1. Standards sets based on historical data: Managers set standards by analyzing historical data when the firm has experience in producing certain product. This historical data must be termpered by giving consideration to expected changes in technology, the production process, inflation and other similar factors. Managers also use task analysis to focus on how much a product should cost (e.g., time and motion studies as mentioned earlier in the text).
2. Cross-functional standard setting useful: Knowledgeable people such as engineers, purchasing agents, production supervisors, and accountants should be brought into the standard-setting process. Cross-functional teams are very useful here.
3. Two types of standards: There are two types of standards that may be used: perfection standards and practical standards.

1. Perfection standards assume ideal world: Perfection standards assume that production takes place in the ideal world: employees always work at peak performance, materials are never defective, and machines never break down. Although some managers feel that ideal standards give employees a goal to shoot for, many behavioral scientists feel that setting unattainable goals has a demotivating effect, as employees simply give up trying to reach the standard.
2. Practical standards encourage productivity: In contract, practical standards are set high enough to encourage efficient and effective operations but not so high as to seem impossible. Behavioral scientists feel that practical standards have a more positive effect on the productivity of employees. Also, variances are more meaningful as they represent deviations from a realistic goal.
3. Service firms use standards: For example, McDonald’s restaurants are noted for using standards, not only for quantities of material (amount of beef per burger) but also for the time allowed to serve customers at the drive-in window or counter.

1. Calculating and comparing input: Variance analysis involves calculating the actual amount of input used in manufacturing and comparing it to the amount of input that should have been used. More specifically, the real cost of production is compared to a budget for that level of production (the standard cost allowed for actual output). The variance is then analyzed into its component parts and used to direct attention to deviations from the plan.
2. Standards established: Standards are established for the amount of material required to produce a finished product (the standard material quantity), the anticipated delivered cost of materials (the standard material price), the number of hours normally needed to manufacture one unit of product (the standard direct-labor quantity), and the estimated hourly cost of compensation (the standard labor rate).
3. Formulas for variance calculations for direct material and labor:

DM Price = (AQ Purchased x AP) — (AQ Purchased x SP)

DM Qty. = (AQ Used x SP) — (SQ Used* X SP)

DL Rate = (AQ x AP) — (AQ x SP)

DL Efficiency = (AX x SP) — (SQ* x SP)

* Standard quantity for the actual production level

1. Notice that the price and rate variance use a similar approach, and the quantity and efficiency variances use a similar approach, with efficiency being another way to say "quantity of hours) allowed.

1. Variance Investigation

1. Time restrictions make selective review necessary: A manager does not have time to examine each variance; therefore, he or she must consider selected factors in deciding when an investigation should take place. The factors include one or more of the following:

1. Size of variance: in absolute and/or relative terms, such as "I will investigate every variance more than $6,0000 or 10% of standard cost."
2. Frequency of occurrence: an otherwise small variance may require investigation if it consistently occurs, as it may indicate an ongoing problem in production or an outdated standard.
3. Trends: a small but ever-increasing variance could be a sign of a growing problem.
4. Controllability: it is useless to investigate items over which no control can be exerted.
5. Favorable variances: a manager should investigate both favorable and unfavorable variances. A favorable variance with advertising expense, for instance, could lead to the conclusion that an insufficient amount is being spent on promotion, which could lead to a loss of customers.
6. Costs and benefits: the decision to investigate involves a cost-benefit analysis, as a number of investigative costs are incurred.

1. Statistical control chart: Some companies use a statistical approach to variance investigation by preparing a statistical control chart. Such charts help to pinpoint random and non-random variances, with a statistically determined critical value being compared to a variance to determine whether or not an investigation is warranted.

1. Variances evaluate personnel: Variances may be used to evaluate personnel, often with regard to salary increases, bonuses, and promotions.
2. Negative and positive incentives created: Such incentives can have positive and negative effects, as a bonus plan may prompt a manager to pursue actions that are not in the best interests of the organization.

1. Importance of identifying who controls: It is rare that one person controls any event; however, it is often possible to identify the manager who is most able to influence a particular variance. These managers are often the following:

1. Direct-material price variances: Purchasing manager
2. Direct-material quantity variance: Production supervisor and/or production engineers
3. Direct-labor rate variance: Production supervisor
4. Direct-labor efficiency variance: Production supervisor

1. Variance often affect more than one input: Variances often interact, making investigation and controllability difficult. For example, a labor efficiency variance may be caused by problems not only with labor but by problems with machinery and material as well. In addition, managers sometimes trade-off variances, purposely incurring an unfavorable variance that is more than offset by favorable variances.

1. Standard Costs and Variances

1. Cost flows: In a standard-cost system, costs flow thought the same accounts in the general ledger as shown earlier in the text; however, they flow through at standard cost. In other words, Work-in-Process Inventory, Finished-Goods Inventory, and Cost of Goods Sold are carried at standard cost.
2. Differences recorded in variance accounts: The differences between standard costs and the actual costs incurred are recorded in variance accounts. Unfavorable variances are recorded as debits; favorable variances are recorded as credits.
3. Closed at end of accounting period: Variances are normally closed at the end of the accounting period to Cost of Goods Sold.

1. Advantages: A standard system has several advantages listed below:

1. Sensible method: It provides a sensible method to compare budgeted costs to actual costs at the actual level of output.
2. Management by exception: Managers can practice management by exception.
3. Benchmark for performance: It provides a benchmark for performance evaluation and employee rewards.
4. Stable product cost: Standard costs provide a stable product cost. Actual costs may fluctuate erratically, whereas standard costs are changed only periodically.
5. Less expensive: Standard systems are usually less expensive to operate than actual or normalized systems.

1. Criticisms: Criticisms of standard costing in the new manufacturing environment include:

1. Too aggregated and untimely: Variances are too aggregated and arrive too late to be useful. Variances should focus on activities, specific product lines, production batches, and/or FMS cells.
2. Focuses on less important production factors: Variances focus too much on the cost and efficiency of labor, which is becoming relatively unimportant factor of production.
3. Less stability of manufacturing environment: Standard costs rely on a stable production environment, and flexible manufacturing systems have reduced the stability, with frequent switching among a variety of products on the same manufacturing line.
4. Too focused on costs rather than quality: Standards focus too much on cost minimization and not enough on product quality, customer service, and other contemporary issues.

1. Firms changing: Firms are making changes in their use of standard costing by focusing more on material and overhead costs, using a variety of cost drivers (other than labor hours), having more frequent revisions of standards to reflect an ongoing cut in non-value-added costs, and so forth. See pages 412-413 of the text for a more complete discussion.

1. Increased focus on different performance measures: Companies are now focusing on an increased number of performance measures. These are tied to areas such as raw material and scrap, product quality, productivity, customer satisfaction, and innovation and learning. Specific measures often include:

1. Customer acceptance measures (e.g., customer complaints, warranty claims, and product returns).
2. Delivery cycle time (i.e., the average time between the receipt of a customer order and the delivery of goods).
3. Manufacturing cycle time (i.e., the total production time per unit).
4. Manufacturing cycle efficiency (i.e., processing time divided by the sum of processing time, inspection time, waiting time, and move time.

1. Balanced approach to performance evaluation: The balanced scorecard is a balanced approach to the area of performance evaluation. Employees are evaluated on a series of financial and nonfinancial measures in a variety of areas, namely, financial, internal operations, customer satisfaction, and innovation and learning. The goal is to broaden-out employees so they look at the diverse attributes that are needed to produce a successful, competitive business.

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