CHAPTER 15 STANDARD COSTING

Question 1

what is a standard cost

Answer 1

A standard cost is the planned unit cost of a product or service. It is an indication of what a unit of product or service should cost.
Standard costs represent ‘target’ costs and they are therefore useful for planning, control and motivation. They are also commonly used to simplify inventory valuation.

Question 2

types of cost standards

Answer 2

There are four main types of cost standards.
Basic standards.
Ideal standards.
Attainable standards.
Current standards.

Question 3

what are basic standards

Answer 3

Basic standards – these are long-term standards which remain unchanged over a period of years. Their sole use is to show trends over time for items such as material prices, labour rates, and labour efficiency. They are also used to show the effect of using different methods over time. Basic standards are the least used and the least useful type of standard.

Question 4

what are ideal standards

Answer 4

Ideal standards – these standards are based upon perfect operating conditions. Perfect operating conditions include: no wastage; no scrap; no breakdowns; no stoppages; no idle time. In search for perfect quality, companies can use ideal standards for pinpointing areas where close examination may result in large cost savings. Ideal standards may have an adverse motivational impact because they are unlikely to be achieved.

Question 5

what are attainable standards

Answer 5

Attainable standards – these standards are the most frequently encountered type of standard. They are based on efficient (but not perfect) operating conditions. These standards include allowances for the following: normal or expected material losses; fatigue; machine breakdowns. Attainable standards must be based on a high performance level so that with a certain amount of hard work they are achievable (unlike ideal standards).

Question 6

what are current standards

Answer 6

Current standards – these standards are based on current levels of efficiency in terms of allowances for breakdowns, wastage, losses and so on. The main disadvantage of using current standards is that they do not provide any incentive to improve on the current level of performance.

Question 7

what is the standard cost per unit

Answer 7

In order to prepare budgets we need to know what an individual unit of a product or service is expected to cost.
A standard cost may be based on either marginal costing or absorption costing.
Standard costs also provide an easier method of accounting since it enables simplified records to be kept.
Once estimated, standard costs are usually collected on a standard cost card.

Question 8

how are standard costs used for calculating and analysing variance

Answer 8

As well as being the basis for preparing budgets, standard costs are also used for calculating and analysing variances.
Basic variance analysis has been seen in the Budgeting chapter when comparing the flexed budget with the actual results.
The following variance analysis produces more detailed results as to the causes of the differences between what the costs and revenues should have been and what they actually were.
The variances that will be looked at are:
Sales variances
Raw material variances
Labour variances
Variable overhead variances
Fixed overhead variances.

Question 9

how are sales volume variance and fixed overhead variance calculated differently

Answer 9

Two of the variances discussed in the following sections are calculated differently depending on the costing system a business uses:
The sales volume variance will be calculated using standard contribution under marginal costing systems and using standard profit under absorption costing systems.
The fixed overhead variance under marginal costing only consists of the fixed overhead expenditure variance, whereas under absorption costing the total fixed overhead variance is split into expenditure and volume (the volume can be further split into capacity and efficiency).

Question 10

what are the causes of sales variances

Answer 10

There are two causes of sales variances
a difference in selling price
a difference in sales volume

Question 11

what is a sales volume variance

Answer 11

The sales volume variance calculates the effect on profit of the actual sales volume being different from that budgeted. The effect on profit will differ depending upon whether a marginal or absorption costing system is being used.
Under absorption costing any difference in units is valued at the standard profit per unit.
Under marginal costing any difference in units is valued at the standard contribution per unit.
Sales volume variance
(Actual quantity sold – Budget quantity sold) × Standard margin.
The Standard margin is the standard contribution per unit (marginal costing), or the standard profit per unit (absorption costing).
If the actual quantity sold is greater than the budget this will produce a favourable variance as it increases profit.

Question 12

what is the sales price variance

Answer 12

The sales price variance shows the effect on profit of selling at a different price from that expected.
Sales price variance
(Actual price – Budget price) × Actual quantity sold
If the actual price is greater than the budget this will produce a favourable variance as it increases profit.

Question 13

what are the causes of material cost variances

Answer 13

There are two causes of material cost variances
a difference in purchase price
a difference in quantity used.

Question 14

what is a materials total variance

Answer 14

The materials total variance is the difference between:
(a)the actual cost of direct material and
(b)the standard material cost of the actual production (flexed budget).
The total variance can be analysed into two sub-variances:
A materials price variance analyses whether the company paid more or less than expected for the materials purchased.
The purpose of the materials usage variance is to quantify the effect on profit of using a different quantity of raw material from that expected for the actual production achieved.

Question 15

what is material price variance and material usage variance

Answer 15

Material price variance = (actual quantity bought × actual price) – (actual quantity bought × standard price).
Material usage variance = (actual quantity used × standard price) – (standard quantity used for actual production × standard price).

the standard quantity is the amount of material that should have been used to produce the actual output.

Question 16

how is unused inventory considered in variances

Answer 16

We need to consider cases where all the material purchased is not used and inventory therefore remains at the end of the period.
The most important thing to understand is that the materials price variance is calculated based on the total of all the materials purchased in the period, whether they are used or not.
This means that any inventory carried to the next period is carried at its standard cost.
Note that the materials usage variance is based on the quantity of materials used as before.

Question 17

what are the 2 causes of labour cost variances

Answer 17

There are two causes of labour cost variances
a difference in rate paid
a difference in hours worked.

Question 18

what is the labour total variance

Answer 18

The labour total variance is the difference between:
(a)the actual cost of direct labour and
(b)the standard direct labour cost of the actual production (flexed budget).
The total variance can be analysed into two sub-variances:
A labour rate variance analyses whether the company paid more or less than expected for labour.
A labour efficiency variance analyses whether the company used more or less labour hours than expected.

• the standard hours are the number of hours that should have been worked to produce the actual output.

Question 19

what are variable overhead total variances

Answer 19

It is normally assumed that variable overheads vary with direct labour hours and the variable overhead total variance will therefore be due to one of the following:
the variable overhead cost per hour was different to that expected (an expenditure variance)
working more or less hours than expected for the actual production (an efficiency variance).

• the standard hours are the number of hours that should have been worked to produce the actual output.

if variable overheads vary with production volume rather than direct labour hours it is not possible to calculate the sub-variances of expenditure and efficiency
in such situations, only the variable overhead total variance can be calculated using the standard variable overhead cost per unit.

Question 20

what are fixed overhead variances

Answer 20

Fixed overhead variances show the effect on profit of differences between actual and expected fixed overheads.
By definition, actual and expected fixed overheads should not change when there is a change in the level of activity, consequently many of the variances calculated are based upon budgets.
However, the effect on profit depends upon whether a marginal or absorption costing system is being used.

Question 21

fixed overhead variances in a marginal costing system

Answer 21

Marginal costing does not relate fixed overheads to units. There is no under- or over-absorption and the fixed overhead incurred is the amount shown in the statement of profit or loss as a period cost.
Since fixed overhead costs are fixed, they are not expected to change when there is a change in the level of activity.
There is only one fixed overhead variance in a marginal costing system.

Question 22

fixed overhead variances in an absorption costing system

Answer 22

In absorption costing, fixed overheads are related to cost units by using absorption rates.
This means that the calculation for fixed overhead variances in an absorption costing system can relate to both a change in expenditure and a change in production levels or volume.
The fixed overhead variances in an absorption costing system are as follows: