P11-12 Setting Standards and Assigning Responsibility for Variances [LO 1] Recyc
ID: 2353916 • Letter: P
Question
P11-12Setting Standards and Assigning Responsibility for Variances [LO 1]
Recycled Plastics, Inc. manufactures a plastic dimensional lumber product from recycled plastic milk jugs. The company purchases consumer-recycled milk jugs in 700-pound bales and then shreds them into small pieces in its grinding department. Once ground, the plastic pieces are mixed in a hopper and extruded into shaped boards in the extrusion department. When the boards are cooled, they are used much as wood lumber would be used to build picnic tables and park benches in the fabrication department.
Recycled Plastics, Inc. has grown from a small 5-person operation to a company employing more than 100 people. The company also contains a sales department, an accounting department, an administration department, and a purchasing department. The president and owner of the company, Alan Roberts, would like to institute a standard cost system; at this point, he has been setting prices based on his rough pen-and-paper estimates of costs.
a. What standards could be set within each of the three production departments of the company? How should standards be set? Who should be involved in setting the standards?
b. What benefits might Recycled Plastics, Inc. receive from adopting a standard costing system? What disadvantages or problems might arise from adopting a standard costing system?
Explanation / Answer
A) Grinding Deptartment - Standards could be set for price of electricity and fuel costs of machinery, price of grinding machine purchases and maintainence and labor costs for workers in the department. Cost of material might also fit within this department. Extrusion Department - Standards could be set for the price of electricity, fuel and fixed overhead costs for the machinery and the area of the department, as well as maintainence costs, labor costs, and material used to extrude the boards. Fabrication Department - Labor costs, machinery maintainence and purchasing costs, fixed and variable overhead costs such as electricity and storage space, could all be standardized within this department. Standards could be set by looking at the price fluxuation over the past year to determine the average price and average increase which has been seen. Then any expected increases could be explored and evaluated. When this information is known, a standard is set which should cover the cost without variance, especially unfavorable variance. If unfavorable variance (the standard is not as high as the actual cost) is found, then appropriate changes need to take place as soon as possible. Involved in the process would be people in accounting which understand the overall overhead costs as well as purchsers for the company, including those who procur the materials and those who procur the machinery and maintanence of machinery. Human resources should also be involved as they would inform of labor costs, including benefits and "hidden costs" which are not always noticed or remembered by mangagers. B) The advantages include easily completing a variance analysis, which provides the company with a benchmark to evaluate performance. As well, it provides consistency, as once a standard is calculated it is generally used for a year or a set term. Additionally, standard costs greatly simplify bookkeeping. Standard costs fit naturally in an integrated system of responsibility accounting. The standards establish what costs should be, who should be responsible for them, and what actual costs are under control. The disadvantages include that it is not flexible, if there is a sudden increase in something (such as fuel) within the market, the budget has already been set and it is not flexible to absorb these changes. Profibility is also skewed by standard costs, as the standard of the product is subtracted from the selling price, rather than the actual cost. Also, important to consider is that there may be a tendency with standard cost reporting systems to emphasize meeting the standards to the exclusion of other important objectives such as maintaining and improving quality, on-time delivery, and customer satisfaction. This tendency can be reduced by using supplemental performance measures that focus on these other objectives. Another difficulty is that just meeting standards may not be sufficient; continual improvement may be necessary to survive in the current competitive environment. For this reason, some companies focus on the trends in the standard cost variances - aiming for continual improvement rather than just meeting the standards. In other companies, engineered standards are being replaced either by a rolling average of actual costs, which is expected to decline, or by very challenging target costs.
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