1. Predetermined or standard performance level-setting Standard. Historical Data. Standard Costing

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1 Week3 Standard Costing and Variance analysis helps MCSs Standard Costing of DM&DL -Part of the budgetary control system (Benchmark) -Expect lasts longer (long-term; constant) Price standard: E.g. Cost of transportation to the plant Quantity standard (last longer): Included on-cost extra salary-related costs: Annual and long service leave, worker s compensation insurance Controlling Costs: 1. Predetermined or standard performance level-setting Standard Engineering Methods -Shift from what the product did cost in the past to what it should cost in the future -Conduct studies Determine exactly how much direct material should be acquired; how much machinery and direct labour should be used Time and motion studies Historical Data -Need to adjust predictions to reflect expected movements in price levels or technological changes in the production process E.g. the amount if rubber required to manufacturer a particular type of tyre this year will probably be the same as it was in last year, unless there has been a significant change in manufacturing process Flexible Budgets (Better than) Static Budgets -Adjusted to take account of changes in actual sales volume -Provide a valid basis for comparing actual and expected costs to budget Labour standard: -Use time and motion techniques -Observe the production workers record the average times for each process -Considering the current wage rate Estimates of future wage rises Quantity Standard: -Based on the company ordering a certain quality of material in specific order quantities from a specified supplier -Combined Approach Standard Costing -Budget amounts contrast with actual activity and give rise to VARIANCE accounts -Fixed for the entire period covered by the budget with NO CHANGES based on actual activity (Even if actual sales volume changes significantly different from the expectations in the static budget the amount listed in the budget are not changed) -For firms that NOT to CHANGE much -Useful when: Practical Standard ( More able to achieve) -Method used : (1) Analysis of historical data (2) Engineering methods Total standard cost: Based on the company s actual output

2 ACTUAL PURCHASE Standard Material Quantity Possible Causes Standard Direct Labour Hours Possible Causes Price Variance Formula PQ(AP-SP) (1) Purchasing manager s ability to bargain AH(AR-SR) (1) Using a mix of employees that differ from the anticipated mix -Effect of purchasing at a price (2)Quality of the materials -Impact of paying a different (2) Changes in basic wage levels that is different from the purchased Labour rate compared to the standard price (3)Price changes (Econ. Conditions) standard (4) Wrong standard ACTUAL USED Standard Material Price Possible Causes Standard Labour Rate Possible Causes Efficiency Variance Formula (Usage of material/ labour) SP(AQ-SQ) -Effect of using a different quantity in production compared to standard (Given the actual output) *Not meaningful to compare standard/ budgeted labour usage at one level of output with the actual hours used a different level of output (1) Quality of materials purchased (2) Engineering not maintaining machines (3) Workers become more efficient in using materials/ Production process changed (4) Wrong standard SR(AH-SH) (Given the actual output) -The costs implications of using a different number of direct labour hours If calculating the price variance based on material used in production (not actual output) NOT recommended!!!!! Delays recognition of the total price variance until the material is used in production The responsibility for the price variance lies with the purchasing department, not with the production department Week 5 Financial performance measures, Motivation and Rewards systems Affect behaviour to tackle Narrow Focus problem; Affect opinion 1. Financial Measures in Profit/ Investment Centres (1) Hiring under/ over-skilled workers (faster) (2)Inefficient scheduling of work (3) Inadequate machine maintenance (4) Wrong standard (without careful analysis of operating conditions and the employee skills) (5) Random Fluctuations: Employee illness, comply fatigue

3 Used to Formula Return on Investment (ROI) Residual Income (RI) Economic Value added Measure the performance of an investment Amount of division operating profit in excess of Measures of shareholder value centre the division s cost of acquiring capital to Value created over a single accounting period -Takes into account both investment centre purchase operating assets profit &the capital invested Strategy: impact on value of the business -Not focus on how much profit each investment Compare the value created by alternative centre earned, but on how well each differentiation/ cost strategies investment centre used its invested capital to Financial policies: E.g. Adoption of particular earn a profit financial and capital structure Reducing cost of capital Corporate governance: e.g. managerial reward systems ROI= Profit RI= Profit (Invested Capital Imputed interst rate) EVA= NOPAT (Capital employed WACC) Invested Capital = Profit (Sales Revenue) Sales Revenue Invested Capital NOPAT=Net operating profit after tax Convert accounting data cash-based = Return on sales Investment turnover figures eliminate the effects of gearing Components Return on sale: How many % you earn for every Imputed Interest Rate: based on the -Cost of debt: i/r(1-tc) $ of sale after covering expense Investment turnover: No. of sales $ generated by every $ of invested capital (Good batches of assets to Sales) expectation on the investment -RRR -Cost of Capital (shares dividend/ debts interest) -Cost of equity -Capital employed: Net working capital (CA-CL)+Fixed assets Invested Capital: E.g. Plant, equipment, buildings -Total Assets: including non-productive assets (E.g. vacant land; construction in progress) -Total productive assets: Exclude -Total assets-current liabilities: Manage certain short-term liabilities (E.g. short term bank loan; employee entitlements:

4 Advantages Limitations provision for long-service leave) Encourage managers to min. resources tied up in assets Manage the use of short term credit to finance operations Asset Measurement: Carrying amount: -Maintains consistency with the balance sheets and definition of profit Depreciation ROI Managers may defer investing in new equipment assets become obsolete uncompetitive Acquisition Costs: -Prevent misleading in ROI Provide a disincentive to invest in new equipment Profit: Performance of manager Attribute to Investment centre (Measuring profit depending on the unit of department manager you are evaluating) Allocating corporate costs, interest and income taxes Recognises controllability Motivational Impact -Encourage managers to focus on profits & -Promote Goal congruence (Link to the assets required to generate company) Tackle NARROW FOCUS Discourage excessive investment in -Takes into account of RRR Measuring assets Performance Encourage managers to focus on -Encourages investment which yield +ve. RI revenue and costs -Evaluate the relative performance of diff. sized investment centres (%) -Management myopia-short term Focus: -Management myopia-short term Focus: Since Profit base just for single year Since Profit base just for single year -Eliminate potential distortions of accrual accounting -Closer to economic reality More accurate

5 Profitability Improvement Excessive cost-cutting activities improve profit; short-term ROI But weaken future profits and the business future competitiveness E.g. Reducing employees no.: profit but affect the product quality or the level of customer services Use Multiple measures invested capital (Market value/ replacement costs: Will not causes a major change in the investment base Longer term ) -Encourage managers to defer asset replacement Managers may try to hold on OLD assets Erode the competitiveness and profits in later yeas reduce the capacity of the business and future profit/ ROI Use ACQUISITION COSTS to measure -Goal congruence-narrow Focus: Only focus batches of revenue/ capital in EACH division Use RI/ EVA - sales revenue; Business unit s invested capital E.g. Reduce inventories, sell plant/ other non-current assets Reducing inventories may have adverse -Cannot be access to different size ($) -Formula is biased 偏袒 in favour of larger business (trading company) -Improve profitability without employing additional capital -Borrow additional funds when profit earned>cost of borrowing -Pay off debt by selling assets (Savings in

6 2. Reward Systems Employees dissatisfied and unmotivated effects on achieving prompt deliveries to customers Disposal of assets may have longer-term consequences of reduced capacity reduced customer satisfaction and loss of future sales Employees Hygiene Factors (Environment factors) satisfied and -Provide the necessary setting for unmotivated motivation but do not themselves motivate employees -E.g. working conditions, wage levels, rules and regulations, relationships with colleagues and job security Prevent dissatisfaction reduced interest >profit lost through asset base) Employees satisfied and Motivation Factors motivated -Intrinsic: Short term performance improvements Expectancy Theory: Design jobs and systems encourage intrinsic (1)Valence: Motivation is motivation influenced by valued outcomes -Choice: opportunity to select activities that (2) Expectancy: Individual make sense perform theses in appropriate performance If able to perform ways that level effort comes from -Competence: accomplishment chosen by the confident/ ability employee skilfully performed (3) Instrumentality: likelihood that -Meaningfulness: pursue a worthy task; larger those outcomes will be realised scheme of things -Progress: significant advancement in achieving the task s purpose -Extrinsic Rewards: (Individual/ group based) -Required by law -Relative talent -Motivational -Internal equity (Proper revenue system ensure internal equity is still maintained) -Linkages to performance

7 -Influence on culture 3. Incentive Plans