Chapter 10: 2nd Generation ABC Systems

ABM and Process Control through Variance Analysis

Introduction: Scientific management as a strategy for running the business

What is scientific management? Finding the “one best way:” a well-

engineered process using work standards (how to do each specific task based on time-and-motion studies).

Similar tasks are grouped together into functional departments (“silos”).

Each silo can operate independently from the other departments due to WIP.

Scientific management’s goal = well-engineered processes

Identify and break-down complex value chain processes into functionally specialized departments to reduce the variety of skills required by individual workers.

Design each task so that it is quick and easy to learn.

Organizations that do this can hire cheap, low skilled workers who are easily trained and replaced.

Thus, labor becomes a variable cost.

Scientific management’s goal = maximize efficiency

Efficiency, or productivity, is the relationship between inputs and outputs.

Maximizing efficiency = minimizing inputs.

Minimizing inputs = minimizing the product’s average cost.

Thus, we measure efficiency by the product’s average cost.

Scientific management’s goal = minimize product’s cost

Minimizing variable costs per product: Hire cheap labor Buy lots of materials to gain quantity

purchase discounts Minimizing average fixed costs per

product: Economies of scale: maximize output to

minimize average unit cost. Maximizing output = keeping busy.

Accounting’s role in support of scientific management

Develop budgets based on engineered standards that represent the one best way.

Use budgets to control operations and reward performance. Each department has its own budget.

Report sales and cost variances from budgeted amounts. Each department has its own variance report.

Management-by-exception

Management-by-exception = focus on our problems.

If it ain’t broke, don’t fix it! Management-by-exception = ignore

what’s working right and focus on what’s wrong.

Scientific Management and boardroom control through variance analysis

Question 1: Are we following the plan? Compare budgeted revenues and costs

to actual revenues and costs by calculating variances.

“No variances?” = “Everything’s OK.” Therefore, Variances = Problems.

Management-by-exception and boardroom control

Question 2: If variances exist, where are they? “Drilling down” into the departments to find

the problems that caused the variances. To do this, management needs variance

reports for each department. Why create departmental variance

reports? Each department is an independent

“functional silo” with its own, unique variances.

Why resource cost variances?

Articulation Auditors require the cost accounting system

to articulate with the financial accounting system

This means costs reported must be verifiable Verify costs by linking them to journal entries

in the General Ledger The General Ledger journal entries record the

purchase of resources So, cost variances are based upon resources

(price and usage)

Boardroom control and investigating variances

Question 3: Are the departments under control? Investigate significant variances. How does the investigation process

work? Traditional management accounting

theory believes the variance report initiates the investigation. Is this how you want your managers to

behave?

Management-by-exception and process control

Process control = how work gets done on a day-by-day basis. This is the operational monitoring and

control function of management. What motivates operational control?

How people are rewarded. Base rewards on performance evaluations. Performance should be evaluated by

variances from the “one, best way.” Thus, employees are motivated to avoid

variances “at all costs.”

Mangement-by-exception and Process Control

Problems with traditional variance analysis

Problem #1: Traditional variance reports are designed

for top management (boardroom control) Traditional variance analysis is not

designed to support process control Problem #2:

Often, only one measure is really important in performance evaluation – budget variances

Since variances measure efficiency, effectiveness (quality) can be sacrificed

Scientific Management, variances, and motivation

Efficiency = minimize average product cost.

Minimize average product cost by maximizing output in each department.

Therefore, people are motivated to maximize output, good or bad! WIP will provide enough good parts if it is

large enough. So, concentrate on keeping busy and

avoiding cost variances.

Variance analysis and reward systems

Variances = “Danger, Danger!”

Assigning responsibility for variances

What really happened?

Variance reports need to support process control

Departments are not truly independent.

Quality problems can be transported from department 1 to department 2.

Quality problems created in one department lead to cost variances “down the line.”

Process control questions

What caused the cost variance? Identify the cause and its source This can be done only in real-time

Has the problem been corrected? Need to code variances in order to

capture this real-time control information Has the problem been prevented

from reoccurring?

Process control and 2nd Generation ABC systems

Therefore, we need to know the sources and causes of cost variances, not just the dollars of excess resources used within each department!

Without this information, people may be motivated to pass-on bad products so they can avoid creating cost variances by fixing them.

Quality Control is another department!