Standard Costs

Budget for a single unit Each unit has standards for:Quantity & Price/

Rate

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Distinguishing between Standards and Budgets

Both standards and budgets are predetermined costs, and both contribute to management planning and control.

There is a difference:

A standard is a unit amount.

A budget is a total amount

Types of standards

1. Ideal standards (perfection standards): developed under the assumption that no obstacles to the production process will be encountered.

2. Attainable Standards: developed under the assumption that there will be occasional problems in the production process.

3. Current standards: are based on the current level of performance, which may be inappropriate for the future, no incentive for workers

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Standard costing system

The management evaluates the performance of a company by comparing it with some predetermined measures

Therefore, it can be used as a process of measuring and correcting actual performance to ensure that the plans are properly set and implemented

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Benefits of Standard Costs

Valuation of stock– Assigning the standard cost to the actual output

Planning – Use the current standards to estimate future sales volume and future costs

Controlling – Evaluating performance by determining how efficiently the current operations

are being carried out Motivation

– Notify the staff of the management’s expectations Setting of selling price

Helps managers: In budget preparation Target levels of performance Identify performance standards Set sales prices Decrease accounting costs

Benefits of Standard Costs

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Responsibility Accounting and Variances

1. Managers should be held responsible only for costs they can control.

2. This is also true in the area of variance analysis.

3. A purchasing agent may be held responsible for direct material price variances, but certainly not direct material quantity (usage) variances.

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Variance analysis

A variance is the difference between the standards and the actual performance

When the actual results are better than the expected results, there will be a favourable variance (F)

If the actual results are worse than the expected results, there will be an adverse variance (A)

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Materials cost variance

Material Price variance Material Usage variance

Labour cost variance

Labour rate variance

Labour Efficiency variance

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Cost variance

•Cost variance = Price variance + Quantity varianceCost variance is the difference between the standard cost and the Actual cost

•Price variance = (standard price – actual price)*Actual quantity A price variance reflects the extent of the profit change resulting from the change in activity level

•Quantity variance = (standard quantity – actual quantity)* standard cost

A quantity variance reflects the extent of the profit change resulting from the change in activity level

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Three types of cost variance

Material cost variance Labour cost variance Variable overheads variance

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Material cost variance

Material price variance

= (standard price – actual price)*actual quantity MPV=(SP-AP)AM SP= standard price per unit of direct material. AP = actual price per unit of material AM = actual quantity of material purchased

Material usage variance

= (Standard materials – actual materials)* standard price = (Standard quantity of materials for actual production – actual quantity of

materials production) * standard price MUV=(SM-AM)SP SM= Standard quantity of materials Total Material cost varince=MPV+MUV

Causes of Material Variances

Materials price variance – factors that affect the price paid for raw materials include the availability of quantity and cash discounts, the quality of the materials requested, and the delivery method used. To the extent that these factors are considered in setting the price standard, the purchasing department is responsible

Materials usage variance – if the variance is due to inexperienced workers, faulty machinery, or carelessness, the production department is responsible.

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Labour cost variance

Labour rate variance

= (standard rate – actual rate)*actual hours LRV=(SR-AR)AH Labour efficiency variance

= (standard Hours – actual Hours)*standard Rate

= Standard hours for actual production – actual hours used) * standard rate LEV=(SH-AH)SP Total Lobour cost variance=LRV +LEV

1. AH = actual number of hours worked.

2. SH = standard number of hours worked.

3. SR = standard labor wage rate.

Causes of Labor Variances

Labor rate variance – usually results from two factors: (1) paying workers higher wages than expected, and (2) misallocation of workers. The manager who authorized the wage increase is responsible for the higher wages. The production department generally is responsible variances resulting from misallocation of the workforce.

Labor efficiency variances - relates to the efficiency of workers. The cause of a quantity variance generally can be traced to the production department.

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Static vs. Flexible BudgetsStatic Budget Flexible Budget

Prepared for only one level of sales volume

Prepared for several different volume levels within a relevant range

Separates fixed and variable costs

Copyright (c) 2009 Prentice Hall. All rights reserved.

Variance = difference between actual and budgetVariance = difference between actual and budget

Favorable – actual amount increases income

Favorable – actual amount increases income

Unfavorable – actual amount decreases income

Unfavorable – actual amount decreases income

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Sales variance

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Actual contribution

Budgeted contribution(Standard margin * Actual Volume)

Budgeted contribution(Standard margin* Standard volume)

Sales margin price variance Sales margin volume variance

Total sales margin variance

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Sales variance

1. Total sales variance= Total budgeted sales actual-Total actual salesTSV=SPV + SVV1.1. Sales price variance=(standard selling price-actual selling price)*Actual quantity of sales2. SPV=(SSP-ASP)AQS

2. 2. Sales volume variance=(Standard quantity of sales – Actual quantity of sales)*Standard selling price1.SVV= (SQS –AQS)*SSP

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Fixed overhead variance

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Actual FO Budgeted FO

Absorbed VO(SP* standardhours for actualoutput

FO expenditure variance/FO spending variance

FO volume variance

Total FO variance(under-/over- absorbed)

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Fixed overhead variance

Fixed overheads variance= Fixed overheads absorbed – Actual fixed overheads incurred

Fixed overheads expenditure varianceBudgeted fixed overheads – Budgeted overheads absorbed

Fixed overheads volume variance= Absorbed fixed overheads – Budgeted overheads absorbed

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Profit reconciliation statement

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Profit reconciliation statement

Profit reconciliation statement is used to sum up all variances

It can help the top management to explain the major reasons for the difference between budgeted and actual profits

The sales margin variance and fixed overheads variance are different between absorption and marginal costing system

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Marginal costing

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Profit Reconciliation Statement$ $ $

Budgeted profit 14000Sales variances

Sales margin price 8000 FSales margin volume 3400 A 4600 F

Materials cost varianceMaterials price 480 AMaterial usage 2400 F 1920 F

Labour cost varianceLabour rate 3200 ALabour efficiency 4000 A 7200 A

Variable overhead varianceVO Expenditure 900 FVO Efficiency 1600 A 700 A

Fixed overhead expenditure variance 400F 980 AActual profit 13020

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Reasons for variances

Material price variance– Price changes in market conditions– Change in the efficiency of purchasing dept. to

obtain good terms from suppliers– Purchase of different grades or wrong types of

materials

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Materials usage variance– More effective use of materials/ wastage arising

from the efficient production process– Purchase of different grade or wrong types of

materials– Wastage by the staff– Change in production methods

Reasons for variances

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Labour rate variance– Non-controllable market changes in the basic wage

rate– Use of higher/lower grade of workers– Unexpected overtime allowance paid

Reasons for variances

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Labour efficiency variance– Purchase of different grade or wrong types of materials– Breakdown of machinery– High/low labour turnover– Changes in production method– Introduction of new machinery– Assignment wrong type of worker to work– Adequacy of supervision– Changes in working condition– Change in motivation methods

Reasons for variances

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Variable overheads expenditure variance– It may be caused by the non-controllable change in the price

level of indirect wages or utility rates since the predetermined rate is set

– It is meaningless to interpret this kind of variance on its own. One should look various components of the fixed overheads

Reasons for variances

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Variable overheads efficiency variance– Both the variable overheads and direct labour cost

vary with the direct labour hours worked

Reasons for variances

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Fixed overheads expenditure– It is meaningless to interpret this kind of variance on

its own. – It may be caused by the change in the price levels

of rent, rates and other fixed expenses

Reasons for variances

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Fixed overhead volume variance– When the level of activity is higher than the

budgeted level, there is a favourable variance

Reasons for variances

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Sales margin price variance– Change in the pricing strategies of the company– Response to the change of pricing policies of its

competitors– Higher profit margin with growing demand for the

product– Lower profit margin for simulating sales

Reasons for variances

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Sales margin volume variance– Change in prices and demand– Change in the market share of its competitiors

Reasons for variances