Nov 242010

The primary focus of other methods of costing is to give the company an accurate view on the cost of products that it sells. While Standard Costing provides this, it differs in that it also focuses on performance measurement and management. Standard Cost gives a target cost that Management can use to measure the effectiveness of the organization and its’ processes.

Most companies that use Standard Cost use it to manage by variance. This requires rigorous variance analysis at all levels. The types of variances that are routinely measured are:

  • Purchase Price Variance (PPV): Depending on the system PPV can have various components. As a rule, it is the difference between the price on the Purchase Order (PO) and the standard cost of the item. The other most common component of PPV is the difference between the invoice from the supplier and the PO.
  • Closed Work Order Variance (CWO): The CWO variance is 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 CWO variances can have various components, as well. Most ERP systems that handle work orders will differentiate between the categories of costs issued to the work order. These are usually Materials, Direct Labor, Factory Burden, and Outside Processing. Within Factory Burden, many systems also differentiate between Variance Burden, Fixed Burden and Material Burden.
  • Direct Labor Application Variance: The Direct Labor variance is the difference between the actual Direct Labor incurred and the Direct Labor charged to work orders.
  • Factory Burden Application Variance: The Factory Burden variance is the difference between the actual Factory Burden incurred and the Factory Burden charged to work orders. In many systems Factory Burden is split into several sub-categories such as Variable Burden, Fixed Burden and Material Burden and each of these sub-categories require separate analysis to determine the drivers of the variances.

Management by Variance

Management by variance is the process of financial review where the focus of the review is on the variances from budget and standard.

The flow of the review is driven by how the organization perceives its’ products and markets. Among the most common categories to follow during the review are product line/family/group, project, or facility. For the sake of discussion, let us assume that product line is the logical grouping. For each product line, the preparer will need to provide production & sales data for the relevant group as well as variance analysis tables similar to those listed in the previous section.

Numbers, however, are almost irrelevant without the narrative to tell the story behind the numbers. The preparer must not only show the numbers but discuss the drivers for the variances, both positive and negative. This allows the organization to plan and implement changes to mitigate continuing drivers of negative variances or, possibly, to further capitalize on operational changes that have yielded positive variances by rolling them out into other areas.

For instance, using the examples from the prior section, if the reduction from a standard 2 hour to make a widget to the actual 1.75 hours was due to the acquisition of new, faster equipment, then it quantifies the savings related to the improvement that was implemented. Conversely, the increase in materials usage could be due to training issues related to employee turnover, or changes in material to improve yield, quality or cost and need to be delved into.

At the conclusion of the review, all attendees should have a clear view of where the financials stand, what the drivers were (both positive and negative), and know all of the action items to be addressed at a later meeting.

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