Management Accounting & Decisions II N12401

Lecture 2

Standard Costing: Review

by Hung Woan-Ting

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Lecture Objectives

1. To revisit the purposes and functioning of

standard costing & variance analysis

2. To understand the usefulness and criticisms of standard costing and variance analysis

3. To be familiar with the basic variance analysis skills and understand the underlying reasons

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1.0 Key Concepts Revisited

Standard costs, Standards and Budgets

Standard Costing System

Effective cost control Prices & Quantity

Planning (static) Budget

Flexible Budget

Static Budget

Flexible Budget

Actual Results

Client-visits 1,000 1,100 1,100

Revenue $180K $198K $194K

Expenses $163K $168K $173K

Net Profit $17K $30K $21K

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1.1 Concepts in Action (#1)

How was the performance of the Hungs business?

Hungs manicure salon has the following financial data for the year ended 30/9/2014:

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1.1 Concepts in Action (#2)

Gymboree - U.S. based childrens clothing maker, customer centric, reported earnings expected to top market expectations.

Improved same-store sales

In line with fashion trends resonate with customers

Creating value-centric propositions (strong product assortment; carefully-timed promotional events; coupon scheme)

In Q2, 2009 G's same-store sales declined by 1% while rival Children's Place dropped by 7%

Better cost and inventory control

done well in controlling inventory, managing their cost structure and cash flow

cost-controls likely to be the greatest positive variance

Source: Reuters.com, August 2009

Further info: Bain pays $1.8b in 2010 for kids clothing firm Gymboree; Gymboree Corporation Q1 2014 Financial Results

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1.2 Standard Costing in Context

CHANGING BUSINESS ENVIRONMENT

ORGANISATION (VALUE & STRATEGY)

PERFORMANCE MANAGEMENT

MANAGEMENT ACCOUNTING

STANDARD COSTING &

VARIANCE ANALYSIS

Primary purposes

Management control (planning; controlling)

Performance measurement (feedback; motivate; evaluation; manage)

Communication (coordinate; organise)

As good as the users

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1.2 Standard Costing in Context

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Functioning of Standard Costing System

1.2 Standard Costing in Context

Responsibility centre

(standard costs vs. actual costs)

Differences analysed

(cost control; accountability)

Investigation and actions (typically MBE

approach)

On-going monitoring (performance

gaps; standards level)

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2.0 Some Evidence in Practice

Survey in UK by Drury et al (1993):

76% organisations operated a SCS

Of these, 72% reported above average or of vital importance for cost control & performance evaluation

Widespread use of standard costing in Ireland (Pierce & ODea, 1998), Singapore (Ghosh, et al, 1996)

In Malaysian, 70% of local firms and 76% of Japanese firms surveyed are using standard costing (Sulaiman, et al, 2005)

Australian companies: standard costing more useful for product costing, budgeting, inventory valuation, management control. Japanese companies: standard costing for cost control at production stage (Wijewardena & Zoysa, 1999)

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2.1 Some Criticisms (be mindful!)

Developed in the last century usefulness in todays business environment?

Delay in feedback reporting

Changing cost structure

Over-emphasizes importance of direct labour

Inconsistency with modern management approaches

Encourages conflicts, not cooperation

Some researchers predicting demise(!)

But WHY the overwhelming evidence of

practice adoption??

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3.0 Basic Variance Analysis (Costs)

VARIABLE COSTS

ANALYSIS

DIRECT MATERIAL

COST

DIRECT LABOUR COST

VARIABLE OH

FIXED COSTS

ANALYSIS

FIXED OH

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Example

Each unit of Product X is suppose to use 9g of direct material costing $4/g.

In March, 100 units of X were made, consuming 825g of material costing $5/g.

Find the variances and the possible causes for

1. Material price variance

2. Material usage variance

3. Total material cost variance

3.1 Direct material cost variances

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3.2 Direct labour cost variances

Example

Each unit of Product Y has a standard time of 9 hours per unit at a standard rate of $4/hour.

In April, 100 units of Y were made, consuming 1000 hours of labour hours costing $5/hour.

Find the variances and the possible causes for

1. Labour rate variance

2. Labour efficiency variance

3. Total labour cost variance

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3.3 Variable MOH variances

Example

The company planned to make 120 units of Z in May and spend $5400 on variable MOH. The companys policy is to absorb the overhead using the direct labour hour basis.

Each unit of Product Z has a standard labour time of 9 hours per unit at a standard labour rate of $4/hour.

In May, 100 units of Z were made, consuming 1000 hours of labour hours. The variable MOH amounted to $5200.

Find the variances and the possible causes for

1. Variable MOH expenditure variance

2. Variable MOH efficiency variance

3. Total variable MOH variance

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GNBCY Ch11, Ch12

D Ch17

Cheatham & Cheatham (1996) Re-designing Cost Systems: Is Standard Costing Obsolete?, Accounting Horizons, Dec, Vol 10(4): 23-31

Johnsen & Sopariwala (2000) Standard Costing is Alive and Well at Parker Brass, Management Accounting Quarterly, Winter, Vol 1(2): 1-9.

KPMG (2010) Standard costing: Insights from leading companies, in association with CIMA.

1. Re-visiting the materials used in MAD1 at this stage would definitely be useful!

End of Lecture

Readings

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Seminar 1 preparation

Attempt the Questions Set (at the back of this handout)

Indicative solutions in Moodle.

Please refer before attending seminar.

Exe.