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Companies already using a standard cost accounting system have a tool at their disposal to drive business performance. There is no need to add costly performance management systems to measure progress toward achieving your strategic goals. When standards are set with the strategic initiatives in mind, variance analysis provides the information to track your progress. Tying incentive pay programs to the variances also focuses management’s attention on achieving the strategic objectives.
Initially, the standard costs need to reflect the strategic initiatives of your company. For example, the strategic planning process results in the anticipation that the direct materials cost can be reduced by 5 percent. This reduction would be reflected in the standard costs by reducing the standard cost of purchased parts by 5 percent. Most accounting systems have a global update procedure that can perform such a function, or the standards could be exported to a spreadsheet or database where a global update could be done and then imported back into the accounting system. Another example would be establishing a goal of a 10 percent increase in efficiency, in which case the hours on routing could be reduced by 10 percent across the manufacturing departments.
For goals to be effective, they must be specific, measurable, attainable, results-oriented and time-based.
Apart from normal budget to actual variance analysis, the performance of key departments like manufacturing and purchasing can be monitored using standard cost variances. To fully benefit from the variances generated in a standard cost environment, the income statement must break out the variances – purchase price variance, inventory adjustments, usage variance, material burden variance, and labor and overhead efficiency and rate variances.
Purchase price variance is the difference between the standard cost and the actual price paid. Usage variance reflects the difference in the amount of raw materials consumed versus what is called for on the bill of material. Any additional usage differences will be caught during cycle counts or the physical inventory and appear as inventory adjustments. The material burden variance would include overhead activities associated with acquiring and handling purchased materials, such as the purchasing department and the receiving department. Efficiency and rate variances often are lumped together in the under/over absorption line on the income statement. To break these out, your accountant will need to use actual hours, standard hours, actual rates and standard rates to compute.
Management’s incentive plans can be set to achieve these goals. The purchasing department could be incentivized to achieve the 5 percent reduction in material cost. Progress toward the goal can be monitored by evaluating the purchase price variance. Likewise, the production management could be incented to achieve efficiency improvements and progress would be monitored by the efficiency variance. In both cases, the cost of attaining these goals could be monitored by looking at the material burden variance and manufacturing rate variances (both labor and overhead variances), which would compare the standard unit cost for these departments to the actual costs incurred.
For goals to be effective, they must be specific, measurable, attainable, results-oriented and timebased. A monthly reporting from your standard costing system provides you with the feedback and monitoring system to judge performance. When the strategic objectives are tied to compensation plans and monitored with a timely reporting system using standard cost, they create a powerful system for achieving your company’s goals.
Questions? Contact:
Partner-In-Charge
Manufacturing and Distribution Services Group
314-290-3391
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or
Partner
Manufacturing and Distribution Services Group
314-290-3220
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