Standard Costing AND Variance Analysis Repaired PDF

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ST STA AND NDA ARD CO COST ST STIN IN ING G AND VA VARI RI RIA ANC NCE E AN ANA ALYS YSIS IS At the end of the chapter, you should be able to: 1. 2. 3. 4.

Discuss the concept of standards and standards-setting. Explain the relevance of the different levels of capacity used in standards-setting. Interrelate standards with planning, organizing, directing, and controlling. Determine and analyze the costs variances of direct materials, direct labor, variable overhead and fixed overhead. 5. Compute the materials mix and yield variances. 6. Explain the various ways of disposing cost variances.

1. DISCUSS THE CONCEPT OF STANDARDS AND STANDARDS-S STANDARDS-SETTING. ETTING.

Manufacturing, service, food, not-for-profit organizations and even financial institutions all make use of standards ( in terms of either costs or quantities) to some extent. Auto service centers offer set labor time standards for the completion of certain work tasks and then measure actual performance against these standards. Fast-food outlets such as Jollibee, McDonalds have exacting standards as to the quantity of meat going into a sandwich, as well as standard for the cost of the meat. Hospitals have standard cost for laboratory tests, for food, laundry and other items for each occupied bed. In short, the business student is likely to run into standard costs concepts in almost any line of business that she or he may enter. When you hear the word standard, what comes first into your mind? In every activities and task that you are doing, be it in school or at home, do you set standards or expectations in your output? If so, were you able to achieve your target or expectations? Were you able to meet the standard you set? In this chapter, we are to focus on the use of standards in costing within the organization. Standards -

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Expected levels of performance Established to institute order, discipline, expectations and normalcy. Expressed and used in many forms: o Societal standards – reflective of ethics, values culture, traditions, beliefs, laws and decrees. o Organizational standards – expressed in policies, procedures, rules, regulations, manuals and systems. can be financial or non-financial, quantitative or non-quantitative. o Standards are oftentimes quantitative for objectivity in measurement. These are standards established and followed in accounting, treasury, engineering, design, legal, administration, marketing, human resources, distribution, customer relations, information technology and other areas of responsibility centers. In the field of financial accounting, the standards used are the International Financial Reporting Standards In the field of taxation, tax laws and regulations are the standards Used in almost all facets of management – planning, organizing, directing, and controlling. o In planning – standards serve as basis for forecasting.  By using standards, we were able to project the expected outcome of a particular

undertaking. Given the output set by management, we can determine what inputs (costs) necessary to produce such output. o

In organizing and directing – standards are used as indicators to monitor production yield rate, conformity or nonconformity with administrative policies, and personnel efficiencies.  In this stage of management, standards serve as guide on whether they are still performing

as expected or they are already deviating from what has been set as standard. o

In contr controlling olling – standards are used in costs variances analyses for on-line monitoring and adjustments and for end-of-the line evaluation and remedial actions.  Given that standards were used in forecasting, organizing and directing, it will be necessary

to analyze the variation with the expectations through the controlling function. Here,

possible causes and reasons of variances were identified and analyzed as basis for remedial actions. Standards setting -

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Strategic in nature Could be set by o management, o outsourced from an independent entity, o developed by the industrial engineering department, or o established with the participation and involvement of lower level managers and personnel.  When standards are developed with the participation of operating personnel and officers, there appears no reason for not meeting them.  Standards set by hands-on personnel are more reflective of the realities in the production line and other facets of business operations. It is a matter of managerial prerogative. This standard setting could either o motivate or de-motivate employees,  if the standards set are too high and improbable to achieve, it will create dysfunctional employee behavior. o give relevance or insignificance in the meaning of their work, or o produce excellent or mediocre performance.  Standards that are set too low would attract mediocre performance and would fail to maximize the potentials of employees.

Standards setting participated by those directly involve in the operations of the business will likely to produce outcomes as expected. Since they were the ones who are actually performing the task, they have the first hand information on what are actually happening in the operations. Organizations need to be careful in setting the standard to be achieved by different areas or centers. It could really affect their motivation to perform the task as well as the level of performance that they will exert for them to achieve the expected target. 2. EXPLAIN THE REL RELEVANCE EVANCE OF THE DIFFERENT L EVELS OF CAPACITY USED IN STANDARDSSETTING. Standard levels -

May be theoretical, practical or lax Theoretical standards (or ideal, maximum efficiency, or perfection standards) o Set at the highest possible capacity where there are no allowances for waster, spoilage, inefficiencies, machine breakdowns and other downtimes, and other interruptions in the production line. o Standards bring the organization at the level of business operations where machines, systems, and personnel are working in the best possible situation without allowances for normal operational interruptions. o It is based on the work of most skilled workers, most efficient machines, and best production design and processes. o These standards may bring in positive attitude and behavior if employees are motivated to strive for quality and excellence. o If the standards are perceived to be too high to attain, employees react negatively – this defeats the motivational purpose of standards. o These are adopted by companies which employ total quality management principles. o Still, these are normally replaced by practical standards in financial planning and controlling to make estimated financial data more reliable. o These standards are usually not attainable because they do not allow for any machine breakdowns or

other work interruptions and require the most skilled and efficient employees working at peak effort 100% of time. -

Practical standards ((or or currently attainable standards) o Normal and expected actual standards and are “light but attainable”

Attain the most reasonable production level , with allowances for machine breakdowns, downtimes, inefficiencies, waste and spoilage, and other normal production disturbances. o These standards still require utmost efficiency and optimum use of resources under normal circumstances. o They are reasonable and attainable. o Variances from such a standard are very useful to management in that they represent deviations that fall outside of normal, recurring inefficiencies that signal a need for management attention. Lax standards (or slack standards) o Provide the maximum allowances for inefficiencies and ineffectiveness and are not geared towards producing less than the reasonable output from the process. o A sure fire formula to slowdown activities and make the business much less competitive and selfsustaining. o

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BUDGETS, STANDARDS, AND NO NORMAL RMAL VOLUME Note: Budgets, standards and normal volume differ in terms of usage (or quantity) but not in their rate per unit unit. Capacity

Budgeted capacity/ Expected actual capacity

Discussion  The estimated level of performance that the company plans to achieve in the next 12 months.

This is the budgeted production that the company sets at the start of the period.  Budgeted quantity is based on budgeted level of production.

This is the budgeted quantity (e.g., materials/ingredients) to produced the budgeted production Standard capacity

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The estimated capacity that should have been used in actual capacity.

Normal capacity/ Normal volume

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May be set based on the average sales demand of the product, engineering estimates and technical specifications, legal variables, cultural orientation, or other factors The average production level of the business over the period covered by the budget The middle point of variations in the budgeted production levels serving as the basis in budgetary planning where the concept of stability is of prime importance. It is also the basis in determining the fixed overhead rate

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Formula Budgeted quantity = Budgeted unit of production x Standard quantity (e.g. pounds or hours) per unit of product Standard quantity = Actual production (in units) x Standard quantity rate per unit produced Standard fixed overhead rate = Budgeted fixed overhead Normal capacity

Take note of the difference between the term “capacity” and “quantity”. Capacity was the number of units to be produced or actually produced while quantity is the required inputs (e.g., pounds, hours, kilograms) to produce such capacity. Sample Problem 1. Capacity Le Levels vels Melanie Corporation acquired a machine with a 200,000 units level of capacity five years ago. Using this machine, the standard labor time is 2 hours per unit. Engineering estimates based on attainable performance is 170,000 units. Management has planned to produce only 160,000 units in the coming year using the same machine. Total production in the last five years is 828,000 with annual production recorded as follows: First year Second year Third year Fourth year Fifth year

180,000 units 140,000 units 170,000 units 182,000 units 156,000 units

The capacity levels are as follows; Units Maximum capacity Practical capacity Budgeted capacity Normal capacity (828,000 units/ 5 yrs) Standard capacity first year

200,000 units 170,000 160,000 165,600 180,000*

Hours (units x 2 hrs) 400,000 hrs 340,000 320,000 331,200 360,000

* The standard hours is based on the actual capacity, and in this case is 180,000 units.

In solving standard costing problem, one of the challenges and difficulties commonly experienced by students was the capacity to be used; was it budgeted, standard or normal? With the table provided earlier, students will be guided on when to use the different volume of activity in determining the required capacity. Standard Costs        

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Comprise the standard quantity and standard price Standard quantity x Standard price Used to motivate optimal productivity and efficiency These are monetary measures with which actual costs are compared to. It may be based on engineering, accounting and statistical quality control studies. These are used in all phases of managerial functions. It is also applied in all types of industries where performance levels could be established based on historical performance, time and motion study, and other means of establishing performance. Standard quantities and prices are to be established by the standard-setting committee created for such purpose. o This sub-committee, under the supervision of the Budget Committee, is composed of the chosen operating managers from various functional lines of operations such as production, purchasing, human resources, payroll, legal, industrial engineering, accounting, among others . Standard costs are bases of intelligent forecasting and projections. The determination of standard unit costs ordinary needs the participation of middle and lower level managers. Let us consider the following standard cost per unit:

Table 1. Departmental Standard Costs Sheet Mela Company Cutting Department Standard Costs Sheet

Direct materials AA – 44 BB – 77 CC -12 Direct labor Variable overhead Fixed overhead Total Standard Unit Cost

Date Established Product

Qty

Price

3 lbs 6 pcs 4 units 4 hrs. 4 hrs. 4 hrs.

@ P 2.00 @ P 6.20 @ P 3.40 @ P 7.00 @ P 3.00 @ P 5.00

11.20.2018 Tungki

Unit Cost P 6.00 37.20 13.60

P 56.80 28.00 12.00 20.00 P 116.80

 The standard mat materials erials per un unit it (e.g., 3 lbs, 6 pcs., 4 units) may be initially determined by the production manager and the s tandard number o f hours to make a unit of output may be based on the study of the industrial engineering department.  The unit materials costs (cost of inputs) shall be primarily determined by the purchasing manager.  The quality and specifi specificcations of the materials shall however be that of the production manager.  The standard labor rate may be estimated on the advice of the human resource manager, legal officer, and the production manager.  The standard variabl variablee overhead rate is determined based on past experiences with adjustments on current and anticipated developments that impact variable overhead.

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The fix fixee d o ove ve verrhe head ad ra rate te is based on normal capacity. STANDARD RATE OR PR PRIICE should be based on A NET BASIS BASIS. STANDARD HOURS AND Q UANTITY should be set AT GROSS BASIS AFTER INC INCLUDING LUDING ALLOWANCES for spoilage, breakdowns, and similar events.  The standard quantities and prices shall be consensusly developed and recommended for approval by the standard-setting committee.

As can be seen, different departments are involved in the determination of standard base or rate to be used in standard costing. Take note also of the basis used in determining standard rate or price (net basis) and standard hours and quantity (gross basis after including allowances). It is necessary for the students to take note of these concepts. Sample Problem 2. Setting Standard Materials Costs Southern Corporation produces product Durito weighing 3.2 lbs., net of the 20% processing loss. It buy materials from a supplier at an invoice price of P 40 per lb. with a normal trade discount of 2/10, n/30. Freight for the delivery of materials costs P 5 per lb. What is the standard materials quantity, price, and cost per unit? Solutions/ Discussions: Since it is not mentioned on when the production loss occurs, it is assumed it is incurred at the beginning of the process. The standard costs are determined as follows: Standard materials input = Standard materials output/ (100 - Loss rate) = 3.2 lbs. / 80% = 4 lbs. Standard price per lb: Purchase price P 40 x 98% Freight-in Standard price per lb.

P 39.20 5.00 P 44.20

Standard materials costs = Standard materials input x Standard net price = 4 lbs. x P 44.20 = P 176.80

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Again, if we are to look on the previous discussion, standard quantity should be on gross basis including allowances for shortage, breakdown and similar events. That is why, instead of using only 3.2 lbs, we used the gross quantity of 4 lbs. which is gross of the loss rate. On the other hand, in determining standard price, we used the net basis. Meaning, we used the purchase price net of trade discount. Additionally, since freight-in is a necessary cost of acquiring the materials, we included such as part of the standard price calculation. As discussed in the first part of standard cost topic, standard cost is equal to standard rate x standard quantity. Thus, after determining the standard price (net basis) and standard quantity (gross basis including allowances), we were able to compute for out standard cost of materials.

Sample Problem 3. Setting Standard Labor Costs Northern Corporation produces product Durito after 45 minutes of direct labor time. The company pays its production personnel for eight (8) hours a day and gives a 30-minute daily paid breaktime. It normally starts its process with 5,000 units and completes at 4,500 good units. It pays its personnel at an hourly rate of P 70 plus social welfare benefits of approximately 10% on the basic rate. What is the standard direct labor hours, rate, and cost per unit? Solutions/ Discussions: The productivity rate is 90% (i.e, 4,500/5,000). Since it is not mentioned on when the loss occurs, it is assumed to have happened at the start of the process. The standards are determined as follows: Standard direct labor hours = Standard output time/ (100 – loss rate) = 45 minutes / 90%/ (7.5/8)

= 53.3333 minutes or 0.888889 hr. Standard direct labor rate per hour: Basic wage rate per hour Fringe benefits (10%) Standard rate per hr.

P 70.00 7.00 P 77.00

Standard direct labor costs = Standard direct labor time x Standard labor rate = 0.888889 hrs. x P 77.00 = P 68.4444 Notes:  It should be noted that standard direct labor hours should be stated at gross of allowances for breakdowns,

and similar events while standard direct rate per hour should be stated on a net basis. Thus, standard direct labor cost is the product of standard direct labor time and standard labor rate. Each department should have its own standard costs sheet. The plant operations should also have its plant’s standard costs sheet which is a summary of all departmental standard costs sheets. An example of a plant standard cost sheet is shown below: Mela Company Laguna Plant Standard Costs Sheet

Date established Product Cutting

Direct materials AA – 44 BB – 77 CC – 12 DD – 55 Direct labor Activity – Operation AA – 12 BB – 23 CC – 44 DD – 55 Variable Overhead Activity/ Operation

3 lbs 6 pcs 4 units 6 units

@ P 2.00 @ P 6.20 @ P 3.40 @ P 2.00

4 hrs 3 hrs 2 hrs 3 hrs

@ P 7.00 @ P 4.00 @ P 6.00 @ P 6.00

Allocation Basis Set-up time

AA – 12 Machine hours BB – 23 CC – 44 DL hours DD – 55 DL hours Total Standard Unit Costs

Standard Rate Basis P 1.25 P 12.00 2.00 8.00 0.75 10.00 1.75 10.00

11.12.2018 Tungki

Assembly

Packaging

Total

P 6.00 37.20 13.60

13.60 12.00

82.40

12.00 18.00

82.00

17.50 P 47.50

56.00 P 220.40

28.00 12.00 12.00

15.00 16.00 7.50 P 139.80

P 33.10

Standard costs shall be regularly evaluated to maintain relevance, validity, and reliability. Uses of standard costs Some of the most regular uses of standard costs are as follows: 1. Profit planning and cost-v cost-volume-profit olume-profit analysis. Standard costs are used in predicting scenarios under varying conditions of volume, prices, and costs leading to the basic analysis and sensitivity analysis of contribution margin, margin of safety, and operating leverage. 2. Responsibility accounting Standard costs are used to make the assignment of controllable and non-controllable costs more meaningful and acceptable to managers of various responsibility centers. 3. Budgeting Standard costs are used as reliable bases in anticipating budgeted costs and expenses. 4. Performance evaluation Standard costs are used as meaningful benchmarks in evaluating actual performances of center managers, otherwise known as “costs variances analysis” 5. Pricing Standard costs are used in setting regular as well as incremental sales prices used in determining the right and winning amount of bid prices most specially in a stiff competitive bidding.

6. I nt nter er erim i...