Solving the Standard Cost Problem - Lean Accounting...

Lean Accounting Summit 2012

Solving the Standard Costing Problemg g

Presented by Brian Maskell

BMA IBMA Inc.bmaskell@maskell.com . www.maskell.com

© 2012 BMA Inc. All rights reserved.This material may not be copied or reproduced in any form without the express permission of BMA Inc.BMA Inc., 100 Springdale Road # 110, Cherry Hill NJ 08003 USA+ 609 239 1080Contact: ibmaskell@maskell.com Web: www.maskell.com

Notes/ Answer Sheet

Solving the Standard Cost Problem

Lean Accounting Summit 2012Orlando, FL ‐ September 12‐14

Brian H Maskell

Standard Cost Problem

Brian H MaskellPresident, BMA Inc.

What is the Standard Cost Problem?

Agenda

What is the Standard Cost Problem?

The Solution: Value Stream Costing

Making Business Decisions using Value Stream Costing

Business Decision Making Example

us ess ec s o a g a p e

Wrap Up

Lean Accounting Summit 2012 Solving the Standard Costing Problem

The Standard Costing Problem

Traditional Measurement Systems

Lean Principles

Principles

… and lead to anti‐lean business decisions

Standard Costing……

Distorts profitability because of overhead allocation

Motivates non‐lean behavior

Distorts costs because it assumes labor is variable

labor is variable

Requires significant detailed reporting

Current State: Standard Costing P&L’s distort profitability

Period 1 Period 2REVENUE

OEM $998,977 $1,039,440Systems $1,002,466 $1,009,246

$2,001,443 $2,048,686

Cost of Goods Sold $1,621,169 81% $1,687,800 82%

GROSS PROFIT $380,274 19% $360,886 18%

ADJUSTMENTSPurchase Price Variance ($60,466) ($59,467)

Materials Usage Variance $94,533 $96,733

g $ , $ ,Labor Variance ($19,718) ($93,895)

Overhead Absorption Variance $38,341 $182,577

SG&A $129,889 6% $135,215 7%

NET PROFIT $197,695 10% $99,723 5%

Future State: Value Stream Income Statement

Period 1 Period 2REVENUE

OEM $998,977 $1,039,440Systems $1,002,466 $1,009,246y , , , ,

$2,001,443 $2,048,686

Materials $829,936 41% $849,526 41%Direct Labor $305,767 15% $312,984 15%

Support Labor $340,245 17% $342,421 17%Machines $113,862 6% $116,550 6%

Outside process $60,043 3% $53,731 3%Facilities $40,250 2% $41,200 2%

Other Costs $12,009 0.6% $9,664 0.5%TOTAL COST $1,702,112 $1,726,076

GROSS PROFIT $299,331 15% $322,610 16%

Inventory Adjustment ($41,593) ($161,426)Corporate Allocations $60,043 $61,461

NET PROFIT $197,695 10% $99,723 5%

Work Against Continuous Improvement

Drill on CNC Machine

Inspect & Pack

Machine on Lathe

Batch 2500

1 minute

4 minutes6 minutes

4 minutes

Total labor time: 15 minutesLabor cost: 5.00Overhead cost: 15.00Material Cost: 1.50TOTAL COST: 21.50

Lead Time: 6 weeksInventory 25 daysBatch size 2500 (10 days)On-Time delivery = 82%

Future State: Lean CellSmaller Drilling

Machine replaces

CNC Machine

Improve flow: reduce batch size,

lead time and inventory

Machine on Lathe

Drill on Drilling

4 minutes

6 minutes

Inspect & Pack

4 minutes

Machine4 minutes Lean Cell

Same Resources in Value Stream = Same Cost

Total labor time: 18 minutesLabor cost: 6.00Overhead cost: 18.00Material Cost 1.50TOTAL COST: 25.50

Lead Time: 2 daysInventory 5 daysBatch size 250 (1 day)On‐Time delivery = 98%

Distort Costs….

Product AStandard Cost $90 06

Product BStandard Cost $109 85Standard Cost = $90.06

Material $42

Labor 17 mins @ $24.23/hr = $6.87

Overhead 600% = $41.19

Actual Cost = $100Material $42P d ti $580/10 $58

Standard Cost = $109.85Material = $42

Labor 24m @ $25/hr = $9.69

Overhead 600% = $58.18

Actual Cost = $100Material $42

Production $580/10 = $58

Standard Cost too low

Production $580/10 = $58

Standard Cost too high

…which leads to poor decision making: Outsourcing product B

Traditional Approach Actual Impact

Standard Cost = $109.85

Outsourced Cost = $85.00

“Savings” of $24.85 per unit

New Material Cost = $ 85Old Material Cost = $ 42

Increase in Actual Material Cost = $43

Actual production cost per hour = $580 because no resources were eliminated

Actual costs increase due to outsourcing

Shop Floor

Distribution

Close out W.O.to put product

in F. G.

Cost Accounting(product costing)

Detailed Reporting

Work Order

InventoryValuation

WIP Val. &

Attempted Inv.Control

Pain in

PlanningLaunches

Production(MRP)

(SOFP)

Customer Service

Not Used

Labor Tracking

Value added by oper. codeInfo. Technology

the Neck

The Solution: Value Stream Costing

The Future State: Value Stream Costing

Understood by everyone• Separates value stream profit from financialSeparates value stream profit from financial

accounting adjustments

Accurate Cost Information• Real spending• Checkbook of the value stream

Relationship to Continuous Improvement• Eliminate waste – reduce actual costs

Root Causes of Costs Identified

Actual Value Stream Costs

Capacity & Operational Performance Measures

Value Stream Costing

Direct Costs

No Allocations

Actual Spending Timely

No Product Costs

Value Stream sets the boundaries for costs

Actual, Direct Costs

M i l • Actual purchases @ actual costMaterials

• Actual payroll of full‐time people assigned to value streamLabor

• Depreciation repairs & maintenancehi

• Depreciation, repairs & maintenance, toolingMachines

Actual, Direct Costs

• Utilities, rent, maintenance & repairF iliti Utilities, rent, maintenance & repair• Charged based on square footage of value streamFacilities

• Actual cost for the periodOutside

processing

• Any other direct cost of the value stream that is under the control of the value streamOther Costs

Monument Costs

Production Support CostsProcess Costs

• Simple allocation to value streams

Support Costs

• Direct assignment of people to value stream D ’t i b

• Don’t assign by allocation

Costs Not Assigned to the Value Stream

Manufacturing Support

New Product Development SG&App

• Resources shared among the value streams

• Appear as support costs

• Lean companies recognize new product development as its own non‐

• Costs not assigned to value streams appear as support costs

pprevenue generating value stream

Value Stream Profit and Loss Statement

M t S t S P t

New Product D i

Support C t

TOTAL DIVISION

VALUE STREAMS

Motors Systems Spare Parts Design Costs DIVISION

Sales $326,240 $748,894 $453,215 $1,528,349Additional Revenue $0 $0 $12,422 $12,422

Material Costs $111,431 $232,774 $149,561 $87,909 $12,764 $594,439Conversion Costs $57,628 $70,406 $81,579 $203,769 $37,645 $451,027

Outside Process Costs $32,433 $22,991 $22,661 $7,531 $85,616Other Costs $16 040 $57 816 $29 459 $72 721 $176 036Other Costs $16,040 $57,816 $29,459 $72,721 $176,036

Tooling Costs $4,843 $12,544 $6,588 $23,975

Value Stream Profit $103,865 $352,363 $175,789 ($364,399) ($57,940) $209,678ROS 31.8% 47.1% 38.8% -23.7% -3.8% 13.7%

$925,314$918,807($6,507)

Opening InventoryClosing InventoryInventory Change

($6,507)

$51,147

$152,0249.9%Division ROS

Corporate Overhead

Division Profit

Inventory Change

Making Business Decisions

Making Business Decisions with Value Stream Costing

Lean Financial Analysis: Actual Change in Revenue, Costs & Profit

Project the actual change in value stream revenue

Ch i it f d d Ch i i

Project the actual change in value stream costs

Changes to capacity & measurements Material cost impact

Change in units of demand Changes in prices

Calculate the future state value stream profitabilityDoes the future state return on sales exceed

the current state?Yes – the decision makes financial sense

No – decision is a poor financial decision

Relationship between: Operational Performance & Costs

I t f d i iImpact of decision on value stream performance measurements

Probable corresponding impact on value stream costs

Relationship between Capacity & Costs ‐ 1

Business I l i

Capacity

Business Decision

Is total capacity changed?

Less Capacity is required

More Capacity is required

CostsIf available capacity is removed from

value stream, costs decrease

If available capacity remains in value stream, no change

in costs

Continued on next slide

Relationship between Capacity & Costs ‐ 2

Business Decision Do we have il bl

Capacity

Requires Increase in Capacity

available capacity for the

decision?

No Yes

Costs Cost to Acquire Capacity

Additional improvements to create capacity

No Impact

How profitable is an order?

Demand Standard Cost

• 1000 units per month

• $14.00 unit price

• $ 15.00 per unit

Std margin per unit = ($1.00)

Loss of $1000 per month Reject order

1. How profitable is the order, with available capacity?

Demand Materials Capacity

• $14.00

• $9.50 per unit actual cost

• Currently available to meet 1000 units

unit price per month

Financial Analysis using Value Stream Costing

2. How profitable is the order, without available capacity?

Demand

Materials

• $9.50 per unit actual cost

Capacity

• Must add one person at

• $14.00 unit price

a cost of $4204

2: Value Stream Costing without available capacity

Business Decision Making Example

Example

Given this annual cost information, calculate the Labor Rate and Overhead Rate (as a percentage of Labor Rate) required for Standard Costing.

Example: standard cost

Calculate the Standard Cost for product Pro‐Valve 602 given the following informationPro Valve 602 given the following information.

Exercise: standard marginThe company receives a request‐for‐quote from a customer for 3000 Pro‐Valve 602’s per month. The customer’s target price is $45 per unit. Your company requires a minimum of 15% margin.p y q gWork out the profitability using Standard Costing.

Example: low cost outsourcingThe company has found an Asian supplier quoting a landed cost of $33.00 for the Pro‐Valve 602. The customer’s target price is $45 per unit. Your company requires a minimum of 15% margin. Work out the profitability from outsourcing this product.

Example: value stream costingWork out the profitability using Value Stream Costing.You need to get 2 new machines and 2 operators to support this volume increase of 3000 units/month

Lean Financial Analysis: Actual Change in Revenue, Costs & Profit

Ch i M t i l C t

Ch i L b C t

Change in Material Cost

$17.50 per unit X 3000 units = $52,500

Change in Machine Cost

Change in Labor Cost

Monthly cost $293,762 / 62 people = $ 4738 per person x 2 new hires = $9476

Change in Machine Cost

Monthly cost $116,533 / 76 machines = $1533 per machine X 2 machines = $3067

Example: summary & decision

Example: box scores show the full impact

Wrap Up

Value Stream Costing: Simple & Easy

Actual Value stream St d d C tinumbers focus

No allocations

No product costing

Standard Costing

Real results

Value Stream Costing: Relevant & Accurate

H h did thHow much did the Value Stream ship?

How much did the l ll

Value Stream actually spend?

Value Stream Costing: reduces costs

Lean Strategy Root Cause Analysis

In Lean, it’s all about flow

• Determined by the rate of flow of orders through a value streamProfitability

• Measuring and managing flowCost Control

• Achieved by eliminating waste, which improves flow & increases capacityCost Reduction

• Increase demand on value stream and use capacity

Profitable Growth

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Solving the Standard Cost Problem - Lean Accounting...

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