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STANDARD COSTINGBy:Sourabh AggarwalHanish KumarArjun NandaObjectiveTo establish controlTo set standards for various elements of costTo fix responsibility

Definition:Standard costingis the process of creating and using estimatedcosts for production activities, usually under the assumption of normal operating conditions. Since standard costs do not necessarily match actual costs incurred, the costaccountantmust calculatevariancesbetween actual and standard costs, and charge the variances to thecost of good sold.StandardThe word standard means a benchmark or yardstick. Standard costis the amount the firm thinks a product or the operation of the process for a period of time should cost, based upon certain assumed conditions of efficiency, economic conditions and other factors.

STEPS IN STANDARD COSTINGStandard costing involves:The setting of standardsAscertaining actual resultsComparing standards and actual costs to determine the variancesInvestigating the variances and causes for the sameTaking appropriate action where necessary

PRELIMINARIES IN ESTABLISHING A SYSTEM OF STANDARD COSTSThe establishment of cost centers with clearly defined areas of responsibility.The type of standard to be operated.The setting of standard costs for each element of cost.

Establishment of cost centers:A cost center is a department or part of a department or an item of equipment or machinery or a person or a group of persons in respect of which costs are accumulated, and one where control can be exercised.

Types of standards:Current Standards: A current standard is a standard which is established for use over a short period of time and is related to current condition. The period for current standard is normally one year. Ideal Standards: This is the standard which represents a high level of efficiency. Ideal standard is fixed on the assumption that favorable conditions will prevail and management will be at its best.Basic Standards: A basic standard may be defined as a standard which is established for use for an indefinite period which may a long period. These standards are revised only on the changes in specification of material and technology productions Normal Standards: As per terminology, normal standard has been defined as a standard which, it is anticipated, can be attained over a future period of time.

Setting Standards:Normally, setting up standards is based on the past experience and standardcommittee which includes general manager, purchase officer, productionengg., production manager, sales manager, cost accountants etc.

There are three main parts of Standard costing:

a) Direct Material(Quality of material, Price of the material, Cost of materials, Ordering cost, Carrying cost)

b) Direct Labour(Standard labor time for producing, Labor rate per hour, Skilled labor, Semi-skilled labor, Unskilled labor)

c)Overhead Expenses(Determination of overheads, Determination of labor hours or units manufactured)

VARIANCE ANALYSISVariance is the difference between a budgeted or standard amount and the actual amount during a given period

Unfavorable VarianceThe variance is said to be either negative () or Adverse (A) or Unfavorable (Unf) if it indicates a loss.

Favorable VarianceThe variance is said to be either Positive (+/Pos) or Favorable (F) if it indicates a gain position or beneficial position in relation to costs/hr.

Direct material variance Total material variance is divided into 2 categoriesMaterial price variance. Direct materials price variance is the difference between the actual purchaseprice and standard purchase price of materials. Formula Materials purchase price variance = (Actualquantitypurchased Actual price) (Actual quantity purchased Standard price)

2) Material usage variance.Direct materials quantity variance or Direct materials usage variance measures thedifference between the quantity of materials used in production and the quantitythat should have been used according to the standard that has been set.FormulaMaterials price usage variance = (Actual quantity used Standard price) (Standard quantity allowed Standard price)

Problem:The Schlosser Lawn Furniture Company uses 12 meters of aluminum pipe at $0.80 per meter as standard for the production of its Type A lawn chair. During one month's operations, 100,000 meters of the pipe were purchased at $0.78 a meter, and 7,200 chairs were produced using 87,300 meters of pipe. The materials price variance is recognized when materials are purchased.

Required:Materials price andquantityvariances.

Solution:Meters of pipeUnit CostAmountActual quantity purchased100,000$0.78 actual$78,000actual quantity purchased100,000$0.80 standard$80,000---------------------------------Materialspurchase pricevariance100,000$(0.02)$(2,000) fav.=====================Actual quantity used87,3000.80 standard$69,840Standard quantity allowed86,4000.80 standard$69120---------------------------------------Materials quantity variance9000.80$720 Unfav=====================

Direct material usage variance is further divided into twocategories.Mix variance: It is that portion of material usage variance which due to thedifference between standard and actual composition of a mixture.Formula:(Standard costing of standard mix) x {actual mix/ standard mix} - standard cost of actual cost Yield variance:It is that portion of material usage variance which due to thedifference between standard yield specified and actual yieldobtained.

Formula :Standard rate ( actual yield - standard yield)Standard rate = standard cost of standard mix Standard yield

Possible causes for price varianceInefficient buying or failure to make timely purchasesIncrease in market price Emergency purchases Bulk purchases Change in transport cost Non-availability of standard qualityLoss of cash discountChange in the method of material collection

Problem: From the data given below, calculate mix and yield variance:

Standard yield = 90% of the inputActual yield = 92% of the input

Raw materialStandardActualA40 units @ rs. 50 per unit50 units @ rs. 50 per unitB60 units @ rs. 40 per unit60 units @ rs. 45 per unitSolution:

Material mix variance:=(40*50+60*40)*100/110 (50*50+40*60)= rs 60 (unf.)

Material yield variance:= (4400)/90 * (92-90) =97.77

Possible causes for quantity variancePoor quality of materialCarelessness in the use of materialInefficient production methodDefective machineryUnskilled employeesWrong specificationChange in mixExperimental productionPilferage

Direct labour varianceTotal labour variance is divided into 2 categories1)Price variance This variance measures any deviation from standard in the average hourly rate paid todirect laborworkers Formula Direct Labor Rate/Price Variance=(Actual hours worked Actual rate) (Actual hours worked Standard rate)

2)Efficiency variance The quantity variance for direct labor is generally called direct labor efficiency variance or direct labor usage variance. Formula Direct Labor Efficiency / Usage / Quantity Variance= (Actual hours worked Standard rate) (Standard hours allowed Standard rate)

Problem :Labor Variance Analysis:The processing of a product requires a standard of 0.8 direct labor hours per unit for Operation 4-802 at a standard wage rate of $6.75 per hour. The 2,000 units actually required 1,580 direct labor hours at a cost of $6.90 per hour.

Required:labor rate variance or Labor price variance.Labor efficiency or usage or quantity variance.

Solution:TimeRateAmountActual hours worked1,580$6.90 actual$10,902Actual hours worked1.580$6.75 standard10,665------------------------Labor rate variance1,580$0.15$237 unfav.===============Actual hours worked1,580$6.75 standard$10,665Standard hours allowed1,600$6.75 standard$10,800---------------------------------Labor efficiency variance(20)6.75 standard$(135) fav.==================Direct labour usage variance is further divided into two categories.1) Mix variance. Formula: (Standard costing of standard mix x actual mix)/standard mix - Standard cost of actual mix 2) yield variance Formula: Standard rate ( actual yield - standard yield) Standard rate = standard cost of standard mix Standard yield

Problem: From the data given below, calculate mix and yield variance:

Standard yield = 90% of the inputActual yield = 92% of the input

Raw materialStandardActual A40 hr @ rs. 50 per hr50 hr @ rs. 50 per hrB60 hr @ rs. 40 per hr60 hr @ rs. 45 per hrSolution:

Material mix variance:=(40*50+60*40)*100/110 (50*50+40*60)= rs 60 (unf.)

Material yield variance:= (4400)/90 * (92-90) =97.77

Possible causes of rate varianceRevision in wagesOvertime for urgent completion of jobChange in gang composition or wrong grade of labourExecutive overtime, special increment/high labour awardsSpecial rates for experimental production

Possible causes of efficiency varianceInefficient/Untrained workersMachinery breakdownPoor quality of materialInefficient supervisionHours lost in waiting, delay in routing material, tools, instructions and improper production schedulingPoor working conditionsChange in design, quality standard of product

OVERHEAD VARIANCEOverhead cost variance can be defined as the difference between the standard cost of overhead allowed for actual output achieved and actual overhead cost incurred. In other words, overhead cost variance is under or over absorption of overheads.

Overhead cost variance can be classified as:1) Variable overhead variance2) Fixed overhead variance

Variable overhead varianceIt is the difference between the standard variable overhead cost allowed for actual output achieved and actual variable overhead cost.Variable overhead variance is divided into two parts:1) Variable overhead expenditure variance Variable overhead expenditure variance= (Actual hours worked x Standard variable overhead rate per hour) (Actual variable overhead)

2) Variable overhead efficiency variance Variable overhead efficiency variance= Standard variable overhead rate per hour(standard hours for actual production actual hours)

Fixed overhead varianceIt is that portion of total overhead cost variance which is due to the difference between the standard cost of fixed overhead allowed for actual output achieved and the actual fixed overhead cost incurred. Formula: Fixed Overhead Variance = (Actual output x Standard fixed overhead rate per unit) (Actual fixed overheads) This variance is analyzed as under: 1) Budget or expenditure variance It is that portion of fixed overhead variance which is due to difference between budgeted fixed overheads and the actual fixed overheads incurred. Formula: Budget or expenditure variance = budgeted fixed overheads - actual fixed overheads incurred

2)Volume VarianceIt is that portion of fixed overhead variance which is due to differencebetween the standard cost of fixed overhead allowed for actual outputand budgeted fixed overheads for the period during which the actualoutput has been achieved.

Formula: Volume Variance = standard rate (actual output budgeted output)Volume variance is divided into three variances:1) Capacity variance It is that portion which is due to working at higher or lower capacity than budgeted capacity. It is related to under and over utilization of plant and equipment. Formula Capacity variance = standard rate (revised budgeted units budgeted units)

Possible causes for capacity varianceSlackening of sales, lack of ordersLock out/strikesPower failureSeasonal cuts in productionMachine breakdowns.

2) Calendar variance It is that portion which is due to the difference between the number of working days in the budget period and the number of actual working days in the period to which the budget is applicable. Formula Calendar variance = inc/dec in production due to more or less working days at the rate of budgeted capacity x standard rate per unit

Possible causes for calendar variance Difference between the budgeted and actual days

3) Efficiency variance It is that portion which is due to the difference between thebudgeted efficiency and actual efficiency achieved. This is relatedto efficiency of workers in plant.

Formula: Efficiency variance = standard rate per hour (standard hoursproduced actual hours)

Analysis of overhead variance can also be made by two variance, three variance and four variance method:1) Two variance The analysis of overhead variances by expenditure and volume is called two variance analysis.

2) Three variance Change in output occurs due to Change in capacity i.e., capacity varianceChange in number of working days giving rise to calendar varianceChange in level of efficiency resulting into efficiency variance

3) Four variance analysis includes:

Expenditure varianceVariable overhead efficiency varianceFixed overhead capacity variance Fixed overhead efficiency variance

Problem:From the following data, calculate overhead varianceBudgeted ActualOutput15,000 units16,000 unitsNo. of working days2527Fixed OverheadsRs. 30,000Rs. 30,500Variable overheadsRs. 45,000Rs. 47,000

Solution:i) Total Overhead Cost Variance:Standard rate = standard overheads / standard output : Fixed: Rs.30, 000/ 15,000 = Rs. 2 : Variable: Rs.45, 000/ 15,000 = Rs. 3TOCV = Actual units x standard rate Actual overheads cost= 16, 000(2+3)-(30, 500+47, 000)= 2, 500(fav.)

ii) Variable Overhead Expenditure Variance:VOEV = Actual units x standard rate Actual variable overheads cost= 16, 000 x 3 47, 000= 1, 000 (fav.)

iii) Fixed Overhead Variance:FOV = Actual units x standard rate Actual fixed overheads = 16, 000 x 2 30, 500= 1, 500 (fav.)

iv) Volume Variance:VV = Actual units x standard rate budgeted fixed overheads = 16, 000 x 2 30, 000= 2, 000 (fav.)

v) Expenditure variance:EV = budgeted fixed overheads - Actual fixed overheads= 30, 000 30, 500= 500 (unfav.)

vi) Capacity variance:CV = standard rate (revised budgeted units budgeted units)Budgeted units for 25 days = 15, 000 unitsBudgeted units for 27 days = 16, 200 unitsRevised budgeted units after 5% increase in capacity = 105*16200/100 = 17, 010CV = 2(17010 16200)=1620 (fav.)

vii) Calendar variance:CV = = inc/dec in production due to more or less working days at the rate ofbudgeted capacity x standard rate per unitWithin 25 days, standard production = 15, 000 unitsWithin 2 days(27-25), production will be increase by = 1,200 unitsCV = 1200 x 2= 2,400(fav.)

viii) Efficiency variance:EV= standard rate per hour (standard hours produced actual hours)Standard production

EV = 2 (16, 000 17, 010)=2,020 (unfav.)

Budgeted production 15, 000 unitsProduction increased due to increase in capacity810 unitsProduction increased due to 2 more working days 1, 200 unitsSales variance:The analysis of variances will be completed only when the actual profit andstandard profit is fully analyzed.

Sales variance is of two types:Sales margin variance methodTotal sales variance = (budgeted quantity x standard margin)- (actual quantity xactual margin)It is of two typesSales margin price variance= (SM AM) AQSales margin volume variance= (BQ-AQ) SMSMVV is divided to mix and quantity varianceSMMV = Standard margin on revised budgeted sales mix- standard margin on actual sales mixSMQV = Standard margin on revised budgeted sales mix- standard margin on budgeted sales mix

2) Sales value variance = actual value of sales- budgeted value of sales

Problem: From the following particulars calculate profit sales variance andsales value variance.

ProductStandardActualUnitsCost per unitPrice per unitUnitsCost per unitPrice per unitX30001012320010.513Y2000151816001417Solution:Total sales margin variance= actual profit budgeted profit =12800 12000 = 800 (F)Sales margin variance due to selling price = actual qty. of sales (actual sale price per unit budgeted sales price per cent) X = 3200 (13 - 12) = 3200 (F) Y = 1600 (17 - 18) = 1600 (A) therefore, 1600 (F)Sales margin variance due to volume = standard profit per unit ( actual quantity of sales budgeted quantity of sales) X = 2 (3200 3000) = 400 (F) Y = 3 (1600 - 2000) = 1200 (A) therefore, 800 (A)

Sales margin variance due to sales mix = standard profit per unit (actual qty. of sales standard promotion for actual sales) X = 2 (3200 2880) = 640 (F) Y = 3 (1600 - 1920) = 960 (A) therefore, 320 (A)Sales margin variance due to sales quantity = standard profit per unit (standard proportion for actual sales budgeted quantity of sales) X = 2 (2880 - 3000) = 240 (A) Y = 3 (1920 - 2000) = 240 (A) therefore, 480 (A)Sales value variance = actual value of sales budgeted value of sales = 68800 72000 = 3200 (A)

Advantages / Benefits of Standard Costing System:The use of standard costs is a key element in amanagement by exceptionapproach. If costs remain within the standards, Managers can focus on other issues. When costs fall significantly outside the standards, managers are alerted that there may be problems requiring attention. This approach helps managers focus on important issues.Standards that are viewed as reasonable by employees can promote economy and efficiency. They provide benchmarks that individuals can use to judge their own performance.Standard costs can greatly simplify bookkeeping. Instead of recording actual costs for each job, the standard costs for materials, labor, and overhead can be charged to jobs.Standard costs fit naturally in an integrated system of responsibility accounting. The standards establish what costs should be, who should be responsible for them, and what actual costs are under control.

Disadvantages / Problems / Limitations of Standard Costing System:Standard cost variance reports are usually prepared on a monthly basis and often are released days or even weeks after the end of the month. As a consequence, the information in the reports may be so stale that it is almost useless. If managers are insensitive and use variance reports as a club, morale may suffer. Employees should receive positive reinforcement for work well done. Management by exception, by its nature, tends to focus on the negative. If variances are used as a club, subordinates may be tempted to cover up unfavorable variances or take actions that are not in the best interest of the company to make sure the variances are favorable.Labor quantity standards and efficiency variances make two important assumptions. First, they assume that the production process is labor-paced; if labor works faster, output will go up. However, output in many companies is no longer determined by how fast labor works. Second, the computations assume that labor is a variable cost. However, direct labor may be essentially fixed, then an undue emphasis on labor efficiency variances creates pressure to build excesswork in processandfinished goodsinventories.

In some cases, a "favorable" variance can be as bad or worse than an "unfavorable" variance. For example, McDonald's has a standard for the amount of hamburger meat that should be in a Big Mac. A "favorable" variance would mean that less meat was used than standard specifies. The result is a substandard Big Mac and possibly a dissatisfied customer.

There may be a tendency with standard cost reporting systems to emphasize meeting the standardsto the exclusion of other important objectives such as maintaining and improving quality, on-time delivery, and customer satisfaction. This tendency can be reduced by using supplemental performance measures that focus on these other objectives.

Just meeting standards may not be sufficient; continual improvement may be necessary to survive in the current competitive environment. For this reason, some companies focus on the trends in the standard cost variances - aiming for continual improvement rather than just meeting the standards. In other companies, engineered standards are being replaced either by a rolling average of actual costs, which is expected to decline, or by very challenging target costs

Difference between Budgetary Control and Standard CostingBudgetary Control Standard CostingBudgetary control is concerned with the operation of business as a Whole.Standard costing is related with the control of cost mainly. Hence, budgetary control is broader than standard costing.Budgets are prepared based on past actual data adjusted to future trends.Standard costs are fixed based on technical assessment.Budgets set up maximum limits of expenses, which the actual expenditure should not normally exceed.Standards are minimum targets which are to be attained by actual performance at specific efficiency level.Budget is a projection of financial accounts.Standard cost is the projection of cost accounts.Budgets can be adopted without standard costing.Standard costing cannot exist without budgeting.Difference between Budgetary Control and Standard CostingStandard costingHistorical costingIt is predetermined cost.It is recorded after production.It is an ideal cost.It is an actual or incurred cost.It is a future cost; it is used for cost control.It is related to past, cannot be used for cost control.It is used for the measurement of operational efficiency of the enterprises. It is used to ascertain the profit or loss incurred during a particular period.

Difference between Standard Costing and estimated cost:Standard costEstimated costIt is scientifically used & it is a regular system based upon estimation or survey.It is used as statistical data and based on lot of guess work.Its object is to ascertain, what the cost should be?Its object is to ascertain, what the cost will be?It is used for effective cost control & proper action to maximize. Its purpose is planning & ascertainment of cost for fixing sale price.It is continuous process of costing & takes into account all the manufacturing process.It is used for specific use i.e. fixing sale price.It is used where standard costing is in operation.It is used where standard costing is not in operation.It is more accurate than estimated cost.It is not as accurate as it is based on past experience.

Reason for difference between actual performance and standard performanceMeasurement errorsOutdated standardsOut of control operations1) Measurement Errors The recorded amount for actual cost or actual uses may differ from actual incurred amount. For e.g. Labour hours for a particular operations may be incorrectly added up or indirect labour cost may be incorrectly classified as direct labour cost.2) Outdated standards Standards become outdated because of change in production conditions like where frequently changes in prices of input occurred, there is danger that standard price may be outdated. Standards can also become outdated where operations are subject to frequent technological changes.3) Out of control operations Variances may result from inefficient operation due to a failure to follow prescribed procedure, faulty machinery or faulty human force.

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