Standard Costs and the Balanced Scorecard

Chapter 10 (Garrison Text)                                                                                                             Dr.M.S.  Bazaz

• A standard is a benchmark or “norm” for measuring performance.
• Both quantity and cost (price) standards are set for major inputs (raw materials, labor, and overhead).
• Actual quantities and actual costs of inputs are compared to these standards.
• Management investigates and focuses on discrepancies (variances).
• This process is called management by exception.
• The purpose is to find the cause of the problem and then eliminate it so that it does not recur.

Setting standards:

• Ideal standards – are those that can be attained only under the best circumstances.  No machine breakdown, and no work interruption are allowed.  Only the most skilled and efficient employees working at peak effort 100% of the time can achieve it.
• May have a motivational value.  Or
• May discourage workers even the good ones.
• Few firms use ideal standards.
• Little meaning of the variances as all would be unfavorable.
• Practical standards – are defined as standards that are “tight but attainable”.
• Allow for normal machine downtime and employees rest periods.
• Variances are very useful to management.
• Serve multi-purposes:
• Signaling abnormal condition
• Used in forecasting cash flow
• Used in inventory planning.

• Standards are almost the same as budgets.  In fact, standard is a unit amount, where as a budget is a total amount.
• Variance Analysis:

• Direct Material Variances:
• Material Price Variance                   = AQ (AP-SP)
• Material Quantity Variance             = SP (AQ – SQ)

Where:          AQ = Actual quantity purchased;   SQ= Standard Quantity
AP = Actual price;                              SP = Standard Price

• Direct Labor Variances:
• Direct Labor Rate Variance            = AH (AR – SR)
• Direct Labor Efficiency Variance  = SR (AH – SH)
• Variable Overhead Variances:
• Variable OH Spending Variance    = AH (AR – SR)
• Variable OH Efficiency Variance  = SR (AH – SH)
• Performance reports starts at the bottom and build upward, with managers at each level receiving information on their own performance as well as information on the performance of each manager under them in the chain of responsibility.  This variance information flows upward from level to level in a pyramid fashion, with the president finally receiving a summary of all activities in the organization.

• Management by exception means that the manager’s attention should be directed toward those parts of the organization where plans are not working out for one reason or another. Time and effort should not be wasted attending to those parts of the organization where things are going smoothly.

• If actual results do not conform to the budget and to standards, the performance reporting system sends a signal to the manager that an “exception” has occurred.  This signal is in the form of a variance from the budget or standards.

• Advantages of Standard Costs:
• As stated above, the use of standard costs is a key element in a management by exception approach.  So long as costs remain within the standards, managers can focus on other issues.  When costs fall significantly outside the standards, managers are alerted that there may be problems requiring attention.  This approach helps manager’s focus on important issues.
• So long as employees view standards as reasonable, they can promote economy and efficiency.  They provide benchmarks that individuals can use to judge their own performance.
• Standard costs can greatly simplify bookkeeping.  Instead of recording actual costs for each job, the standard costs for materials, labor, and overhead can be charged to jobs.
• Standard costs fit naturally in an integrated system of “responsibility accounting.”  The standards establish what costs should be, who should be responsible for them, and whether actual costs are under control.

• Problems with Standard Costs:                              

Most of potential problems from the use of Standard Costs result from  (see page 444,445 of your book for detail):

• Improper use of standard costs.
• Improper application of management by exception principles
• Use of standard costs where they are not applicable.

• Balanced Scorecard  -- consists of an integrated set of performance measures that are derived from the company’s strategy and that support the company’s strategy throughout the organization.

• Performance measure used in the balanced scorecard approach tend to fall into the four groups,  (see Exhibit 10-11 of your book):
• Financial
• Customer
• Internal business processes (what company does to satisfy customers) and
• Learning and growth.
• While the entire organization will have an overall balanced scorecard, each responsible individual will have his or her own personal scorecard as well.

• Manufacturing Cycle Efficiency (MCE)  -- is computed by relating the value-added time to the throughout time:          MCE = Value Added Time / Throughput (manufacturing cycle time)

                                               Delivery cycle time = Wait time + Throughput time
Throughput time = Process time + inspection time + Move time + Queue time

• Through concerted efforts to eliminate the non-value-added activities of inspecting, moving, and queuing, some companies have reduced their throughput time to only a fraction of previous levels.
• By monitoring the MCE, companies are able to reduce non-value-added activities and thus get products into the hands of customers more quickly and at a lower cost.