Standard costing and variance analysis has been in use since the early twentieth century. In recent years the role of standard costing and variance analysis as a useful part of the management accounting tool kit has been increasingly questioned.
The extent to which standards and/or variances have a role to play in modern business is open to question. This will be linked to the adaptation of processes, markets and policies in a changing business environment. The rate of change in product type and design due to technological improvement, customer requirements and increased competition has led to rapid change in how businesses operate. The need to respond to customer demands for speedy availability of products, shortening product life cycles and higher quality standards has contributed to a number of changes in the way in which businesses operate. These include:
- Just-in-time systems allied to flexible manufacturing systems aimed to ensure that customer demand may be satisfied on a 'pull through' basis. Stocks and work-in progress will be minimised and the business operating cycle tailored to cater for the specific customer requirements.
- Total quality programmes aim at continuous improvement, with the identification and elimination of non-value added activities and the effective provision of value added activities.
- Greater emphasis on the value chain, from close links with suppliers of input materials and services to identification of customer needs in respect of quality, delivery and changing requirements through time.
- Accurate product costing and pricing information to facilitate improvement in planning and decision-making. This will include the use of activity-based costing and budgeting systems and the use of target costing.
- Improved speed and flexibility of information availability. This may be linked to the availability of on-line information in a computer integrated manufacturing environment.
What of standards and variances in modern business? Can planning and decision-making be accomplished in an effective manner without reference to some standard or base and without recourse to some measurement through time of the achievement of, progress towards or variation from such standard or base? What elements of a traditional standard cost/variance model will still have some relevance?
Questions may be raised and discussed in a number of areas in which standards and variances may feature:
Many candidates are unable to carry out the necessary computational aspects of an examination question. This is likely to be caused, at least in part, because of a lack of understanding of the physical situation which the data is intended to represent. A further problem is a lack of ability to relate the physical information that has been calculated and the discussion about its relevance as a business tool in planning, control, etc. The example that follows provides an illustration of the use of standards and discussion of their relevance.
Linguella plc has prepared standard material and assembly labour specifications for product A as follows:
- Each finished unit of product A contains 2 units of component X and should require 0.15 hours of assembly labour time.
- The standard input requirements for the product must allow for losses of 10% of material and labour input during processing.
- The standard purchase price for component X is £8 per unit.
- The standard wage rate for assembly labour is £6 per hour.
Customer demand for period 2 for product A is budgeted at 2,280 units. It is budgeted that returns of faulty product units from customers requiring free replacement will be 5% of goods delivered to customers.
No stocks of raw material, work-in-progress or finished goods are planned.
We are required to calculate both the material purchases budget for component X and the assembly labour budget for period 2. As part of a quality management initiative it is also required that we calculate the budgeted internal and external failure cost for both material (component X) and assembly labour.