Management Accounting – Standard Costing

1. Management Accounting – Standard Costing

2. Definition • CIMA, has defined standard cost as “a predetermined cost which is calculated from managements standards of efficient operations and the relevant necessary expenditure.” • They are the predetermined costs based on a technical estimate of material, labour and overhead for a selected period of time and for a prescribed set of working conditions. In other words, a standard cost is a planned cost for a unit of product or service rendered.

3. Standard costing • Is a technique of using standard costs for the purposes of cost control. It is a system of cost accounting which is designed to find out how much should be the cost of a product under the existing conditions. • The actual cost can be ascertained only when production is undertaken. The predetermined cost is compared to the actual cost and a variance between the two enables the management to take the necessary corrective measures.

4. Why use a Standard costing system • To assist in budget setting • To act as a control device by highlighting those activities that do not conform to plan. • To provide a prediction of future costs • To simplify the task of tracing costs to products for stock valuation • To provide a challenging target that individuals are motivated to achieve

5. Operation of a standard costing system • Standard costing is most suited for a business whose activities consist of a series of common repetitive operations • A standard costing system can be applied to a business which produces many different products so long as production consists of a series of common operations

6. Cost Variances • A cost variance is the difference between the standard cost of a product and its actual cost • Cost variances are calculated for each element of cost separately • Material • Labour • Overhead

7. Example of cost variances • Consider the material cost for producing 1000 units of a product • The standard cost of 1 unit is calculated as 2 kg of material at £2 per kg = £4/unit • To produce 1000 units in period 1, the process ACTUALLY uses 2200 kg with a cost of £2.30/kg • Standard cost of direct labour 2hrs@£3/hr • Actual cost of producing 1000 units was 1900 hours @ £3.20

8. Example – Materials • The total actual and standard costs can now be calculated as follows: • Standard cost (1000units x 2000kg x £2)=£4,000 • Actual cost (1000units x 2200kg x £2.3)= £5,060 • Total material variance £1,060 • We need to analyse this into two parts • The material price variance • The material usage variance

9. The Material Price Variance • This is calculated as: • Actual Price x Act Quantity (AP x AQ) • Less • Standard Price x Act Quantity (SP x AQ) • (AP) £2.30 x (AQ) 2200 kg = £5060 • Less • (SP) £2.00 x (AQ) 2200 kg = £4400 • =Material Price Variance = £660 adverse

10. The Material Usage Variance • This is calculated as: • Standard Price x Act Quantity (SP x AQ) • Less • Standard Price x Std Quantity (SP x SQ) • (SP) £2.00 x (AQ) 2200 kg = £4400 • Less • (SP) £2.00 x (SQ) 2000 kg = £4000 • =Material Usage Variance = £400adverse

11. Example – Direct Labour • The total actual and standard costs can now be calculated as follows: • Standard cost (2000 hrs x £3.00) = £6000 • Actual cost (1900 hrs x £3.40) = £6460 • Total labour variance = £460 • We need to analyse this into two parts • The labour rate variance • The labour efficiency variance

12. The Labour Rate Variance • This is calculated as: • Actual rate x Actual hours (AR x AH) • Less • Standard rate x Actual hours (SR x AH) • (AR) £3.40 x (AH) 1900 hours = £6460 • Less • (SR) £3.00 x (AH) 1900 hours = £5700 • = Labour Rate Variance = £760 adv

13. The Labour Efficiency Variance • This is calculated as: • Standard Rate x Act hours (SR x AH) • Less • Standard Rate x Std hours (SR x SH) • (SR) £3.00 x (AH) 1900 hrs = £5700 • Less • (SR) £3.00 x (SH) 2000 hrs = £6000 • = Labour Efficiency Variance = £300 fav

14. Types of cost standards • The determination of standard costs raises the problem of how demanding the standard should be. • Should they represent ideal of faultless performance or should they represent easily attainable performance? • Standard are normally classified as • Basic cost standards • Ideal standards • Currently attainable standards

15. Setting Standards • Normally, setting up standards is based on the past experience. The total standard cost includes direct materials, direct labour and overheads. • Normally, all these are fixed to some extent. The standards should be set up in a systematic way so that they are used as a tool for cost control.

16. Setting Standards for Direct Materials • There are several basic principles which ought to be appreciated in setting standards for direct materials. Generally, when you want to purchase some material what are the factors you consider. If material is used for a product, it is known as direct material. On the other hand, if the material cost cannot be assigned to the manufacturing of the product, it will be called indirect material. Therefore, it involves two things: • Quality of material • Price of the material

17. Setting Standards for Direct Labour Cost • If labour is engaged directly to produce a product, this is known as direct labour.The benefit derived from the workers can be assigned to a particular product or a process. The time required for producing a product would be ascertained and labour should be properly graded. Different grades of workers will be paid different rates of wages. The times spent by different grades of workers for manufacturing a product should also be studied for deciding upon direct labour cost. The setting of standard for direct labor will be done basically on the following: • Standard labour time for producing • Labour rate per hour

18. Setting Standards of Overheads • The very purpose of setting standard for overheads is to minimize the total cost. Standard overhead rates are computed by dividing overhead expenses by direct labour hours or units produced. The standard overhead cost is obtained by multiplying standard overhead rate by the labour hours spent or number of units produced. The determination of overhead rate involves three things: • Determination of overheads • Determination of labour hours or units manufactured • Calculating overheads rate by dividing A by B

19. Variance analysis – absorption costing • ABC Ltd produces washing powder in bulk • The standard cost per drum of washing powder is made up as follows: • Raw materials 100 kg at £2.00 per kg • Direct Labour 12 hours at £3 per hr • Fixed production overhead per month are budgeted at £90,000 based on 7500 drums produced

20. Actual costs • Raw materials (900,000 kg) £1,755,000 • Labour (110,000 hrs paid) £ 341,000 • Total £2,096,000 • Fixed production costs £ 86,000 • Total £2,182,000 • During the month 7800 drums were produced

21. Standard cost card • The standard cost card per drum: • Raw material (100 x £2) £200 • Labour (12 hours x £3) £ 36 • Fixed prodn overhead (12hrs x £1) £ 12 • Standard cost per drum £248

22. Material Variance Act Price (AP) x Act Qty (AQ) = £1,755,000 Std Price (SP) x Act Qty (AQ) =£2 x 900,000 kg = £1,800,000 Std Price (SP) x Std Qty (SQ) = £2 x 780,000 kg = £1,560,000 Price Variance £45000 F Usage Variance £240,000 A Total Total Material Variance = £195,000 Adverse

23. Labour Variance Act Rate (AR) x Act Hours (AH) = £341,000 Std Rate (SR) x Act Hours (AH) =£3 x 110,000 hrs = £330,000 Std Rate (SR) x Std Hours (SH) = £3 x 93,600 hrs = £280,800 Rate Variance £11,000 A Total Efficiency Variance £49,200 A Total Labour Variance = £60,200 Adverse