Standard Costs ACG 4361 5-2 Prepared by Diane Tanner University of North Florida 5-2

Standard Costs What is a standard cost? The unit ‘cost’ that management believes should be incurred to produce a single good or service (cost object) under anticipated conditions Not all budgeted costs are standards. Budgeted costs can be standards, but only if a company employs a standard cost system.

Benefits of Standard Costing Used to control costs Allows for comparison to actual costs Functions as a benchmark Part of a continuous improvement plan Compares production performance to best levels of performance in competitors Differences are flagged for investigation if significant Provide feedback to initiate corrective action

How are Standard Costs Developed? Formulas or recipes Price lists provided by suppliers Time and motion studies conducted by industrial engineers Union contracts Analyses of past data Insight from management Expected economic changes Historical costs Once developed, standard costs must be monitored and updated periodically.

Determining a Material Cost Standard Standard cost of materials = Standard quantity allowed per unit × Standard price per raw material denomination Material quantity standard Based on the unit denomination in which the company orders its raw materials E.g., pounds, feet, tons, ounces, kilograms Material price standard Based on the price a company purchases each ‘unit’ of of materials E.g., $1 per pound, or $2 per square foot :

Determining a Labor Cost Standard Standard cost of labor = Standard hours allowed per unit × Standard price per labor hour Labor quantity standard (or labor efficiency standard) Based on hours because that is how direct labor wages are paid Minutes must be converted to hours Labor price standard (or labor rate standard) Based on the hourly wage rate Fringes are included as part of the hourly rate :

Ideal Versus Attainable Standards Ideal standards Assumption that no obstacles to the production process will be encountered Highest efficiency must be employed Called ‘perfection’ standards Often discourages employees Attainable Standards Assumption that there will be occasional problems in the production process Such as equipment failure, labor turnover, and materials defects Motivates employees better than ideal standards

P Q Standard Costs Mind your P’s and Q’s Standard Quantity Standard Price Budgeted price of material (per RM denomination) Budgeted price of labor (per hour) Q Standard Quantity Budgeted quantity of material (in RM denominations) Budgeted quantity of labor hours

Investigation of Standard Cost Variances Should be investigated if material in amount Management by exception Based on Fixed percentage Fixed dollar amount Statistical analysis Variances Are not a clear sign of good or bad performance Flag a potential problem Have many reasonable explanations Consider costs versus benefits

Standard Cost Example Darco produces bins and uses a standard cost system. Its cost driver for overhead is the number of direct labor hours. Budgeted units 800 bins Budgeted materials 0.53 lb. @ $5.00 per lb. Budgeted labor 0.45 hours @ $13.00 per hour Budgeted variable overhead $1,872 Budgeted fixed overhead $3.70 per DLH Budget and Standards VOH = $1,872 0.45 × 800 Direct materials (0.53 × $5) $2.65 Direct labor (0.45 × $13) 5.85 = $5.20 per DLH VOH (0.45 × $5.20) 2.34 FOH (0.45 × $3.70) 1.67 $1,332 FOH = ? 0.45 × 800 Standard Cost $12.51 = $3.70 per DLH

Standard Cost Transactions The standard cost moves through the accounts as production occurs. Raw Materials Work in Process Finished Goods CGS 2.65 2.65 + DL + MOH 12.51 12.51 12.51 12.51 For each unit started in production, $2.65 is moved from Raw Materials to WIP. As each unit is completed, $12.51 is moved from WIP to Finished Goods. As each unit is sold, $12.51 is moved from Finished Goods to Cost of Goods Sold.

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