SETTING WORK STANDARDS

BY

J. A. OYETADE
B.SC, FCA, MBA

BEING A PAPER PRESENTEDAT A WOKSHOP ON:

COST REDUCTION AND COST CONTROL ORGANSIED BY THAMESMEAD CONSULTANCY LIMITED AT AVALON HOTEL OFFA, TH th KWARA STATE. 6 -8 and 13th - 15TH OF NOVEMBER 2007.

SETTING WORK STANDARDS INTRODUCTION This topic takes it root from standard and cost accounting. It actual performance does not deviate from standard pre-planned activities. There will be no variance to analyze and there will be no need to keep setting standards. Since it is obvious that many factors outside and within the organization will not allow actual performance and standards set to be the same, emphasis will always to be a continuing review of standards. All the essence of planning in an organization is based to set new standards or review the existing ones in order to achieve optimal result. STANDARD COSTING DEFINED Standard costing is a technique which establishes predetermined estimates of the costs of products and services and then compares these predetermined costs with actual costs as they are incurred. The predetermined costs are known as STANDARD COSTS and the difference between the standard costs and actual cost is known as VARIANCE. The process by which the total difference between actual cost and standard cost is broken down into its difference elements is known as VARIANCE ANALYSIS. Standard costing in practice is a detailed process and requires considerable development work before it is a useful tool. It can be sued in a variety of costing situations. Batch and mass production, process manufacture, transport. Certain aspects of repetitive clerical work and even in jobbing manufacture. Undoubtedly, however, the greatest benefit is gained when the manufacturing method involves a substantial degree of repetition. Its major application in practice is in organizations involved in mass production and /or repetitive assembly work. STANDARD COST Previously this has been simply defined as a predetermined cost. More formally, a standard cost can be defined as, a predetermined calculation of how much costs should be under specific working conditions. It is built up from as assessment of the value of costs elements and correlates technical costs to the priced and or wage rate s expected to apply during the period in which standard cost is intended to be used. Its main purposes are to

provide bases for control through variance accounting, for the valuation of stock and work in progress and, in some cases, for fixing selling prices. Terminology. This is along, technical description, but close study of it shows that a standard costs is a target costs which should be attained. The build- up of a standard cost is based on sound technical and engineering studies, known production methods and layouts, work studies and work measurement, material specification and wage and material price projections. A standard cost is not an average of previous costs. They are likely to contain the result of past inefficiencies and mistakes. Furthermore changes in methods, technology and costs make comparisons with the past of doubtful value for control purpose. TYPES OF STANDARDS There are four main types of standards; basic, ideal, attainable and current. a) Basic Standards: - These are long term standards which would remain unchanged over the years. Their sole use is to show trends over time for such items as material prices; labour rates and efficiency and the effect of change methods. They cannot be used to highlight current efficiency or inefficiency would not normally form part of the reporting system except as a background statistical exercise. The formal definition of a basic standard is: a standard established for over a long period from which a current standard can be developed Terminology. b) Ideal Standards: - These are based on the best possible operating condition i.e. no breakdowns, no material wastage, no stoppage or idle time, in perfect inefficiency. Ideal Standards, if used, would be revised periodically to reflect improvements in methods, materials and technology. Clearly ideal standard would be unattainable in practice and accordingly are rarely used. However the use could be considered worthwhile for investigative and development purpose but not for normal day-to-day control activities. The formal definition of an ideal standard is: a standard which can be and under the most favorable conditions

No provision is made e.g. for shrinkable, spoilage or machine breakdown users believe that the resulting unfavorable variances will remind management of the need for improvement in all phases of operations. Ideal standards are not widely used in practice because they may influence employee motivation adversely . Terminology. c) Attainable Standard: - This is by far most frequent encountered standard. It is currently attainable standard based on efficiency (but not perfect) operating conditions. The standard would include allowances for normal materials for realistic allowances for fatigue, machine breakdown etc. it must be stressed however that an attainable standard must be based on a high performance so that its achievement is possible, but has to be worked for. Attainable standard provide a tough, but realistic target and thus can provide motivation for management. They can be used for product costing, for cost control, for valuation and as a basis for budgeting Attainable standards would be revised periodically to reflect the conditions expected to prevail during the end period when the standard would apply. Unless otherwise stated, all subsequent references to standard mean attainable standards. The formal definition of an attainable standard is :- a standard which attained if a standard unit of work is carried out efficiently, a machine operated or material properly used. Allowances are made for normal shrinkage, waste and machine breakdown. The standard represents future performance and objectives which are reason attainable. Besides having a desirable motivational impact on employee attainable standards serve other purposes. E.g. cash budgeting, investment valuation and budgeting departmental performance. Terminology. d) Current Standard: This is a standard which is set for use over a limited period to reflect current conditions. Where stable condition and prices exist the current standard is equivalent to an attainable standard but where, for example temporary problem exist with material quality or there is an unexpected price to deal with the temporary problem.

A particular example of the use of current standard is in inflation circumstances where current standard could be set, perhaps on a month by month basis, using the performance levels agreed for the attainable standard for the year with the price levels adjusted by suitable indices for month by month control. The formal definition of a current standard is: - a standard established for use over a short period of time, related to current conditions. Terminology NOTES ON THE TYPES OF STANDARD a) The type of standard used (basic, ideal, attainable, current) directly affects the level of the variance which can arise and the meaning which can be attached to the variance. b) There are very real problems in determining the level of attainment in standards so it follows that, to a greater or lesser extent, all standards contain a subjective element. c) Like budget setting of standards, particularly relating to price and wage levels, is dependent on forecasting skill. This means that variances can rise from both difference in efficiency levels and from forecasting errors. This fact should be remembered when interpreting any variance. STANDARDS AND BUDGETS Both standards and budgets are concerned with settings performance and cost level for control purposes. They therefore are similar in principle although they differ in scope. Standard are a unit concept i.e. they apply to particular products to individual operations or processes. Budget are concerned with totals, they lay down limits for functions and departments and for the firm as a whole. As an illustration standard material costs of the various products in a firm could be as follows:-

Standard Material Cost/Unit Product Product Product Etc Etc 000 X321 Y592 Y728 etc etc N 3.50 7.25 1.50 etc etc

Planned Production

Total Material Cost N 17,500 10,875 3,750 etc etc

5000units 1500units 2500units etc etc

OVERALL TOTAL = MATERIAL BUDGET = N275,

In this way the detailed unit standards are used as the basis for developing meaningful budgets. This is particularly so for direct material and direct labour costs which are more amendable to close control through standard costing, whereas checks would normally be controlled by functional and departmental budgets. Further differences are that budgets would be revised on a periodic basis, frequently as an annual exercise, whereas standards are revised only when they are inappropriately for current operating conditions. Such revisions may take place more or less frequently than budget revisions. The accounting treatment of standard and budgets also differ. Budget are memorandum figures and do not form part of the double entry accounting system whereas standards and the resulting variances are included. SETTINS TANDARDS Meaningful standards which can be used for control purpose rest on foundation of properly organized, standardized methods and procedures and comprehensive information system. It is little point trying to develop a standard for a product if the production method is not decided upon. A standard cost implies that a target or standard exist for every single element which contributes to product: the types , usage and price materials and parts, the grades, rates of and time for labour involved, the production methods

and layouts, the tools and jigs and so on. Considerable effort is involved in establishing standards cost for each part or product recorded on a standard cost card with the increased usage of computers for costing purposes frequently. Nowadays, there is no physical standard cost card. When a computer is used, the standard costs are recorded on a magnetic disc or tape file and can be accessed and processed as required. Whether a computer manual system is used, there are no differences in the method of day to day operation. The following paragraphs explain some of the detailed procedures involved in setting standards.

SETTING STANDARDS MATERIALS The materials content of a product; raw materials, sub- assemblies, piece finishing materials etc. Is derived from technical and engineering specification frequently in the form of a Bill of Materials. The standard quantities required including allowances for normal and inevitable losses in production, that is, machining evaporation, and expected levels of breakages and rejections. The process of analysis is valuable in itself because savings and alternative materials and ways of using materials are frequently discovered. The responsibility for providing materials prices is that of the buying department. The prices used are not the past costs, but the forecast expected costs for the relevant budget period. The expected costs should take into account trends in material prices anticipated changes in purchasing policies, and cash discount, carriage and packaging charges and any other factor which influence material costs.

SETTING STANDARDS LABOUR Without detailed operation and process specifications it would be impossible to establish standard labour times. The agreed methods of manufacture are the basis of setting the standard labour times. The techniques of work measurement are involved frequently combined with work study projections based on elemental analysis when part is not yet in production. The labour standard must specify the exact grades of labour to be used as well as the

times involved. Planned labour times are expressed standard hours) or standard minutes). The concept of a standard hour/ minute important and can be defined as, The quality of work achievable at standard period of time. Terminology.. It will be noted that a standard hour represents a given content. Indeed, production for a given period is frequently described as so many standard hours rather than a quantity of parts. Once the times and grades of labour have been established, a forecast can be made of the relevant wage rate for appropriate future period. This is usually done by the Personnel Department. NOTE It must be understood that a standard hour or minutes is a measure of work content, not a measure of time. SETTING STANDARD OVERHEADS The predetermined overhead absorption rates become the standards for overheads for each cost centre using the budgeted standard labour hours as the activity base. For realistic control, overheads must be analysed into their fixed and variable components and separate absorption rates calculated for both fixed and variable overheads thus: Standard Variable O. A. R. = centre centre And Standard fixed O. A. R. = centre Budgeted variable overheads for cost Budgeted standard labour hours for cost Budgeted fixed overheads for cost Budgeted standards labours hours for cost centre The level of activity adopted, expressed in standard labour hours, is the budgeted expected annual activity level which is the basis of the Master Budge. For reporting and control purposes this would be classed as 100% capacity.

SETTING STANDARDS SALES PRICE AND MARGIN Fundamental to any form of standard costing, budgeting and profit planning is the anticipated selling price for the product. The setting of the selling price is frequently a top level decision and is based on a variety of factors including; he anticipated market demand, competing products, manufacturing costs, inflation estimates and so on. Finally, after discussion and investigation, a selling price is established at which it is planned to sell the product during the period concerned. This becomes the standard costs and the standard selling price. Where a standard marginal costing system is used, the standard contribution is calculated following the normal marginal costing principles. NOTES Normally when standard cost is mentioned it means total standard costs, i.e. total absorption costs principles are used incorporating fixed and variable costs. Standard marginal costing is also employed, but we should assume that total absorption cost principles are involved whenever the term standard cost is used without qualification. When marginal costing principles are used the term standard marginal cost is employed. RESPONSIBILITY FOF SETTING STANDARDS The line managers who have to work with and accept the standards must be involved in establishing them. These managers and their superiors have the ultimate responsibility for setting the standards. Work study staffs, Accountants and other specialist provide technical support information, but do not make the final decisions upon standards and performance levels. THE STANDARD COST CARD The process of setting standard results in the establishment of the standard for the product. The makeup of the standard cost is recorded on a standard cost in practice there may be numerous detailed cards together with a summary card to given product, or the standard cost details may be on a computer file. The principles however, remain the same.

A simple standard cost card is shown below:STANDARD COST CARD PART NOL X291 DESCRIPTION QUANTITY 100 TOOL REF 15983 WORK STUDY NO. D592/6 COST TYPE STANDAR AND QUANTITY D PRICE OR RATE Direct Material 2.5kg p101 1000 Units A539 Direct labour Machine Operation Grade 15 4.8hrs 9.2 hrs Assembly Grade 8 16.4hrs Production Overhead Machine Hour Rate Labour Hour Rate DEPT 7 Stub joint REF.WS255 DEPT 19 N 37.50 BATCH DRAWING TOTAL N 37.00 37.50 74.50

DEPT 15 N 28.70

N =N= 14.8kg 37.00 =N=3.75 100

12.00 =N= 2.5 hr =N= 2.5 hr =N= 1.75 hr 52.80 =N= 11hrs =N= 6hr 101.80 101.12 161.62 98.40 127.10 23.70 28.70

12.00 23.00 28.70 63.70 153.92 98.40 252.32

STANDARD COST SUMMARY =N= DIRECT MATERIALS DIRECT LABOUR PRODUCTION OVERHEADS 74.50 63.70 252.32

=N= 90.52 STANDARD COST CARD REVISION OF STANDARDS To show trends and to be able to compare performance and costs between different periods, standards would be rarely changed. On the other hand, for day to day control and motivation purposes a standard which reflects the most up to date position are required and consequently revisions would need to be made continually. The above positions reflect the extremes of the situation. There is no doubt that standards which are right up to date provide a better target and are more meaningful to the foremen and managers involved, but the extent and frequency of standard revision is a matter of judgment. Minor changes in rates, prices and usage are frequently ignored for a time, but their cumulative effect soon becomes significant and changes need to be made prior to computer maintained standard cost files, standard costs revisions were a time consuming chore as it was necessary to ensure that all the effects of a change were recorded. For example, a price change of a common raw material would necessitate alterations to: a) The standard costs cards of all products, parts and assemblies using the materials; b) Any price lists, stock sheets and catalogues involving the material and products derived from the material. Because of such factors, commonly all standards costs are revised together at regular, periodic intervals such as every six or twelve months, rather than on an individual random basis. BEHAVIOURAL ASPECT O STANDARDS The points made regarding the importance of the human aspects of budgeting apply equally to standard costing. Both techniques employ similar principles and both rely absolutely upon the people who have to work to the budgets and standards. Because of the detailed nature of standard costing and its involvement with foreman and production workers, communication becomes of even greater importance. Production workers frequently regard any form of performance evaluation with deep suspicion and if a cost conscious, positive attitude is to be developed, close attention must be paid

to the behavioral aspects of the system. Full participation, realistic standards, prompt and accurate reporting, no undue pressure or ensure - all contribute to an acceptable system. Remember if the system is not accepted by the people involved it will be unworkable. ADVANTAGES OF STANDARD COSTING 1. Standard costing is an example of management by exception. By studying the variance, managements attention is directly towards those items which are not proceeding according to plan. Management is able to delegate cost control through the standard costing system knowing that variances will be reported. 2. The process of setting, revising and monitoring standards encourage appraisal of methods, materials and techniques so leading to cost reductions. 3. Standard costs represent what the parts and productions should costs. They are not merely averages of past performance and consequently they are a better guide to pricing than historical costs. In addition, they provide a simpler basis of inventory valuation. 4. A properly developed standard costing system with full participation of and involvement creates a positive, cost effective attitude through all levels of management right down to the shop floor.

DISADVANTAGES OF STANDARD COSTING 1. It may be expensive and time consuming to install and to keep p to date. 2. In volatile conditions with rapidly changing methods, rates and price standards quickly become out of date and thus lose their control and motivate effects. This can cause resentment and loss of goodwill. 3. There is research evidence to suggest that overly elaborate variance imperfectly understood by line managers and thus they are ineffective for control purposes.

SUMMARY a) Standard costing involve comparing actual cost with predetermined costs and analyzing the differences, known as variances. b) There are four main types of standards, Basic standard, ideal standard, attainable standard and current standard. c) Basic standard are long term standards which remain unchanged for long periods; ideal represent represent perfect working conditions and performance attainable standards are standards are he most common. d) Standards relate to individual items, process and products; budgets relates to totals e) Setting standards is a detailed, lengthy process usually based on engineering and technical studies of times, materials and methods. Standards are set for each of the elements which make up the standard costs: labour, material overhead. f) Accountants, work study engineers and other specialist provide technical for advice and information, but do not set the standards. This is the responsibility the line managers and their superiors. g) The culmination of the standard setting process is the preparation of a standard cost card for the product showing the target cost for the following periods. h) Difficulties arise with the two frequent revisions of standards. Consequently it is common practice to revise them on a periodic basis, half yearly or yearly. i) The behavioural aspects of standard costing, like budgeting, are all important. The system must be acceptable to the people who will have to operate it. CONCLUSION This paper tried to focus on different types of standards that are available for organizational activities measurement. Each organization is therefore advised to apply a combination of some of the above stated standards in planning activities that will maximize the wealth of the owners of the organization and the work force.