Standard costing

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

Introduction Standard cost the estimated cost of a process, resource, or item used in a manufacturing enterprise, entered in an account and compared with the actual cost so that anomalies are readily detectable.

Introduction Standard costing An estimated or predetermined cost of performing an operation or producing a good or service, under normal conditions. Standard costs are used as target costs (or basis for comparison with the (actual costs), and are developed from historical data analysis or from time and motion studies.

Procedures of standard costing system Set the predetermined standards for sales margin and production costs Collect the information about the actual performance Compare the actual performance with the standards to arrive at the variance Analyze the variances and ascertaining the causes of variance Take corrective action to avoid adverse variance Adjust the budget in order to make the standards more realistic

Functions of standard costing system Valuation 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

Functions of standard costing system Motivation Notify the staff of the management’s expectations Setting of selling price

Variance

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)

Cost variance

Cost variance Cost variance = Price variance + Quantity variance Cost 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

Three types of cost variance Material cost variance Labour cost variance Variable overheads variance

Material and labour variance

Material cost variance Material price variance = (standard price – actual price)*actual quantity Material usage variance = (Standard quantity – actual quantity)* standard price = (Standard quantity for actual production – actual quantity production) * standard price

Labour cost variance Labour rate variance = (standard price – actual price)*actual quantity Labour efficiency variance = (standard quantity – actual quantity)*standard price = Standard quantity for actual production – actual quantity used) * standard price

Overheads variance Variable overheads variance Fixed overheads variance

Variable overheads variance Variable overheads variance is the difference between the standard variable overheads absorbed into the actual output and the actual overheads incurred

Fixed overhead variance Fixed overheads variance = Fixed overheads absorbed – Actual fixed overheads incurred Fixed overheads expenditure variance Budgeted fixed overheads – Budgeted overheads absorbed Fixed overheads volume variance = Absorbed fixed overheads – Budgeted overheads absorbed

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

Reasons for variances 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 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 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