Introduction

Standard costing is an important subtopic of manufacturing cost accounting. Standard costs are
associated with manufacturing companies and are utilized to manage the costs of direct material,
direct labor, and manufacturing overhead.
In lieu of assigning actual or average costs of direct material, direct labor, and manufacturing
overhead and rolling these costs into their products, most manufacturers assign a standard cost to
their systems. This means that their inventories and cost of goods sold are valued using the
standard costs, and not the actual or average costs, of a product. The Manufacturers pays their
vendors at actual costs which can vary over time. This result in differences between the actual
costs and the standard costs, and those differences are known as variances.

Standard costing and the related variances are valuable to measure the performance of inventory
and product production. When a variance arises, management becomes aware that manufacturing
costs have differed from the standard (planned, expected) costs.

 If the actual cost is greater than the standard cost the variance is referred to as
unfavorable; and unfavorable variances result in the company’s actual profit being less
than planned.
 If the actual cost is less than the standard cost the variance is referred to as favorable; and
favorable variances result in the company’s actual profit being less planned.
Timely reporting of these manufacturing variances allows management to take action on
the differences from the planned amounts.

This, however, is not the only reason that manufacturers utilize standard costs. In the
manufacturing process, materials are issued to work orders and job orders and taken out of the
perpetual inventory and show up on the balance sheet on what is known as work in process.
Because work in process no longer has any part number identity, it is retained as a gross value on
the balance sheet. If a part is issued to a work order and the value of that part is written to the
general ledger work in process account at its current value. If the company were using average
cost to value their products and the item in question is received at a higher price prior to the
work order being completed, then the item will be relieved from inventory in the future at the
new value, causing a negative balance in the work in process account. Multiply this by thousands
of transactions and you will see why it is important to utilize standard costs in a manufacturing
system.

The perpetual inventory is maintained at standard cost (including Direct Materials and
Subassemblies), and the standard cost of finished goods becomes the sum of the standard costs
of the following values:

 Direct material
 Direct labor
 Manufacturing overhead
 Variable manufacturing overhead
 Fixed manufacturing overhead

Standard costing
This is generally best suited to organisations with repetitive activities. It is probably most
relevant to manufacturing organisations with repetitive production processes. Standard costing
cannot be applied easily to non-repetitive activities because there is no clear basis for observing
and recording operations. It is difficult to determine a clear standard.

Two commonly used approaches are used to set standard costs.

1. Past historical records can be used to estimate labour and material usage.

2. Engineering studies can be used. This may involve a detailed study or observation of
operations in terms of material, labour and equipment usage.

The most effective control is achieved by identifying standards for quantities of material, labour
and services to be used in an operation, rather than an overall total product cost. Variances from
standard on all component parts of cost should be reported to identify the cause – and ultimate
responsibility – for the variance from standard.

Variance analysis
Variance analysis involves breaking down the total variance to explain:

1. How much of it is caused by the usage of resources differing from the standard

2. How much is caused by cost of resources differing from the standard

Together, variances can help to reconcile the total cost difference by comparing actual and
standard cost. The main purpose of variances is to provide reasons for off-standard performance.
In this way, management can improve operations, correct errors and deploy resources more
effectively to reduce costs.
Direct material standards and variance analysis

Direct material standards are derived from the amount of material required for each product or
operation. This should take into account the most suitable material for the product specification
and design. It should also include any anticipated wastage or losses in the process.

Direct material standards should also consider the standard price of the material, based on the
most suitable and competitive price as required by the most suitable quality of material. These
prices should also include economic order quantity, discounts and credit terms offered by
suppliers.

The standard material used and the standard cost of the material are combined to calculate the
standard material cost. By comparing the actual material price and the actual material used with
the standards calculated, the material price and the material usage variance can be determined.

Material mix and yield variances

The direct material usage variance measures the change in total material cost caused by using a
non-standard amount of material in production. It is also possible to subdivide this variance into
a direct material mix variance and a direct material yield variance. This is mostly undertaken in
process industries where a standard input mix is the norm.

Identifiable components of input are combined during production to produce an output in which
the individual components are no longer separately identifiable. It is sometimes necessary to
vary the input mix. As a result, this may lead to an output from the process that will differ from
what was expected. The material mix variance therefore measures the change in cost caused by
an alteration to the constituents of the input mix. The material yield variance measures the
change in cost brought about by any deviation in output from the standard process output.

Direct labour standards and variance analysis

Direct labour standards are derived from the analysis of activities required for different
operations. Often a time and motion study is carried out to determine the most efficient
production method, including operating conditions, equipment required and best practice.
Following this, the time is analysed to determine the standard hours required to complete an
operation. Standard wage rates are identified using rates of pay for employees required to carry
out the operation, which are normally set by the company. This standard time and standard wage
rate are combined to calculate the standard labour rate.
Overhead standards – variable overheads

Where overheads vary with activities, a standard variable overhead rate is used. However,
several different activity measures exist and it is important for the organisation to identify which
measure influences overhead cost the most. For example, volume related variable overheads
could vary with direct labour, machine hours, material quantities or number of units. In practice,
the most frequently used are direct labour hours or machine hours.

The variable overhead rate per unit is applied to the standard labour or machine usage to
calculate a standard variable cost per unit. The two variances calculated for variable overheads
are:

1. The variable overhead expenditure variance, which is equal to the difference between the
budgeted flexed variable overheads for the actual direct labour or machine hours of input, and
the actual variable overheads incurred.

2. The variable overhead efficiency variance, which is the difference between the standard hours
of input and the actual hours of input for the period, multiplied by the standard variable overhead
rate.

Overhead standards – fixed overheads

These overheads are largely independent of changes in activity and remain unchanged in the
short term over wide ranges of activity. The budgeted annual fixed overhead is divided by the
budgeted level of activity to determine the standard fixed overhead rate per unit of activity.

Machine hours are normally used for machine-related overheads and direct labour hours are used
for more labour-related overheads. This standard rate is applied to the standard labour or
machine usage per unit to calculate the standard fixed overhead cost for a product.

The total fixed overhead variance is the difference between the standard fixed overhead charged
to production and the actual fixed overhead incurred. An under- or over-recovery of overheads
may occur because the fixed overhead rate is calculated by dividing budgeted fixed overheads by
budgeted output. If actual output or fixed overhead expenditure differs from budget, then an
under or over recovery will occur.

Therefore under- or over-recovery may be due to a fixed overhead expenditure variance arising
from actual expenditure differing from budgeted expenditure.

Alternatively, a fixed overhead volume variance may arise from actual production differing from
budgeted production.
Other variances – sales variances

Sales variances can be used to analyze the performance of the sales function in a similar way to
those for manufacturing costs. Sales variances are calculated in terms of profit or contribution
margin, rather than on sales value.

Other variances – planning and operational variances.

Some variances will arise due to factors that are almost or entirely within the control of
management.

These are referred to as operational variances. Variances that occur from changes in factors
external to the business are referred to as planning variances. As planning variances are not
under the control of operational management, it cannot be held accountable for them.
Advantages and Disadvantages

Advantages

1. Management by Exception

The standard costing is an example of management by exception.

By studying the variances, management’s attention is directed towards those items, which are

not proceeding according to the plan. Most of the management’s time is saved and can be

directed to other value adding activities. Management only concentrates on the ‘few’ exceptions

reported.

2. Cost Reduction

The process of setting, revising and monitoring standards encourages

reappraisal of methods, materials and techniques thus leading to cost reductions. Analysis of

unfavourable variances directs cost analysis to factors that are making costs to exceed the

budgeted costs thus these factors can be controlled, leading to cost reduction.

3. Pricing

Standard costs serve a s a reliable base of calculating total cost of producing a

good or service, to which a margin can be added to determine the selling price.

4. Inventory

Valuation Standard costing makes inventory valuation much easier, if the

actual number of physical units in the inventory is known, then the inventory value is simply

determined by multiplying the standard cot per unit by the physical units.

5. Motivation

A properly developed standard costing system requires the full participation of

all management levels (upper, middle and lower levels) and the employees. This creates

motivation for the employees as they feel part of the system.

6. Cost Control
A well implemented standard costing system acts as a yardstick against

which all costs are measured to determine whether the variance from the standard is favourable

or unfavourable. This creates cost consciousness in the organization and in the end enables the

organization to control costs.

7. Budgeting is made easier

One of the greatest benefits of standard costing is to be found

in setting budgets for the organization and its departments. As earlier illustrated once the

desired output units are known, then the budgeted cost is simply the output units desired

multiplied by the standard cost per unit.

Disadvantages

[Link] system of standard costing is expensive to install

A lot of money is spent in studying output requirements in terms of labour, materials and overheads.

[Link] Consuming

A lot of time is also spent in developing and installing reliable standard costing systems.

[Link]:

In fast changing conditions (e.g. inhyperinflationary economies where

prices of labour, materials and overheads change rapidly), standards become out of date

quickly. They therefore lose their control and motivational effects.

[Link] to Understand

Some standard costing systems are overly elaborate and are

therefore not well understood by line managers and employees. This makes their implementation
difficult.

[Link] depends on Environment

For standard costing systems to be effective in

cost control and performance evaluation, then a participative and democratic management style
 is required. The top management and employees need to be committed to attaining the set

standards of performance. An effective and efficient management information system is also

required so as to provide employees and managers with reliable, accurate and timely feedback

regarding their performance. Lack of one or more of these requirements frustrates the success

of a standard costing system so that its effectiveness cannot be realized.

[Link] is Subjective

As we have already seen, there are several types of standards that an

organization can adopt (basic, ideal, attainable and cement). What is therefore a standard in an

organization depends on its management. It is also important to note that what is referred to as

a significant variance depends on the organization’s management, thus the subjectivity. If this

subjectivity is poorly managed, (for example, punishing employees for insignificant unfavourable

variances of for variances arising from factors beyond their control), then a standard costing

system can lead to employee frustration and poor goal congruence in the organization.

Problems with Standard Costing

 Cost-plus contracts. If you have a contract with a customer under which the customer pays you
for your costs incurred, plus a profit (known as a cost-plus contract), then you must use actual
costs, as per the terms of the contract. Standard costing is not allowed.
 Drives inappropriate activities. A number of the variances reported under a standard costing
system will drive management to take incorrect actions to create favorable variances. For
example, they may buy raw materials in larger quantities in order to improve the purchase price
variance, even though this increases the investment in inventory. Similarly, management may
schedule longer production runs in order to improve the labor efficiency variance, even though it
is better to produce in smaller quantities and accept less labor efficiency in exchange.
 Fast-paced environment. A standard costing system assumes that costs do not change much in
the near term, so that you can rely on standards for a number of months or even a year, before
updating the costs. However, in an environment where product lives are short or continuous
improvement is driving down costs, a standard cost may become out-of-date within a month or
two.
 Slow feedback. A complex system of variance calculations are an integral part of a standard
costing system, which the accounting staff completes at the end of each reporting period. If the
 production department is focused on immediate feedback of problems for instant correction, the
reporting of these variances is much too late to be useful.
 Unit-level information. The variance calculations that typically accompany a standard costing
report are accumulated in aggregate for a company’s entire production department, and so are
unable to provide information about discrepancies at a lower level, such as the individual work
cell, batch, or unit.

Reasons for using a Standard Costing System:

There are several reasons for using a standard costing system:

Cost Control: The most frequent reason cited by companies for using standard costing systems
is cost control. One might initially think that standard costing provides less information than
actual costing, because a standard costing system tracks inventory using budgeted amounts that
were known before the first day of the period, and fails to incorporate valuable information about
how actual costs have differed from budget during the period. However, this reasoning is not
correct, because actual costs are tracked by the accounting system in journal entries to accrue
liabilities for the purchase of materials and the payment of labor, entries to record accumulated
depreciation, and entries to record other costs related to production. Hence, a standard costing
system records both budgeted amounts (via debits to work-in-process, finished goods, and cost-
of-goods-sold) and actual costs incurred. The difference between these budgeted amounts and
actual amounts provides important information about cost control. This information could be
available to a company that uses an actual costing system or a normal costing system, but the
analysis would not be an integral part of the general ledger system. Rather, it might be done, for
example, on a spreadsheet program on a personal computer. The advantage of a standard costing
system is that the general ledger system itself tracks the information necessary to provide
detailed performance reports showing cost variances.

Smooth out short-term fluctuations in direct costs: Similar to the reasons given in the
previous chapter for using normal costing to average the overhead rate over time, there are
reasons to average direct costs. For example, if an apparel manufacturer purchases denim fabric
from different textile mills at slightly different prices, should these differences be tracked
through finished goods inventory and into cost-of-goods-sold? In other words, should the
accounting system track the fact that jeans production on Tuesday cost a few cents more per unit
than production on Wednesday, because the fabric used on Tuesday came from a different mill,
and the negotiated fabric price with that mill was slightly higher? Many companies prefer to
average out these small differences in direct costs.

When actual overhead rates are used, production volume of each product affects the
reported costs of all other products: This reason, which was discussed in the previous chapter
on normal costing, represents an advantage of standard costing over actual costing, but does not
represent an advantage of standard costing over normal costing.

Costing systems that use budgeted data are economical: Accounting systems should satisfy a
cost-benefit test: more sophisticated accounting systems are more costly to design, implement
and operate. If the alternative to a standard costing system is an actual costing system that tracks
actual costs in a more timely (and more expensive) manner, then management should assess
whether the improvement in the quality of the decisions that will be made using that information
is worth the additional cost. In many cases, standard costing systems provide highly reliable
information, and the additional cost of operating an actual costing system is not warranted.
Standard Costing and Variance Analysis Formulas:
Direct Materials Variances:

Materials purchase price variance Formula:

Materials purchase price variance = (Actual quantity purchased × Actual price) – (Actual
quantity purchased × Standard price)

Materials price usage variance formula

Materials price usage variance = (Actual quantity used × Actual price) – (Actual quantity used ×
Standard price)

Materials quantity / usage variance formula

Materials price usage variance = (Actual quantity used × Standard price) – (Standard quantity
allowed × Standard price)

Materials mix variance formula

(Actual quantities at individual standard materials costs) – (Actual quantities at weighted
average of standard materials costs)

Materials yield variance formula

(Actual quantities at weighted average of standard materials costs) – (Actual output quantity at
standard materials cost)

Direct Labor Variances:

Direct labor rate / price variance formula:

(Actual hours worked × Actual rate) – (Actual hours worked × Standard rate)

Direct labor efficiency / usage / quantity formula:

(Actual hours worked × Standard rate) – (Standard hours allowed × Standard rate)

Direct labor yield variance formula:

(Standard hours allowed for expected output × Standard labor rate) – (Standard hours allowed
for actual output × Standard labor rate)

Factory Overhead Variances:

Factory overhead controllable variance formula:

(Actual factory overhead) – (Budgeted allowance based on standard hours allowed*)

Factory overhead volume variance:

(Budgeted allowance based on standard hours allowed*) – (Factory overhead applied or charged
to production)
Factory overhead spending variance:
(Actual factory overhead) – (Budgeted allowance based on actual hours worked)

Factory overhead idle capacity variance formula:

(Budgeted allowance based on actual hours worked) – (Actual hours worked × Standard
overhead rate)

Factory overhead efficiency variance formula:

(Actual hours worked × Standard overhead rate) – (Standard hours allowed for expected output ×
Standard overhead rate)

Variable overhead efficiency variance formula:

(Actual hours worked × Standard variable overhead rate) – (Standard hours allowed × Standard
variable overhead rate)

Variable overhead efficiency variance formula:

(Actual hours worked × Fixed overhead rate) – (Standard hours allowed × Fixed overhead rate)

Factory overhead yield variance formula:

(Standard hours allowed for expected output × Standard overhead rate) – (Standard hours
allowed for actual output × Standard overhead rate)
 STANDARD COSTING AND ITS ROLE IN TODAY'S MANUFACTURING
ENVIRONMENT
Mike Lucas argues that reports of the death of standard costing have been greatly
exaggerated

In recent years, writers such as Kaplan and Johnson,[1] Ferrara[2] and Monden and Lee[3] have
argued that standard costing variance analysis should not be used for cost-control and
performance-evaluation purposes in today's manufacturing world. Its use, they argue, is likely to
induce behaviour which is inconsistent with the strategic manufacturing objectives that
companies need to achieve in order to survive and prosper in today's intensely competitive
international economic environment.

Standard costing variance analysis continues, however, to be included in undergraduate curricula

and professional examination syllabuses. Students, having struggled through the learning
process, may be dismayed to discover that many consider the knowledge they have acquired
obsolete.

It could be argued that standard costing variance analysis is still widely used in practice and this
is sufficient justification for learning about it. The mainstream of management accounting,
however, has always been prescriptive -- specifying best practice rather than merely descriptive
-- simply describing what goes on in practice for better or worse. The inclusion of, and certainly
the importance attached to, standard costing variance analysis in management accounting
syllabuses is therefore an issue in need of clarification.

The case against standard costing

Drury,[4] for example, has described how the scientific management principles of F.W. Taylor
provided the impetus for the development of standard costing systems. The scientific
management engineers divided the production system into a number of simple repetitive tasks in
order to obtain the advantages of specialisation and to eliminate the time wasted by workers
changing from one task to another.

Once individual tasks and methods have been clearly defined it is a relatively simple matter to
set standards of performance using work study and time and motion study. These standards of
performance then serve as the basis for financial control: monetary values are assigned to both
standards and deviations from standard, i.e. variances. These variances are then attributed to
particular operations/ responsibility. centres.

Companies operating in today's manufacturing environment, however, are likely to have

strategies based on objectives such as improving quality, increasing flexibility to meet
customers' individual requirements, reducing manufacturing lead times and delivery times,
reducing inventories and unit costs. To help achieve these objectives, manufacturing strategies
such as just-in-time (IIT), advanced manufacturing technology (AMT) and continuous
improvement are often applied. Kaplan et al argue that standard costing is counter-productive in
such an environment.

The major criticisms levelled at standard costing variance analysis are as follows:

1. In a JIT environment, measuring standard costing variances for performance evaluation may
encourage dysfunctional behavior. The primary purpose of the JIT production system is to
increase profits by decreasing costs. It does this by eliminating excessive inventory and/or work-
force? Items will be produced only at the time they are needed and in the precise amounts in
which they are needed -- thus removing the necessity for inventories. Running the business
without inventories requires the ability to produce small batch sizes economically. In order to do
so, set-up times must be reduced. Performance measures should therefore be such as to motivate
managers and workforce to work towards reducing set-up times in order to achieve the sub-goal
of economic small batch size as a prerequisite for achieving the lower inventories. Performance
measures that benefit from large batch sizes or from producing for inventory should therefore be
avoided; standard costing variances are just such measures!

Specifically:

(a) Efficiency variances measure labour hour input against the standard labour hours of the
production achieved. Producing in smaller batch sizes will mean that more labour time is spent
on machine set-ups and consequently the standard hours of output will be lower relative to the
labour hour input -- resulting in adverse efficiency variances.

(b) The fixed overhead volume variance arises as a result of a given level of overhead
expenditure being spread over a different number of units from the number budgeted. Adjusting
output downwards to meet a fall in short-term demand will, however, mean fewer units to absorb
the fixed overhead, resulting in an adverse volume variance. Hence managers may be motivated
to produce for stock in direct contravention of the philosophy of JIT.

(c) Materials price variance: adverse materials price variances may result from buying in small
quantities in order to keep stocks low as part of the JIT philosophy. Measuring this variance may
therefore put pressure on purchasing managers to buy in bulk to obtain quantity discounts and
thus favourable price variances

2 In an AMT environment, the major costs are those related to the production facility rather than
production volume related costs such as materials and labour which standard costing is
essentially designed to plan and control
Standard costing is concerned with comparing actual cost per unit with standard cost per unit.
Fixed costs imputed to the product unit level are only notionally 'unit' costs. Any difference
between the actual and standard fixed cost per unit is not therefore meaningful for controlling
operations, as it does not necessarily reflect under or overspending --it may simply reflect
differences in production volume. What matters is the total fixed overhead expenditure rather
than the fixed overhead cost per unit.

Therefore, in an AMT environment, standard costing variances have at best a minor role to play
and at worse they may be counter-productive insofar as they force managers to focus on the
wrong issues. An activity-based cost management (ABCM) system may be more appropriate,
focusing on activities that drive the costs in service and support departments which form the bulk
of controllable costs.

3. In a JIT/AMT/continuous improvement environment, the workforce is usually, organised into

empowered, multi-skilled teams controlling operations autonomously. The feedback they require
is real time and in physical terms. Periodic financial variance reports are neither meaningful nor
timely enough to facilitate appropriate control action.

4. In a total quality management (TQM) environment, standard costing variance measurement

places an emphasis on cost control to the likely detriment of quality

TQM requires a total managerial and worker ethos of improving and maintaining quality, and of
resolving problems relating to this. The emphasis of standard costing is on cost control; variance
analysis is likely to pull managerial and worker interest away from perhaps critical quality
issues. Thus cost control may be achieved at the expense of quality and competitive advantage.

5. A continuous improvement environment requires a continual effort to do things better, not

achieve an arbitrary standard based on prescribed or assumed conditions.

Ferrara has suggested that standard costing based on engineering standards -- which in turn are
predicated on the notion of a 'one best way' -- is only appropriate in the static, bygone world of
cost-plus pricing (the world in which the Scientific Management School lived?). In such a world,
a standard cost is established specifying what a product should cost and to this is added the
required profit mark up to arrive at the selling price. Cost management then consists of ensuring
that standards are adhered to.

In today's intensely competitive environment (the argument goes), we no longer look to the total
unit cost in order to determine selling price; instead, we use the selling price to help determine
the cost the market will allow. This allowable or target cost per unit is a market-driven cost that
has to be achieved if desired profits are to be achieved. In a highly competitive, dynamic world
there is likely to be considerable downward pressure on this allowable cost. Cost management
must therefore consist of both cost maintenance and continuous cost improvement.
In such a competitive, improvement-seeking environment, of what value is standard costing
based on predetermined engineering standards which creates a mind set of achieving the standard
rather than of continuous cost reduction?

6 In a largely automated production system, it is argued, the processes are so stable that
variances simply disappear

Gagne and Discenza," for example, contend that 'with the use of statistical quality control and
automation, the production processes are very consistent and reliable. Variances often cease to
exist'. If this is true, emphasis should be switched to the product design stage as most costs are
effectively committed during this phase. A target cost that is achievable through the designer's
efforts can be established and the designer then controls the design activities of a new product
using the target cost as an economic guideline.[5]

The case for standard costing

Although the foregoing criticisms appear persuasive, surely the basic principle of standard
costing variance analysis remains sound, i.e. specifying in advance what should be achieved and
then measuring the extent to which it is being achieved. The unit cost of a product has profound
implications for the firm's competitive position and is thus worthy of such control.

Clearly, however, the criticisms must be addressed. The following deals with the criticisms one
by one and suggests modifications, where appropriate that will enable standard costing to
continue to have a major role in cost control and performance evaluation.

1 In a JIT environment, measuring standard costing variances may give rise to dysfunctional
behaviour There is no reason why standard costing should not be valuable in a JIT environment

(a) There may be some truth in the suggestion that a measure which compares the total cost of
time (set up and operating) to the number of units produced might encourage production in large
batches in order to reduce the proportion of time spent on machine set ups. If this is seen as a
risk, alternative means of countering it might be:

- to exclude set up times from the labour input side of the equation and/or

- to adopt a counter balancing performance indicator which penalises/discourages long runs,e.g.

inventory level or average batch size.

(b) The fixed overhead volume variance admittedly has no relevance for control purposes -- it
does not arise as a result of over/under spending but simply as a result of variations in the
number of units produced. Indeed, there is a strong case for not allocating non-volume related
costs to the product unit level (and not, by implication, including them in standard costs). If non-
volume related costs are allocated to the product unit level, the resultant unit cost will not be the
incremental cost of producing a unit and will not therefore be appropriate for decision-making. A
solution would be the use of a standard marginal costing system rather than a standard
absorption costing system.

Alternatively, as suggested for

(a) above, a counter-balancing measure may give similar results, e.g.

(b) stock levels.

(c) The tendency of measuring a materials price variance to encourage purchasing managers to
buy in bulk and hence add to inventory can be obviated by the attitude of senior management to
the interpretation of variances. As long as adverse variances are not used as a stick to beat
managers with, but rather as part of a learning process with a view to improvement, their
avoidance through dysfunctional behaviour need not be a major problem. Any such tendencies
towards dysfunctional behaviour may also be checked by measuring other indicators, e.g.
inventory level.

2 In an AMT environment most costs are non-volume related

Advocates of ABCM have, quite reasonably, argued that fixed costs should not be imputed to the
product unit level.[7] By implication, therefore, they cannot be controlled via a standard costing
system. Critics, however, often go further, arguing that since in a JIT/AMT environment most
costs are not volume-related, standard costing variance analysis does not have a significant role
to play in cost management. This charge is not borne out by the empirical evidence! Fechner,[8]
for example, cites surveys by Drury and Tayles (1994), Joyce and Blaney (1990) and Dean
(1991), which have found that many manufacturing industries, in different countries, have
overhead costs of no more than 30% of total cost (and some of this will be volume-related!). The
70% constituted by direct cost will, usually, be volume-related.

These findings are consistent with evidence cited by Drury[4] of surveys into AMT industries
which suggest that:

(a) materials cost represents the largest percentage of total manufacturing cost;

(b) direct labour costs may account for up to 15% of total cost, i.e. large enough to warrant
controlling!

3 In a JIT/AMT/continuous improvement environment, work teams need real time, quantitative

(as opposed to financial) feedback. In addition to quantitative feedback, periodic financial
information also has a role to play in:
(a) informing work teams of the financial implications of their activities. For example, a work
team may be aware of a problem with materials yields. To improve yields, they may change the
way they operate. This may result, however, in increased labour hour consumption which more
than offsets the savings in materials costs. If real time feedback is required, integrated
computerised manufacturing and accounting systems can now provide financial variance
information in real time;

(b) facilitating management control at a more senior level. Senior management will usually wish
to monitor the financial consequences of work team activities. Also an element of parochialism
may exist for work teams, encouraging them to maximise their output/efficiency to the possible
detriment of other functions or departments. Financial variances provide the overall picture. In
addition, variance information (especially trends in variances) will be useful for senior
management for planning purposes

4. Over-emphasis on cost control can be detrimental to quality

This is a danger which management should be aware of. This does not justify the abandonment
of cost control, however! It simply reinforces the need to measure performance through a range
of indicators-cost, quality, lead times, inventory levels and so forth.

5. Engineering standards are incompatible with continuous improvement

Whilst, historically, engineering standards have been the norm, this does not have to be so! Take
for example, Japanese 'Kaizen costing' as used in Toyota plants.[3] The essential principle of
controlling unit product cost embodied in standard costing is preserved, the only difference being
that Kaizen uses the actual production cost of the previous year as the basis for comparison
(rather than a predetermined engineering standard) and a target reduction rate is applied to this.
The variance calculation is thus: (Cost Base - Target Reduction) -Actual Cost this Period

Whether this modification to traditional standard costing is appropriate will depend on

circumstances. In some production technologies the scope for continuous improvement/cost
reduction is very limited and maintaining engineering standards may be the overriding
imperative.

Importantly, too, it should not be forgotten that previous year's actual costs (on which
improvement is sought) may include low efficiency levels relative to standards that might be
expected in the industry.

6 In a largely automated production system, most costs are committed at the product design
stage. While many costs are, indeed, committed at the product design stage, there is usually
considerable scope for cost variability at the production stage. This is exemplified by the manner
in which Kaizen is intended to complement target costing. Target costing is applied in managing
costs at the product design stage via value engineering. Kaizen is then used to encourage
continuous improvement, i.e. cost reduction. It does this by targeting reductions to current unit
costs and then comparing actual reductions against these targets.