Standard costing and variance analysis Part 1 Flashcards
Standard cost
Definition?
What is it different to and how (3)?
Definition:
- refers to predetermined costs, or target costs that should be incurred under efficient operating conditions.
Note:
- different from budgeted costs:
- A budget relates to an entire activity or operation;
- A standard presents the same information on a per unit basis;
- A budget provides the cost expectation for the total activity, a standard provides cost expectation per unit of activity.
Suitability of Standard Costing
Where is standard costing particularly effective and suitable? (4)
Repetitive Activities:
- It works well for processes that involve repeated operations, where the input required for each unit of output can be clearly defined.
Observable Activities:
- It’s applicable to activities that can be easily monitored, allowing for standards to be established and compared against actual performance.
Defined Production Requirements:
- This includes situations where requirements like materials and labor can be precisely specified and measured.
Industry Suitability:
- It is commonly used in manufacturing organizations and other sectors like certain areas of the banking industry.
Overview of standard costing system
Picture - 4 steps
Overview of Standard Costing System
What is it?
What is it about?
What are known as the standard costs?
What does it collect?
The difference…?
The causes…?
- A technique which establishes predetermined estimates of the costs of products and services and compares them with actual costs incurred.
- It is about standard costs i.e. “A standard expressed in money, built up from an assessment of the value of cost elements”.
- The predetermined costs are known as the “standard costs”.
- It collects actual costs and output data and compares the actual results with the predetermined estimates.
- The difference between the standard cost and the actual costs is known as the variance.
- The causes of the variance are investigated, the management learns and effect corrective actions.
Standard costs analysed by operations and products (example)
Purpose of standard costing system
To provide (2)
To assist?
To act?
To simplify?
To provide?
To control?
To provide?
- To provide a prediction of future costs that can be used for decision-making.
- To provide a challenging target that individuals are motivated to achieve.
- To assist in setting budgets and evaluating performance.
- To act as a control device by highlighting those activities that do not conform to plan.
- To simplify the task of tracing costs to products for inventory valuation.
- Provide a formal basis for assessing performance and efficiency + decision making.
- Control costs through established standards and the analysis of variances.
- Provide the basis for estimating e.g. quotations.
Types of standards - Basic
What is it?
Standards do not…?
They are not…?
- Basic standards – “a standard established for use over a long period from which a current standard can be developed”.
- Standard do not change from year to year but remain static and provide a base against which to measure action.
- Basic standards are not widely met in practice.
Types of standards - Ideal
What are they?
Standard set…?
Standard will not…?
- Standards which can be attained under the most favourable conditions, with no allowance for normal losses, waste, inefficiencies, delays and machine down time.
- Standard set on assumption of maximum efficiency.
- Standard will not be achieved and sustained for any significant period of time, if at all.
Types of standards - Attainable
What is it?
Difficult but…?
Allowances…?
- A standard which can be attained if a standard unit of work is carried out efficiently, a machine properly operated or material properly used.
- Difficult but not impossible to achieve.
- Allowances are made for normal losses, waste and machine downtime.
Types of standards (3/3,3,3)
Basic Standard
- Basic standards – “a standard established for use over a long period from which a current standard can be developed”.
- Standard do not change from year to year but remain static and provide a base against which to measure action.
- Basic standards are not widely met in practice.
Ideal Standard
- Standards which can be attained under the most favourable conditions, with no allowance for normal losses, waste, inefficiencies, delays and machine down time.
- Standard set on assumption of maximum efficiency.
- Standard will not be achieved and sustained for any significant period of time, if at all.
Attainable Standard
- A standard which can be attained if a standard unit of work is carried out efficiently, a machine properly operated or material properly used.
- Difficult but not impossible to achieve.
- Allowances are made for normal losses, waste and machine downtime.
Two approaches used to set standard costs
- Past historical records: used to estimate labour and material usage.
- Engineering studies: a detailed study of each operation is undertaken based on careful specifications of materials, labour and equipment and on controlled observations of operations.
Establishing cost standards
Formula
Note:
the standard costs for each operation = the quantity of input that should be used per unit of output (the quantity standard) x the amount that should be paid for each unit of input (the price standard).
Standard Setting
The standards set for each product or service will comprise the following: (4)
- Direct material = standard quantity [x] standard price per unit of the material.
- Direct labour = Standard labour hours [x] the standard hourly rate.
- Variable overhead = Standard hours (labour or machine) [x] standard rate per hour
- Fixed overhead
Standard Setting
What needs to be done?
3 things
What should be done for them?
- Identify the resources required for each output, including:
- Each type of raw material
- Each grade and skill of labour
- Each type of machine - Estimate should be made for each.
Direct material standards
What are material quantity standards?
What is the standard price determined by?
Material quantity standards:
- These represent the exact amount of materials required for each production process. This information is typically documented in a “bill of materials,” ensuring efficiency and consistency in material usage.
Standard price:
- Determined by the purchasing department, this is the cost agreed upon after thoroughly comparing and selecting the best supplier options. It ensures materials are cost-effective while maintaining quality.
Product: Luxe direct materials (picture)
Overhead standards
What are standard hours?
What is it suitable to be used?
Picture
Standard hours:
- output measure that can act as a common denominator for adding together the production of unlike items.
- Suitable to be used in a department making several different products or operations.
Benefits of Standard Costing System (5)
- Makes managers and employees more cost conscious
- Helps to pinpoint waste/problems
- Acts as a guide to areas where improvements in the area of operations can be made
- Integrates management accounting and engineering functions
- Setting of standards involves defining goals and reviewing roles in achieving the goals, e.g. workers will know the expectation with regard to output such as so many units per hour.
Criticisms of Standard costing (4)
- Over-emphasis on price and efficiency and no consideration for quality which is a major competitive factor.
- SC uses volume variance to measure the extent to which production capacity is being utilised without considering consequences of overproduction and unnecessary build up of stock.
- SC provides static standards which is at odd with the philosophy of continuous improvement.
- SC variance reporting system tend to create internal competition and arguments concerning who to take responsibility for adverse variances. This promotes internal conflicts rather than cooperation.
Update standards
What should be done to the standards?
- Standards should be continuously reviewed and, where significant changes in production methods or input prices occur, they should be changed in order to ensure that standards reflect current targets.
Variance Analysis
What is a cost variance?
What does variance analysis do?
Picture?
Variance Analysis
- A cost variance is the difference between budgeted, planned or standard cost and the actual cost incurred.
- Variance analysis seeks to offer explanation as to the sources of the variances observed. This focuses managerial attention easily to where it should.
Total Material Variance (Usage Variance)
Formula
(Sq - Aq)Sp
Where Sq = Standard quantity for actual production
Aq = Actual quantity used
Sp = Standard price per unit of material
Possible reasons for usage variance (5)
Quality of Material:
- Lower-quality materials may lead to higher waste and scrap levels, causing more material usage than anticipated.
Efficiency in Material Use:
- Poor handling or inefficient processes can result in materials being used in excess.
Staff Supervision and Training:
- Lack of proper supervision or inadequate training for workers might lead to errors or inefficiencies, increasing material usage.
Efficiency of Machinery/Production Methods:
- Inefficient or faulty machinery and outdated production techniques may cause more material to be consumed.
Pilferage:
- This refers to the small-scale theft of materials, which reduces the available stock and affects usage calculations.
Total Material Variance (Usage Variance) & Total Material Variance (Price Variance)
Formulas for both
Total Material Variance (Usage Variance)
Formula
(Sq - Aq)Sp
Where Sq = Standard quantity for actual production
Aq = Actual quantity used
Sp = Standard price per unit of material
Total Material Variance (Price Variance)
Formula
(Sp - Ap)Aq
Where Sp = Standard price per unit of material used
Ap = Actual price paid per unit of material
Aq = Total actual quantity of materials purchased
To do with favcourable price variance
Note (3)
Note:
- Favourable price variance might be due to the purchase of inferior quality materials, which may lead to inferior product quality or more wastage.
- The favourable price variance could be offset by excess usage.
- Price variance can be calculated on quantity purchased or quantity used, the former is recommended.
Total material variance
Two formulas
Total material variance = standard material cost (SC) for the actual production – actual cost (AC)
TMV= material price variance + material usage variance
Total Labour Variance (Rate Variance)
Formula?
Picture?
Total Labour Variance (Efficiency Variance)
Formula?
Total Labour Variance (Rate Variance)
Formula
(SR - AR)AH
Where:
- SR = Standard rate per hour
- AR = Actual rate per hour
- AH = Total actual hours for actual production
Total Labour Variance (Efficiency Variance)
Formula
(SH - AH)SR
Where:
- SH = Total standard hours for actual production
- AH = Total actual hours for actual production
- SR = Standard rate per labour hour
Total Labour Variance (Rate Variance)
Possible reasons for variance (5)
Pay award:
- Variances can arise from salary increases agreed upon, like those from collective bargaining or annual pay reviews.
Pay grade of labour:
- Using workers with different skill levels or grades than originally planned can lead to cost differences.
Effect of overtime:
- Overtime work often incurs higher rates, increasing labor costs.
Effect of bonus scheme:
- Performance-related bonuses or incentive programs can impact overall pay rates.
Limited controllability:
- Departmental managers generally have limited control over these factors, meaning they arise from broader organizational or external decisions.
Total Labour Variance (Efficiency Variance)
Possible reasons for variance (4)
Labour Turnover:
- Changes in the workforce can disrupt efficiency due to the time needed for new hires to adapt.
Level/Quality of Supervision:
- Poor supervision can lead to inefficiencies, while effective oversight ensures tasks are completed optimally.
Level of Training/Grade of Labour:
- A well-trained workforce performs more efficiently compared to those with less training or lower skill levels.
Work Methods/Quality of Machinery:
- Outdated or poor-quality equipment and ineffective work methods can slow down productivity.
Total labour variance
2 formulas?
- Total labour variance = standard labour cost (SC) for the actual production – actual labour cost (AC)
- TLV= labour rate variance + labour efficiency variance
Total Variable
Overhead Variance
Picture?
Variable Overhead
What may it vary with (2)
What may it include (4)
Variances may be due to (2)
Variances (2)
- May vary with direct labour or machine hours.
- May include items such as indirect labour, indirect materials, electricity, maintenance, etc.
- Variances may result due to:
- Price of items have changed from budget
- The efficiency (quantity) with which items were used being different from standard
Variances:
- Overhead expenditure variance
- Overhead Efficiency variance
Total Variable Overhead Variances (Formula)
Total variable overhead variance = standard variable overhead charged to production (SC) – actual overheads incurred (AC)
Total Variance (OV) = variable overhead expenditure variance + variable overhead efficiency variance
Variable Overhead Expenditure Variance
Formula?
Possible reasons for variance
(OAR x AH) - AVO
Where:
- OAR = Std. overhead absorption rate per hour
- AH = Actual hours worked
- AVO = Total actual variable overheads
Possible reasons for variance:
- Price of individual cost items change
- Inefficiently use individual variable overhead items
Variable Overhead Efficiency Variance (Formula)
(SH - AH)OAR
Where:
- SH = Standard hours for actual production
- AH = Actual hours worked
- OAR= Standard overhead absorption rate
Similarities between materials, labour and overhead variances
How can the 3 quantity variances be formulated?
And the price variances?
- The 3 quantity variances (i.e. material usage, labour efficiency and variable overhead efficiency variances) can be formulated as:
- (SQ – AQ) x SP
- SQ: the standard quantity of resources consumed for the actual production
- AQ: the actual quantity of resources consumed
- SP: the standard price per unit of the resource
The price variances (i.e. material price, wage rate and variable overhead expenditure variances) can be formulated as:
- (SP – AP) x AQ
- SP: the standard price per unit of a resource
- AP: the actual price per unit of resource
- AQ: the actual quantity of resources acquired/used
Fixed overheads
Total Fixed Overhead
Variance
Total Fixed Overhead
Variance
BFO - AFO
BFO = Budgeted fixed overhead
AFO = Actual fixed overhead
Note: This is the same as saying:-
(SHP x FOAR) –** Actual F/Ohd Expenditure**
SHP = Standard hour for actual production
FOAR = Fixed Overhead absorption rate
Fixed overhead expenditure variance
Formula?
Fixed ovehead volume variance
Formula?
What does volume variance seek to identify?
Under marginal costing what is it?
Under absorption costing what is it?
Fixed overhead expenditure variance
= standard fixed overhead for budgeted output level – actual fixed overhead expenditure for actual output level
Fixed overhead volume variance
= (actual production volume - budgeted production volume) * FOAR/unit
Volume variance seeks to identify the portion of total fixed overhead variance that is due to actual production being different from budgeted production.
Under marginal costing system, total fixed overhead variance is the difference between the standard fixed overhead charged to production and the actual fixed overhead incurred.
With an absorption costing system, an additional fixed overhead ‘volume variance’ is calculated. In addition, the sales margin variance must be expressed in unit profit margins instead of contribution margins.
Sales Variance
Achieving planned profit depends on what?
What does sales variance show?
What is the most significant feature of sales variance calculations?
Achieving planned profits depends on management’s ability to control sales and costs
Sales variances show the effect of sales activity on profits
The most significant feature of sales variance calculations is: variance is calculated in terms of profit or contribution margins rather than sales values
Total sales margin variance
Picture
Sales Margin Price Variance
What is done so that production variances do not distort the calculation of the sales margin variance?
Formula
Sales Margin Volume Variance
What does it measure
Formula
Total Sales Margin Variance
What does it identify?
Formula?
Sales Margin Price Variance
- In order to ensure that production variances do not distort the calculation of the sales margin price variance, the standard unit variable cost should be deducted from both the actual and the standard selling prices.
Formula:
[(Actual selling price – standard variable cost) – (Standard selling price – standard variable cost)] x Actual sales volume
The above formula can be simplified as:
(AP- SP) x AQ
AP: actual selling price
SP: standard selling price
AQ: actual sales quantity
Sales Margin Volume Variance
Measures the impact of variation between actual and budgeted sales volume on contribution margin.
Formula:
(AQ – SQ) x SM
AQ = Actual sales volume
SQ = Standard sales volume
SM = Standard contribution margin
Total Sales Margin Variance
Identifies the combined effects of variations in selling price and volume on budgeted profit/contribution.
Formula:
(ASR – SCOS) – SC
ASR: actual sales revenues (AP x AQ)
SCOS: standard variable cost of sales (SCOS/unit x AQ)
SC: budgeted contribution (SM/unit x SQ)
Can be analysed into:
Sales margin price variance
Sales margin volume variance
Causes of sales margin variances (4,2)
- Poor standards
- In-effective marketing strategies
- Product/service quality
- External factors beyond the control of management
- Response to changes in selling price of competitors
- Impact of economic recession
Difficulties in interpreting sales margin variances
What may be argued and why?
What may be preferable and why?
- It may be argued that it is not very meaningful to analyse the total sales margin variance into price and volume components, since changes in selling prices are likely to affect sales volume.
- For control and performance appraisal it may be preferable to compare actual market share with target market share for each product.
Reconciliation (Budgeted and Actual Profit)
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