Appendix A

Examples of Terms and Definitions

The following terms and definitions are examples that can be used as a boilerplate to

develop cost terminology that is unique for your organization. You may copy these

definitions to a word processing program and modify them to reflect the business

processes of your company. Words placed in brackets [ ] represent alternative choices,

which have different costing implications.

Standard costs are the sum of the standard labor, materials, and overhead costs required

to produce a product or provide a service using the process specifications under

[normal, efficient] operating conditions. These specifications are determined during

the annual budgeting process. Overheads costs will [include, exclude] allocated

charges from support departments such as facilities, engineering, and maintenance

and [include, exclude] the general and administrative costs associated with running

the site such as accounting, human resources, and information systems.

Expected costs are the sum of the labor, materials, and overhead costs using the most

current process specifications as defined by line management. They differ from

standard costs in that they reflect changes to the time or materials standards that

occurred after the standard costs were finalized. Typically expected costs are based

on the most current operational parameters, which are costed at standard rates.

Actual costs represent an approximation of the actual resources consumed to

manufacture a product or provide a service. Actual materials costs are based on the

actual materials consumed and the average actual cost of each materials component.

Labor and overhead are applied to the product using a standard rate that is calculated

based on the actual costs of the prior [three, six, nine, twelve] months.

Theoretical yield represents the maximum good output for a particular process based on

the input of a key ingredient, component, or document and given the current process

design and specifications.

Standard yield represents expected good output for a particular process under [normal,

efficient] operating conditions and given the current process specifications. The

difference between 100 percent and the standard yield represents the output that is

lost as part of the normal process. This expected loss is included in the product cost.

Standard materials are the components, ingredients, supplies, or packaging components

required to produce the expected output at each stage of the manufacturing or service

delivery process. It takes into consideration the expected yield and scrap losses that

will occur as a normal part of the process.

Scrap represents unusable materials or production units (whether partially or fully

completed) that do not meet customer requirements.1 These materials or units must

either be sold at a minimal value or disposed of in a safe and reasonable manner.

Normal scrap is inherent to the production process and arises even under the

efficient operating conditions. It should be included in the product cost based on the

units of good output.

Abnormal scrap is defective materials or units of output that are not inherent to the

process and should not occur under efficient operating conditions, such as defects

caused by a power outage or a lack of employee training. This type of scrap will be

charged to cost of sales as a loss in the period incurred.

The scrap factor quantifies the amount of normal scrap that will be generated by the

production process. It is expressed as a percentage of the quantity required for each

component or ingredient and will be used to calculate the standard materials quantity

for each item in the bill of materials.2

Rework represents units of production that do not meet customer specifications and are

subsequently repaired. Rework costs are considered a loss in the period incurred and

expensed to cost of sales.

Standard run time is the labor or machine time consumed in manufacturing the product

or providing the service. It is based on the current process specifications under

[normal, efficient] operating conditions. Standard time will include a provision for

unavoidable operator allowances and unavoidable delays.

Normal operating conditions describe the environment in which a product is

manufactured or the service delivery process takes place. It should consider the

common allowances and delays that occur during the process. Normal operating

conditions are usually determined based on historical experience.

Unavoidable operator allowance includes a provision for operator fatigue and any other

unscheduled breaks that might affect labor productivity. This allowance is factored

into the standard for the particular operation and should be excluded from the planned

allowances that are included in the total labor hours available per employee

calculation.

Unavoidable delays includes a provision for unscheduled interruptions such as

equipment reliability and any other factors that may affect the production or service

delivery process. This allowance is factored into the standard for the particular

operation.

Setup includes all activities performed at the start and end of a business process such as

equipment setup, material handling, assembly, disassembly, documentation, and

cleanup. The activities that occur at the start of an operation will be measured

separately from the activities performed at the end of an operation to identify

potential process improvements.

Process time is the time required to complete a particular operation. It is the sum of the

setup time plus the standard run time. Process time does not include queue time or

the waiting time between operations.

Theoretical capacity will be based on 3 eight-hour shifts, 7 days per week, 52 weeks per

year.3

Practical capacity will be based on 2 eight-hour shifts, 5 days per week, 48 weeks per

year.

Available capacity is calculated based on the number of manned shifts for a particular

time period.

Total labor hours available per employee represent the productive time available per

employee after subtracting planned allowances for nonproductive time. It is

calculated by taking labor hours paid based on a 2,080-hour year (40 hours per week

* 52 weeks) less planned allowances such as holidays, vacations, sick leave, breaks,

and others. Nonproductive time related to management decisions such as training or

meetings will be included in the planned allowances and deducted from the total labor

hours available per employee. Nonproductive time due to requirements of the

process such as uniform changes or showering may be included in the time standards.

Actual hours used are the actual process or labor hours that were used to produce the

actual output for the period.

ENDNOTES

1. In management accounting theory, scrap is called spoilage, which is defined as

unacceptable units of production, whether fully or partially completed, that are

discarded or sold for reduced value. In practice, however, managers use the term

scrap for any type of defective material or product that does not meet customer

specifications.

2. For simplicity, some companies use one scrap factor for all its components. If

the scrap varies significantly from one type of materials to another, this decision

may distort the true cost of the item under evaluation.

3. Capacity definitions should reflect the operating reality of your organization.

These definitions provided are for illustration purposes only.