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Chapter I 3 Standard Cost and Variance Analysis 'Tonifh we will uncinpt tn aiuwcr hive memphvsiral qiiestitmK: I. How did ihv imiver^e come to be? 2. Wttiit is the metmins: of life? tintt.-?. Whui ihc ItcH are staruiani costs all ahoui?" S tandard costs are widely used hy manufacturing organizations. In a survey of management accounting practices conducted in the early 1990s, 67 percent of the respondents used standard cost systems.' Moreover, 87 percent of the respondents employed the same cost system for internal and external reporting.^ This chapter examines standard cost systems in a real-world setting. It covers the advantages and disadvantages of standard cost sys316 Standard Cost and Variance Analysis 117 terns, explains the standard-setting process, and shows how to perform variance analysis. The discussion focuses on manufacturing entities, the primary users of standard cost systems. Nevertheless, it also contains a section on standard costs in the service sector that explains how service organizations can use these costs. What Are Standard Costs? Standard costs are predetermined costs that are usually expressed on a per unit basis.^ They constitute a carefully formulated estimate of what future costs should be, based on a desired level of productivity and process efficiency, and a set of assumptions about the operating environment. The set of factors that can affect standard costs was discussed in Chapter 10 (see Figures 10-5 and 10-6). Standard costs generally consist of three major elements: labor, materials, and overhead. How to calculate each cost element and perform a cost roUup was discussed in Chapter 10. These procedures do not change under a standard cost system. However, in a standard cost system, the management team establishes the standards of performance up-front, such as the amount of labor hours required, the expected materials usage, the process yield, and normal scrap levels. These physical standards are priced and then added together to calculate the standard cost of the product or service. Once the standard cost has been established, it is typically not changed until the next standard-setting cycle. Standard Costs as a Management Control System Management control is the process by which managers influence other members of the organization to implement the organizational strategies. Figure 13-1 depicts the functions of a typical management control system.** The organization makes plans, implements these plans, and then has a mechanism to monitor the actual results against the plan. A standard cost system is part ofthe management control process. Other management control systems are budgets, performance evaluations, and quality control. A control system operates through a repetition of five sequential steps:^ Step 1. Establish standards of performance. Standards of performance apply to many aspects of the organization, such as cost, 18 Costing Principles and Systems quality, and customer service. Cost standards typically incorporate more than one standard since they reflect expected levels of manufacturing performance, such as process yields, product quality, and overhead spending levels. Step 2. Measure actual performance. The organization measures the actual results of the process. Manual or automated data collection systems are required to gather information about the process. In a standard cost system, the information collected usually includes labor hours, machine hours, and materials usage. This information is generally collected on the production floor. Step 3. Analyze performance and compare it with the standards. Once the actual results have been measured, these are compared against the standard to identify significant deviations in the expected performance. A standard cost variance is the difference between the actual cost and the standard cost of a product or service. Managers and their accountants identify and analyze variances on a regular basis. This process is called variance analysis. Variances often signal problems that may require investigation and possible action. Step 4. Construct and implement an action plan. This step is a critical aspect of any management control system. In a standard cost system, tbe variance analysis will highlight potential problem areas. Then management must identify the source of the problem and develop plans to correct or improve the situation. The effectiveness of a standard cost system depends on management's ability to act on the information provided. Step 5. Review and revise standards. Modern organizations are in a constant state of change. This dynamic business environment requires that cost standards be updated periodically to reflect these cbanges. Typically cost standards are updated at least once a year during the standard-setting process. However, if the variances are significant, the cost standards should be revised during interim periods. Advantages and Disadvantages of Standard Costs Standard costs have multiple uses. They provide a mechanism to control costs by monitoring actual versus planned results. They are a basis for isolating unanticipated product costs at various points in Standard Cost and Variance Analysis 319 Figure 1 3 - 1 . The Management Control System. Planning implementation Control Appropriate Action Strategy Revision Feedback Source: Adapted from Accounting Texts and Cases (8th edition), Robert N. Anthony and james S. Reece, McGraw-Hill Companies, 1989. Used with permission. the manufacturing process and highlighting areas that require attention. Standard costs are also used to establish budgets. Physical standards of labor and materials assist the organization in planning the materials and capacity requirements of the firm. They are used to develop budgeted unit costs that later become the standard costs for the next fiscal year. Standard costs can provide a simple means to value inventory. Once standard costs are established, the total inventory value can be easily calculated by multiplying the units in inventory at the end of an accounting period by their respective standard costs. Inventory valuation using standard costs is not accepted by generally accepted accounting principles (GAAP). Companies that use standard cost systems must adjust their inventory at reasonable intervals using one of the recognized valuation methods.'^ Another use of standard costs is the determination of product profitability. By comparing the expected selling price to the standard cost, you can understand the product's contribution to the bottom line. This information can assist managers in deciding their product mix and directing sales and marketing strategies. Standard costs are used to motivate employees. They provide an incentive to achieve a tangible goal. This use of standard cost may not be as prevalent as in the past. Manufacturing managers have physical standards that they use to control and monitor performance on the floor. The standard cost system often provides information that is too late and too summarized to be useful to production personnel. Finally, standard costs are said to reduce the paperwork in- 320 Costing Principles atid Sysiems volved in recording inventory transactions. This statement is less true today than it was 20 or 25 years ago. Current inventory management systems can record inventory transactions at actual cost with no incremental paperwork or record-keeping. However, standard costs provide more direct traceability between the physical movement of inventory and the values reported in the general ledger. For example, suppose a cost analyst wanted to verify the cost of sales figure reported in the monthly income statement. He could multiply the standard cost per unit times the number of units sold to obtain the standard cost of sales for the period. Under an actual cost system, he would have to obtain the cost of each inventory transaction at the time it was recorded in the general ledger and then sum all these transactions to calculate the cost of sales. A standard cost system makes it easier to reconcile and report inventory flows because tbe cost does not vary from period to period. Standard cost systems have three major drawbacks. One is the lack of flexibility, hi most organizations, standard costs are prepared once ayear.'Once set, they are rarely changed. This accounting practice is in direct conflict with current management thinking that emphasizes flexihle processes and adaptability to the environment. The second major drawback is the complexity of standard cost systems. Generally these systems are not user friendly. They are designed by accountants and for accountants witbout considering the needs of manufacturing personnel. Moreover, variance analysis often adds a layer of complexity to the record-keeping process that makes it difficult to understand and analyze cost behavior. Accountants spend a substantial amount of time and effort analyzing cost variances instead of helping line managers identify problems and opportunities in a more timely manner. The third drawback is that standard costs do not necessarily reflect the actual costs incurred. If cost variances are significant, the actual cost may be higher or lower than the standard. Cost variances, however, are commonly reported as an aggregate number and are rarely used to calculate the actual manufacturing cost per unit on a regular basis. Standard costs, which management uses as the basis of many business decisions during the year, may or may not reflect tbe actual manufacturing costs of the product. Standard cost systems can be a valuable tool if they are properly designed and administered by the management team in coordination with the finance department. It is particularly appropriate for organizations that operate in a stable environment and have not implemented sophisticated computer applications to help run the Standard Cost and Variance Analysis business. Management control should take place on the production floor or on the service frontline, not in the finance department. Cost analysts should spend less time analyzing cost variances and more time helping managers understand their cost structure and how their decisions affect product or service costs. The Standard-Setting Process Standard setting usually occurs once a year during the budget preparation process. Accountants generally coordinate the process and are responsible for issuing the guidelines, setting due dates, assigning responsibilities, and communicating management expectations. Figure 13-2 summarizes the steps in setting standards and who is responsible for each step. The steps are in sequential order, although some may be done in parallel with others. Some areas have joint responsibility for a taskfor example, the review of the bill of materials and the routing file. This joint responsibility encourages consensus building among areas and ensures the accuracy of the information provided. In some companies that I have visited, the engineering group reviews the labor standards and the hill of materials, with little input from production personnel. This process results in lahor standards that are perceived as too tight hy the production employees and hills of materials that do not accurately reflect what is happening on the production floor. Once the responsible parties have submitted all the information, the cost analyst prices the physical standards and performs the cost rollup. She then reviews the information for reasonableness and highlights inconsistencies, problems, or opportunities to management. The mechanics of this calculation were discussed in detail in Chapter 10. How to Set Standards Physical standards of performance are the basis of standard costs. Management defines the specifications for the quantities of lahor, material, and other services that should be consumed in the manufacture of a product or the delivery of a service. These physical standards are priced to obtain the standard cost. Costing Principles and Systems Figure 13-2. The Standard-Setting Procesa. Task Issue calendar, management guidelines, key assumptions, and identify tasks and responsibilities Determine new product transfers and process or product design changes Review and update bill of materials structures Review and update labor standards and routing file Obtain sales or production forecasts Issue salary guidelines Review historical cost data, pending contract negotiations, expected cost increases 8. Set raw materials standards 9. Budget overhead spending levels 10. 11. 12. 13. Calculate overhead rates Perform cost roUup Review and analyze costs Finalize cost standards Responsibility Accounting Engineering Engineering/production Engineering/production Production planning Human resources Purchasing/materials management/ accounting Purchasing/materials management Production and support departments Accounting Accounting All Accounting/all Materials Quantity Standards Malerial quantity standards are based on the standard bill of materials (BOM), which is developed from the product specifications. These standards identify the type of material required and the amount that should he used to manufacture the product. There are three methods that can be used to set materials quantity standards: Engineering studies. These studies identify the best type of material for the purpose and the proper quantity to use. They focus on finding those materials that will provide the hest combination of quantity, production methods, quality, functionality, and cost. Many companies rely on engineering studies to set their materials quantity standards. Standard Cost and Variance Analysis 333 Analysis of past experience. This method considers the materials consumption patterns for the same or similar products in prior periods. The standards are based on historical data that may include an undetermined amount of waste and excess usage. This shortcoming may he minimized by an arbitrary reduction in the quantity of materials allowed to compensate for known excess usage. In contrast to the use of engineering studies, this method does not focus on finding the best materials available that meet manufacturing criteria. However, it is a less costly method and may he quite satisfactory depending on the company's business needs. Test runs under controlled conditions. In this method, standards are defined by running tests under conditions that can be standardized and controlled. It avoids one of the principal drawbacks of the past experience method in that external causes of variations can be isolated and eliminated during the test runs. The physical quantity standards are converted to cost standards by multiplying the standard quantity by the standard materials price per unit. Materials price standards should represent the expected cost of materials for the time period covered by the standard-setting cycle. Labor Standards Labor standards have been used extensively to improve productivity and reduce costs. These standards are established by determining the time required to complete an operation when working under standard conditions. In setting lahor standards, it is important not only to time the operation but also to take into account other factors that may influence the effectiveness with which an employee performs a taskfor example, the facilities layout, the condition of the equipment, the quality of the materials, and employee training. There are two methods that can be used to set labor standards. The first method relies on the use of experts, who determine what the standard should be and how it should he set. These experts can be company employees or outside consultants. The second method relies on a variety of industrial engineering techniques such as time and motion studies, work sampling, work activity analysis, and detailed flowcharting.^ Labor performance standards are converted to cost standards by multiplying the standard labor time by the standard labor rate, 324 Cosiing Principles and Systems which represents the expected cost of direct labor employees over the standards period. It is largely determined by external factors such as labor regulations or minimum wage laws. However, a manager usually has discretion over the mix of employees used in an operation and in this manner can affect the standard labor rate for that particular operation. Overhead Standards The technique for setting overhead standards differs from labor and materials because the overhead category covers a variety of costs. Some of these costs are fixed, such as building depreciation, and others vary with the level of activity, such as electricity. The first step is to develop a budget for the indirect costs that will be charged to the product or service. This budget is usually developed by a cost center. The total indirect costs for each cost center are divided by a measure of activity that is then used to assign the overhead costs to the product or service. The finance department typically determines the overhead assignment methodology and calculates the standard overhead rate. Generally a manufacturing facility has multiple overhead rates. Chapter 10 discussed how to calculate the overhead rate and how to use this rate to assign indirect costs to a product (see Figures 10-8 and 10-9). Traditional standard cost systems have used direct labor hours, machine hours, or unit volume to assign overhead costs to products or services. How Tight Should the Cost Standards Be? This question is often debated back and forth by operations managers. There is a wide range of possibilities depending on the performance expectations of management and their assessment of how the standards may affect employee behavior. Theoretical standards are the costs that can be achieved under the best possible conditions: it is extremely unlikely that they will occur. Theoretical standards can create motivational problems because managers and their employees will be judged against a goal that they perceive is unattainable. Practical or currently attainable standards are those that are achievable within a specific set of performance parameters. These costs allow for inefficiencies, such as scrap and yield losses, that occur as a normal part of the production process. Management can set practical standards in two ways. One way is to set reasonable standards that Standard Cost and Variance Analysis 235 employees consider achievable. These standards may incorporate inefficiencies that management has identified in advance, such as new employees, a new product introduction, or a change in suppliers. Another way is to set ambitious standards that are tighter than reasonable standards but looser than perfection. Only a very efficient operation would achieve these standards. The relative tightness or looseness of a cost standard is negotiated during the standard-setting process and is determined by the line managers. Although accountants may advise and influence the process, the final decision rests with the line management, not the finance group. Consensus building is important. If the standard is viewed as unrealistic or imposed from above, it will undermine the effectiveness of the system as a management control tool. Variance Analysis Variance analysis examines the differences hetween actual and standard costs to determine their underlying causes and identify opportunities for cost improvement. The variance calculation is generally done by a computer application. However, cost analysts should understand how the calculation is performed and should be able to duplicate the calculation if asked. Although most computer applications that I have worked with use the general formulas I outline in this chapter, some companies have adapted these formulas to their particular situation. Therefore, the variance calculation formula for your company may vary somewhat from the formulas presented here. Cost analysts need a solid understanding of the manufacturing processes and a good relationship with production personnel to analyze variances effectively. Cost variances should contain no surprises. They should merely highlight the financial results of a situation or decision that management already knows. This section reviews the calculation of lahor, material, and overhead variances and discusses the possible sources of these variances. All calculations are based on the data furnished in Figure 13-3 for The Computer Company. Materials Variances A materials variance is the difference between the actual materials costs and the standard materials costs for the actual volume of units Costing Principles and Systems Figure 13-3. Standard and Actual Cost Data, The Computer Company. Standard cost Materials Labor Overhead Total standard cost per unit 2 units @ $3.50 per unit .20 hours @ $5.50 per hour 1 unit @ $6.00 per unit Actual costs incurred Materials used Materials purchased Labor Overhead costs 2,000 units 4,000 units @ $4.00 per unit 400 hours $5.25 $ 7.00 1.10 6.00 $14.10 $16,000 S 2,100 $ 5,000 Other information Budgeted volume Actual volume produced 1,000 1,200 purchased, or produced. It is broken down into a price variance and an efficiency or usage variance. A materials price variance is the difference between the actual and the standard unit price multiplied by the actual quantity of materials purchased or used. The formula is as follows: Materials price = (Actual unit price - standard unit price) X variance actual quantity purchased or used. The materials price variance can be computed at the time of purchase (a materials purchase price variance) or at the time the materials are issued to the production floor. The materials purchase price variance for The Computer Company is calculated as follows: Materials = (Actual price standard - price) X actual quantity purchase purchased price variance = ($4.00 - $3.50) X 4,000 units = $2.000 Unfavorable If the price variance were calculated at the time of usage, the calculation would be: I Standard Cost and Variance Analysis 227 Materials = (Actual price - standard price) x actual quantity price used variance = ($4.00 - $3.50) X 2,000 units = $1,000 Unfavorable The materials price variance is unfavorable because the actual unit price of $4.00 is greater than the standard of $3.50. Companies generally compute the materials price variance at the time of purchase. Most computer applications provide reports that detail the materials price variances for the components purchased or used during the month. A materials efficiency variance is the difference between the actual quantity of materials used and the standard quantity that should have been used for the actual output achieved, multiplied by the standard unit price. The standard quantity per unit of output is found in the bill of materials. In the example, the standard quantity allowed to make 1 unit of finished product is 2 units of raw materials. This quantity is multiplied by the 1,200 units produced to obtain the total expected materials usage for the period. The materials efficiency variance is calculated as follows: Materials = (Actual quantity - standard quantity) X standard efficiency price variance = (2,000 - [2 units X 1,200 units]) X S3.50 = (2,000 - 2.400) X $3.50 = $1,400 Favorable In this example, the variance of $1,400 is favorable because the actual quantity used, 2,000 units, was less than the standard quantity of 2,400 units required to produce 1,200 units of the end product. Labor Variances Labor variances show the difference between the actual labor costs incurred and the expected labor costs for the actual output achieved. Labor variances are also divided into a labor price variance (also known as labor rate variance) and a labor efficiency variance. The lahor price variance is caused by paying more or less than the standard rate. In the example shown in Figure 14-3, this variance is calculated as follows: 228 Costing Principles and Systems Labor price ^ (Actual price - standard price) X actual hours variance worked = ($5.25 - S5.50) X 400 hours = $100 favorable The price variance of $100 is favorable because the actual amount paid, $2,100, was less than the expected amount of $2,200 based on the standard wage rate ($2,200 = $5.50 X 400 labor hours). The labor efficiency variance measures the savings or the additional costs incurred because the hours worked were different than the standard allowed. The standard hours allowed for 1.200 units was 240 hours (.20 unit X 1,200 units). The labor efficiency variance is calculated as follows: Labor = [Actual hours - standard hours) X standard rate efficiency = (400 - 1.20 per unit X 1,200 units]) X $5.50 variance = (400 - 240) X $5.50 = $880 Unfavorable The variance of $880 is unfavorable because the actual hours used exceeded the standard allowed for 1.200 units by 100 hours. Overhead Variances An overhead variance is the difference hetween the actual overhead costs incurred and the total overhead costs charged to the products or services for the period. Theoretically, variances are calculated separately for variable and fixed overhead. There are two variable overhead variances (a spending variance and an efficiency variance) and two fixed overhead variances (the budget variance and the volume variance). This type of analysis is known as a four-way variance analysis and in my experience is not widely used. Generally companies compute only two variances: the spending variance and the volume variance. The spending variance isolates how much of the total overhead variance was due to spending more or less money than what was called for in the budget. The volume variance shows what portion of the variance resulted from the failure to operate at the budgeted activity level. The overhead variances for The Computer Company are shown in Figure 13-4. In this example, the spending variance of $1,000 is favorable because the actual overhead costs incurred of $5,000 were less than the budgeted amount of $6,000. The vohime variance of $1,200 is 329 Standard Cost and Variance Analysis Figure 13-4. Overhead Variance Calculations, The Computer Company. Total Standard Actual Costs Incurred $5,000 Budgeted Costs $6,000 ($6.00 X 1,000 units) Spending $1,000 Favorable Overhead Costs $7,200 (S6.00 X 1,200 units) Volume $1,200 Favorable Total Overhead Variance $2,200 Favorable Spending variance (Actual costs - budgeted costs) ($5,000 - S6.Q00) $1,000 Favorable Volume variance (Budgeted costs - standard costs) ($6,000 - S7.200) $1,200 Favorable Total overhead variance = $1,000 + $1,200 = $2,200 Favorable also favorable because the company operated at higher activity levels (1,200 units) than was originally budgeted (1,000 units). Sources of Variances Variance analysis can highlight opportunities for cost reduction and continuous improvement if the causal factors are identified and acted on. The many factors that can generate a cost variance fall into four major categories: Inefficient operations. The operations did not perform as expected due to machine breakdowns, labor absenteeism, power blackouts, water shortages, or other difficulties. Inaccurate standards. The standard cost was incorrect due to an error in the bill of materials, an incorrect routing, an erroneous labor standard, or an error in forecasting material prices or labor rates. lio Costing Principles and Systems Incorrect actual costs. The costs were not properly recorded in the general ledger. This mistake is more common than you might thinkfor example, an accountant charges utilities to the wrong department: an accounting clerk keys in the wrong data into the accounts payahle system; a production manager puts the wrong account number on a purchase order. An error in the recording of actual costs will most likely result in a cost variance. An implementation breakdown. This variance occurs hecause the operations did not happened as planned, such as a delayed installation of new machine, a parts shortage, or a canceled product. The cost analyst should assist the responsible manager in identifying significant variances and their causes. Variances should he examined individually and as a whole. An unfavorable variance in one area can be offset by a favorable variance in another. Let us return to The Computer Company. The favorable labor variance and the favorable materials efficiency variance of $100 and $1,400. respectively, offset the $1,000 unfavorable materials price variance. One possible explanation for this situation is that although the company purchased a more expensive component, it was smaller and easier to handle. As a result, the production employees were able to work at a faster pace with less materials losses than with the original part. The variance analysis is the heart of a standard cost system. It provides a systematic mechanism to compare actual versus expected performance and pinpoint potential problem areas. Because standard costs contain numerous assumptions about the internal and external environment, managers and accountants should expect cost variances to occur within normal limits. They show the financial consequences of actions that initially appear as nonfinancial measures, such as material losses or process yields. Variance analysis can provide useful information to management. Unfortunately, I have seen managers dismiss variance reports because they are too late, too summarized, or not relevant to the current operating environment. A good cost analyst can compensate for these deficiencies by tailoring variance information to meet the needs of the operations personnel. Standard Costs in the Service Sector Standard cost systems are primarily found in the manufacturing sector. However, service organizations also use standards for planning Standard Cost and Variance Analysis 331 and control purposes. Examples of service organizations that use standards include banks, fast food chains, hospitals, aud insurance companies. In a service setting, the standard cost is the expected cost of a unit of service. Its cost elements vary depending on the type of service organization. Formal standard cost systems are more likely to be found in service factories or service shops whose operations resemble manufacturing entities. These operations can be controlled in many of the same ways that one controls a manufacturing firm. Service standards can be clearly established, and a control mechanism can be put in place to compare the actual and the expected levels of performance. As one moves up the service continuum, from service factory to professional service organizations, the use of standards to control quality and cost becomes more difficult. Standard costs also can be very useful to service organizations for planning purposes. Knowing how much it should cost to provide a service can be of great assistance to managers in their decisionmaking process. They can use this information to outsource services, negotiate contracts, or make decisions on tbe nature of their service offerings. Moreover, materials quantity standards and labor time standards can be used to plan inventory levels, schedule labor, determine service capacity, and estimate total costs. The Future of Standard Cost Systems Despite tbe prevalence of standard cost systems in manufacturing enterprises, these systems have serious limitations for organizations that operate in a dynamic business environment. Standard costs were designed for another time and era when cost accounting systems were used to control the production floor. Computer technology has shifted the control process to operations personnel, where it rightfully belongs. Management information systems can provide performance results on a real-time basis. Managers do not have to wait until the end of the week or month to obtain feedback on their operations. As a control tool, standard cost systems may have outlived their usefulness. Unfortunately accounting professionals are reluctant to let go of a practice that has worked for decades. Even the newer concepts such as activity-based accounting are often implemented within a standard cost framework. Standard cost systems can also steer managers in the wrong direction. In companies that use standard cost systems, managers often Costing Principles aiuJ Systems lose sight of the actual manufacturing cost of a product. Standard cost systems focus on identifying and explaining cost variances. They often do not report actual cost information per unit. When the cost variances are significant, the standard cost is not an accurate representation of the actual production costs incurred for a given product. If the sales and marketing functions of an organization rely on standard cost information to determine product profitability and make pricing decisions, important business decisions could be based on faulty information. Some companies that use standard cost systems calculate actual costs on a regular basis. At one of my former employers, we reported actual cost every quarter for all major products. Significant deviations to the standards were analyzed and explained in this report. Management used this report primarily for planning and measurement. In the future. I envision more companies moving toward actual cost systems. Standard cost variance analysis will no longer be required because inventory transactions will be recorded at actual cost. This change will free up significant resources in the finance department and will allow cost analysts to function more as business partners within the organization. The accounting focus will shift firom variance analysis to understanding the underlying cost structure of a product or process, highlighting significant cost trends, identiiying cost reduction opportunities, and educating operations personnel on the financial impact oftheir day-to-day decisions. The analyst's role will become proactive instead of reactive. Companies will still need physical standards to estimate their unit costs for planning purposes. These expected unit costs, based on the most recent information on prices and usage requirements, will be used to compare actual cost figures for management decision making. Standards for control purposes will be less important as variances to physical standards are tracked in real time on the production floor or the frontline operations. Chapter Summary Standard cost systems are widely used in manufacturing organizations. They can also be found, though to a lesser degree, in service factories and service shops. Standard costs are budgeted unit costs that are established to motivate a desired performance level. They can serve a variety of purposes in an organization but are used primarily for planning and control. Standard Cost and Variance Analysis 333 Standard costs consist of three major elements: labor, materials, and overhead. Operations personnel usually establish labor or materials quantity standards, which are converted to cost standards by multiplying these hy a standard price or rate. Variance analysis compares the actual cost against the standard cost to identify problem areas and possible cost reduction opportunities. Standard cost systems may have limited usefulness for companies that operate in a dynamic business environment. Because standard costs are set for a given time periodusually six months or a yearthey may not reflect the actual or even the expected cost based on the most recent price and usage information. Moreover, finance departments spend a significant amount of resources analyzing and explaining standard cost variances that provide little value added to the organization. Although physical standards are important to monitor the actual results of the operations, deviations from standards are best controlled at the source, on the production floor, or in the frontline operation. Although standard costs systems may not he replaced in the near future, I envision more organizations moving toward actual costs systems as computer technology continues to evolve and integrated business applications become more widely used. Notes 1. Jeffrey R. Cohen and Laurence Paquette, "Management Accounting Practices: Perception oControlleis," Journal of Cost Management [Fall 1991). 2. These findings confirm my own research in the manufacturing industry. Lianabel Oliver, "The Current State of Cost Accounting Practices in Modem Manufacturing Firms" (unpublisbed manuscript, 1991). 3. See Charles T. Horngren and George Foster, Cost Accounting: A Managerial Emphasis (Englewood Cliffs, N.J.: Prentice Hall. 1991), p. 222. 4. Robert N. Antony and James S. Reece, Accounting Text and Cases (Homewood, 111.; Richard D. Irwin, 1989), p. 8. 5. See Irvin N. Gleim and Dale L. Flesher, CMA Review, 6th ed. (Gainesville, Fla.: Gleim Publications, 1994), 1:530-539, for an overview of the controlling process, 6. For valuation purposes, inventory costs may be determined by specific identification: first-in, first-out (FIFO); last-in, last-out (LIFO); and average costs. It is beyond the scope of this book to explain the different inventory valuation methods for financial statement reporting. See Belverd E. Needles. Jr., Henry R. Anderson, and lames C. Caldwell, Principles of Accounting (Boston: Houghton Mifflin, 1990), pp. 429-436. 7. Cohen and Paquette, "Management Accounting Practices." Cosiing Principles and Systems For more information, see Standard Costs and Variance Analysis (Montvale, N.J.: Institute of Management Accountants. 1974), pp. 26-51. In motion studies, the actions of individual workers are broken down into its constituent parts and these parts are studied to determine where improvements can be made. Time studies use stopwatches and videotaping to time the elements of a job to determine where improvement opportunities exist and how the job can be redesigned. Work sampling is used to set standards for jobs that have a high variety built into them. In tliis method, an analyst observes what the workers are doing at random points in time, thereby providing the analyst with insight into the percentage of time spent doing a variety of tasks. Work activity analysis lists in chronological order the work performed, noting the task, the time spent on it, and the number of items completed. Detailed flowcharting shows a precise diagram of the job and examines this diagram for improvement and standard setting. See Roger W. Schmenner, Seivice Operations Management (Englewood Cliffs. N.J.: Prentice Hall, 1995), Chap. 6