10-1 Management by exception is a managerial technique in which only significant deviations from expected performance are investigated.
10-2 Any control system has three basic parts: a predetermined or standard performance level, a measure of actual performance, and a comparison between standard and actual performance. The system works by making the comparison between actual and standard performance and then taking action to bring about a desired consequence.
10-3 One method of setting standards is the analysis of historical data. Historical cost data provide an indicator of future costs. The methods for analyzing cost behavior described in Chapter 7 are used to predict future costs on the basis of historical costs. These predictions then form the basis for setting standards. Another method for setting standards is task analysis, which is the analysis of a production process to determine what it should cost to produce a product or service. The emphasis shifts from what the product did cost in the past to what it should cost in the future. An example of task analysis is a time-and-motion study conducted to determine how long each step performed by direct laborers should require.
10-4 A perfection (or ideal) standard is the cost expected under perfect or ideal operating conditions. A practical (or attainable) standard is the cost expected under normal operating conditions. Many behavioral scientists question the effectiveness of perfection standards. They feel that employees are more likely to perform well when they strive to achieve an attainable standard than when they strive, often unsuccessfully, to achieve a perfection standard.
10-5 A bank could use standards to specify the required amount of time to process a loan application or process a bank transaction.
10-6 Standard material prices include the purchase price of the material and any transportation costs incurred to obtain the material. The standard quantity of material is the amount required to be included in the finished product plus an allowance for normal waste expected in the production process.
10-7 An unfavorable direct-material price variance means that a higher price was paid for the material than was expected when the standard was set. A favorable variance has the opposite interpretation.
10-8 The manager in the best position to influence the direct-material price variance is the purchasing manager.
10-9 An unfavorable direct-material quantity variance means that a larger amount of material was used in the production process than should have been used in accordance with the standard. A favorable variance has the opposite interpretation.
10-10 The manager in the best position to influence the direct-material quantity variance usually is the production manager.
10-11 The direct-material price variance is based on the quantity purchased (PQ). Deviations between the actual and standard price, which are highlighted by the price variance, relate to the purchasing function in the firm. Timely action to follow up a significant price variance is facilitated by calculating this variance as soon as possible after the material is purchased.
The direct-material quantity variance is based on the amount of material used in production (AQ). The quantity variance highlights deviations between the quantity of material actually used (AQ) and the standard quantity allowed (SQ). Therefore, it makes sense to compute this variance at the time the material is used in production.
10-12 An unfavorable direct-labor rate variance means that a higher labor rate was paid than was anticipated when the standard was set. One possible cause is that labor rate raises granted were above those anticipated in setting the standards. Another possible cause is that more highly skilled workers were used to perform tasks than were required or were anticipated at the time the standards were set. A favorable variance has the opposite interpretation.
10-13 In some cases, the manager in the best position to influence the direct-labor rate variance is the production manager. In other cases, the personnel manager or union negotiator would have greater influence.
10-14 The interpretation of an unfavorable direct-labor efficiency variance is that more labor was used to accomplish a given task than was required in accordance with the standards. A favorable variance has the opposite interpretation.
10-15 The manager in the best position to influence the direct-labor efficiency variance usually is the production manager.
10-16 The issue of quantity purchased versus quantity used does not arise in the context of direct labor, because direct labor is purchased and used at the same time. Unlike direct material, direct labor cannot be purchased and inventoried for later use.
10-17 Several factors that managers often consider when determining the significance of a variance are as follows: size of variance, extent to which the variances are recurring, trends in the variances, controllability of the variances, and the perceived costs and benefits of investigating the variances.
10-18 Several ways in which standard-costing should be adapted in the new manufacturing environment are as follows:
(a) Reduced importance of labor standards and variances: As direct labor occupies a diminished role in the new manufacturing environment, the standards and variances used to control labor costs also decline in importance.
(b) Emphasis on material and overhead costs: As labor diminishes in its importance, material and overhead costs take on greater significance.
(c) Cost drivers: Identification of the factors that drive production costs takes on greater importance in the cost management system.
(d) Shifting cost structure: Advanced manufacturing systems require large outlays for production equipment, which entail a shift in the cost structure from variable costs toward fixed costs. Overhead cost control becomes especially critical.
(e) High quality and no defects: Total quality control programs that typically accompany a JIT approach strive for very high quality levels for both raw materials and finished products. One result should be very low material price and quantity variances and low costs of rework.
(f) Non-value-added costs: A key objective of a cost management system is the elimination of non-value-added costs. As these costs are reduced or eliminated, standards must be revised frequently to provide accurate benchmarks for cost control.
(g) New measures and standards: In the new manufacturing environment, new measures must be developed to control key aspects of the production process. As new measures are developed, standards should be established as benchmarks for performance. An example is the manufacturing cycle efficiency measure, which is defined as processing time divided by the sum of processing time, inspection time, waiting time, and move time.
(h) Real-time information systems: A computer-integrated manufacturing system enables the managerial accountant to collect operating data as production takes place and to report relevant performance measures to management on a real-time basis. This enables managers to eliminate the causes of unfavorable variances more quickly.
10-19 Under a standard-costing system, standard costs are used for product-costing purposes as well as for control purposes. The costs entered into Work-in-Process Inventory are standard costs. From that point forward, standard costs flow through all the manufacturing accounts. When goods are finished, the standard cost of the finished goods is removed from the Work-in-Process Inventory account and transferred to the Finished-Goods Inventory account. When goods are sold, the standard cost of the goods sold is transferred from the Finished-Goods Inventory account to Cost of Goods Sold.
10-20 Advantages of a standard-costing system include the following:
(a) Standard costs provide a basis for sensible cost comparisons. Standard costs enable the managerial accountant to compute the standard allowed cost, given actual output, which then serves as a sensible benchmark to compare with the actual cost incurred.
(b) Computation of standard costs and cost variances enables managers to employ management by exception.
(c) Variances provide a means of performance evaluation and rewards for employees.
(d) Since the variances are used in performance evaluation, they provide motivation for employees to adhere to standards.
(e) Use of standard costs in product costing results in more stable product costs than if actual production costs were used.
(f) A standard-costing system usually is less expensive than an actual- or normal-costing system.
10-21 Seven areas in which operational performance measures are being used are as follows:
10-22 Manufacturing cycle efficiency (MCE) is defined as processing time divided by the sum of the following four items: processing time, inspection time, waiting time, and move time.
10-23 Examples of customer-acceptance measures include the number of customer complaints, the number of warranty claims, the number of products returned and the cost of repairing returned products.
10-24 An aggregate productivity measure is defined as total output divided by total input. Such a measure is limited because it is expressed in dollars, rather than in physical attributes of the production process, and it is too highly aggregated. A preferable approach to productivity measurement is to record multiple physical measures that capture the most important determinants of a company's productivity.
10-25 Eight criticisms of standard costing in an advanced manufacturing setting are the following:
(a) Variances are too aggregate and too late to be useful.
(b) Variances are not tied to specific product lines, production batches, or FMS cells.
(c) Standard-costing systems focus too much on direct labor.
(d) Frequent switching among products in an FMS cell makes cost standards less appropriate.
(e) Shorter product life cycles mean that individual standards are soon outmoded.
(f) Traditional standard costs are not defined broadly enough to include important costs, such as the total cost of ownership.
(g) Traditional standard-costing systems tend to focus too much on cost minimization, rather than increasing product quality or customer service.
(h) Automated manufacturing processes are highly reliable in meeting production specifications. As a result variances from standards tend to be very small or nonexistent.
10-26 Responses will vary widely on this question. Here are some possibilities for a bank:
• Customer: (a) local market share; (b) number of repeat customers.
• Innovation and learning: (a) new financial products; (b) employee suggestions received and implemented.
10-27 An airline could measure the frequency and cost of customer complaints about lost or damaged luggage. After reducing the number of such incidents, the cost savings could be shared with the relevant employees (e.g., front-counter ticket agents and baggage-handling personnel).