Page 183 - Accounting Best Practices

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Costing Best Practices
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scrap rates and purchase price variances, while many companies have no reporting
for overhead costs at all. Hence, most accounting departments are misallocating
their time in reporting on the smallest component of product costs.
The best practice that addresses this problem is one of the easiest to imple-
ment—simply stop reporting on labor variances. The accounting staff will have
more time to spend on reports concerning costs that make up a larger proportion of
product costs. The problem with this best practice is the remarkable uproar it fre-
quently incites, especially on the part of traditional production managers who were
raised on the concept of tight control over labor costs. Thus, the best way to imple-
ment this item is to carefully educate the production staff on the following points:
• Direct labor is really a fixed cost. In many manufacturing situations, the direct
labor staff cannot be sent home the moment there is no work left to do. Instead,
a company must think about retaining them since they are trained and more
efficient than other people who might be brought in off the street. Accordingly,
it makes a great deal of sense to guarantee regular working hours to the direct
labor staff (within reason). By doing so, it becomes apparent that direct labor
is not a variable cost at all and requires much less detailed investigation and
reporting work for the accounting staff.
• Other reports are more valuable. If the accounting department only has enough
resources to issue a fixed number of reports, there is a good argument for elimi-
nating the least useful ones (labor reporting) in favor of ones involving more
costs, such as materials and overhead. One can reinforce this argument by for-
mulating trial report layouts for new reports that will replace the labor reports.
• Target costing is the real area of concern. Many studies have shown that
costs are not that variable once a product design is released to the factory
floor. Instead, the primary area in which costs can truly be impacted is during
the product design (see the ‘‘Implement Target Costing” section later in this
chapter). A strong argument in this area, especially if combined with visits to
other companies that have installed target costing, will go a long way toward
convincing management on this point.

If production management can be convinced that these three points are accurate,
it becomes much easier to eliminate labor variance reporting, either completely
or in part.
The only situation in which this best practice should not be implemented is
one where labor costs still make up the majority of product costs (an increasingly
rare situation) and where those costs are variable. If labor costs are highly fixed
in nature, there is not much point in continuing to issue reports showing that the
costs have not changed from period to period.
Cost: Installation time: