ACC304/ACC324 COST & ACTIVITY MANAGEMENT TOPIC 6 Standard Costing & Variance Analysis

Sub-topic 6.1 Standard Costing

INTRODUCTION 1) In this chapter, we look at standard costs of products and services and the purposes of preparing standard costs. 2) The sub-topics in this chapter includes; What is standard costing? Setting standards.

WHAT IS STANDARD COSTING?

3) Standard costing is a control technique, which compares standard costs and revenues with actual results to obtain variances, which are used to stimulate improved performance. Standards are predetermined measurable quantities, set in defined conditions and expressed in monetary terms. Thus, a standard cost is a planned unit cost. 4) Standard costing is most effectively used where output or production is routine and regular. Thus, it can be easily and accurately measured. It enables a detailed comparison of individual inputs of material, labour and other production costs to be made with standard inputs. 5) The total standard cost is built up from standards for each cost elements; Standard quantities of materials at standard prices. Standard quantities of labor time at standard rates. Standard variable production overheads will usually be calculated based on standard labor times. If absorption costing is used, pre-determined fixed production overhead absorption rates will be calculated based on budgeted information. 6) Therefore, management has to estimate the following; The expected prices for material, labor & expenses. Efficiency levels in the use of material & labor. Budgeted overhead costs and budgeted volumes of activity. 7) Standard Cost Card the standard cost of each of the elements of a product is brought together and totaled here.

8) Standard costs are comprised of 2 elements which are multiplied together; Std Costs = Physical measure of the resources required X for each unit of output (allowing for NL, wastage discounts & inefficiency) Expected price to be paid for each unit of the resource (allowing for inflation level)

9) Below, shows the standard cost for a single unit of a product; Direct Materials Material Y 4 kg at 2 per kg 8 Material Z - 5 litres at 3 per litre 15 Direct Labour Grade A 4 hours at 1.50 per hour Grade B 8 hours at 3.00 per hour 6 24

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Standard Direct Costs Variable production overheads 12 hours at 1.00 per hour Standard Variable Production costs Fixed Production Overheads 12 hours at 2.00 per hour Standard Full Production costs Administration & Marketing Overheads Standard Cost of Sale Standard Profit Standard Selling Price

30 53 12 65 24 89 11 100 30 130 ===

10) Standard costs set, should be revised on a regular basis, ie at least once a year to reflect any changes made in the organization in respect of methods of operations or otherwise. 11) Uses of standard costs are for; i. ii. iii. iv. v. Stock valuations and valuation of production costs. Budget preparations Basis for pricing decisions. Budgetary control (Variance Analysis) Promote the use of Management By Exception.

12) There are 4 types of standards that an organization can set; Basic std, Ideal std, Attainable std and Current std. See below for explanation. 2

13) Types of performance standards will include; i. ii. Basic Standard a standard established for use over a long period, from which, a current standard can be developed. Ideal Standard a standard, which can be attained under the most favorable conditions (ie perfect operating conditions), with no allowance for normal losses, wastages and machine downtime. Also known as potential standards. 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. Allowances are made for normal losses, waste and machine downtime. This standard has a desirable motivational impact on employees because it represents future performance and objectives, which are reasonably attainable. Current Standard a standard established for use, over a short period of time, related to current conditions.

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14) Standard costing as a control technique i. Standard costing therefore involves the following; The establishment of predetermined estimates of the costs of products or services. ii. The collection of actual costs. The comparison of the actual costs with the predetermined estimates.

The predetermined costs are known as standard costs and the difference between standard and actual costs is known as a variance. The process by which the total difference between standard and actual results is analyzed is known as variance analysis . Standard costing is best suited in situation where there is a degree of repetition in the production process, ie suited to mass production and repetitive assembly work .

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15) Problems in setting standards includes; i. ii. iii. iv. v. vi. vii. Deciding how to incorporate inflation into planned unit costs. Agreeing on a performance standard. Deciding on the quality of materials to be used. Estimating material prices where seasonal price variations or bulk purchase discounts may be significant. Finding sufficient time to construct accurate standards as standard setting can be a time-consuming process. Incurring the cost of establishing standards. setting up and maintaining a system for

Dealing with possible behavioral problems, managers responsible for the achievement of standards possibly resisting the use of a standard costing control system for fear of being blamed for any adverse variances.

16) The advantages of standard costing are; i. ii. iii. iv. v. Carefully planned standards are an aid to more accurate budgeting . Std costs provide a yardstick against which actual costs can be measured. The setting of standards involves determining the best materials and methods, which may lead to economies . A target of efficiency is set for employees to reach and consciousness is stimulated. cost

Variances can be calculated which enable the principle of management by exception to be operated. Only the variances, which exceed acceptable tolerance-limit need to be investigated by management with a view to control action. Standard costs simplify the process of bookkeeping in cost accounting, because they are easier to use than LIFO, FIFO and weighted average costs. Standard times simplify the process of production scheduling . Standard performance levels might provide an incentive for individuals to achieve targets for themselves at work.

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QUESTION 1 BOOM Ltd makes a product called the Boomerang. A unit of Boomerang is made up of three types of materials. 8kgs of direct material A, 5 litres of direct material B and 4 meters of direct material C are needed. The cost per unit of measurement for direct material A, B and C is 2, 3 and 4 respectively. Two types of labour are involved in the production of a Boomerang, skilled and semi-skilled. Skilled labour is paid 10 per hour and semi-skilled labour is 6 per hour. Thrice as many skilled labour hours as semi-skilled labour hours are needed to produce a Boomerang, three semi-skilled labour hours being needed. Variable production overheads are incurred at BOOM Ltd at the rate of 3.00 per direct labour (skilled) hour. A system of absorption costing is in operation at BOOM Ltd. The basis of absorption is direct labour (skilled) hours. The budgeted fixed production overheads are 270,000 and the budgeted production of the Boomerang is 6,000 units. Administration, selling and distribution overheads are added to products at the rate of 13.00 per unit. A mark-up of 25% is made on the Boomerang. Required: Draw up a standard cost card for the Boomerang.