much focus on one thing can reduce the incentive of employees to reduce waste and abuse particularly if those reductions signal a negative variance.
Slide 3
The use of performance reports is an essential element of “management by exception” which is a management philosophy that is geared towards focusing only on problems of the system while ignoring what is working. For this philosophy to work at its peak, variances or deviations from budget or standards needs to be assessed for materiality. This is where the problem needs to be significant enough to create profit and budgetary problems. Remember no process is static and your variance will not be the same value every time it is measured.
And finally, standard costs are used worldwide. Standard costs where first employed by the Japanese right after WWII and is generally used by organizations within industrialized nations for cost management and budgetary control.