The main goal of alternative types of cost accounting is to provide the organization a realistic view of the cost of goods that it sells. Although Standard cost accounting offers this, it differs because it also focuses on performance measurement and management. Standard costing provides a cost objective that Leadership is able to use to evaluate the performance of the firm and its’ processes.
Many companies which use standard cost accounting utilize it to manage by variance. This approach requires thorough variance analysis at all levels. The types of variances which are routinely measured are:
Purchase price Variance (PP V):
Dependent upon the software program, PP V may have numerous components. Typically, it is the difference between the price on the Purchase Order (PO) and the standard cost of the item. The other most typical element of PP V is the difference between the invoice from the supplier and the PO.
Closed Work Order Variance (C W O):
The C W O variance will be the difference between the standard cost associated with the item being produced and the actual costs charged to the work order. Depending on the system C W O variances might have numerous components, as well.
Most computer systems that handle work orders will distinguish between the types of costs issued to the work order. These are typically Materials, Direct Labor, Factory Burden, and Outside Processing. Within Factory Burden, some systems also distinguish between Variance Burden, Fixed Burden and Material Burden.
Direct Labor Application Variance:
The Direct Labor variance will be the difference between the actual Direct Labor incurred and the Direct Labor charged to work orders.
Factory Burden Application Variance:
The Factory Burden variance will be the difference between the actual Factory Burden incurred and the Factory Burden charged to work orders. In most systems Factory Burden is split up into a number of sub-categories such as variable overhead, fixed overhead and material burden and each of the sub-categories need its’ own analysis to look for the drivers of the variances.
Management by Variance
Management by variance is the method of financial review in which the emphasis of the analysis is on the variances from budget and standard.
The flow of the review is driven by how the firm sees its’ products and markets. Among the most common classifications to go through during the review is product line/family/group, job, or location.
For the sake of discussion, let’s assume that product line will be the logical group. For every product line, the person doing the analysis will have to present production & sales data relating to the specific groups in addition to variance analysis tables much like those listed in the prior section.
Numbers, on the other hand, are nearly meaningless with no narrative to paint the picture behind the numbers. The person preparing the analysis must not only show the numbers, but examine the drivers of the variances, both positive and negative.
This allows the business to plan and carry out modifications to offset ongoing drivers of negative variances or, maybe, to further capitalize on operational changes which have shown positive variances by rolling them out into other areas.
For example, utilizing the illustrations from the prior section, if the decrease from the standard 2 hour to produce a widget to the actual 1.75 hours was because of the purchase of newer, faster machines, then it quantifies the cost savings associated with the improvement that was put in place.
On the other hand, the rise in materials usage could be because of training issues associated to employee turnover, or changes in materials to improve yield, quality or cost and is in need or rigorous analysis.
At the end of the review, all participants should be clear on where the financial statements stand, exactly what the drivers are (both positive and negative), and know all of the action items to be tackled at a later meeting.