Standards Reduce Workload
Systems for costing are data intensive
Actual cost systems are data intensive, with very many transactions that vary all the time, but most of the time, inconsequentially. The aggregate of these transactions is important, and the aggregate should not vary very much unless there is something going on that is of importance. A standard is built by being thoughtful about the item ... whether cost or value. The aim is to determine what the cost or the value should be. In the aggregate the cost should be the unit standard cost times the number of items. The aggregate of actual costs should be about the same as the aggregate standard cost. If there is a substantial difference, then there needs to be analysis to see what is causing the variance.
Standards for cost
Standard costs variance analysis reduces workload
A standard is simply what one expects … what is the norm. It is a useful construct to facilitate comparison … it is an important tool in simplifying high volume measurement.
A standard cost is theoretical construct … it is what cost should be expected based on a technical analysis of the costs of production and other relevant factors. If the actual costs are different from the standard cost, there is a prima facia case that something is wrong either with the implementation or with the assumptions used in computing the standards.
Standard costs and variance analysis is embedded in most modern management information systems used for corporate decision making and oversight. If there are no variances or very small variances the management and decision makers do not need to become engaged in change anything … but if there is a variance then some effective reaction is needed.
Standard costs common in analytical accounting
Standard cost is a very simply idea … it is what something should cost based on technical considerations. In every factory I worked in … on every construction site … every activity that was going on had a standard cost. This was the cost that we expected based on technical considerations. If our actual costs were higher than the standard cost, then there were questions. Something was wrong! This might have been the calculation of the standard cost was wrong, or it was something that was going wrong in the factory or construction process. If the total of the standard costs was about the same as the total of the actual costs, it could be concluded that the operation was going according to plan.
Standard cost is useful and efficient for comparison. Standard cost may be used to compare actual performance against the standard. The standard for different approaches to the same activity can be compared. The standard cost for different places can be compared. The standard cost changes over time can be compared. All the time actual performance against standard can be compared.
Cost efficiency is defined in the TVM framework as the relationship between what something did cost, the actual cost … with what it should have cost, the standard cost.
Cost effectiveness in the TVM framework is the relationship between the cost of a set of activities and the impact on society … and in the TVM system it is standard value that is used to quantify impact.
A foundry at a company in Georgia was critical to the overall company operations … but out of control, with over 10,000 different castings flowing through the works. Nobody had any idea how much these different castings cost to make … and used a crude “per pound” costing for planning and pricing. The results were bad. Per pound costing sent the wrong signal to the design engineers who designed castings to be lighter and lighter, but actually more and more difficult and costly to make.
There were less than 20 different operations in the foundry to produce the casting … and each casting was produced using about 7 of these operations. By having a standard cost for each operation … and a production or manufacturing standard for each casting … a standard cost for the casting could be compute that was very much equivalent to reality. When engineers started designing to a cost standard that reflected the reality of production quite accurately, it became possible to have significantly lower costs and higher quality.
Author's personal experience at Southern States Inc, Hampton, GA
How much should have been done?
How much should have been done with the money is a key question that becomes easy to answer with variance analysis when there are standard costs. It is used internally in almost every well managed corporate enterprise in one form of another, but is rare in the public sector, the not for profit sector and the international official relief and development assistance (ORDA) sector.
The international official relief and development assistance (ORDA) sector is notorious in the secrecy associated with all its performance data. As long as there is no accessible cost data about their activities they are able to operate at will be very very low cost efficiency. It is then impossible to know how much of the resources they are entrusted with has been used to good effect or not.
Standards for value
Using standards for value
Value is subjective ... but very useful. Arguably, the core of TVM is the use of value withing a framework of accounting. Everyone knows that value is important ... but nobody wants to embrace value as a numeric measurable elements, despite the fact of its centrality to quality of life, and of everything that is important in society.
TVM uses standards for value. Value is a subjective idea and there are as many views of what a quantified value should be as there are people who think about this subject. However, value is very important, and in order to manage value there needs to be a set of metrics about value so some solution to this has to be developed.
The idea of standard value along the same lines as a standard cost is an elegant solution. The standard value assigned to anything does not have to be perfect, but it must be reasonable and then it can serve as a benchmark against which everything may be measured and compared.
The standard value approach helps with the understanding of complex systems. The single standard value eliminates a whole set of variables that are not critical to decision making about progress and performance per se, while maintaining the core idea that value is important.
Establishing value standards
TVM uses an iterative process to establish standard values, and uses these values to understand the socio-economic performance of the community. When the consumption of value (a standard value calculation) exceeds the product of value ... that is the creation of value (another standard value calculation), then there is value destruction. If value creation exceeds value consumption there is value adding.
It is recognized that value is subjective, and that value is difficult to quantify … but value is the most important element in quality of life, and ignoring value is tantamount to saying that decision making may ignore impact on quality of life. This is not a reasonable conclusion.
Value is the driver of quality of life ... society will be at its best when the available resources are used with a maximum of productivity. A measure like profit, or cash flow is important for sustainability ... but it is the mix of value and profit rather than just profit alone that should be driving decisions about the allocation of resources.
TVM uses standard value as a way to quantify value ... essentially a concept derived from standard cost accounting. In TVM, everything has a standard value tabulated and in the record ... a best estimate of what the value is based on what is known.
For example ... good health has a value ... but people are uncomfortable with putting a money number to define a value like this. Education has a value … as does opportunity.
In some cases value and cost may be the same … or value and price may be the same. These money accounting metrics may be a good proxy for value, but this is not always the case.