Study These for the Finals : Poduction Management
What is the critical role of production management in business ?
Give at least 4 differences between production management in small business vs large business. Explain
Discuss the concept of efficiency and effectiveness and their relevance to production management
Give some concepts and learnings in production management that you find to be the most important both as a student of business management and future employee or entrepreneur. Example ( Quality, Productivity, Delivery)
What are the reason for understanding the aspect of production capacity and utilization.
Why is production planning and scheduling important?
What aspects of production management are important in both small and large business enterprises?
Name at least 8 types or categories/calssification of machines used in production and at least 2 examples.
Thursday, October 2, 2008
Tips for the Final Exams
Study These for the Finals : Poduction Management
What is the critical role of production management in business ?
Give at least 4 differences between production management in small business vs large business. Explain
Discuss the concept of efficiency and effectiveness and their relevance to production management
Give some concepts and learnings in production management that you find to be the most important both as a student of business management and future employee or entrepreneur. Example ( Quality, Productivity, Delivery)
What are the reason for understanding the aspect of production capacity and utilization.
Why is production planning and scheduling important?
What aspects of production management are important in both small and large business enterprises?
Name at least 8 types or categories/calssification of machines used in production and at least 2 examples.
What is the critical role of production management in business ?
Give at least 4 differences between production management in small business vs large business. Explain
Discuss the concept of efficiency and effectiveness and their relevance to production management
Give some concepts and learnings in production management that you find to be the most important both as a student of business management and future employee or entrepreneur. Example ( Quality, Productivity, Delivery)
What are the reason for understanding the aspect of production capacity and utilization.
Why is production planning and scheduling important?
What aspects of production management are important in both small and large business enterprises?
Name at least 8 types or categories/calssification of machines used in production and at least 2 examples.
Friday, August 22, 2008
Course Syllabus
RATIONALE
PRODUCTIVITY in production operations is dependent on the work environment, working methods, as well as the speed of work. Production/Operations techniques which will help improve work environment will result in continuous work; those techniques which will enhance working methods will result in better work; and those that increases speed of work will result to faster work. In order to compete effectively in an ever-changing business environment, small and medium enterprises must be able to produce better quality goods and services continuously at a faster rate.
COURSE OBJECTIVES
In general, the training program will enable the participants to relate the whole production management function to the whole business enterprise and to acquire the knowledge, skills and techniques required to make work faster and better in order to create value for the company.
Specifically, at the end of the course, the participants will be able to:
Analyze the various phases of production/operations and its relationship to the other functional areas of the enterprise;
Recognize basic problems in layout arrangements and materials handling design;
Describe the procedure in the conducts of method study as well as demonstrate the various techniques of work measurement;
Identify the scope of materials management and enumerate the advantages of proper inventory levels of materials and supplies;
Appreciate the need for an effective maintenance program and safe working conditions;
Demonstrate examples of basic manufacturing operations which can be automated to enhance productivity;
Describe several quantitative techniques used in planning and controlling production operations;
Motivate production personnel; and Initiate and develop productivity and quality improvement systems for their company.
COURSE CONTENT
The course will cover the following topics:
The Production/Operations Management Function
Introduction to Case Study
Production/Operations Processes and Standards Forecasting and Decision Making
Planning for Operations and Capacity
Production/Operations Budgeting and Control
Materials Flow and Plant Layout Materials Management and Inventory Control
Total Quality Management Statistical Process Control
Method Study and Work Measurement
Improving Productivity of Human Resources
Total Production/Operations Maintenance and Working Conditions
Manufacturing Automation and Computer Applications
Project Presentation
METHODOLOGY
Majority of the sessions will employ the lecture-discussion method. Exercises on the various techniques of work study will be emphasized as well as case studies on inventory management and production planning.
PRODUCTIVITY in production operations is dependent on the work environment, working methods, as well as the speed of work. Production/Operations techniques which will help improve work environment will result in continuous work; those techniques which will enhance working methods will result in better work; and those that increases speed of work will result to faster work. In order to compete effectively in an ever-changing business environment, small and medium enterprises must be able to produce better quality goods and services continuously at a faster rate.
COURSE OBJECTIVES
In general, the training program will enable the participants to relate the whole production management function to the whole business enterprise and to acquire the knowledge, skills and techniques required to make work faster and better in order to create value for the company.
Specifically, at the end of the course, the participants will be able to:
Analyze the various phases of production/operations and its relationship to the other functional areas of the enterprise;
Recognize basic problems in layout arrangements and materials handling design;
Describe the procedure in the conducts of method study as well as demonstrate the various techniques of work measurement;
Identify the scope of materials management and enumerate the advantages of proper inventory levels of materials and supplies;
Appreciate the need for an effective maintenance program and safe working conditions;
Demonstrate examples of basic manufacturing operations which can be automated to enhance productivity;
Describe several quantitative techniques used in planning and controlling production operations;
Motivate production personnel; and Initiate and develop productivity and quality improvement systems for their company.
COURSE CONTENT
The course will cover the following topics:
The Production/Operations Management Function
Introduction to Case Study
Production/Operations Processes and Standards Forecasting and Decision Making
Planning for Operations and Capacity
Production/Operations Budgeting and Control
Materials Flow and Plant Layout Materials Management and Inventory Control
Total Quality Management Statistical Process Control
Method Study and Work Measurement
Improving Productivity of Human Resources
Total Production/Operations Maintenance and Working Conditions
Manufacturing Automation and Computer Applications
Project Presentation
METHODOLOGY
Majority of the sessions will employ the lecture-discussion method. Exercises on the various techniques of work study will be emphasized as well as case studies on inventory management and production planning.
Capacity Factors
Machine Capacity
Labor Capacity/Efficiency
Number of Operating Time (hours)
Set-Up Time
Demobilization Time
Maintenance Time
Downtimes
Line Balance
Labor Capacity/Efficiency
Number of Operating Time (hours)
Set-Up Time
Demobilization Time
Maintenance Time
Downtimes
Line Balance
Plant Capacity
Determining Capacity
Capacity available is the capability of a system or resource to produce a quantity of output in a particular time period.
The question we are often faced with is how to establish how much capacity we have available in our plant. There is two different ways of determining this.
Capacity can be calculated by taking into account the number of machines, the hours worked etc. This is termed rated capacity. The alternative is to measure capacity by averaging the performance in previous periods. This is termed demonstrated capacity. We will examine the two methods in turn.
Calculating Rated Capacity
Traditionally, to calculate the rated capacity you require the following information;
l The number of hours per shift the work center will work.
l The number of machines or men in the work center.
l The number of shifts worked per day.
l The number of days per week the work center will work.
l How many hours overtime is scheduled as a percentage increase to a normal scheduled shift or work week.
l The utilization of the work center. This is usually taken from history.
l The efficiency of the work center, again taken from history.
Example:
If a work center works two eight hour shifts per day, five days a week, with six machines, 10% planned overtime, a machine utilization of 90%, and an efficiency of 90%, what will be the rated capacity per week in standard hours?
These factors are multiplied together to calculate the available rated capacity
Rated capacity = 2 x 8 x 5 x 6 x 1.1 x 0.9 x 0.9
= 427.7 Std Hrs per week.
With the introduction of the theory of constraints, rated capacity is calculated in a different way.
Rated capacity = hours available x efficiency x activation.
where activation is a function of scheduled production and availability is a function of up time. The differences are:
l Availability
Traditionally the hours that are available equals the clocked time scheduled, whereas with the TOC principle availability is the time the machine is actually available and fit to be used.
l Activation
This replaces the traditional utilization and is the number of hours we need to use the machine for scheduled production, versus the time it is available.
Measuring Demonstrated Capacity
Other names for demonstrated capacity are the measured capacity, or the actual capacity. Demonstrated capacity is the real world. It is established by averaging the actual output, in standard hours, produced during previous periods.
Demonstrated capacity is defined as the proven capacity calculated from actual performance data, usually expressed as the average number of items produced multiplied by the standard hours per item.
Demonstrated capacity is the capacity that has been proven time and time again; it is not just the standard hours that can be produced, but also the standard hours that historically have been produced repeatedly.
Example:
To determine the actual capacity of a printed circuit board assembly line you do the following:-
l Record the actual standard hours produced per week for the last ten weeks. This could be tabulated from output reports.
l Total the standard hours for the ten weeks.
l Average the ten weeks; this indicates the average output. This can then be used as the demonstrated capacity. See the table below.
Demonstrated capacity is the average of the total standard hours produced over a number of periods.
Week Standard Hours
No. Produced
1 370
2 401
3 395
4 400
5 380
6 403
7 414
8 375
9 412
10 390
Total 3940
Average per week = 3940
10
= 394 Std Hours
We have said demonstrated capacity is the real world. It is the proven capacity. It is what we know we can produce time and time again. Therefore it is the capacity that we use for loading the shops. It is the figure we load into the work center file. It is the capacity available, thus it is the figure we use for calculating the capacity plan. When you consider the real world it is pointless loading a workshop to the rated capacity if it is different from the demonstrated capacity. It is only practical to load the shops with the amount we know we can get out. If you put more in on a regular basis, the work in process would just increase, the lead times would get longer and chaos would eventually reign. We have to be practical whether we like it or not. Demonstrated capacity is what we should use for loading the shops.
Rated Vs. Demonstrated Capacity
If the rated and demonstrated capacity are worlds apart it means we have a problem. Either the rated capacity is incorrectly calculated, or there is something wrong in manufacturing. It means that we ought to get our industrial engineers to sort out what has gone wrong. The one thing we do know is that we must continue using demonstrated capacity until we have resolved the problem. Then of course, we will see the standard hours produced gradually start improving and gradually equal the rated capacity. We continue to use the demonstrated capacity figure as this reflects reality.
A further point worth considering is the assumption that the demonstrated output will continue, but that is only true if the circumstances at the manufacturing work center remain the same. For example, if the product mix changes, or if we upset the labor force, then the volume of standard hours we do produce will change. We need to apply the knowledge of these factors to the capacity figure before using it.
Capacity available is the capability of a system or resource to produce a quantity of output in a particular time period.
The question we are often faced with is how to establish how much capacity we have available in our plant. There is two different ways of determining this.
Capacity can be calculated by taking into account the number of machines, the hours worked etc. This is termed rated capacity. The alternative is to measure capacity by averaging the performance in previous periods. This is termed demonstrated capacity. We will examine the two methods in turn.
Calculating Rated Capacity
Traditionally, to calculate the rated capacity you require the following information;
l The number of hours per shift the work center will work.
l The number of machines or men in the work center.
l The number of shifts worked per day.
l The number of days per week the work center will work.
l How many hours overtime is scheduled as a percentage increase to a normal scheduled shift or work week.
l The utilization of the work center. This is usually taken from history.
l The efficiency of the work center, again taken from history.
Example:
If a work center works two eight hour shifts per day, five days a week, with six machines, 10% planned overtime, a machine utilization of 90%, and an efficiency of 90%, what will be the rated capacity per week in standard hours?
These factors are multiplied together to calculate the available rated capacity
Rated capacity = 2 x 8 x 5 x 6 x 1.1 x 0.9 x 0.9
= 427.7 Std Hrs per week.
With the introduction of the theory of constraints, rated capacity is calculated in a different way.
Rated capacity = hours available x efficiency x activation.
where activation is a function of scheduled production and availability is a function of up time. The differences are:
l Availability
Traditionally the hours that are available equals the clocked time scheduled, whereas with the TOC principle availability is the time the machine is actually available and fit to be used.
l Activation
This replaces the traditional utilization and is the number of hours we need to use the machine for scheduled production, versus the time it is available.
Measuring Demonstrated Capacity
Other names for demonstrated capacity are the measured capacity, or the actual capacity. Demonstrated capacity is the real world. It is established by averaging the actual output, in standard hours, produced during previous periods.
Demonstrated capacity is defined as the proven capacity calculated from actual performance data, usually expressed as the average number of items produced multiplied by the standard hours per item.
Demonstrated capacity is the capacity that has been proven time and time again; it is not just the standard hours that can be produced, but also the standard hours that historically have been produced repeatedly.
Example:
To determine the actual capacity of a printed circuit board assembly line you do the following:-
l Record the actual standard hours produced per week for the last ten weeks. This could be tabulated from output reports.
l Total the standard hours for the ten weeks.
l Average the ten weeks; this indicates the average output. This can then be used as the demonstrated capacity. See the table below.
Demonstrated capacity is the average of the total standard hours produced over a number of periods.
Week Standard Hours
No. Produced
1 370
2 401
3 395
4 400
5 380
6 403
7 414
8 375
9 412
10 390
Total 3940
Average per week = 3940
10
= 394 Std Hours
We have said demonstrated capacity is the real world. It is the proven capacity. It is what we know we can produce time and time again. Therefore it is the capacity that we use for loading the shops. It is the figure we load into the work center file. It is the capacity available, thus it is the figure we use for calculating the capacity plan. When you consider the real world it is pointless loading a workshop to the rated capacity if it is different from the demonstrated capacity. It is only practical to load the shops with the amount we know we can get out. If you put more in on a regular basis, the work in process would just increase, the lead times would get longer and chaos would eventually reign. We have to be practical whether we like it or not. Demonstrated capacity is what we should use for loading the shops.
Rated Vs. Demonstrated Capacity
If the rated and demonstrated capacity are worlds apart it means we have a problem. Either the rated capacity is incorrectly calculated, or there is something wrong in manufacturing. It means that we ought to get our industrial engineers to sort out what has gone wrong. The one thing we do know is that we must continue using demonstrated capacity until we have resolved the problem. Then of course, we will see the standard hours produced gradually start improving and gradually equal the rated capacity. We continue to use the demonstrated capacity figure as this reflects reality.
A further point worth considering is the assumption that the demonstrated output will continue, but that is only true if the circumstances at the manufacturing work center remain the same. For example, if the product mix changes, or if we upset the labor force, then the volume of standard hours we do produce will change. We need to apply the knowledge of these factors to the capacity figure before using it.
Friday, July 11, 2008
Standard Costs
Standard Cost
Learning Objectives
To undePtand the meaning of standard costing, its meaning and definition
To learn its advantages and limitations
To learn how to set of standards and determinations
To learn how to revise standards
Introduction
You know that management accounting is managing a business through accounting information. In this process, management accounting is facilitating managerial control. It can also be applied to your own daily/monthly expenses, if necessary. These measures should be applied correctly so that performance takes place according to plans. Planning is the first tool for making the control effective. The vital aspect of managerial control is cost control. Hence, it is very important to plan and control costs. Standard costing is a technique which helps you to control costs and business operations. It aims at eliminating wastes and increasing efficiency in performance through setting up standards or formulating cost plans.
Meaning of Standard
When you want to measure some thing, you must take some parameter or yardstick for measuring. We can call this as standard. What are your daily expenses? An average of P50! If you have been spending this much for so many days, then this is your daily standard expense.
The word standard means a benchmark or yardstick. The standard cost is a predetermined cost which determines in advance what each product or service should cost under given circumstances.
Standard cost is the amount the firm thinks a product or the operation of the process for a period of time should cost, based upon certain assumed conditions of efficiency, economic conditions and other factors.
Definition
Standard cost is "a predetermined cost which is calculated from managements standards of efficient operations and the relevant necessary expenditure." They are the predetermined costs on technical estimate of material labor and overhead for a selected period of time and for a prescribed set of working conditions. In other words, a standard cost is a planned cost for a unit of product or service rendered.
The technique of using standard costs for the purposes of cost control is known as standard costing. It is a system of cost accounting which is designed to find out how much should be the cost of a product under the existing conditions. The actual cost can be ascertained only when production is undertaken. The predetermined cost is compared to the actual cost and a variance between the two enables the management to take necessary corrective measures.
Advantages
Standard costing is a management control technique for every activity. It is not only useful for cost control purposes but is also helpful in production planning and policy formulation. It allows management by exception. In the light of various objectives of this system, some of the advantages of this tool are given below:
Efficiency measurement-- The comparison of actual costs with standard costs enables the management to evaluate performance of various cost centers. In the absence of standard costing system, actual costs of different period may be compared to measure efficiency. It is not proper to compare costs of different period because circumstance of both the periods may be different. Still, a decision about base period can be made with which actual performance can be compared.
Finding of variance-- The performance variances are determined by comparing actual costs with standard costs. Management is able to spot out the place of inefficiencies. It can fix responsibility for deviation in performance. It is possible to take corrective measures at the earliest. A regular check on various expenditures is also ensured by standard cost system.
Management by exception-- The targets of different individuals are fixed if the performance is according to predetermined standards. In this case, there is nothing to worry. The attention of the management is drawn only when actual performance is less than the budgeted performance. Management by exception means that everybody is given a target to be achieved and management need not supervise each and everything. The responsibilities are fixed and every body tries to achieve his/her targets.
Cost control-- Every costing system aims at cost control and cost reduction. The standards are being constantly analyzed and an effort is made to improve efficiency. Whenever a variance occurs, the reasons are studied and immediate corrective measures are undertaken. The action taken in spotting weak points enables cost control system.
Right decisions-- It enables and provides useful information to the management in taking important decisions. For example, the problem created by inflation, rising prices. It can also be used to provide incentive plans for employees etc.
Eliminating inefficiencies-- The setting of standards for different elements of cost requires a detailed study of different aspects. The standards are set differently for manufacturing, administrative and selling expenses. Improved methods are used for setting these standards. The determination of manufacturing expenses will require time and motion study for labor and effective material control devices for materials. Similar studies will be needed for finding other expenses. All these studies will make it possible to eliminate inefficiencies at different steps.
Limitations of Standard Costing
It cannot be used in those organizations where non-standard products are produced. If the production is undertaken according to the customer specifications, then each job will involve different amount of expenditures.
The process of setting standard is a difficult task, as it requires technical skills. The time and motion study is required to be undertaken for this purpose. These studies require a lot of time and money. There are no inset circumstances to be considered for fixing standards. The conditions under which standards are fixed do not remain static. With the change in circumstances, if the standards are not revised the same become impracticable.
The fixing of responsibility is not an easy task. The variances are to be classified into controllable and uncontrollable variances. Standard costing is applicable only for controllable variances. For instance, if the industry changed the technology then the system will not be suitable. In that case, we will have to change or revise the standards. A frequent revision of standards will become costly.
Setting Standards
Normally, setting up standards is based on the past experience. The total standard cost includes direct materials, direct labor and overheads. Normally, all these are fixed to some extent. The standards should be set up in a systematic way so that they are used as a tool for cost control.
Various Elements which Influence the Setting of Standards
Setting Standards for Direct Materials
There are several basic principles which ought to be appreciated in setting standards for direct materials. Generally, when you want to purchase some material what are the factoP you consider. If material is used for a product, it is known as direct material. On the other hand, if the material cost cannot be assigned to the manufacturing of the product, it will be called indirect material. Therefore, it involves two things:
Quality of material
Price of the material
When you want to purchase material, the quality and size should be determined. The standard quality to be maintained should be decided. The quantity is determined by the production department. This department makes use of historical records, and an allowance for changing conditions will also be given for setting standards. A number of test runs may be undertaken on different days and under different situations, and an average of these results should be used for setting material quantity standards.
The second step in determining direct material cost will be a decision about the standard price. Material’s cost will be decided in consultation with the purchase department. The cost of purchasing and store keeping of materials should also be taken into consideration. The procedure for purchase of materials, minimum and maximum levels for various materials, discount policy and means of transport are the other factoP which have bearing on the materials cost price. It includes the following:
Cost of materials
Ordering cost
Carrying cost
The purpose should be to increase efficiency in procuring and store keeping of materials. The type of standard used-- ideal standard or expected standard-- also affects the choice of standard price.
Setting Direct Labor Cost
If you want to engage a labor force for manufacturing a product or a service for which you need to pay some amount, this is called wages. If the labor is engaged directly to produce the product, this is known as direct labor. The second largest amount of cost is of labor. The benefit derived from the workeP can be assigned to a particular product or a process. If the wages paid to workeP cannot be directly assigned to a particular product, these will be known as indirect wages. The time required for producing a product would be ascertained and labor should be properly graded. Different grades of workeP will be paid different rates of wages. The times spent by different grades of workeP for manufacturing a product should also be studied for deciding upon direct labor cost. The setting of standard for direct labor will be done basically on the following:
Standard labor time for producing
Labor rate per hour
Standard labor time indicates the time taken by different categories of labor force which are as under:
Skilled labor
Semi-skilled labor
Unskilled labor
For setting a standard time for labor force, we normally take in to account previous experience, past performance records, test run result, work-study etc. The labor rate standard refeP to the expected wage rates to be paid for different categories of workeP. Past wage rates and demand and supply principle may not be a safe guide for determining standard labor rates. The anticipation of expected changes in labor rates will be an essential factor. In case there is an agreement with workeP for payment of wages in the coming period, these rates should be used. If a premium or bonus scheme is in operation, then anticipated extra payments should also be included. Where a piece rate system is used, standard cost will be fixed per piece. The object of fixed standard labor time and labor rate is to device maximum efficiency in the use of labor.
Setting Standards of Overheads
The next important element comes under overheads. The very purpose of setting standard for overheads is to minimize the total cost. Standard overhead rates are computed by dividing overhead expenses by direct labor houP or units produced. The standard overhead cost is obtained by multiplying standard overhead rate by the labor houP spent or number of units produced. The determination of overhead rate involves three things:
Determination of overheads
Determination of labor houP or units manufactured
Calculating overheads rate by dividing A by B
The overheads are classified into fixed overheads, variable overheads and semi-variable overheads. The fixed overheads remain the same irrespective of level of production, while variable overheads change in the proportion of production. The expenses increase or decrease with the increase or decrease in output. Semi-variable overheads are neither fixed nor variable. These overheads increase with the increase in production but the rate of increase will be less than the rate of increase in production. The division of overheads into fixed, variable and semi-variable categories will help in determining overheads.
Determination of Standard Costs
How should the ideal standards for better controlling be determined?
1. Determination of Cost Center
A cost center is a department or part of a department or an item of equipment or machinery or a pePon or a group of pePons in respect of which costs are accumulated, and one where control can be exercised. Cost centeP are necessary for determining the costs. If the whole factory is engaged in manufacturing a product, the factory will be a cost center. In fact, a cost center describes the product while cost is accumulated. Cost centeP enable the determination of costs and fixation of responsibility. A cost center relating to a pePon is called pePonnel cost center, and a cost center relating to products and equipments is called impePonal cost center.
2. Current Standards
A current standard is a standard which is established for use over a short period of time and is related to current condition. It reflects the performance that should be attained during the current period. The period for current standard is normally one year. It is presumed that conditions of production will remain unchanged. In case there is any change in price or manufacturing condition, the standards are also revised. Current standard may be ideal standard and expected standard.
3. Ideal Standard
This is the standard which represents a high level of efficiency. Ideal standard is fixed on the assumption that favorable conditions will prevail and management will be at its best. The price paid for materials will be lowest and wastes etc. will be minimum possible. The labor time for making the production will be minimum and rates of wages will also be low. The overheads expenses are also set with maximum efficiency in mind. All the conditions, both internal and external, should be favorable and only then ideal standard will be achieved.
Ideal standard is fixed on the assumption of those conditions which may rarely exist. This standard is not practicable and may not be achieved. Though this standard may not be achieved, even then an effort is made. The deviation between targets and actual performance is ignorable. In practice, ideal standard has an advePe effect on the employees. They do not try to reach the standard because the standards are not considered realistic.
4. Basic Standards
A basic standard may be defined as a standard which is established for use for an indefinite period which may a long period. Basic standard is established for a long period and is not adjusted to the preset conations. The same standard remains in force for a long period. These standards are revised only on the changes in specification of material and technology productions. It is indeed just like a number against which subsequent process changes can be measured. Basic standard enables the measurement of changes in costs. For example, if the basic cost for material is P. 20 per unit and the current price is P. 25 per unit, it will show an increase of 25% in the cost of materials. The changes in manufacturing costs can be measured by taking basic standard, as a base standard cannot serve as a tool for cost control purpose because the standard is not revised for a long time. The deviation between standard cost and actual cost cannot be used as a yardstick for measuring efficiency.
5. Normal Standards
As per terminology, normal standard has been defined as a standard which, it is anticipated, can be attained over a future period of time, preferably long enough to cover one trade cycle. This standard is based on the conditions which will cover a future period of five yeaP, concerning one trade cycle. If a normal cycle of ups and downs in sales and production is 10 yeaP, then standard will be set on average sales and production which will cover all the yeaP. The standard attempts to cover variance in the production from one time to another time. An average is taken from the periods of recession and depression. The normal standard concept is theoretical and cannot be used for cost control purpose. Normal standard can be properly applied for absorption of overhead cost over a long period of time.
6. Organization for Standard Costing
The success of standard costing system will depend upon the setting up of proper standards. For the purpose of setting standards, a pePon or a committee should be given this job. In a big concern, a standard costing committee is formed for this purpose. The committee includes production manager, purchase manager, sales manager, pePonnel manager, chief engineer and cost accountant. The cost accountant acts as a co-coordinator of this committee.
7. Accounting System
Classification of accounts is necessary to meet the required purpose, i.e. function, asset or revenue item. Codes can be used to have a speedy collection of accounts. A standard is a pre-determined measure of material, labor and overheads. It may be expressed in quality and its monetary measurements in standard costs.
Revision of Standards
For effective use of this technique, sometimes we need to revise the standards which follow for better control. Even standards are also subjected to change like the production method, environment, raw material, and technology.
Standards may need to be changed to accommodate changes in the organization or its environment. When there is a sudden change in economic circumstances, technology or production methods, the standard cost will no longer be accurate. Standards that are out of date will not act as effective feed forward or feedback control tools. They will not help us to predict the inputs required nor help us to evaluate the efficiency of a particular department. If standards are continually not being achieved and large deviations or variances from the standard are reported, they should be carefully reviewed. Also, changes in the physical productive capacity of the organization or in material prices and wage rates may indicate that standards need to be revised. In practice, changing standards frequently is an expensive operation and can cause confusion. For this reason, standard cost revisions are usually made only once a year. At times of rapid price inflation, many manageP have felt that the high level of inflation forced them to change price and wage rate standards continually. This, however, leads to reduction in value of the standard as a yardstick. At the other extreme is the adoption of basic standard which will remain unchanged for many years. They provide a constant base for comparison, but this is hardly satisfactory when there is technological change in working procedures and conditions.
Summary
Basically, standard costing is a management tool for control. In the process, we have taken standards as parameters for measuring the performance. Cost analysis and cost control is essential for any activity. Cost includes material labor and overheads. Sometimes, we need to revise the standards due to change in uses, raw material, technology, method of production etc. For a proper organization, it is required to implement this under a committee for the activity. It is a continued activity for the optimum utilization of resources.
Learning Objectives
To undePtand the meaning of standard costing, its meaning and definition
To learn its advantages and limitations
To learn how to set of standards and determinations
To learn how to revise standards
Introduction
You know that management accounting is managing a business through accounting information. In this process, management accounting is facilitating managerial control. It can also be applied to your own daily/monthly expenses, if necessary. These measures should be applied correctly so that performance takes place according to plans. Planning is the first tool for making the control effective. The vital aspect of managerial control is cost control. Hence, it is very important to plan and control costs. Standard costing is a technique which helps you to control costs and business operations. It aims at eliminating wastes and increasing efficiency in performance through setting up standards or formulating cost plans.
Meaning of Standard
When you want to measure some thing, you must take some parameter or yardstick for measuring. We can call this as standard. What are your daily expenses? An average of P50! If you have been spending this much for so many days, then this is your daily standard expense.
The word standard means a benchmark or yardstick. The standard cost is a predetermined cost which determines in advance what each product or service should cost under given circumstances.
Standard cost is the amount the firm thinks a product or the operation of the process for a period of time should cost, based upon certain assumed conditions of efficiency, economic conditions and other factors.
Definition
Standard cost is "a predetermined cost which is calculated from managements standards of efficient operations and the relevant necessary expenditure." They are the predetermined costs on technical estimate of material labor and overhead for a selected period of time and for a prescribed set of working conditions. In other words, a standard cost is a planned cost for a unit of product or service rendered.
The technique of using standard costs for the purposes of cost control is known as standard costing. It is a system of cost accounting which is designed to find out how much should be the cost of a product under the existing conditions. The actual cost can be ascertained only when production is undertaken. The predetermined cost is compared to the actual cost and a variance between the two enables the management to take necessary corrective measures.
Advantages
Standard costing is a management control technique for every activity. It is not only useful for cost control purposes but is also helpful in production planning and policy formulation. It allows management by exception. In the light of various objectives of this system, some of the advantages of this tool are given below:
Efficiency measurement-- The comparison of actual costs with standard costs enables the management to evaluate performance of various cost centers. In the absence of standard costing system, actual costs of different period may be compared to measure efficiency. It is not proper to compare costs of different period because circumstance of both the periods may be different. Still, a decision about base period can be made with which actual performance can be compared.
Finding of variance-- The performance variances are determined by comparing actual costs with standard costs. Management is able to spot out the place of inefficiencies. It can fix responsibility for deviation in performance. It is possible to take corrective measures at the earliest. A regular check on various expenditures is also ensured by standard cost system.
Management by exception-- The targets of different individuals are fixed if the performance is according to predetermined standards. In this case, there is nothing to worry. The attention of the management is drawn only when actual performance is less than the budgeted performance. Management by exception means that everybody is given a target to be achieved and management need not supervise each and everything. The responsibilities are fixed and every body tries to achieve his/her targets.
Cost control-- Every costing system aims at cost control and cost reduction. The standards are being constantly analyzed and an effort is made to improve efficiency. Whenever a variance occurs, the reasons are studied and immediate corrective measures are undertaken. The action taken in spotting weak points enables cost control system.
Right decisions-- It enables and provides useful information to the management in taking important decisions. For example, the problem created by inflation, rising prices. It can also be used to provide incentive plans for employees etc.
Eliminating inefficiencies-- The setting of standards for different elements of cost requires a detailed study of different aspects. The standards are set differently for manufacturing, administrative and selling expenses. Improved methods are used for setting these standards. The determination of manufacturing expenses will require time and motion study for labor and effective material control devices for materials. Similar studies will be needed for finding other expenses. All these studies will make it possible to eliminate inefficiencies at different steps.
Limitations of Standard Costing
It cannot be used in those organizations where non-standard products are produced. If the production is undertaken according to the customer specifications, then each job will involve different amount of expenditures.
The process of setting standard is a difficult task, as it requires technical skills. The time and motion study is required to be undertaken for this purpose. These studies require a lot of time and money. There are no inset circumstances to be considered for fixing standards. The conditions under which standards are fixed do not remain static. With the change in circumstances, if the standards are not revised the same become impracticable.
The fixing of responsibility is not an easy task. The variances are to be classified into controllable and uncontrollable variances. Standard costing is applicable only for controllable variances. For instance, if the industry changed the technology then the system will not be suitable. In that case, we will have to change or revise the standards. A frequent revision of standards will become costly.
Setting Standards
Normally, setting up standards is based on the past experience. The total standard cost includes direct materials, direct labor and overheads. Normally, all these are fixed to some extent. The standards should be set up in a systematic way so that they are used as a tool for cost control.
Various Elements which Influence the Setting of Standards
Setting Standards for Direct Materials
There are several basic principles which ought to be appreciated in setting standards for direct materials. Generally, when you want to purchase some material what are the factoP you consider. If material is used for a product, it is known as direct material. On the other hand, if the material cost cannot be assigned to the manufacturing of the product, it will be called indirect material. Therefore, it involves two things:
Quality of material
Price of the material
When you want to purchase material, the quality and size should be determined. The standard quality to be maintained should be decided. The quantity is determined by the production department. This department makes use of historical records, and an allowance for changing conditions will also be given for setting standards. A number of test runs may be undertaken on different days and under different situations, and an average of these results should be used for setting material quantity standards.
The second step in determining direct material cost will be a decision about the standard price. Material’s cost will be decided in consultation with the purchase department. The cost of purchasing and store keeping of materials should also be taken into consideration. The procedure for purchase of materials, minimum and maximum levels for various materials, discount policy and means of transport are the other factoP which have bearing on the materials cost price. It includes the following:
Cost of materials
Ordering cost
Carrying cost
The purpose should be to increase efficiency in procuring and store keeping of materials. The type of standard used-- ideal standard or expected standard-- also affects the choice of standard price.
Setting Direct Labor Cost
If you want to engage a labor force for manufacturing a product or a service for which you need to pay some amount, this is called wages. If the labor is engaged directly to produce the product, this is known as direct labor. The second largest amount of cost is of labor. The benefit derived from the workeP can be assigned to a particular product or a process. If the wages paid to workeP cannot be directly assigned to a particular product, these will be known as indirect wages. The time required for producing a product would be ascertained and labor should be properly graded. Different grades of workeP will be paid different rates of wages. The times spent by different grades of workeP for manufacturing a product should also be studied for deciding upon direct labor cost. The setting of standard for direct labor will be done basically on the following:
Standard labor time for producing
Labor rate per hour
Standard labor time indicates the time taken by different categories of labor force which are as under:
Skilled labor
Semi-skilled labor
Unskilled labor
For setting a standard time for labor force, we normally take in to account previous experience, past performance records, test run result, work-study etc. The labor rate standard refeP to the expected wage rates to be paid for different categories of workeP. Past wage rates and demand and supply principle may not be a safe guide for determining standard labor rates. The anticipation of expected changes in labor rates will be an essential factor. In case there is an agreement with workeP for payment of wages in the coming period, these rates should be used. If a premium or bonus scheme is in operation, then anticipated extra payments should also be included. Where a piece rate system is used, standard cost will be fixed per piece. The object of fixed standard labor time and labor rate is to device maximum efficiency in the use of labor.
Setting Standards of Overheads
The next important element comes under overheads. The very purpose of setting standard for overheads is to minimize the total cost. Standard overhead rates are computed by dividing overhead expenses by direct labor houP or units produced. The standard overhead cost is obtained by multiplying standard overhead rate by the labor houP spent or number of units produced. The determination of overhead rate involves three things:
Determination of overheads
Determination of labor houP or units manufactured
Calculating overheads rate by dividing A by B
The overheads are classified into fixed overheads, variable overheads and semi-variable overheads. The fixed overheads remain the same irrespective of level of production, while variable overheads change in the proportion of production. The expenses increase or decrease with the increase or decrease in output. Semi-variable overheads are neither fixed nor variable. These overheads increase with the increase in production but the rate of increase will be less than the rate of increase in production. The division of overheads into fixed, variable and semi-variable categories will help in determining overheads.
Determination of Standard Costs
How should the ideal standards for better controlling be determined?
1. Determination of Cost Center
A cost center is a department or part of a department or an item of equipment or machinery or a pePon or a group of pePons in respect of which costs are accumulated, and one where control can be exercised. Cost centeP are necessary for determining the costs. If the whole factory is engaged in manufacturing a product, the factory will be a cost center. In fact, a cost center describes the product while cost is accumulated. Cost centeP enable the determination of costs and fixation of responsibility. A cost center relating to a pePon is called pePonnel cost center, and a cost center relating to products and equipments is called impePonal cost center.
2. Current Standards
A current standard is a standard which is established for use over a short period of time and is related to current condition. It reflects the performance that should be attained during the current period. The period for current standard is normally one year. It is presumed that conditions of production will remain unchanged. In case there is any change in price or manufacturing condition, the standards are also revised. Current standard may be ideal standard and expected standard.
3. Ideal Standard
This is the standard which represents a high level of efficiency. Ideal standard is fixed on the assumption that favorable conditions will prevail and management will be at its best. The price paid for materials will be lowest and wastes etc. will be minimum possible. The labor time for making the production will be minimum and rates of wages will also be low. The overheads expenses are also set with maximum efficiency in mind. All the conditions, both internal and external, should be favorable and only then ideal standard will be achieved.
Ideal standard is fixed on the assumption of those conditions which may rarely exist. This standard is not practicable and may not be achieved. Though this standard may not be achieved, even then an effort is made. The deviation between targets and actual performance is ignorable. In practice, ideal standard has an advePe effect on the employees. They do not try to reach the standard because the standards are not considered realistic.
4. Basic Standards
A basic standard may be defined as a standard which is established for use for an indefinite period which may a long period. Basic standard is established for a long period and is not adjusted to the preset conations. The same standard remains in force for a long period. These standards are revised only on the changes in specification of material and technology productions. It is indeed just like a number against which subsequent process changes can be measured. Basic standard enables the measurement of changes in costs. For example, if the basic cost for material is P. 20 per unit and the current price is P. 25 per unit, it will show an increase of 25% in the cost of materials. The changes in manufacturing costs can be measured by taking basic standard, as a base standard cannot serve as a tool for cost control purpose because the standard is not revised for a long time. The deviation between standard cost and actual cost cannot be used as a yardstick for measuring efficiency.
5. Normal Standards
As per terminology, normal standard has been defined as a standard which, it is anticipated, can be attained over a future period of time, preferably long enough to cover one trade cycle. This standard is based on the conditions which will cover a future period of five yeaP, concerning one trade cycle. If a normal cycle of ups and downs in sales and production is 10 yeaP, then standard will be set on average sales and production which will cover all the yeaP. The standard attempts to cover variance in the production from one time to another time. An average is taken from the periods of recession and depression. The normal standard concept is theoretical and cannot be used for cost control purpose. Normal standard can be properly applied for absorption of overhead cost over a long period of time.
6. Organization for Standard Costing
The success of standard costing system will depend upon the setting up of proper standards. For the purpose of setting standards, a pePon or a committee should be given this job. In a big concern, a standard costing committee is formed for this purpose. The committee includes production manager, purchase manager, sales manager, pePonnel manager, chief engineer and cost accountant. The cost accountant acts as a co-coordinator of this committee.
7. Accounting System
Classification of accounts is necessary to meet the required purpose, i.e. function, asset or revenue item. Codes can be used to have a speedy collection of accounts. A standard is a pre-determined measure of material, labor and overheads. It may be expressed in quality and its monetary measurements in standard costs.
Revision of Standards
For effective use of this technique, sometimes we need to revise the standards which follow for better control. Even standards are also subjected to change like the production method, environment, raw material, and technology.
Standards may need to be changed to accommodate changes in the organization or its environment. When there is a sudden change in economic circumstances, technology or production methods, the standard cost will no longer be accurate. Standards that are out of date will not act as effective feed forward or feedback control tools. They will not help us to predict the inputs required nor help us to evaluate the efficiency of a particular department. If standards are continually not being achieved and large deviations or variances from the standard are reported, they should be carefully reviewed. Also, changes in the physical productive capacity of the organization or in material prices and wage rates may indicate that standards need to be revised. In practice, changing standards frequently is an expensive operation and can cause confusion. For this reason, standard cost revisions are usually made only once a year. At times of rapid price inflation, many manageP have felt that the high level of inflation forced them to change price and wage rate standards continually. This, however, leads to reduction in value of the standard as a yardstick. At the other extreme is the adoption of basic standard which will remain unchanged for many years. They provide a constant base for comparison, but this is hardly satisfactory when there is technological change in working procedures and conditions.
Summary
Basically, standard costing is a management tool for control. In the process, we have taken standards as parameters for measuring the performance. Cost analysis and cost control is essential for any activity. Cost includes material labor and overheads. Sometimes, we need to revise the standards due to change in uses, raw material, technology, method of production etc. For a proper organization, it is required to implement this under a committee for the activity. It is a continued activity for the optimum utilization of resources.
Monday, June 30, 2008
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