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
Sunday, June 29, 2008
Assignments July 3, 2008
1) Review the concept of Efficiency and Effectiveness
2) Review the concepts of variable costs and fixed costs
3) Be ready for a learning assessment (examination)
2) Review the concepts of variable costs and fixed costs
3) Be ready for a learning assessment (examination)
Friday, June 27, 2008
Variable costs or direct costs are expenses that change in direct proportion to the activity of a business. Along with fixed costs, variable costs make up one of the two components of total cost.
Explanation
For example, a manufacturing firm pays for raw materials. When activity is decreased, less raw material is used, and so the spending for raw materials falls. When activity is increased, more raw material is used and spending therefore rises. Note that the changes in expenses happen with little or no need for managerial intervention.
There are many expense categories in business that consist of both fixed and variable components, like electricity. A company will pay for line rental and maintenance fees each period regardless of how much power gets used. And some electrical equipment (air conditioning or lighting) may be kept running even in periods of low activity. These expenses can be regarded as fixed. But beyond this, the company will use electricity to run plant and machinery as required. The busier the company, the more the plant will be run, and so the more electricity gets used. This extra spending can therefore be regarded as variable.
In retail the cost of goods is almost entirely a variable cost; this is not true of manufacturing where many fixed costs, such as depreciation, are included in the cost of goods.
Although taxation usually varies with profit, which in turn varies with sales volume, it is not normally considered a variable cost.
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Variable costs are expenses that change in proportion to the activity of a business. In other words, variable cost is the sum of marginal costs. It can also be considered normal costs. Along with fixed costs, variable costs make up the two components of total cost. Direct Costs, however, are costs that can be associated with a particular cost object. Not all variable costs are direct costs, however; for example, variable manufacturing overhead costs are variable costs that are not a direct costs, but indirect costs.Variable costs are sometimes called unit-level costs as they vary with the number of units produced.
For example, a manufacturing firm pays for raw materials. When activity is decreased, less raw material is used, and so the spending for raw materials falls. When activity is increased, more raw material is used and spending therefore rises. Note that the changes in expenses happen with little or no need for managerial intervention.
A company will pay for line rental and maintenance fees each period regardless of how much power gets used. And some electrical equipment (air conditioning or lighting) may be kept running even in periods of low activity. These expenses can be regarded as fixed. But beyond this, the company will use electricity to run plant and machinery as required. The busier the company, the more the plant will be run, and so the more electricity gets used. This extra spending can therefore be regarded as variable.
In retail the cost of goods is almost entirely a variable cost; this is not true of manufacturing where many fixed costs, such as depreciation, are included in the cost of goods.
Although taxation usually varies with profit, which in turn varies with sales volume, it is not normally considered a variable cost.
In most of the concerns, salary is paid on monthly rates. Though there may exist a labour work norm based on which the direct cost (labour) can be absorbed in to cost of the product, salary cannot be termed as variable in this case.
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In cost accounting, a part of management accounting, fixed costs are expenses that do not change in proportion to the activity of a business, within the relevant period or scale of production. For example, a retailer must pay rent and utility bills irrespective of sales. Unit fixed costs, called average fixed costs (AFC), decline with volume, following a rectangular hyperbola as the inverse of the volume of production: AFC = FC/N.
Variable costs by contrast change in relation to the activity of a business such as sales or production volume. In the example of the retailer, variable costs may primarily be composed of inventory (goods purchased for sale), and the cost of goods is therefore almost entirely variable. In manufacturing, direct material costs are an example of a variable cost. An example of variable costs are the prices of the supplies needed to produce a product.
Along with variable costs, fixed costs make up one of the two components of total cost. In the most simple production function, total cost is equal to fixed costs plus variable costs.
In microeconomics and business, the difference between fixed costs and variable costs (and the related terms average cost and marginal cost) is crucial, as each will influence production decisions for profit maximization differently. In the most simple cases, fixed costs do not affect production decisions, because they cannot be changed, and management will choose to produce if sales prices are above the cost of each additional unit (marginal cost).
Fixed costs should not be confused with sunk costs. From a pure economics perspective, fixed costs may not be fixed in the sense of invariate; they may change, but are fixed in relation to the quantity of production for the relevant period. For example, a company may have unexpected and unpredictable expenses unrelated to production, and these would not be considered part of variable costs.
It is important to understand that fixed costs are "fixed" only within a certain range of activity or over a certain period of time. If enough time passes, all costs become variable. Similarly, not all indirect costs are fixed costs; for example, advertising expenses or labour costs are indirect costs that are variable over a slightly longer time frame, as they may not be subject to change in the short term, but may be easily adjustable over a longer time frame. For example, a firm may not be able to vary the number of employees (and hence labour costs) in the short term due to contract obligations, but be able to lay employees off or otherwise change these costs.
In accounting terminology, fixed costs will broadly include all costs (expenses) which are not included in cost of goods sold, and variable costs are those captured in costs of goods sold. The implicit assumption required to make the equivalence between the accounting and economics terminology is that the accounting period is equal to the period in which fixed costs do not vary in relation to production. In practice, this equivalence does not always hold, and depending on the period under consideration by management, some overhead expenses (such as sales, general and administrative expenses) can be adjusted by management, and the specific allocation of each expense to each category will be decided under cost accounting.
In business planning and management accounting, usage of the terms fixed costs, variable costs and others will often differ from usage in economics, and may depend on the intended use. For example, costs may be segregated into per unit costs (costs of goods sold), fixed costs per period, and variable costs as a proportion of revenue. Capital expenditures will usually be allocated separately, and depending on the purpose, a portion may be regularly allocated to expenses as depreciation and amortization and seen as a fixed cost per period, or the entire amount may be considered upfront fixed costs.
Semi variable cost is an expense which contains both a fixed cost component and a variable cost component. The fixed cost element shall be a part of the cost that needs to be paid irrespective of the level of activity achieved by the entity. On the other hand the variable component of the cost is payable proportionate to the level of activity.
It shows similarities to telephone bills. One must pay line rental and on top of that a price that depends on how heavy one is using the service. So it changes with output. Another example is satellite television. A price for the box must be paid monthly and to get additional movies, more money has to be given.
Cost of energy, such as electricity, is a good example as it is integral to production of goods and services. This component straddles both the fixed and variable universe because electrical power is essential for the basic operation of the business in lighting and heating - this portion is a sunk cost that is foregone regardless of production. As demand ramps up, more energy is required to ramp up the production process in the use of machinery or large banks of computers for instance. Cost of electrical energy will then rise accordingly as production activities increase. Therefore, the cost electricity can be viewed as semi variable.
Another example is salaried employees who are also compensated by commissions. This group is paid on a fixed salary plus they are also rewarded based on the volume of sales they can generate, or, other forms of quantitative measures based on revenues to the firm.
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In economics, and cost accounting, total cost (or total costs) describes the total economic cost of production and is made up of variable costs, which vary according to quantity produced such as raw materials, plus fixed costs, which are independent of quantity produced such as expenses for assets like buildings.
The rate at which total cost changes as the amount produced changes is called marginal cost; this is the marginal unit variable cost. If one assumes that the unit variable cost is constant, as in cost-volume-profit analysis, then total cost is linear in volume, and given by TC = FC + unit VC * N.
Explanation
For example, a manufacturing firm pays for raw materials. When activity is decreased, less raw material is used, and so the spending for raw materials falls. When activity is increased, more raw material is used and spending therefore rises. Note that the changes in expenses happen with little or no need for managerial intervention.
There are many expense categories in business that consist of both fixed and variable components, like electricity. A company will pay for line rental and maintenance fees each period regardless of how much power gets used. And some electrical equipment (air conditioning or lighting) may be kept running even in periods of low activity. These expenses can be regarded as fixed. But beyond this, the company will use electricity to run plant and machinery as required. The busier the company, the more the plant will be run, and so the more electricity gets used. This extra spending can therefore be regarded as variable.
In retail the cost of goods is almost entirely a variable cost; this is not true of manufacturing where many fixed costs, such as depreciation, are included in the cost of goods.
Although taxation usually varies with profit, which in turn varies with sales volume, it is not normally considered a variable cost.
-----------
Variable costs are expenses that change in proportion to the activity of a business. In other words, variable cost is the sum of marginal costs. It can also be considered normal costs. Along with fixed costs, variable costs make up the two components of total cost. Direct Costs, however, are costs that can be associated with a particular cost object. Not all variable costs are direct costs, however; for example, variable manufacturing overhead costs are variable costs that are not a direct costs, but indirect costs.Variable costs are sometimes called unit-level costs as they vary with the number of units produced.
For example, a manufacturing firm pays for raw materials. When activity is decreased, less raw material is used, and so the spending for raw materials falls. When activity is increased, more raw material is used and spending therefore rises. Note that the changes in expenses happen with little or no need for managerial intervention.
A company will pay for line rental and maintenance fees each period regardless of how much power gets used. And some electrical equipment (air conditioning or lighting) may be kept running even in periods of low activity. These expenses can be regarded as fixed. But beyond this, the company will use electricity to run plant and machinery as required. The busier the company, the more the plant will be run, and so the more electricity gets used. This extra spending can therefore be regarded as variable.
In retail the cost of goods is almost entirely a variable cost; this is not true of manufacturing where many fixed costs, such as depreciation, are included in the cost of goods.
Although taxation usually varies with profit, which in turn varies with sales volume, it is not normally considered a variable cost.
In most of the concerns, salary is paid on monthly rates. Though there may exist a labour work norm based on which the direct cost (labour) can be absorbed in to cost of the product, salary cannot be termed as variable in this case.
-------------
In cost accounting, a part of management accounting, fixed costs are expenses that do not change in proportion to the activity of a business, within the relevant period or scale of production. For example, a retailer must pay rent and utility bills irrespective of sales. Unit fixed costs, called average fixed costs (AFC), decline with volume, following a rectangular hyperbola as the inverse of the volume of production: AFC = FC/N.
Variable costs by contrast change in relation to the activity of a business such as sales or production volume. In the example of the retailer, variable costs may primarily be composed of inventory (goods purchased for sale), and the cost of goods is therefore almost entirely variable. In manufacturing, direct material costs are an example of a variable cost. An example of variable costs are the prices of the supplies needed to produce a product.
Along with variable costs, fixed costs make up one of the two components of total cost. In the most simple production function, total cost is equal to fixed costs plus variable costs.
In microeconomics and business, the difference between fixed costs and variable costs (and the related terms average cost and marginal cost) is crucial, as each will influence production decisions for profit maximization differently. In the most simple cases, fixed costs do not affect production decisions, because they cannot be changed, and management will choose to produce if sales prices are above the cost of each additional unit (marginal cost).
Fixed costs should not be confused with sunk costs. From a pure economics perspective, fixed costs may not be fixed in the sense of invariate; they may change, but are fixed in relation to the quantity of production for the relevant period. For example, a company may have unexpected and unpredictable expenses unrelated to production, and these would not be considered part of variable costs.
It is important to understand that fixed costs are "fixed" only within a certain range of activity or over a certain period of time. If enough time passes, all costs become variable. Similarly, not all indirect costs are fixed costs; for example, advertising expenses or labour costs are indirect costs that are variable over a slightly longer time frame, as they may not be subject to change in the short term, but may be easily adjustable over a longer time frame. For example, a firm may not be able to vary the number of employees (and hence labour costs) in the short term due to contract obligations, but be able to lay employees off or otherwise change these costs.
In accounting terminology, fixed costs will broadly include all costs (expenses) which are not included in cost of goods sold, and variable costs are those captured in costs of goods sold. The implicit assumption required to make the equivalence between the accounting and economics terminology is that the accounting period is equal to the period in which fixed costs do not vary in relation to production. In practice, this equivalence does not always hold, and depending on the period under consideration by management, some overhead expenses (such as sales, general and administrative expenses) can be adjusted by management, and the specific allocation of each expense to each category will be decided under cost accounting.
In business planning and management accounting, usage of the terms fixed costs, variable costs and others will often differ from usage in economics, and may depend on the intended use. For example, costs may be segregated into per unit costs (costs of goods sold), fixed costs per period, and variable costs as a proportion of revenue. Capital expenditures will usually be allocated separately, and depending on the purpose, a portion may be regularly allocated to expenses as depreciation and amortization and seen as a fixed cost per period, or the entire amount may be considered upfront fixed costs.
Semi variable cost is an expense which contains both a fixed cost component and a variable cost component. The fixed cost element shall be a part of the cost that needs to be paid irrespective of the level of activity achieved by the entity. On the other hand the variable component of the cost is payable proportionate to the level of activity.
It shows similarities to telephone bills. One must pay line rental and on top of that a price that depends on how heavy one is using the service. So it changes with output. Another example is satellite television. A price for the box must be paid monthly and to get additional movies, more money has to be given.
Cost of energy, such as electricity, is a good example as it is integral to production of goods and services. This component straddles both the fixed and variable universe because electrical power is essential for the basic operation of the business in lighting and heating - this portion is a sunk cost that is foregone regardless of production. As demand ramps up, more energy is required to ramp up the production process in the use of machinery or large banks of computers for instance. Cost of electrical energy will then rise accordingly as production activities increase. Therefore, the cost electricity can be viewed as semi variable.
Another example is salaried employees who are also compensated by commissions. This group is paid on a fixed salary plus they are also rewarded based on the volume of sales they can generate, or, other forms of quantitative measures based on revenues to the firm.
--------------
In economics, and cost accounting, total cost (or total costs) describes the total economic cost of production and is made up of variable costs, which vary according to quantity produced such as raw materials, plus fixed costs, which are independent of quantity produced such as expenses for assets like buildings.
The rate at which total cost changes as the amount produced changes is called marginal cost; this is the marginal unit variable cost. If one assumes that the unit variable cost is constant, as in cost-volume-profit analysis, then total cost is linear in volume, and given by TC = FC + unit VC * N.
Flowcharting
What is a flowchart? --
A flowchart is an organized combination of shapes, lines, and text that graphically illustrates a process or structure.
For example, you might need to tell a co-worker how to complete a simple task. To you, it may seem simple, but to your co-worker, it may not. If you describe the task in words, it might sound both complicated and confusing: "If you don't need to do step 4, skip to step 7. When you finish step 7, you can go back to step 2..."
Pretty simple, isn't it?
Putting these same instructions in a flowchart takes the confusion out and makes the complicated look simple. Using flowcharts to describe this very same flow of tasks can dramatically reduce the learning curve.
Here's an example of how you could use shapes, lines, and text to build a chart:
The shapes (such as rectangles, circles, or diamonds) represent each step or decision point in the process.
The lines show the continuity of the process, demonstrating the paths the user should follow.
The text briefly describes each part of the process. Follow along on this simple flowchart:
Basic flowchart Symbols
We get a lot of calls requesting definitions for flowcharting symbols. In the past, we have hesitated to define them because flowcharting symbols are dynamic and their meanings continue to grow and change depending on who uses them. Although standards have been established (i.e. ISO, ANSI), people deviate form these standards to suit their own needs. In many cases, individual companies develop standards for their internal use.
Remember, the key to flowcharting is consistency! If you choose to use a symbol in a non-standard fashion, make sure you do it consistently so the reader of the chart knows your meaning for that symbol every time they see it.
In the end, there is no "one" definition for flowcharting symbols. We can, however, provide you with some guidelines for commonly used symbols. The following represents the most commonly used symbols are their generally accepted meanings:
The Process Symbol represents any process, function, or action and is the most frequently used symbol in flowcharting.
The Document Symbol is used to represent any type of hard copy input or output (i.e. reports).
Offpage Connector Symbols are used to indicate the flowchart continues on another page. Often, the page number is placed in the shape for easy reference.
The Input/Output Symbol represents data that is available for input or resulting from processing (i.e. customer database records).
Comment Symbols are used when additional explanation or comment is required. This symbol is usually connected to the symbol it is explaining by a dashed line.
The Decision Symbol is a junction where a decision must be made. A single entry may have any number of alternative solutions, but only one can be chosen.
The Connector Symbol represents the exit to, or entry from, another part of the same flowchart. It is usually used to break a flow line that will be continued elsewhere. It's a good idea to reference page numbers for easy location of connectors.
A flowchart is an organized combination of shapes, lines, and text that graphically illustrates a process or structure.
For example, you might need to tell a co-worker how to complete a simple task. To you, it may seem simple, but to your co-worker, it may not. If you describe the task in words, it might sound both complicated and confusing: "If you don't need to do step 4, skip to step 7. When you finish step 7, you can go back to step 2..."
Pretty simple, isn't it?
Putting these same instructions in a flowchart takes the confusion out and makes the complicated look simple. Using flowcharts to describe this very same flow of tasks can dramatically reduce the learning curve.
Here's an example of how you could use shapes, lines, and text to build a chart:
The shapes (such as rectangles, circles, or diamonds) represent each step or decision point in the process.
The lines show the continuity of the process, demonstrating the paths the user should follow.
The text briefly describes each part of the process. Follow along on this simple flowchart:
Basic flowchart Symbols
We get a lot of calls requesting definitions for flowcharting symbols. In the past, we have hesitated to define them because flowcharting symbols are dynamic and their meanings continue to grow and change depending on who uses them. Although standards have been established (i.e. ISO, ANSI), people deviate form these standards to suit their own needs. In many cases, individual companies develop standards for their internal use.
Remember, the key to flowcharting is consistency! If you choose to use a symbol in a non-standard fashion, make sure you do it consistently so the reader of the chart knows your meaning for that symbol every time they see it.
In the end, there is no "one" definition for flowcharting symbols. We can, however, provide you with some guidelines for commonly used symbols. The following represents the most commonly used symbols are their generally accepted meanings:
The Process Symbol represents any process, function, or action and is the most frequently used symbol in flowcharting.
The Document Symbol is used to represent any type of hard copy input or output (i.e. reports).
Offpage Connector Symbols are used to indicate the flowchart continues on another page. Often, the page number is placed in the shape for easy reference.
The Input/Output Symbol represents data that is available for input or resulting from processing (i.e. customer database records).
Comment Symbols are used when additional explanation or comment is required. This symbol is usually connected to the symbol it is explaining by a dashed line.
The Decision Symbol is a junction where a decision must be made. A single entry may have any number of alternative solutions, but only one can be chosen.
The Connector Symbol represents the exit to, or entry from, another part of the same flowchart. It is usually used to break a flow line that will be continued elsewhere. It's a good idea to reference page numbers for easy location of connectors.
Sunday, June 22, 2008
June 28 Assignment
1)Review the past lessons taken during the Firts and Second Sessions
2)Be ready for a quiz
3)Read and Study Production Flow Charting - What are its uses. How are they done. Manualization of Production Processes
4)Understanding the concepts in PRODUCTION COSTS
Direct Production Costs, Variable Costs, Fixed Production Overhead Costs, Computation Formulas
Happy Learning
PS
Send to me you email addresses as well as your CP number if you have at:
rmi@up-alumni.com
2)Be ready for a quiz
3)Read and Study Production Flow Charting - What are its uses. How are they done. Manualization of Production Processes
4)Understanding the concepts in PRODUCTION COSTS
Direct Production Costs, Variable Costs, Fixed Production Overhead Costs, Computation Formulas
Happy Learning
PS
Send to me you email addresses as well as your CP number if you have at:
rmi@up-alumni.com
Production Management Notes - Session 1 and 2
Production is one of the functions of business. It is responsible for the development and credation of products and services that will be sold to the market. Production function is as equally important with the business functions of marketing, administration and finance.
Production is the processes of converting raw materials into semi-finished and finished products.
Production Management - the management of those resources and activities of a business that are required to produce goods for sale to consumers or to other organizations. Production management is concerned with the manufacturing industry. The growing interest in the production management task in service industries has led to the use of operations management as a more general term.
The level of production activities is dependent on what products or services that are being produced, how they are produced and when they are needed by the marketing function.
Two Guiding Principles in Production
1) Efficiency
2) Effectiveness
INPUT COSTs/OUTPUT
Efficiency involves the measurement of the cost of inputs relative to outputs.
Example - If an enterprise A spends P1,000.00 to produce 100 pairs of slippers, then the cost to produce one pair is P10.00. If enterprise B spends PP750.00 to produce 100 pairs of slippers, then the cost per unit is P7.50. Under this scenario, enterprise be is more cost efficient. The lower the cost to produce one unit of production volume, the higher its cost efficiency. It is the inverse of cost of inputs/volume of outputs.
This gives the cost per unit of production, and so one measure of efficiency. Another measure would be to look at how much each particular factor of production (labour / capital / land) manages to produce. In this way we can measure productivity. For example to calculate labour productivity: In a garment factory, the following are:
Sewer A = Can finish "edging sewing" 20 pieces per day
Sewer B = can finish "edging sewing" 25 pieces per day
Obviously Sewer B has higher productivity and is more cost efficient, because he/she produces 25 pieces, 5 pieces more than Sewer A.
But supposing Sewer A is paid P200.00 per day and Sewer B is paid P300.00 per day. How will labor efficency and productivity be affected ? In this scenario, the labor efficiency of Sewer A is P200.00/20 while Sewer B has P P300.00/25 resulting in Sewer A's P10.00 cost to produce one unit while Sewer B has a per unit prodution cost of P12.00. Under this circumstances, Sewer A is more labor efficient and productive.
Effectiveness - is when you achieve the purpose or objective of the task or activities. Examples. Company A has the objective of producing 10,000 units of baseball caps for its customers who will attend the independence day parade and is able to do so but the cost to produce the 10,000 caps is P500,000. Company B is only able to produce 6,000 caps but incurring a cost of P180,000.00. Under this scenarios Company A has a per unit production cost of P50.00 per baseball cap while company B has a production cost of P30.00. per unit. Which company is more effective? The answer is Company A. Although it produced baseball caps at a higher costs, it was able to achieve its purpose of producing the 10,000 baseball caps. So, effectiveness is not about costs but rather the achievement of the production goal.
In production managemet, these two concepts should always serve as a guide. What is more important? Cost Efficiency or Effectiveness. There is no right or wrong answers depending on the expected outcomes of what management wants to achieve. It is prudent though that minimization of costs and the maximization of effectiveness should be the proper options.
Effective production management involves understanding of the characteristics of various types of production systems, identification of the dynamics of the different phases of the management process, realizing the potential of different analytical tools, learning the nuances of the implementation of these tools, visualizing the impact of various uncertain situations and developing the ability to react under various scenarios to achieve consistently excellent business results. There are evidences to show how a number of organizations achieved world class status by effective management of their production systems. These organizations achieved superior quality, higher productivity, perfect delivery performance, overall customer satisfaction and enterprise excellence all with lower cost.
Types of Production Systems
Job production (Craft) - this is a method of production where companies use all their factors of production to complete one job at a time. This will usually happen where products are all unique or they are being produced on a very small scale. Examples. Artists painting, basket weaving, sculptor pieces, jewelry making
Batch production - this is a method of production where one operation is completed on a number of units of the product, before they are then passed on to the next stage of the process. Examples: Food Processing like tocino,ham, balut making, softdrinks,
Flow production (assembly line) - this is where production takes place as a continuous process. The product flows from one process onto the next. This will usually happen where the product is standardised, and can be made using a production line automotive assembly, computer assembly
Combination of Batch and Assembly line - this is the type of production system that uses both batch and assemblyline systems. Examples. Fashion garments,
Production is the processes of converting raw materials into semi-finished and finished products.
Production Management - the management of those resources and activities of a business that are required to produce goods for sale to consumers or to other organizations. Production management is concerned with the manufacturing industry. The growing interest in the production management task in service industries has led to the use of operations management as a more general term.
The level of production activities is dependent on what products or services that are being produced, how they are produced and when they are needed by the marketing function.
Two Guiding Principles in Production
1) Efficiency
2) Effectiveness
INPUT COSTs/OUTPUT
Efficiency involves the measurement of the cost of inputs relative to outputs.
Example - If an enterprise A spends P1,000.00 to produce 100 pairs of slippers, then the cost to produce one pair is P10.00. If enterprise B spends PP750.00 to produce 100 pairs of slippers, then the cost per unit is P7.50. Under this scenario, enterprise be is more cost efficient. The lower the cost to produce one unit of production volume, the higher its cost efficiency. It is the inverse of cost of inputs/volume of outputs.
This gives the cost per unit of production, and so one measure of efficiency. Another measure would be to look at how much each particular factor of production (labour / capital / land) manages to produce. In this way we can measure productivity. For example to calculate labour productivity: In a garment factory, the following are:
Sewer A = Can finish "edging sewing" 20 pieces per day
Sewer B = can finish "edging sewing" 25 pieces per day
Obviously Sewer B has higher productivity and is more cost efficient, because he/she produces 25 pieces, 5 pieces more than Sewer A.
But supposing Sewer A is paid P200.00 per day and Sewer B is paid P300.00 per day. How will labor efficency and productivity be affected ? In this scenario, the labor efficiency of Sewer A is P200.00/20 while Sewer B has P P300.00/25 resulting in Sewer A's P10.00 cost to produce one unit while Sewer B has a per unit prodution cost of P12.00. Under this circumstances, Sewer A is more labor efficient and productive.
Effectiveness - is when you achieve the purpose or objective of the task or activities. Examples. Company A has the objective of producing 10,000 units of baseball caps for its customers who will attend the independence day parade and is able to do so but the cost to produce the 10,000 caps is P500,000. Company B is only able to produce 6,000 caps but incurring a cost of P180,000.00. Under this scenarios Company A has a per unit production cost of P50.00 per baseball cap while company B has a production cost of P30.00. per unit. Which company is more effective? The answer is Company A. Although it produced baseball caps at a higher costs, it was able to achieve its purpose of producing the 10,000 baseball caps. So, effectiveness is not about costs but rather the achievement of the production goal.
In production managemet, these two concepts should always serve as a guide. What is more important? Cost Efficiency or Effectiveness. There is no right or wrong answers depending on the expected outcomes of what management wants to achieve. It is prudent though that minimization of costs and the maximization of effectiveness should be the proper options.
Effective production management involves understanding of the characteristics of various types of production systems, identification of the dynamics of the different phases of the management process, realizing the potential of different analytical tools, learning the nuances of the implementation of these tools, visualizing the impact of various uncertain situations and developing the ability to react under various scenarios to achieve consistently excellent business results. There are evidences to show how a number of organizations achieved world class status by effective management of their production systems. These organizations achieved superior quality, higher productivity, perfect delivery performance, overall customer satisfaction and enterprise excellence all with lower cost.
Types of Production Systems
Job production (Craft) - this is a method of production where companies use all their factors of production to complete one job at a time. This will usually happen where products are all unique or they are being produced on a very small scale. Examples. Artists painting, basket weaving, sculptor pieces, jewelry making
Batch production - this is a method of production where one operation is completed on a number of units of the product, before they are then passed on to the next stage of the process. Examples: Food Processing like tocino,ham, balut making, softdrinks,
Flow production (assembly line) - this is where production takes place as a continuous process. The product flows from one process onto the next. This will usually happen where the product is standardised, and can be made using a production line automotive assembly, computer assembly
Combination of Batch and Assembly line - this is the type of production system that uses both batch and assemblyline systems. Examples. Fashion garments,
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