Accounting: The Language of Business - Vol. 1 (Part 141)

Accounting — the department where everybody counts.

 Performance Evaluation Using Variances from Standard Costs (Part H)

by

Charles Lamson

.

Standards for Nonmanufacturing Expenses

Using standards for nonmanufacturing expenses, such as service, selling, and administrative expenses, is not as common as using standards for manufacturing costs. This is often due to many nonmanufacturing expenses not directly relating to a unit of output or other measure of activity. For example, the administrative expenses associated with the work of the office manager are not easily related to a measurable output. In these cases, nonmanufacturing expenses are normally controlled by using static budgets.

However, when manufacturing activities are repetitive and produce a common output, standards can be applied. In these cases, the use of standards is similar to that described for a manufactured product. For example, standards can be applied to the work of customer service personnel who process sales orders. A standard cost for processing a sales order (the output) could be developed. The variance between the actual cost of processing a sales order and the standard cost (a predetermined cost, an estimated future cost, an expected cost, a budgeted unit cost, a forecast cost, or the "should be" cost) could then be used used to control sales order processing costs.

Nonfinancial Performance Measures

Many managers believe that financial performance measures such as variances from the standard, should be supplemented with nonfinancial measures of performance. Measuring both financial and non-financial performance helps employees consider multiple, and sometimes conflicting, performance objectives. For example, one company had a machining operation that was measured according to a direct labor time standard. Employees did their work quickly in order to create a favorable direct labor unit variance. Unfortunately, the fast work resulted in poor quality that, in turn, created difficulty in the assembly operation. The company decided to use both a labor time standard and a quality standard in order to encourage employees to consider both the speed and quality of their work.

In the preceding example, nonfinancial performance measures brought additional perspectives, such as quality of work, to evaluating performance. Some additional examples of nonfinancial performance measures are as follows:

Nonfinancial Performance Measures

Inventory turnover

On-time delivery

Elapsed time between a customer order and product delivery

Customer preference rankings compared to competitors

Response time to a service call

Time to develop new products

Employee satisfaction

Number of customer complaints

Nonfinancial measures can be linked to either the input or output of an activity or process. A process is a sequence of activities linked together for performing a particular task. For example the procurement process consists of the "create a purchase order" and "select vendor" activities that are performed in procuring materials. The relationship between a process or activity and its inputs and outputs is shown as follows:

To illustrate nonfinancial measures for a single activity consider the counter service activity of a fast food restaurant. The following input output relationship could be identified:

The outputs of the counter service activity include the customer line wait, order accuracy, and service experience. The inputs that impact these outputs include the number of employees, level of employee experience and training, reliability of the french fryer, menu complexity, fountain drink supply, and the like. Also, note that the inputs for one activity could be the outputs of another. For example, fryer reliability is an input to the counter service activity, but it is an output of the french frying activity. Thus, a chain of inputs and outputs can be developed between a set of connected activities or processes. The fast food restaurant can develop a set of linked nonfinancial performance measures across the chain of inputs and outputs. The output measures tell management how the activity is performing, such as keeping the line wait to a minimum. The input measures are the levers that impact the activities performance. Thus, if the fast-food restaurant line wait is too long, then the input measures might indicate a need for more training, more employees, or better fryer reliability. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 932-933*

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