Standard Costing

Project submitted in partial fulfillment of the course in Advanced Cost accounting At M.com Part 1 2013-14

By Mayuri Shetty

Guiding Teacher

C.A Wani Rajni Udaykumar

University of Mumbai. Kelkar Vaze College, Mumbai.

CERTIFICATE

This is to certify that the project Titled Standard Costing is being submitted by me in partial fulfillment of the course in Advanced Cost accounting M.com Part I during 2013-14

Date: 13/09/2013

Signature

REMARKS

Guiding Teachers : Rajni Signature ___________ C.A Wani Signature ___________

External Teacher :

Signature__________

ACKNOWLEGMENT

I take this opportunity to express my profound gratitude and deep regards to my teaching guide Dr.Rangasai and Dr. Kurusu Sir for his exemplary guidance, monitoring and constant encouragement throughout the course. The blessing, help and guidance given by him time to time shall carry me a long way in the journey of life on which I am about to embark Lastly, I thank almighty and my friends for their constant encouragement without which this project would not be possible.

CONTENT

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 companys 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 companys 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, managements attention is directed towards those items, which are not proceeding according to the plan. Most of the managements 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 1.The 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. 2.Time Consuming A lot of time is also spent in developing and installing reliable standard costing systems. 3.Obsolescence: In fast changing conditions (e.g. in prices of labour, materials and overheads change rapidly), standards become out of date quickly. They therefore lose their control and motivational effects. 4.Hard 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. 5.Effectiveness 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. 6.It 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 organizations 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 companys 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 costof-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 workforce? 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 nonvolume 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.