W. BentzEMBA 8021 Agenda for October 27, 1999 Comments on Copeland Wellesley Paint Co. Case On measuring capacity Standards for Toledo Tool

W. BentzEMBA 8022 Standard “That which is established by authority, custom, or general consent, as a model or example; criterion; test; in general, a definite level, degree, material, character, quality, or the like, viewed as that which is proper and adequate for a given purpose.”

W. BentzEMBA 8023 Standard “In business, a carefully thought-out method of performing a task, a carefully drawn specification covering material or equipment.” Webster’s New International Dictionary

W. BentzEMBA 8024 Relevance to Standard Costs These dictionary definitions are quite consistent with the salient features of a standard costing system. An important point is to remember that costing systems exist within a management structure, not as independent entities.

W. BentzEMBA 8025 Context Standard costs reflect a comprehensive plan of managing in which studies are used to predetermine the desired magnitude of every expense, performance is compared with these standards, and attention is focused on variances. For simplicity and clarity, performance is expressed in dollars.

W. BentzEMBA 8026 The management cycle Evaluate Plan By identifying important variances from plan--sliced & diced--one can zero in on significant variances. Plan OperateEvaluate

W. BentzEMBA 8027 Objective In developing standard cost systems, the objective is to determine what should be the material, labor and support activity costs of activities, operations, products, and services. The process begins with activity costs.

W. BentzEMBA 8028 Overview of Uses The major uses of standard costs include: –Information for decision-making –Control of costs –Performance measurement –Projection of financial consequences

W. BentzEMBA 8029 Info. for Decision-making C-V-P analysis Product-mix and special-order decisions Pricing and bidding are facilitated by the availability of a file of contemporary standards from which estimates can be developed Outsourcing decisions

W. BentzEMBA Cost Control Standard cost represent desired levels of cost per unit of activity, product or service at the level of operations. Standard costs communicate cost targets for people to use as reference points in their efforts to control costs.

W. BentzEMBA Cost Control vs. Reduction Cost reduction arises from changes in the product, inputs, production processes, or support activities that lead to a reduction in the costs expected. A new cost level is achieved because the cost environment has improved.

W. BentzEMBA Cost Control Cost control, on the other hand, takes place within a production context as it now exists. The objective is to achieve the level of efficiency and cost that is inherent in current operations, inputs, etc. Control means achievement of plan.

W. BentzEMBA Performance Measurement Price and quantity standards represent plans concerning desired cost efficiency under specified conditions. As plans, standards define and communicate to associates the performance expected.

W. BentzEMBA Performance Measurement II Standards serve as benchmarks for use in evaluating relative performance in terms of both efficiency and productivity. Standards help decompose any differences between actual and standard cost by entity, product, activity, territory, market, or responsible party.

W. BentzEMBA Performance Measurement III Performance Measurement III Standard costs facilitate the decomposition of differences between actual and planned costs by nature of the effect: price, quantity, yield, or mix.

W. BentzEMBA Profit Planning The cost information reflected in standards is useful for –Pro-forma financial statements –Cost budgets –Cash budgets –Purchase budgets –Integrated profit plans

W. BentzEMBA Account Structure Integration Standard cost systems can be an integral component of the financial accounting structure, or they can be “off-line,” and independent of the formal account structure. Modern enterprise systems integrate costing systems to better facilitate the full range of benefits of having standards.

W. BentzEMBA Outline of an On-line System Predetermined standard costs are set for each item of expense for each activity Materials and labor are charged to production at standard cost Work-in-process and Finished Goods are priced at standard cost

W. BentzEMBA Outline of an On-line System Variances of actual cost from standard cost are recorded for each element of expense by activity Costs can be tracked by cost centers (responsibility centers) Costs can be monitored by expense category, i.e. direct labor Costs can be monitored by activity or activity type

W. BentzEMBA 80220

W. BentzEMBA One can compare expense categories across cost centers.

W. BentzEMBA Drill-down Sequences Company costs  factory costs  cost center costs  activity costs  activity cost elements  transactions Company variances  factory variances  cost center variances  activity variances  activity cost element variances

W. BentzEMBA Variances in Dollars Reporting variances in dollars is a way to determine the relative importance of diverse variances, and to combine the variances by activity, product, responsible manager, or performance entity. Adding the effects of physical measures would be nonsensical.

W. BentzEMBA What is normal costing? Normal costing refers to the allocation of support costs to production activities based on the level of driver activity volume that is forecast for one or more fiscal years.

W. BentzEMBA Why Normal Costing Represents an attempt to determine the basic cost of making products, excluding seasonal and other transitory effects on cost or volume.

W. BentzEMBA Why Normal Costing A key issue is to isolate the effect of volume changes on unit costs when costs are in line with budget, but volumes differ from projections. This discussion focuses on the volume issues, not cost issues.

W. BentzEMBA Normal Costing Normal activity cost rate = Cost of providing capacity A measure of activity level Issues to resolve: –What measure of capacity –The costs to be included in the “regular” cost of providing capacity.

W. BentzEMBA What Measure of Capacity The issues is to decide the desired level of capacity at which one would consider the level of capacity that must be provided for the production of goods and services with uncertain demand.

W. BentzEMBA What Utilization Rate? Even if the committed resources in the form of facilities and skilled personnel are known for the period, we still have some choices. We still must decide what level of facility utilization to use to calculate support activity rates.

W. BentzEMBA Causes of Unutilized Capacity Errors in predicting demand Long lead times that make forecasting difficult Regulation and capacity regulation (hospitals) Actions of competitors

W. BentzEMBA Break for it!