Solving the Standard Cost Problem - Lean Frontiers

Lean Accounting Summit 2012

Solving the Standard Costing Problem g g Presented by Brian Maskell BMA I BMA Inc. [email protected] . 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 1080 Contact: [email protected] Web: www.maskell.com

Notes/ Answer Sheet

Lean Accounting Summit 2012 Solving the Standard Costing Problem

Solving the Standard Cost Problem Standard Cost Problem Lean Accounting Summit 2012 Orlando, FL ‐ September 12‐14

Brian H Maskell Brian H Maskell President, BMA Inc.

Agenda What is the Standard Cost Problem? The Solution: Value Stream Costing Making Business Decisions using Value Stream Costing Business us ess Decision ec s o Making a g Example a pe Wrap Up

© 2012 BMA Inc. All rights reserved. Contact: [email protected]

Copyright 2012 BMA Inc. All rights reserved.

Page 1


The Standard Costing Problem Traditional Measurement Systems Lean Principles

… and lead to anti‐lean business decisions © 2012 BMA Inc. All rights reserved. Contact: [email protected]

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 © 2012 BMA Inc. All rights reserved. Contact: [email protected]


Page 2


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

Cost of Goods Sold

Period 1

Period 2

$998,977 $1,002,466 $2,001,443

$1,039,440 $1,009,246 $2,048,686

$1,621,169

81%

$1,687,800

82%

GROSS PROFIT

$380,274

19%

$360,886

18%

ADJUSTMENTS Purchase Price Variance Materials Usage g Variance Labor Variance Overhead Absorption Variance

($60,466) $94,533 $ , ($19,718) $38,341

SG&A

$129,889

6%

$135,215

7%

NET PROFIT

$197,695

10%

$99,723

5%

($59,467) $96,733 $ , ($93,895) $182,577


Future State: Value Stream Income Statement REVENUE OEM Systems y

Period 1

Period 2

$998,977 $1,002,466 , , $2,001,443

$1,039,440 $1,009,246 , , $2,048,686

Materials Direct Labor Support Labor Machines Outside process Facilities Other Costs TOTAL COST

$829,936 $305,767 $340,245 $113,862 $60,043 $40,250 $12,009 $1,702,112

41% 15% 17% 6% 3% 2% 0.6%

$849,526 $312,984 $342,421 $116,550 $53,731 $41,200 $9,664 $1,726,076

41% 15% 17% 6% 3% 2% 0.5%

GROSS PROFIT

$299,331

15%

$322,610

16%

Inventory Adjustment Corporate Allocations

($41,593) $60,043

NET PROFIT

$197,695

($161,426) $61,461 10%

$99,723

5%



Page 3


Work Against Continuous Improvement Drill on CNC Machine

Inspect & Pack

Batch 2500

1 minute

Grind

4 minutes

Machine on Lathe

6 minutes

4 minutes

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

Lead Time: 6 weeks Inventory 25 days Batch size 2500 (10 days) On-Time delivery = 82%


Improve flow: reduce batch size, lead time and inventory

Future State: Lean Cell Smaller Drilling Machine replaces

Machine on Lathe 4 minutes

Grind 6 minutes

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

Drill on Drilling Machine 4 minutes

Inspect & Pack 4 minutes

CNC Machine

Lean Cell Same Resources in Value Stream = Same Cost

Lead Time: 2 days Inventory 5 days Batch size 250 (1 day) On‐Time delivery = 98%



Page 4


Distort Costs…. Product A Standard Cost $90 06 Standard Cost = $90.06 Material $42 Labor 17 mins @ $24.23/hr = $6.87 Overhead 600% = $41.19

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

Standard Cost too low

Product B Standard Cost $109 85 Standard Cost = $109.85 Material = $42 Labor 24m @ $25/hr = $9.69 Overhead 600% = $58.18

Actual Cost = $100 Material $42 Production $580/10 = $58 $ $

Standard Cost too high


…which leads to poor decision making: Outsourcing product B Traditional Approach Standard Cost = $109.85 Outsourced Cost = $85.00 “Savings” of $24.85 per unit

Actual Impact New Material Cost = $ 85 Old 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



Page 5


Detailed Reporting Cost Accounting (product costing)

Distribution

Close out to put in

Launches

Work Order

Planning (MRP)

Production

(SOFP)

Pain in the Neck Info. Technology

Shop Floor

W.O. product F. G.

WIP Val. & Attempted Inv. Control

Inventory Valuation

Not Used Value added

by oper. code

Customer Service

Labor Tracking © 2012 BMA Inc. All rights reserved. Contact: [email protected]

Solving the Standard Cost Problem

The Solution: Value Stream Costing



Page 6


The Future State: Value Stream Costing Understood by everyone • Separates 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 © 2012 BMA Inc. All rights reserved. Contact: [email protected]

Root Causes of Costs Identified

Actual Value Stream Costs

Capacity & Operational Performance Measures



Page 7


Value Stream Costing Direct Costs

No Allocations

Actual Spending

Timely

No Product Costs © 2012 BMA Inc. All rights reserved. Contact: [email protected]


Page 8


Value Stream sets the boundaries for costs



Page 9


Actual, Direct Costs

M Materials i l

• Actual purchases @ actual cost • Actual payroll of full‐time people assigned to value stream

Labor Machines hi

• Depreciation, repairs & maintenance, Depreciation repairs & maintenance tooling


Actual, Direct Costs F iliti Facilities Outside processing Other Costs

• Utilities, rent, maintenance & repair Utilities, rent, maintenance & repair • Charged based on square footage of value stream

• Actual cost for the period

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



Page 10


Monument Costs Production Process Costs

Support Costs Support Costs

• Simple allocation to value streams

• Direct assignment of people to value stream • Don’t assign by D ’t i b allocation


Costs Not Assigned to the Value Stream Manufacturing Support pp • Resources shared among the value streams • Appear as support costs pp

New Product Development p • Lean companies recognize new product development as its own non‐ revenue generating value stream

SG&A • Costs not assigned to value streams appear as support costs



Page 11


Value Stream Profit and Loss Statement VALUE STREAMS New Product D i Design

M t Motors

S t Systems

S Spare Parts P t

Sales $326,240 Additional Revenue $0

$748,894 $0

$453,215 $12,422

Material Costs $111,431 Conversion Costs $57,628 Outside Process Costs $32,433 Other Costs $16,040 $16 040 Tooling Costs $4,843

$232,774 $70,406 $22,991 $57 816 $57,816 $12,544

$149,561 $81,579 $22,661 $29 459 $29,459 $6,588

$87,909 $203,769

Value Stream Profit $103,865 ROS 31.8%

$352,363 47.1%

$175,789 38.8%

($364,399) -23.7%

Support C t Costs

TOTAL DIVISION $1,528,349 $12,422

$12,764 $37,645 $7,531

$594,439 $451,027 $85,616 $176 036 $176,036 $23,975

($57,940) -3.8%

$209,678 13.7%

$72 721 $72,721

Opening Inventory Closing Inventory Inventory Change

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

Corporate Overhead

$51,147

Division Profit $152,024 Division ROS 9.9% © 2012 BMA Inc. All rights reserved. Contact: [email protected]


Page 12



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 Change in units of demand i it f d d

Ch Changes in prices i i

Project the actual change in value stream costs Changes to capacity & measurements

Material cost impact

Calculate the future state value stream profitability Does the future state return on sales exceed the current state?

Yes – the decision makes financial sense No – decision is a poor financial decision



Page 13


Relationship between: Operational Performance & Costs IImpact of decision t fd i i on value stream performance measurements

Probable corresponding impact on value stream costs


Relationship between Capacity & Costs ‐ 1 Business Business Decision

IIs total capacity l i changed?

Less Capacity is required

Capacity

Costs

If available capacity is removed from value stream, costs decrease

If available capacity remains in value stream, no change in costs

More Capacity is required

Continued on next slide



Page 14


Relationship between Capacity & Costs ‐ 2 Do we have available il bl capacity for the decision?

Business Decision Requires Increase in Capacity

Capacity

No

Cost to Acquire Capacity

Costs

Yes

Additional improvements to create capacity

No Impact


How profitable is an order? Demand

Standard Cost

• 1000 units per month

• $ 15.00 per unit

• $14.00 unit price

Std margin per unit = ($1.00)

Loss of $1000 per month

Reject order



Page 15


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

Materials

Capacity


• $9.50 per unit actual cost

• Currently available to meet 1000 units per month th



Financial Analysis using Value Stream Costing



Page 16


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

Materials

Capacity


• $9.50 per unit actual cost

• Must add one person at a cost of $4204




Page 17


2: Value Stream Costing without available capacity



Page 18



Business Decision Making Example



Page 19


Example

Given this annual cost information, calculate the Labor Rate and Overhead Rate (as a percentage of Labor Rate) required for Standard Costing. © 2012 BMA Inc. All rights reserved. Contact: [email protected]


Page 20


Example: standard cost Calculate the Standard Cost for product Pro‐Valve Pro Valve 602 given the following information. 602 given the following information



Page 21


Exercise: standard margin The 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. p y q g Your company requires a minimum of 15% margin. Work out the profitability using Standard Costing.



Page 22


Example: low cost outsourcing The 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.



Page 23


Example: value stream costing Work 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



Page 24


Lean Financial Analysis: Actual Change in Revenue, Costs & Profit Ch Change in Material Cost i M t i lC t $17.50 per unit X 3000 units = $52,500

Ch Change in Labor Cost i L b C t Monthly cost $293,762 / 62 people = $ 4738 per person x 2 new hires = $9476

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



Page 25


Example: summary & decision



Page 26


Example: box scores show the full impact



Page 27


Wrap Up


Value Stream Costing: Simple & Easy Actual numbers

Value stream focus

No allocations

No product costing

Standard Costing St d d C ti

Real results



Page 28


Value Stream Costing: Relevant & Accurate How much did the H h did th Value Stream ship?

How much did the Value Stream actually l ll spend?


Value Stream Costing: reduces costs

Lean Strategy

Root Cause Analysis



Page 29


In Lean, it’s all about flow Profitability

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

Cost Control

• Measuring and managing flow

Cost Reduction Profitable Growth

• Achieved by eliminating waste, which improves flow & increases capacity • Increase demand on value stream and use capacity



Page 30


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Page 31

Solving the Standard Cost Problem - Lean Frontiers

Solving the Standard Cost Problem - Lean Frontiers

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