Week 7 Discussion
COLLAPSE
Costing Systems and Analysis
Option 1
Discuss the usage and creation of standard costs by an operation. How are these costs developed? How can they be used in the creation of a forecast? How can these be used in an individual or organizational measurement system?
– OR –
Option 2
Discuss a current business activity that you or your department does that could be improved by leveraging Variance Analysis. Discuss the perspective you could gain, and what a “favorable price” and a “favorable quantity” variance mean in this application.
Post your initial response by Wednesday, midnight of your time zone, and reply to at least 2 of your classmates’ initial posts by Sunday, midnight of your time zone.
1st person to respond to
Chris
RE: Week 7 DiscussionCOLLAPSE
Professor and Class,
We have used variance analysis a few time in our antique car restoration business and it was really eye opening. Variance analysis is the process of identifying, measuring, and investigating the causes of significant differences (variances) between budgeted plans and actual results (1). We failed miserably with our property plant and equipment section of the balance sheet. We usually try and budget around $500 per month or $6,000 per year for new tools and equipment. Last year we spent $14,500 on new equipment which would not be a favorable variance. The main culprit of this was the owner of the company purchasing tools and equipment from sales people that come into the shop selling their latest, greatest product and falls for it hook-line and sinker!! A majority of the stuff purchased, they guys in the shop do not even use. I learned during this process that we do not need to purchase half of the stuff that we do. I would consider this wasteful spending!! In a year that we are purchasing the building and property that we have been renting, we need to really keep an eye on all expenses.
Chris
References:
1. Gene Siciliano. Finance for nonfinancial managers, second edition.
JWI 530
The Mary Story
WHAT’S MY REAL COST?
WHAT’S MY REAL COST?
Mary worked on a custom-made perfume project with Mike, the
VP of Operations. Not only did she learn some interesting things
about how specialty orders are handled vs. standard products, she
learned a lot about fixed and variable costs as they apply to the
overall production process.
During her tour of the plant and subsequent meetings with Mike, the
two talked quite a bit about SKU’s, and how they relate to accounting.
SKU is short for “Stock Keeping Unit”, and they are typically given a
numeric value. The numbers associated with unique SKUs provide a
way of keeping track of items produced, and the costs associated
with those items. Their warehouse was almost filled to capacity.
Calculating required storage space was one of the many tasks Mary
was determined to work out. Mary knew that there were expensive
products such as fragrance ingredients, labels, and branded
packaging in all those boxes. Inventory = Money!
After returning to her office from the plant tour, she reviewed a report
Andrea had provided for her reference. After she reviewed the
figures, she checked her email to find some follow-up notes from
Andrea. She refilled her coffee, and set her mind to making an outline
– and following through. Mary was on a quest to streamline costs
where ever she could! With regards to the report, Mary assumed that
all she needed to do in the fragrance division was to sort the list from
the highest profit per oz. to lowest profit per oz.…and then start
cutting the lowest profit producing SKUs. It sounded too easy…
Andrea’s notes reminded Mary that before she could get her cost
slashing “axe” out, she first needed to understand the allocation
methods that were used in calculating the total cost. Andrea wrote
that Cost is not always cost… Some costs are direct costs, and are
easily traceable to the individual unit. Items such as the perfume
formula or the cost of the bottle, even the label on that bottle are
considered raw material costs – these are all examples of direct cost,
as they are linked directly to a product.
But there are also indirect costs – the things that are necessary to
create the product; but in an indirect way. One example of these
costs would be the salary of the Plant Manager, as that cost impacts
all of the units produced. Other examples would include items such
as rent expense, equipment depreciation, and insurance. All of the
indirect costs are pooled, and then ‘spread out’ or allocated over the
products on the same basis. There are a host of different allocation
methods available. The key is to choose the allocation method that
most accurately reflects which units drive the cost, but to do so in a
way that is not cost-prohibitive to administer.
The simplest allocation method is to spread the costs evenly over the
units. If the indirect cost pool is $100 and there are 10 SKUs, each
unit is assigned $10 of cost. But what if SKU A has 10x the unit
volume of all of the rest? Another method is to spread the cost based
on units of production. Again, if the cost pool is $100 and there are 2
SKUs, one with 90 units produced and the other 10 units, SKU A
would absorb $90 and SKU B would be allocated $10. This method is
typically a more accurate representation of the cost per SKU – if
indeed production volume is the activity that mostly drives the cost.
Andrea reminded Mary that she also needed to consider what would
happen if the cost pool was related to a “rework,” for instance, a
salvage department for dealing with production and quality control
issues. Suppose in this example, that all of the quality issues come
from SKU B; SKU B would have to pay 100% of the salvage
department’s cost!
There is a special type of Accounting called “Activity Based Costing”,
or ABC. This approach makes very close observations related to
internal processes, and identifies each individual pocket of indirect
spend, such as the salvage group. The goal is to identify the single
best driver and use the measurement of that driver, like quality issues
by SKU. Allocation is then based on the activity. One drawback with
ABC is that it’s very expensive, and it requires lots of record keeping
in order to run properly. This means extra work for accountants and
for people in operations, who may have to track and report at
incredible levels of detail. Its great data, but it often comes with a high
cost. Mary learned that her company would implement activity-based
approaches where practical. They focused on the largest elements of
cost, and used ABC when a tracking or reporting system already
existed.
For example, they would allocate storage costs based on the number
of units of a SKU in the warehouse. This approach utilized data they
already had from the warehouse operations report. But for the all
other items, they would simply allocate based on the number of units
of production. This approach produced the best results with the least
expense. The “best results / least expense” philosophy really
resonated with Mary.
But before she could make her final cuts, she needed to think about
any unusual characteristics of the SKUs she was evaluating, such as
complicated handling, small batch sizes, or unusual packaging that
might not be reflected in the SKU P&L report. The SKU P&L report
can be an incredible tool, but Mary knew that a savvy manager needs
to understand its limitations. She also knew she had to ask follow-up
questions and ensure that the answers made sense on every level.
Financial data can get you 80% of the way to the final answer, but
there is never a replacement for the judgment and experience of a
great Business Manager.
As she finished reading through Andrea’s notes on these important
topics, Mary felt a real sense of her duties and goals. She was getting
“hands on” experience working directly with Mike in the plant, and
Andrea was supplementing that knowledge by sharing key details
about the financial aspects of the manufacturing process. And both
types of knowledge were helping Mary to realize what her “Real
Costs” were.
