Three Requirements of an Effective Cost System – Part Two
In part one, we examined the role of having a complete view of costs that extends beyond just the cost to manufacture products. Here, we’ll drill down on product costs and discuss how multiple sets of product costs are vital in helping manufacturing companies make sound, informed business decisions.
Multiple Cost Sets
One of the most important concepts in effective cost management is having access to multiple views of production costs. To benchmark and analyze performance, comparisons between cost sets can expose problems or advantages that exist in the manufacturing process. The differences among these cost sets can be as distinct as apples and oranges, and understanding how to use them can make a significant impact on how you make decisions for the business. While you can have a number of cost views, we believe that the basic set includes Frozen Standard Costs, Current Standard Costs, Actual Costs and Going-to Standard Costs.
Frozen Standard Costs
To ensure consistency in financial reporting, frozen standard costs are used as the basis. Frozen standards allow companies to compare budgeted versus actual spending to expose variances that occurred during the period. These standards are generally set annually based on current supplier prices and market conditions and are usually stored in ERP or data warehouse systems for financial reporting.
Current Standard Costs
While frozen standards allow a company to take a snapshot of performance from year to year, current standards are much more fluid. Current standard costs are the production costs occurring today based on raw material prices, production efficiencies and utilizations and other changing business conditions. These costs are used to predict spending for the period and help manufacturing and cost managers make better business decisions.
This cost view is the ultimate indicator of cost performance. Once the finished goods are produced, actual costs are the tally of what was spent to produce them. It is a historical view of production that aids in predicting future costs. This number is not consistent over time because it incorporates the changing costs over the period analyzed.
Going-to Standard Costs
While analyzing past cost performance is useful, predicting future costs is equally valuable. Going-to standards allows cost managers to estimate spending for future orders and is useful as a simulation tool for building budgets for future periods.
But just having multiple views of costs is not enough. The true value comes from the ability to report on variances between these different cost sets to determine problems or opportunities within the manufacturing process. For example, if current standard costs are significantly lower than the actual costs could indicate that machine efficiencies are lower on a particular production line. Using multiple views allows companies to peel back the layers and gain a level of analysis unparalleled by traditional ERP systems.
The final installment of this series will discuss why integration of your cost system is critical to its acceptance in the organization and why system design must include input from all areas of the business. Want to get a tweet when the next post is available? Follow us on Twitter.