07 - Standard Costing Flashcards
What are the learning outcomes of the chapter on Standard Costing?
- Explain the difference between ascertaining costs after the event and establishing standard costs in advance.
- Explain why planned standard costs, prices and volumes are useful in setting a benchmark.
- Calculate standard costs for the material, labour and variable overhead elements of the cost of a product or service.
- Calculate variances for materials, labour, variable overhead, sales prices and sales volumes.
- Prepare a statement that reconciles budgeted contribution with actual contribution.
- Prepare variance statements.
What is Standard Costing?
Definition
Standard Costing is a control technique that reports variances by comparing:
- actual cost
- to pre-set standards facilitating action through management by exception.
How does one use Standard Costs?
The pre-set standards require managers to plan in advance the amount and price of each resource that will be used in providing a service or manufacturing a product.
These resources include:
- Manpower
- Money
- Time
- Equipment
- Raw materials.
These pre-set standards, for selling prices and sales volumes as well as for costs, provide:
- a basis for planning,
- a target for achievement
- and a benchmark against which the actual costs and revenues can be compared.
The actual costs and revenues recorded after the event are then compared with the pre-set standards and the differences are recorded as variances.
What is a favourable variance and an adverse variance?
Favourable variance
If a resource price is below standard, or if sales volume or selling prices is above standard, the result will be a favourable variance.
Adverse variance
If a resource price is above standard, or if sales volume or selling prices is below standard, the result will be a favourable variance.
Why would you use standard costing and variance analysis?
Careful analysis of the variances and their presentation to management can help to direct managers’ attention to areas of the business that are performing below or above expectation.
If certain variances are large or significant, then managers can concentrate their attention on these activities where any corrective action is likely to be most worthwhile.
If other variances are small or not significant then managers can ignore these activities, knowing that they appear to be conforming to expectations.
This is the principle of management by exception that is mentioned in CIMA’s definition of standard costing.
What is a Standard Cost?
A standard cost is a carefully predetermined unit cost which is prepared for each cost unit.
It contains details of the standard amount and price of each resource that will be utilised in providing the service or manufacturing the product.
Exceptions
It can be difficult to apply standard costing in some types of service organisation, where cost units may not be standardised and they are more difficult to measure.
What is required to produce a Standard Cost Card?
In order to be able to apply standard costing, it must be possible to identify a measurable cost unit.
This can be a unit of product or service but it must be capable of standardising, for example, standardised tasks must be involved in its creation.
The cost units themselves do not necessarily have to be identical.
Example
For example, standard costing can be applied in situations such as costing plumbing jobs for customers where every cost unit is unique. However, the plumbing jobs must include standardised tasks for which a standard time and cost can be determined for monitoring purposes.
Storing
The standard cost may be stored on a standard cost card but nowadays it is more likely to be stored on a computer, perhaps in a database. Alternatively, it may be stored as part of a spreadsheet so that it can be used in the calculation of variances.
Details for the Standard Cost Card
For every variable cost
- the standard amount of resource to be used is stated,
- as well as the standard price of the resource.
This standard data provides the information for a detailed variance analysis, as long as the actual data is collected in the same level of detail.
Standard costs and standard prices provide the basic unit information which is needed for valuing budgets and for determining total expenditures and revenues.
What is a Standard?
Definition
A standard is a benchmark measurement of resource usage or revenue or profit generation, set in defined conditions.
Describe different bases that can be used for setting standards?
- Prior period
- Comparable organisations
- Organisational objectives
Prior period
A prior period level of performance by the same organisation: The use of this basis indicates that management feels that performance levels in a prior period have been acceptable. They will then use this performance level as a target and control level for the forthcoming period.
Comparable organisation
The level of performance achieved by comparable organisations: When using this basis management is being more outward-looking, perhaps attempting to monitor their organisation’s performance against ‘the best of the rest’.
Organisational objectives
The level of performance required to meet organisational objectives: This basis sets a performance level which will be sufficient to achieve the objectives which the organisation has set for itself.
What type of standards are there?
- Ideal standard
- Attainable standard
- Current standard
Describe the ideal standard.
Standards may be set at ideal levels which make no allowance for inefficiencies such as losses, waste and machine downtime.
This type of ideal standard is achievable only under the most favourable conditions and can be used if managers wish to highlight and monitor the full cost of factors such as waste etc.
However this type of standard will almost always result in adverse variances since a certain amount of waste etc. is usually unavoidable.
This can be demotivating for individuals who feel that an adverse variance suggests that they have performed badly.
Describe the attainable standard.
Standards may also be set at attainable levels which assume efficient levels of operation, but which include allowances for factors such as losses, waste and machine downtime.
This type of standard does no have the negative motivational impact that can arise with an ideal standard because it makes some allowance for unvoidable inefficiencies.
Adverse variances will reveal whether inefficiencies have exceeded this unavoidable amount.
Describe the current standard.
Standards based on current performance levels (current wastage, current inefficiencies) are known as current standards.
Their disadvantage is that they do not encourage any attempt to improve on current levels of efficiency.
What is the purpose of standard costs?
The main purpose of standard costs is to provide a yardstick or benchmark against which actual performance can be monitored.
If the comparison between actual and standard cost is to be meaningful, then the standard must be valid and relevant.
It follows that the standard cost should be kept as up-to-date as possible.
This may necessitate frequent updating of standards to ensure that they fairly represent:
- the latest methods and operations,
- and the latest prices which must be paid for the resources being used.
The standards may not be updated for every small change; however, any significant changes should be adjusted as soon as possible.
What are the sources of information for standard costs?
Predetermined hourly rates are derived for production overhead. These overhead absorption rates represent the standard hourly rates for overhead in each cost centre. They can be applied to the standard labour hours or machine hours for each cost unit.
The overheads will be analysed into their fixed and variable components so that a separate rate is available for fixed production overhead and for variable production overhead. This is necessary to achieve adequate control over the variable and fixed elements.
