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1. Abstract
Standard costs are aid in the planning, operations and gaining insights in to the probable impact of managerial decision on cost levels and profit. Standard cost is used for Establishing Budgets, Controlling cost and motivating and measuring efficiencies. Standard cost are also used for promoting possible cost reduction and assigning cost to material, work in process and finished goods inventories. Nowadays many companies are adopting the standard cost for their planning and budgeting.
2. Introduction
A standard is a benchmark or norm for measuring performance. Standards are set for both the cost and the quantity of inputs needed to manufacture goods or to provide services. Quantity standards indicate how much of an input, such as labor time or raw materials, should be used to make a product or provide a service. Cost standards indicate what the cost of the input should be. Standards are normally set so that they can be attained by reasonable, though highly efficient, efforts. Such practical standards are believed to positively motivate employees. When standards are compared to actual performance, the difference is referred to as a variance. Variances are computed and reported to management on a regular basis for both the price and the quantity elements of direct materials, direct labor, and overhead. Price variances are computed by taking the difference between actual and standard prices and multiplying the result by the amount of input purchased. Quantity variances are computed by taking the difference between the actual amount of the input used and the amount of input that is allowed for the actual output, and then multiplying the result by the standard price of the input. Not all variances require management time or attention. Only unusual or particularly significant variances should be investigatedotherwise a great deal of time would be spent investigating unimportant matters. Additionally, it should be emphasized that the point of the investigation should not be to find someone to blame. The point of the investigation is to pinpoint the problem so that it can be fixed and operations improved. Traditional standard cost variance reports are often supplemented with other performance measures. Overemphasis on standard cost variances may lead to problems in other critical areas such as product quality, inventory levels, and ontime delivery.
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
The standard quantity per unit for direct materials is the amount of material that should go into each finished unit of product. The standard quantity should reflect: Engineered (bill of materials) requirements. Expected spoilage of raw materials. Unavoidable waste of materials in the production process. Materials in expected scrapped units (rejects).
EXAMPLE: The standard quantity of verilon in one jogging suit is computed as follows: Bill of materials requirement ..................................... Allowance for waste ..................................................... Allowance for rejects .................................................... Standard quantity per jogging suit ........................ 2.8 yards 0.6 yards 0.1 yards 3.5 yards
Once the price and quantity standards have been set, the standard cost of materials (verilon) for one unit of finished product can be computed: 3.5 yards per jogging suit $6 per yard = $21 per jogging suit
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
Many companies prepare a single standard rate for all employees in a department, based on the expected mix of high and low wage rate employees. This procedure: Simplifies the use of standard costs Allows monitoring the actual mix of employees in the department
EXAMPLE: The standard rate per hour for the expected labor mix is determined by using average wage rates, fringe benefits, and employment taxes as follows: Average wage rate per hour.......................................... Average fringe benefits ................................................... Average employment taxes ........................................... Standard rate per direct labor-hour ........................... $13 4 1 $18
The standard hours per unit for direct labor specifies the amount of direct labor time required to complete one unit of product. This standard time should include: Engineered labor time per unit. Allowance for breaks, personal needs, and cleanup. Allowance for setup and other machine downtime. Allowance for rejects.
EXAMPLE: The standard hours required to produce a jogging suit have been determined as follows: Basic labor time per unit............................................... Allowance for breaks and cleanup............................ Allowance for setup and downtime ......................... Allowance for rejects ...................................................... Standard hours per jogging suit................................ 1.4 hours 0.1 hours 0.3 hours 0.2 hours 2.0 hours
Once the time and rate standards have been set, the standard cost of labor for one unit of product can be computed: 2.0 hours per jogging suit $18 per hour = $36 per jogging suit.
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
EXAMPLE: Speeds, Inc. applies overhead cost to products on the basis of direct labor-hours. The variable portion of the predetermined overhead rate is $4 per direct labor-hour. Using this rate, the standard cost of variable overhead for one unit of product is: 2.0 hours per jogging suit $4 per hour = $8 per jogging suit.
EXAMPLE: Referring back to the standard costs computed for materials, labor, and overhead, the standard cost for one jogging suit would be: Standard Cost Card for Jogging Suits (1 ) Standard Quantity or Hours 3.5 yards 2.0 hours 2.0 hours (2) Standard Price or Rate $6 per yard $18 per hour $4 per hour (1) (2) Standard Cost $21 36 8 $65
Direct materials ............................................ Direct labor .................................................... Variable manufacturing overhead ........ Total standard cost per suit ....................
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
10.1 Types of Standard 1. Quantity Standard Quantity standard describes how much input should be allowed or used to produce a unit of product. 2. Cost or price standard Cost or price standard incorporates how much should be input cost produce a unit of a product. If either of the above standards significantly deviate from the actual result, management should investigate the area of discrepancy to find out the problem and eliminate it. This is called management by exception. If the actual result (Quantity or cost) is less than the standard performance (Quantity or cost), the deviation is favorable which is denoted by F and if the actual result is greater than standard performance that leaves the unfavorable result which is denoted by U
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
A variance is the difference between what was planned or expected and what was actually accomplished. A standard cost system has at least two types of variances. A price variance focuses on the difference between standard and actual prices. A quantity variance is concerned with the difference between the standard quantity of input allowed for the actual output and the actual amount of the input used. The standard quantity allowed (standard hours allowed in the case of labor and overhead) is the amount of materials (or labor) that should have been used to complete the output of the period.
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
11.1 DIRECT MATERIAL VARIANCES To illustrate variance analysis, refer to the standard cost card for Speeds, Inc.s jogging suit. The following data are for last months production: 5,000 units $108,000 20,000 yards
Number of suits completed ..................................... Cost of material purchased (20,000 yards $5.40 per yard) ......................... Yards of material used................................................ -
Using these data and the data from the standard cost card, the material price and quantity variances are: Actual Quantity of Input, at Actual Price (AQ AP) 20,000 yards $5.40 per yard = $108,000 Actual Quantity of Input, at Standard Price (AQ SP) 20,000 yards $6.00 per yard = $120,000 Standard Quantity Allowed for Output, at Standard Price (SQ SP) 17,500 yards* $6.00 per yard = $105,000
Total Variance, $3,000 U * 5,000 suits 3.5 yards per suit = 17,500 yards F = Favorable U = Unfavorable
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
DIRECT MATERIAL VARIANCES (continued) The direct material variances can also be computed as follows:
MATERIAL PRICE VARIANCE: Method one: MPV = (AQ AP) (AQ SP) = ($108,000) (20,000 yards $6.00 per yard) = $12,000 F Method two: MPV = AQ (AP SP) = 20,000 yards ($5.40 per yard $6.00 per yard) = $12,000 F The material price variance should be recorded at the time materials are purchased. This permits: Early recognition of the variance. Recording materials at standard cost.
MATERIAL QUANTITY VARIANCE: Method one: MQV = (AQ SP) (SQ SP) = (20,000 yards $6.00 per yard) (17,500 yards* $6.00 per yard) = $15,000 U *5,000 suits 3.5 yards per suit = 17,500 standard yards Method two: MQV = SP (AQ SQ) = $6.00 per yard (20,000 yards 17,500 yards) = $15,000 U
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
11.2 DIRECT LABOR VARIANCES The following data are for last months production: Number of suits completed (as before) ................................................ Cost of direct labor (10,500 hours @ $20 per hour) ............................................................ 5,000 units $210,000
Using these data and the data from the standard cost card, the labor rate and efficiency variances are:
Actual Hours of Input, at the Actual Rate (AH AR) 10,500 hours $20 per hour = $210,000
Actual Hours of Input, at the Standard Rate (AH SR) 10,500 hours $18 per hour = $189,000
Standard Hours Allowed for Output, at the Standard Rate (SH SR) 10,000 hours* $18 per hour = $180,000
Total Variance, $30,000 U * 5,000 suits 2.0 hours per suit = 10,000 hours. F = Favorable U = Unfavorable
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
DIRECT LABOR VARIANCES (continued) The direct labor variances can also be computed as follows:
LABOR RATE VARIANCE: Method one: LRV = (AH AR) (AH SR) = ($210,000) (10,500 hours $18 per hour) = $21,000 U Method two: LRV = AH (AR SR) = 10,500 hours ($20 per hour $18 per hour) = $21,000 U LABOR EFFICIENCY VARIANCE: Method one: LEV = (AH SR) (SH SR) = (10,500 hours $18 per hour) (10,000 hours* $18 per hour) = $9,000 U *5,000 suits 2.0 hours per suit = 10,000 hours Method two: LEV = SR (AH SH) = $18 per hour (10,500 hours 10,000 hours) = $9,000 U
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
11.3 VARIABLE MANUFACTURING OVERHEAD VARIANCES The following data are for last months production: Number of suits completed (as before) ................................. Actual direct labor-hours (as before) ...................................... Variable overhead costs incurred ............................................. 5,000 units 10,500 hours $40,950
Using these data and the data from the standard cost card, the variable overhead variances are: Actual Hours of Input, at the Actual Rate (AH AR) Actual Hours of Input, at the Standard Rate (AH SR) 10,500 hours $4 per hour = $42,000 Standard Hours Allowed for Output, at the Standard Rate (SH SR) 10,000 hours* $4 per hour = $40,000
$40,950
* 5,000 suits 2.0 hours per suit = 10,000 hours. F = Favorable U = Unfavorable
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
VARIABLE OVERHEAD VARIANCES (continued) The variable manufacturing overhead variances can also be computed as follows:
OVERHEAD SPENDING VARIANCE: Method one: VOSV = (AH AR) (AH SR) = ($40,950) (10,500 hours $4.00 per hour) = $1,050 F Method two: VOSV = AH (AR SR) = 10,500 hours ($3.90 per hour* $4.00 per hour) = $1,050 F * $40,950 10,500 hours = $3.90 per hour OVERHEAD EFFICIENCY VARIANCE: Method one: VOEV = (AH SR) (SH SR) = (10,500 hours $4.00 per hour) (10,000 hours** $4.00 per hour) = $2,000 U ** 5,000 suits 2.0 hours per suit = 10,000 hours Method two: VOEV = SR (AH SH) = $4.00 per hour (10,500 hours 10,000 hours) = $2,000 U
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
EXERCISE 10-9 Material and Labor Variances Topper Toys has developed a new toy called the Brainbuster. The company has a standard cost system to help control costs and has established the following standards for the Brainbuster toy: Material requirements, kilograms of white chocolate per dozen truffles . . . . . . 0.80 kilograms Allowance for waste, kilograms of white chocolate per dozen truffles. . . . . . . . 0.02 kilograms Allowance for rejects, kilograms of white chocolate per dozen truffles . . . . . . . 0.03 kilograms Purchase price, fi nest grade white chocolate . . . . . . . . . . . . . . . . . . . . . . . . 9.00 per kilogram Purchase discount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5% of purchase price Shipping cost from the supplier in Belgium . . . . . . . . . . . . . . . . . . . . . . . . . . 0.20 per kilogram Receiving and handling cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.05 per kilogram Direct materials: 8 diodes per toy at $0.30 per diode Direct labor: 1.2 hours per toy at $7 per hour During August, the company produced 5,000 Brainbuster toys. Production data on the toy for August follow: Direct materials: 70,000 diodes were purchased at a cost of $0.28 per diode. 20,000 of these diodes were still in inventory at the end of the month. Direct labor: 6,400 direct labor-hours were worked at a cost of $48,000. Page - 458 Chapter 10 Required: 1. Compute the following variances for August: a. Direct materials price and quantity variances. b. Direct labor rate and efficiency variances. 2. Prepare a brief explanation of the possible causes of each variance.
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
12.1 Potential Problems with the Use of Standard Costs The improper use of standard costs can present a number of potential problems. 1. Standard cost variance reports are usually prepared on a monthly basis and often are released days or even weeks after the end of the month. As a consequence, the information in the reports may be so outdated that it is almost useless. Timely, frequent reports that are approximately correct are better than infrequent reports that are very precise but out of date by the time they are released. Some companies are now reporting variances and other key operating data daily or even more frequently. 2. If managers are insensitive and use variance reports as a club, morale will suffer. Employees should receive positive reinforcement for work well done. Management by exception, by its nature, tends to focus on the negative. If variances are used as a club, subordinates may be tempted to cover up unfavorable variances or take actions that are not in the best interests of the company to make sure the variances are favorable.
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
3. Labor quantity standards and efficiency variances make two important assumptions. First, they assume that the production process is labor-paced; if labor works faster, output will go up. However, output in many companies is not determined by how fast labor works; rather, it is determined by the processing speed of machines. Second, the computations assume that labor is a variable cost. However, direct labor may be essentially fixed. If labor is fixed, then an undue emphasis on labor efficiency variances creates pressure to build excess inventories. 4. In some cases, a favorable variance can be as bad as or worse than an unfavorable variance. For example, McDonalds has a standard for the amount of hamburger meat that should be in a Big Mac. A favorable variance would mean that less meat was used than the standard specifics. The result is a substandard Big Mac and possibly a dissatisfied customer. 5. Too much emphasis on meeting the standards may overshadow other important objectives such as maintaining and improving quality, on-time delivery, and customer satisfaction. This tendency can be reduced by using supplemental performance measures that focus on these other objectives. 6. Just meeting standards may not be sufficient; continual improvement may be necessary to survive in a competitive environment. For this reason, some companies focus on the trends in the standard cost variancesaiming for continual improvement rather than just meeting the standards. In other companies, engineered standards are replaced either by a rolling average of actual costs, which is expected to decline, or by very challenging target costs. In sum, managers should exercise considerable care when using a standard cost system. It is particularly important that managers go out of their way to focus on the positive, rather than just on the negative, and to be aware of possible unintended consequences.
Nevertheless, standard costs are found in the vast majority of manufacturing companies and in many service companies, although their use is changing. For evaluating performance, standard cost variances are often complemented by a performance measurement system called the balanced scorecard.
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
13. Conclusion
In modern cost accounting, the concept of recording historical costs was taken further, by allocating the company's fixed costs over a given period of time to the items produced during that period, and recording the result as the total cost of production. This allowed the full cost of products that were not sold in the period they were produced to be recorded in inventory using a variety of complex accounting methods, which was consistent with the principles of GAAP (Generally Accepted Accounting Principles). It also essentially enabled managers to ignore the fixed costs, and look at the results of each period in relation to the "standard cost" for any given product. An important part of standard cost accounting is a variance analysis, which breaks down the variation between actual cost and standard costs into various components (volume variation, material cost variation, labor cost variation, etc.) so managers can understand why costs were different from what was planned and take appropriate action to correct the situation.
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Term-paper on: Standard Costs Prepared for: Tanzila Ahmed Course: ACT-201, Sec - 08
REFERENCES:
Managerial Accounting by Garrison, Noreen & Brewer. 12th Edition Principles of Accounting by Weygandt, Kieso & Kimmel. 9th Edition Managerial Accounting by James Jiambalvo, 2nd Edition http://en.wikipedia.org/wiki/Cost_accounting#Standard_cost_accounting www.managerialaccounting.org/
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