Standard Costing: A Managerial Control Tool

Standard Costing: A Managerial Control ToolPamela Gonzalez LirianoSource: Conerstones of Managerial Accounting, 5th editionBudgets set standards that are used to control and evaluate managerial performanceTo determine the unit standard cost for a particular input, two decisions must be made:The quantity decision: The amount of input that should be used per unit of output

The pricing decision: The amount that should be paid for the quantity of the input to be usedQuantity StandardsPrice StandardsStandard cost per unit = Quantity standard x Price standardSources for Quantity Standards, Historical ExperienceEngineering StudiesInput from Operating Personnel

WHY STANDARD COST SYSTEMS ARE ADOPTEDTo improve planning and controlComparing actual costs with budgeted costs identifies variances.Overall variances can be further broken down into a price variance or a usage or efficiency variance if unit price or quantity standards have been developed. To facilitate product costingCosts are assigned to products using quantity and price standards for all three manufacturing costs: direct materials, direct labor, and overhead.Standard costing and variance analysis for controlling cost and evaluating performance can have strong ethical implications.Advantages of Standard product costingStandard Cost SheetThe standard cost sheet provides the production data needed to calculate the standard unit cost. It also shows the quantity of each input that should be used to produce one unit of output.

Variance analysisActual cost = AP x AQPlanned cost = SP x SQThe total budget variance is the difference between the actual cost of the input and its planned cost

Because responsibility for deviations from planned prices tends to be located in the purchasing or personnel department and responsibility for deviations from planned usage of inputs tends to be located in the production department, it is important to separate the total variance into price and usage (quantity) variances.Price variance = (AP - SP) x AQUsage variance = (AQ - SQ) x SP

Unfavorable (U) variances occur whenever actual prices or actual usage of inputs are greater than standard prices or standard usage. When the opposite occurs, favorable (F) variances are obtained. control limits

The materials price variance is computed by using the actual quantity of materials purchased, and the materials usage variance is computed by using the actual quantity of materials used

Measures what should have been paid for raw materials and what was actually paidMeasures the direct materials actually used and the direct materials that should have been usedUsing the variance information to exercise control is fundamental to a standard cost system. The responsibility for controlling the materials price variance usually belongs to the purchasing agent.Pressure to produce favorable variances may result in the purchase of materials of lower quality than desired or excessive inventory purchases in order to get quantity discounts.Analysis of Materials Price VarianceThe first step in variance analysis is to decide whether the variance is significant. what is its cause?Once the reason is known, corrective action can be taken if necessaryand if possible.The responsibility for controlling the materials usage usually belongs to the production manager.Pressure to produce favorable variances may allow defective units to be transferred to finished goods and ultimately cause customer relations problems.If variance is significant, investigation is needed to find out the causes for the deviation.The importance of evaluating current business conditions and updating standards to reflect any changes in these conditions cannot be overlooked. Typically, materials variances are added to cost of goods sold if unfavorable and are subtracted from cost of goods sold if favorable.

The total labor variance measures the difference between the actual costs of labor and their budgeted costs for the actual level of activity.

The labor rate and labor efficiency variances always will add up to the total labor variance.Total labor variance = Labor rate variance + Labor efficiency varianceLRV = (AR - SR) x AHThe labor rate variance (LRV) computes the difference between what was paid to direct laborers and what should have been paid,The labor efficiency variance (LEV) measures the difference between the labor hours that were actually used and the labor hours that should have been usedLEV = (AH - SH) x SR Calculating labor variances initiates the feedback process.Responsibility must be assigned, variance significance must be assessed, and the variances must be accounted for and disposed of at the end of the year.

In addition to standard costing, some companies choose to employ other cost management practices, such as kaizen costing and target costing.Kaizen costing focuses on the continuous reduction of the manufacturing costs of existing products and processes.Target costing focuses on the reduction of the design costs of existing and future products and processes.Target cost per unit = Expected sales price per unit - Desired profit per unitAccounting for VariancesThe accounts containing the variances between applied standard costs and actual costs are closed, which allows the amount of actual costs to ultimately impact the final cost of goods sold number that appears in the financial statements.

In recording variances, unfavorable variances always are debits, and favorable variances always are credits.Exercises10-3310-3510-3610-4310-4510-4610-47