Chapter 10: Standard Costs and
Variances
•Control and Performance Measurement
•Benefits of Quantitative Measurement of Performance
•Performance Measurement and Overall Strategy of the
Organization
• Standards
–Quantity Standard
–Cost (price) Standard
•Management by Exception
•Setting Standard Costs
•Ideal Vs. Practical Standard
•General Model for Variance Analysis
Control and Performance
Measurement
• One of the important functions of management is
Control. To do this, performance evaluation or
measurement is a management tool. Performance
measurement is related with personal life as well
as organization.
Example: Feedback on Midterm is important for
further planning for the next evaluation
requirements i.e. and Final. You may have to
concentrate on math practice and/or reading the
text, and/or group study……..
Benefits of Quantitative Measurement
of Performance
• Quantitative measurements of performance
can yield two types of benefits:
1. Performance feedback can help improve
the“production process” through a better
understanding of what works and what does
not. Ex: more skilled laborers may be required.
2. Feedback on performance can sustain
motivation and effort. Ex: an excellent grade in
MT will encourage to keep up the effort.
Achieving the target level sales will motivate
employees to increase the sales volume in the
next quarter.
Performance Measurement and Overall
Strategy of the Organization
• Performance measurement should be related with the
overall strategy of the organization.
• It will vary from organization to organization.
• A company like Sony that bases its strategy on rapid
introduction of innovative consumer products should use
different performance measures than a company like
Federal Express where on-time delivery, customer
convenience, and low costs are key competitive
advantages.
• Sony may want to keep close track of 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.
Standard
• A Standard is a ‘Benchmark’ or ‘Norm’ for
measuring performance.
• We see the use of ‘Standard’ everywhere, in real
life, in business organizations.
• Examples from real life: come to class on time,
put the key in the ignition - the car must start,
return home on time, expected grade is ‘A’.
Standards- Three variable
components of production
• Standards are set for
the price of:
Raw MaterialCost/unit
Labor- Rate/hour
Overhead- Rate/hour
• Standards are set for
quantity/time:
Raw MaterialQty.(pound/feet/ounce) per
unit of FG
Labor-hour per unit of FG
Overhead-hour per unit of
FG
Management By Exception
• A system of management in which standards are
set for various operating activities, with actual
results then compared to these standards. Any
differences that are deemed significant are brought
to the attention of management as “exceptions.”
• If either the quantity or the cost of inputs departs
significantly from the standards, managers
investigate the discrepancy. The purpose is to find
the cause of the problem and then eliminate it so
that it does not recur. This process is called
‘management by exception’
Setting Standard Costs
• Setting Price and Quantity standards require
combined expertise of the following persons:
Accountant
Purchasing Manager
Engineers
Production Supervisors
Line Managers
Production Workers
• In addition past records of purchase price and input
usage can be helpful for setting standards.
Ideal Versus Practical Standards
Standards tend to fall into one of two
categories:
Ideal Standards: Ideal standard can be
attained only under best circumstances.
– No machine break-down
– No work interruption
– Requires most skilled and efficient workers and
employees
– Variances have little meaning and
– Difficult to ‘manage by exception’
Ideal Versus Practical Standards
Practical Standards: Practical standards are
‘tight but attainable’ and allow for:
– Normal machine break-down
– Employee rest period
– Can be attained through ‘reasonable’ efforts by
the average workers
– Variances should be taken care
– Deviations signal need for management’s
attention
Balanced Scorecard
• A Balanced Scorecard (BSC) consists of an
integrated set of performance measures that are
derived from the company’s strategy throughout
the organization.
• A strategy is essentially a theory about how to
achieve the organization’s goal. Example: Faculty
without foreign degree (preferably from USA,
Canada, UK) does not teach at NSU.
• Under the BSC approach, top management
translates its strategy into performance measures
that employees can understand and can do
something about.
Example: In a bank cash counter - Amount of time
customers have to wait.
Common Characteristics of BSC
• Performance measures used in the BSC approach
tend to fall into four groups:
– Learning and Growth: Learning is necessary to
improve internal business processes.
– Internal Business Processes: Improving business
processes is necessary to improve customer satisfaction.
– Customer: Improving customer satisfaction is
necessary to improve financial result.
– Financial: Generating financial resources for its owner
is the ultimate goal of the organizations.
• In BSC approach, continual improvement is
encouraged. In many industries this is a matter of
survival. If an organization does not continually
improve, it will eventually lose out to competitors
that do.
Some Measures of Internal Business
Process Performances
• Delivery Cycle Time: The amount of time from when an
order is received from a customer to when the completed
order is shipped. Cutting the DCT may give a company a
key competitive advantage – and may be necessary for
survival.
• Throughput (Manufacturing Cycle) Time: The amount
of time required to turn raw materials into completed
products. The TP time is made up of process time,
inspection time, move time and queue time.
• Manufacturing Cycle Efficiency (MCE): The MCE is
computed by relating the value added time to the TP time.
The formula is;
MCE = Value added time/TP time
Example: Page # 454 (10th )