3.8 COST ACCOUNTING MODELS
3.8.1 Volume-based costing systems
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confirmed in section 5.6.12, the final cost of metallurgical research projects is often not included in the cost estimates of projects and this may lead to budget overruns.
Thus far, three of the methods of cost estimation suitable for life cycle costing, as stated by Emblemsvag (2003:36), namely analogy, parametric and engineering cost methods, have been discussed. The most suitable method of the above mentioned, to be used in metallurgical research projects, is engineering cost methods. Cost accounting methods, including standard costing, attribute costing, feature costing and activity-based costing will now be discussed.
96 3.8.1.1 Standard costing
A standard is a norm or benchmark for measuring performance. Managers, assisted by engineers and accountants, set quantity and costs standards for each major input such as raw material and labour time. Quantity standards indicate how much of an input should be used in manufacturing a unit or in providing a service. Cost (or price) standards indicate what the costs of inputs are compared to these standards. Actual quantities and actual costs of inputs are compared to these standards. Any discrepancy is investigated by the manager. The purpose is to find the cause of the problem and then eliminate it so that it does not recur. This approach is referred to as management by exception.
Standard costs are not the same as budgeted costs. A budget relates to an entire activity or operation, whereas a standard presents the same information on a per unit basis.
Standard costing is best suited to an organisation whose activities consist of a series of common or repetitive operations and the input required to produce each unit of output can be specified. Standard costing cannot be applied to non-repetitive activities, since there is no basis for observing repetitive operations and consequently, targets cannot be set (Drury 2008:420; Garrison
& Noreen 2003:425).
Figure 3.8 provides an overview of a standard costing system.
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Figure 3.8 An overview of a standard costing system
Source:
Adapted from Drury (2004:728)
It is clear from the box below the first arrow in figure 3.8 that the operation of a standard costing system also makes possible a detailed analysis of the variance to be reported. Variances should be investigated and should result in appropriate remedial action being taken. If it is found that the variance is due to a permanent change in the standard, the standard should be changed.
Standard costing has numerous advantages but also some disadvantages.
(a) Advantages
The use of standard costs is a key element in a management by exception approach. As long as costs remain within the standards, managers can focus on other issues. This approach helps managers focus on important issues.
Standard cost of actual output recorded for each responsibility centre
Actual costs traced to each responsibility centre
Standard and actual costs compared and variances
analysed and reported
Variances investigated and corrective action taken
Standards monitored and adjusted to reflect changes in standard usage and/or prices
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As long as employees view standards reasonable, they can promote economy and efficiency. Individuals are provided with benchmarks that can be used to judge their own performance.
Standard costs can simplify bookkeeping. The standard costs for materials, labour and overhead can be charged to jobs instead of recording actual costs for each job.
Standard costs fit naturally into an integrated system of responsibility accounting. The standards establish what costs should be, who should be responsible for them and whether actual costs are under control.
(b) Disadvantages
Standard cost variance reports are usually prepared on a monthly basis and often released days or weeks after the end of the month. The information may be so stale that it is almost useless.
Morale may suffer if managers are insensitive and use variance reporting as a club. Management by exception tends to concentrate on the negative.
Labour quantity and efficiency standards make two assumptions. First, they assume that the production process is labour paced - if labour works faster, output will increase. Second, they assume that labour is variable costs.
Labour, however, may be fixed, in which case the undue emphasis on labour efficiency variances creates pressure to build excess work in process and finished goods inventories.
A favourable variance may be as bad as or worse than an unfavourable variance. For example, if McDonalds has a standard for the amount of meat in a hamburger, and there is a favourable variance, less meat was used than the standard. This results in a substandard product and possibly a dissatisfied customer.
The emphasis may be on meeting the standards to the exclusion of other key objectives such as maintaining and improving quality, on-time delivery and customer satisfaction.
To survive in a competitive market, more than simply meeting standards is necessary, say, continuous improvement.
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Traditional variance analysis of variable and fixed overhead provides little useful information for managers because the relative importance and proportion of overhead grows in comparison to direct material and direct labour (Garrison & Noreen 2003:444; Garrison et al 2003:516; Jackson &
Sawyers 2003:346).
In a survey conducted in 1987, 94% of the companies contacted reported that they used labour hours to allocate overhead costs. According to Emblemsvag (2003:39), this is shocking news, given the known limitations of using only direct labour as the allocation base. He argues that most people in the industry do not know what their products cost and that many companies have survived despite their cost management systems. In the 1980 recession, many companies learnt that this is not a desirable situation. Volume-based costing systems are therefore not attractive under any circumstance for life cycle costing purposes, because they perform too poorly.