Standard Costing and Variance Analysis PDF

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Mindanao State University College of Business Administration and AccountancyDEPARTMENT OF ACCOUNTANCYMarawi CitySTANDARD COSTING AND VARIANCE ANALYSISAccounting 142STANDARD COSTING AND ITS USES Standards are the measures used as basis, benchmark or “norm” for comparison to measure performance or ach...

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Mindanao State University College of Business Administration and Accountancy

DEPARTMENT OF ACCOUNTANCY Marawi City

STANDARD COSTING AND VARIANCE ANALYSIS Accounting 142 STANDARD COSTING AND ITS USES Standards are the measures used as basis, benchmark or “norm” for comparison to measure performance or achievement. In business situations, they serve as a measure of acceptable performance established by management as a guide in making economic decisions. In management accounting, standards relate to the cost and quantity of inputs used in manufacturing goods or providing services. Under a standard costing system, the costs of products or services are determined using standard costs.

H.

A standard cost is a carefully or scientifically predetermined cost established by management to be used as a basis for comparison with actual costs. Standard costs are normally set for the three cost elements of production namely, materials, labor and manufacturing overhead. Benefits from Use of Standard Costing There are numerous reasons why several entities adopt standard costing. A business can derive important benefits from standard costs in areas such as: A. Cost control – standard costs serve as a readily available basis for comparison with actual costs, thereby allowing preparation of timely reports which provide management immediate feedback on the results of operations. The standard costing control loop follows:  Establishing standards to be used.  Measuring actual performance or results.  Comparing actual performance or results with the standards.  Analyzing the variances.  Investigating the variances that must be investigated.  Taking corrective action if needed which may include revision of the standards. B. Cost awareness and cost reduction – if all the employees could be aware of the cost implications of their actions, they could be expected to exert better efforts to help in the whole company’s cost control and cost reduction programs. C. Preparation of cost reports – the use of standard costs simplifies costing procedures and expedites preparation of cost reports enabling managers to plan, analyze and control productive operations. D.

E.

F.

Costing of inventories – with standard costs, the value of inventories can be readily determined without necessarily waiting for the actual costs to be accumulated and summarized. Preparation of budgets – budgeting is one of the planning tools used by management. In preparing budgets, standard costs play a vital role, for these are used to estimate the selling price as well as determine the cost of production expected to be incurred for the budget period under consideration. Motivation and performance appraisal – with the use of standards, performance appraisal is facilitated. The standard set is used as a common denominator with which the performance of different employees can be objectively compared, analyzed and evaluated. If employees could be well informed on the importance and objectives of using standards in performance appraisal, such employees may be properly motivated to work hard to at least attain the standard.

G. Pricing decisions – in most cases, standard costs, instead of actual costs, are used in setting selling

may include unexpected efficiencies or inefficiencies of production that cannot be anticipated at the time the selling price is set. Standard costs may also be used as a basis for setting bid and contract prices. Application of management concepts – with the use of standard costing, the application of the concepts of management by objective and management by exception are facilitated.  Management by objective means that managers establish specific goals or objectives for all business activities. Eventually, actual results and operations are compared with these objectives. When performance is significantly different from the desired level, appropriate action is done by management.  Management by exception states that managers will maximize their efficiency if they concentrate only on those operational factors showing material deviations from the plan. Standards provide a quick and ready reference for identifying and reporting deviations from the planned performance levels.

Standard Costing and Other Costing Methods Standard costing is not another accounting method for accumulating manufacturing costs. It is rather used in conjunction with such methods such as job order costing, process costing or backflush costing. However, standard costing differs from the costing methods used in determining the costs of products. The table below illustrates such difference: Cost of a Product Direct materials Direct labor Factory overhead

Actual Actual Actual Actual

Normal Actual Actual Applied

Standard Standard Standard Standard

Applied factory overhead is equal to the predetermined overhead rate multiplied by the actual production whereas standard factory overhead is equal to the standard factory overhead rate times the standard production. DEVELOPING AND ESTABLISHING STANDARDS Standards are used to motivate employees to improve efficiencies and to reduce and control costs. In this regard, standards should be established in such a way that they are not too “tight” or impossible to attain so as not to discourage the employees from trying to reach them. Standards may be set on the following bases: A. A prior period level of performance by the same organization.

B.

When management feels that performance levels in a prior period have been acceptable, they can use this performance level as a target and control level for the forthcoming period. The level of performance achieved by comparable organizations.

If management wants to be more outward looking, it can attempt to monitor their organization’s performance against ‘the best of the rest’ by using the performance level of comparable organizations as a target for the forthcoming period. C. The level of performance required to meet the objectives of the organization. Management can set a performance level which

prices because the former reflects the desired or expected cost of production, whereas actual costs

will be sufficient to achieve the objectives which the organization has set for itself.

Prepared by: Mohammad Muariff S. Balang, CPA, First Semester, AY 2013-2014

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Types of Performance Standards A. Theoretical or ideal capacity – the standards are set based on operating at full speed without interruptions. It allows for no machine breakdowns or work interruptions and requires that workers operate at peak efficiency 100% of the time. B. Practical or currently attainable capacity – the standards are set based on theoretical capacity reduced by the allowance for unavoidable interruptions. They allow for normal machine downtime and employee rest periods and day offs and can be attained through reasonable, but highly efficient, efforts by the average worker. Practical standards are the ones normally used for product costing and cash budgeting purposes. C. Normal capacity – the standards are based on the average production level over a long period of time. It is the middle point where variations in production levels over a longer span of time would finally settle down. D.

Expected annual or budgeted capacity – the standards are based on estimated level of performance that the company plans to achieve in the next twelve months. Note that theoretical capacity is larger than practical capacity which is larger than normal capacity. Expected annual capacity fluctuates above and below normal capacity. Other Considerations in Setting Standards A standard cost should contain details of the standard amount and price of each resource that will be utilized in providing the service or manufacturing the product. Thus, in developing standards, the following should be taken into consideration: A. Quantity standards – indicate the quantity of raw materials or labor time required to produce a unit of product or to provide services. B. Cost standards – indicate what the cost of the quantity standards (materials quantity and labor time) should be. Cost and quantity standards are determined separately for two reasons: A. The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw material used. B. The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before being used in production. Setting price and quantity standards require the combined expertise of everyone who has responsibility for purchasing and using inputs. In a manufacturing setting this might include accountants, engineers, purchasing managers, production supervisors, line managers, and production workers. Standards should be designed to encourage efficient future operations, not just a repetition of past inefficient operations.  SETTING DIRECT MATERIAL STANDARDS Standard Material Price The standard price per unit for a direct material should reflect the final, delivered cost of the material, net of any discounts and inclusive of handling costs. The standard price is for a particular grade of material, purchased in a particular lot size, and delivered by a particular type of carrier. The sources of information in setting the cost standard for direct materials include the following: A. Quotations and estimates received from potential suppliers. B. Trend information obtained from past data on material prices. C. Details of any bulk discounts which may be available. D. Information on any charges which will be made for

E. F.

The quality of material to be used as this may affect the price to be paid. For internally manufactured components, the predetermined standard cost for the component will be used as the standard price.

When more than one direct material is used for a production process, a standard unit price must be computed for each individual direct material. Standard Material Usage The standard quantity of a direct material per unit of output in a traditional standard cost system reflects the amount of material going into each unit of finished product, as well as an allowance for unavoidable waste, spoilage, and other normal inefficiencies. The number of different direct materials and the related quantities each required to complete one unit can be developed from engineering studies, analysis of past experiment and test runs under controlled conditions and is summarized in a bill of materials. Standard Direct Material Cost Standard cost of materials per unit of product

=

Standard quantity per unit of product

x

Standard price per unit of materials

 SETTING DIRECT LABOR STANDARDS Standard Labor Rate The standard rate per hour for direct labor should include not only wages, but also fringe benefits and other laborrelated costs. Ordinarily, the standard rate is an average that assumes a specific mix of higher and lower paid workers. The sources of information in setting the cost standard for direct labor include the following: A. The personnel department for the wage rates for employees of the required grades with the required skills. B. Forecasts of the likely outcome of any trades union negotiations currently in progress. C. Details of any bonus schemes in operation. Standard Labor Time The standard direct labor-hours per unit of output is the direct labor time allowed to complete a unit of product. In traditional standard cost systems this standard time includes allowances for coffee breaks, personal needs of employees, clean-up and machine downtime. The quantity standards for labor can be established by conducting a time and motion study or by considering previous experience in processing the same product. Standard Direct Labor Cost Standard labor cost per unit of product

=

Standard time or hours per unit of product

x

Standard labor rate per hour

 SETTING FACTORY OVERHEAD STANDARDS Standard Variable Factory Overhead Standards for variable manufacturing overhead are usually expressed in terms of direct labor-hours or machine hours. The standard hours for variable overhead represent the standard hours for whatever base is used to apply overhead cost to products or services. If direct labor-hours is the basis for applying overhead to products, then the quantity standard for variable manufacturing overhead will be the quantity standard for direct labor. As to the price factor, the variable overhead rate per hour is used. Standard Fixed Factory Overhead Fixed overhead costs are usually expressed in terms of total figures. To set the standard rate for fixed overhead, the total fixed overhead costs is computed using the practical or normal capacity level as the base. The standard time for overhead is usually expressed in terms of direct labor standard time or machine hours.  STORING STANDARD COST DATA The standard cost may be stored on a standard cost sheet as illustrated below. If this is the case, each department

packaging and carriage inwards.

should have its own standard cost sheet and the entire

Prepared by: Mohammad Muariff S Balang CPA First Semester AY 2013-2014

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plant operations should also have its own standard cost sheet which summarizes all of the departmental standard costs sheets.

D.

STANDARD COST SHEET Product GT -800 Direct materials: Material No. 143 Material No. 144 Direct labor: Bonding Finishing Total prime cost Variable factory overhead: Bonding Finishing Fixed factory overhead Standard unit cost

40 kilos at P53.00 50 kilos at P45.00

P 2,120.00 2,250.00

48 hours at P25.00 30 hours at P20.00

P 1,200.00 600.00

48 hours at P7.50 30 hours at P5.00

P

360.00 150.00

P 4,370.00

1,800.00 P 6,170.00

STANDARD COSTS VERSUS BUDGETED COSTS Both standards and budgets are predetermined amounts. However, a standard is a unit amount, whereas a budget is a total amount. A. Total budgeted costs – the cost that should be incurred for budgeted production. Total budgeted cost

B.

=

Budgeted production

x

Standard cost per unit

Total standard costs – the cost that should have been incurred for actual production. Total standard cost

=

Actual production

x

A statistical control chart is a chart on which successive cost observations are plotted in the form of a graph. The chart shows certain fixed points, representing the expected distribution of the particular item and only actual observations which fall outside predetermined limits would be regarded as non-random and worth investigating.

510.00 400.00 P 13,250.00

Nowadays, with technological advancements, standard cost data are more likely to be stored on a computer or in a database. Alternatively, it may be stored as part of a spreadsheet so that it can be used in the calculation of variances. Moreover, the standard cost may be prepared using either absorption costing principles or variable costing principles.

Standard cost per unit

ACCUMULATION OF ACTUAL COSTS When a company uses a standard cost system, it does not mean that there is no more need for actual costs. Actual costs should likewise be recorded and accumulated. They should always be made available for comparison with the standard costs to determine any deviations. A standard cost system should be used in conjunction with the other systems of cost accumulation like process costing and job order costing systems. VARIANCE ANALYSIS Variance analysis refers to the act of computing and interpreting variances. It is performed to know the difference between actual and standard costs and the reasons for such difference. The variance analysis cycle is a continuous five-step process: A. Prepare standard cost performance report. The cycle begins with the preparation of standard cost performance reports by the accounting department. B. Analyze variances. The standard cost performance reports highlight variances which are differences between actual results and what should have occurred according to the standards.  A variance may be favorable (credit) or unfavorable (debit). A variance is said to be favorable if it causes actual profit to be greater than budget. Inversely, it is said to be adverse if it causes actual profit to be less than budget.  Thus, if actual cost is more than the standard costs, the variance is unfavorable. If the actual cost is less than standard costs, the variance is favorable.  Variances need to be studied, analyzed and given solutions regardless of whether they are favorable or unfavorable. C. Identify questions. The variances raise questions such as “Why did this variance occur?” and “ Why is this variance larger than it was last period?”

Receive explanations. The significant variances are investigated to discover their root causes.  All variances are not worth investigating. Some variances need not be investigated.  Methods for highlighting a subset of variances as exceptions include: a. Looking at the size of the variance. b. Looking at the size of the variance relative to the amount of spending. c. Plotting variance analysis data on a statistical control chart.

E.

Take corrective actions. Corrective actions are taken depending on the reason of the occurrence of the variance and the next period’s operations are carried out. A normal variance is ordinarily delegated to lower management for analysis, explanations and corrective actions , whereas, an exceptional variance is given top priority by upper management (i.e. management by exception).

COMPUTATION AND ANALYSIS OF VARIANCES In materials, labor and variable factory overhead costs, the variances are analyzed using the two way method: A. Price variance – difference between actual price and standard price. The actual price represents the actual amount paid for the input used whereas the standard price represents the amount that should have been paid for the input used.  Price variance for direct materials.  Rate variance for direct labor.  Spending variance for variable factory overhead. B.

Quantity variance – difference between actual quantity and standard quantity. The actual quantity represents the actual amount of direct materials, direct labor, and variable manufacturing overhead used whereas the standard quantity refers to the standard quantity of inputs allowed for the actual level of output achieved.  Quantity or usage variance for direct materials.  Time or efficiency variance for direct labor.  Efficiency variance for variable factory overhead.

 DIRECT MATERIAL VARIANCES

Important Points and Discussions: A.

The materials price variance indicates how much of the total materials variance was caused by paying a different price for the materials used whereas the materials usage variance reveals how much of the total materials variance was caused by using a different quantity of material compared with the standard allowance for the production achieved. B. The materials price variance is computed using the entire amount of material purchased during the period. The materials quantity variance is computed using only the portion of materials that were used in production during the period. C. Possible causes of materials price variance include:  Random fluctuations in market prices.  Materials substitution.  Market shortages or excesses.

Prepared by: Mohammad Muariff S Balang CPA First Semester AY 2013-2014

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 Unexpected price increases or decreases.  Failure to take cash discounts. D. Possible causes of materials usage variance include:  Change in product specifications.  Materi...