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INTRODUCTION
'The planned unit cost of the product, component or service produced in a period is known as standard
costing. The standard cost may be determined on a number of bases. The main use of standard costs is in
performance measurement, control, stock valuation and in the establishment of selling prices.’ CIMA Official
Terminology, 2005
Variance analysis
‘The evaluation of performance by means of variances, whose timely reporting should maximise the
opportunity for managerial action.’
CIMA Official Terminology, 2005
Overview and comparison
Standard costing is a control system that enables any variances from standard cost or budget to be analysed in
some detail. This allows for more effective cost control.A standard costing system consists of the following
four elements:
1. Setting standards for each operation.
2. Comparing actual with standard performance.
3. Analysing and reporting variances arising from the difference between actual and standard
performance.
4. Investigating significant variances and taking appropriate competitive action. Standard costing and variance
analysis application
Standard costing
This is generally best suited to organisations with repetitive activities. It is probably most relevant to
manufacturing organisations with repetitive production processes. Standard costing cannot be applied easily
to non-repetitive activities because there is no clear basis for observing and recording operations. It is difficult
to determine a clear standard.
The total fixed overhead variance is the difference between the standard fixed overhead charged to
production and the actual fixed overhead incurred. An under- or over-recovery of overheads may occur
because the fixed overhead rate is calculated by dividing budgeted fixed overheads by budgeted output. If
actual output or fixed overhead expenditure differs from budget, then an under or over recovery will occur.
Therefore under- or over-recovery may be due to a fixed overhead expenditure variance arising from actual
expenditure differing from budgeted expenditure. Alternatively, a fixed overhead volume variance may arise
from actual production differing from budgeted production.
Other variances –
sales variancesSales variances can be used to analyse the performance of the sales function in a similar way to
those for manufacturing costs. Sales variances are calculated in terms of profit or contribution margin, rather
than on sales value. Other variances – planning and operational variances.
Some variances will arise due to factors that are almost or entirely within the control of management. These
are referred to as operational variances. Variances that occur from changes in factors external to the business
are referred to as planning variances. As planning variances are not under the control of operational
management, it cannot be held accountable for them.
However, standard cost variances often do not appear as part of profit and loss information. Over half of
companies using standard costing based their reports on actual costs. Some companies added back variances,
while others updated material standards so that they approximated actual costs. Despite not appearing in the
account, most of the standard cost companies calculated some material and labour variances for control
purposes. Overhead variances were much less well used and reported, and only one company sub-divided
both variable and fixed overheads.
The conclusion from the report was that although most manufacturing
companies do use standard costing, they tend to be very selective in their use of variance analysis, especially
overhead variances. The use of fixed overheads was particularly scarce.
1.The analysis of variances facilitates action through ‘management by exception’. Here managers concentrate
on business areas that are performing below or above expectations. Managers can largely ignore those that
appear to be conforming to expectation.
2.The setting of standards and revision and monitoring encourages reappraisal of methods, materials and
techniques. This leads to cost reductions and process improvement.
3.A properly developed and understood standard costing system with full participation and involvement
creates a positive attitude towards cost control throughout the organisation.
4. Modern technology and reporting software has allowed for variance analysis to be undertaken
automatically without the need for complex manual calculations. Microsoft Excel Work Essentials is a
commonly used tool to undertake variance analysis.
Reported drawbacks
1.Standard costing principles are at odds with modern business trends such as continual improvement and
responding to individual customer needs. The ‘McDonaldisation’ of society has led to criticisms of
standardising services in order to reduce costs, but at the risk of reduced customer service and individuality.
The problem is that driving down costs is often associated with:
2. Reduced quality
3. The externalisation of costs
4. A lack of attention to the individual needs of customers
All these factors seem to contradict modern thinking about the direction in which business practice is moving
in many areas of the economy.
The two underlying principles of standard costing are that:
1. A standard set before a period is a satisfactory measure throughout the period.
2. The performance is acceptable if it meets this standard.
These principles are at odds with the spirit of JIT (Just in Time) manufacturing. JIT organisations adopt a
climate of continuous improvement and the idea of normal levels of wastage and efficiency is unacceptable
because of the drive to zerowastage and increasing efficiency. Consequently, standard costing may become
less used in modern manufacturing environments.
• Standard costing and variance reporting may be time consuming and expensive to run.
• If the standard is incorrect or outdated, any comparison with actual is also likely to be incorrect or
misleading. In modern business environments with rapidly changing conditions, standards quickly become out
of date and lose their control and motivational effects.
• Elaborate and complex variances, especially overhead variances, are often not well understood by managers
and are ineffective for control purposes.
• There are several reasons why actual results may differ from standard. The combination of the four factors
below makes standard costing and variance analysis very difficult in practice.
1. Variance may occur as a result of an error in measuring the actual outcome.
2. The standard may be out of date because of a change in operating conditions.
3. Variances might result from inefficient or efficient operations.
4. Variances can be caused by random, uncontrollable factors.
• How managers use standard costs for planning and control in the management process:
1. Planning-For budget development; product costing, pricing, and distribution –
2.Performing-For measurement of expenditures and control of costs as they occur Standard Costing
• How managers use standard costs for planning and control in the management process:
Evaluating—For variance analysis
Communicating—For variance reports
The primary difference between standard costing in a service organization and standard costing in a
manufacturing organization is that a service organization has no direct materials costs.
• In a standard costing system, costs are entered into the Materials, Work in Process, and Finished Goods
Inventory accounts and the Cost of Goods Sold account at standard cost; actual costs are recorded separately.
• The following elements are used in determining a standard cost per unit: –
- Direct materials price standard
-Direct materials quantity standard
-Direct labor rate standard
- Direct labor time standard
- Standard variable overhead rate
-Standard fixed overhead rate
• How standards are developed: – The direct materials price standard is based on a careful estimate of all
possible price increases, changes in available quantities, and new sources of supply in the next accounting
period.
The direct materials quantity standard is based on product engineering specifications, the quality of direct
materials, the age and productivity of machines, and the quality and experience of the work force. – The direct
labor rate standard is defined by labor union contracts and company personnel policies.
The direct labor time standard is based on current time and motion studies of workers and machines and
records of their past performance.
The standard variable overhead rate and standard fixed overhead rate are found by dividing total budgeted
variable and fixed overhead costs by an appropriate application base.
Standard direct materials cost is the product of the direct materials price standard and the direct materials
quantity standard.
Standard direct labor cost is the product of the direct labor rate standard and the direct labor time standard.
Standard overhead cost is the sum of the standard variable overhead rate and standard fixed overhead rate.
A product’s standard unit cost is the sum of the following: –
Standard direct materials cost
– Standard direct labor cost
– Standard overhead cost
• Variance analysis is the process of computing the differences between standard costs and actual costs and
identifying the causes of those differences.
Role of flexible budgets – A flexible budget summarizes expected costs for a range of production levels: •
Budgeted fixed and variable costs
• Budgeted variable cost per unit Variance Analysis
The flexible budget formula determines total budgeted costs for a range of levels of output.
Variance analysis has four steps:
– Compute the amount of the variance.
– Determine the cause of any significant variance.
– Identify performance measures that will track those activities, analyze the results of the tracking, and
determine what is needed to correct the problem.
– Take corrective action.
Total direct materials cost variance is the sum of the direct materials price variance and the direct materials
quantity variance.
– Direct Materials Price Variance = (Standard Price – Actual Price) × Actual Quantity
– Direct Materials Quantity Variance = Standard Price × (Standard Quantity Allowed – Actual Quantity)
Computing and Analyzing Direct Labor Variances
• Total direct labor cost variance is the sum of the direct labor rate variance and the direct labor efficiency
variance.
– Direct Labor Rate Variance = (Standard Rate – Actual Rate) × Actual Hours
Computing and Analyzing Direct Labor Variances
• Total direct labor cost variance is the sum of the direct labor rate variance and the direct labor efficiency
variance.
– Direct Labor Efficiency Variance = Standard Rate × (Standard Hours Allowed – Actual Hours)
In a standard costing system, predetermined estimates of the costs of products and services will be
established and then compared with the actual costs as they are incurred. Predetermined costs are
standard costs, which should be incurred under efficient operations (Drury, 2009). The difference
between the standard costs and the actual costs is known as a variance. Here, it is to point out that
standards costs are not the same as budgeted costs. The principal differences between them lie in their
scope. Both are concerned with laying down cost limits for controlling. However, budgeted costs impose
limits to total cost for an organisation and standard costs are attached to products and to individual
manufacturing operations (Glautier, 2011).
As indicated, standard costing systems are applied in cost centers where “the output can be measured
and the input required to produce each unit of output can be specified” (Drury, 2009, p. 277). Therefore,
standard costing is most suited to organizations such as manufacturing companies where activities
consist of a series of common or repetitive operations. It also can apply to service industries such as
transport, computing and banking (number of cheques) and to parts of the public sector (street
cleaning, refusal disposal) (Lucey, 1996). In addition, organizations that produce a wide range of
products can use a standard costing system as long as the manufacturing consists of a series of common
operations.
One of the main objectives of an organisation is to minimise the cost of production and to control the
costs as they are limited resources within a business (Gupta, 2010). Management accounting
literature provides several tools in order to achieve these objectives. In this context, the system for
collecting and reporting revenue and cost information by areas of responsibility is called responsibility
accounting (Siegel & Shim, 2006). It is based on the assumption that managers should be held
responsible for their performance. A well-designed responsibility accounting system integrates
responsibility centers within the organisation. In addition, responsibility centers are units within the
organization, which have control over costs and revenues (Siegel & Shim, 2006). There are different
types of responsibility centers such as profit centers, investment centers, revenue centers and cost
centers. In the following report, the focus is on cost centers. Here, a variance analysis based on
standard costing is a performance measure of a cost center (Siegel & Shim, 2006). In addition, a
standard costing system is a useful tool facilitating decision-making.
RESEARCH METHODOLOGY
OBJECTIVES OF STUDY
To study the cost control by establishing standard costing and variance analysis.
To provide formal basis for assessing performance and efficiency.
To aasist in setting budgets.
To study about causes of variance analysis.
SCOPE OF STUDY
Standard costing includes a advantage that it can be used for product costing,for controlling costs,and for
decision making purposes.
Standard costing are used to assign per unit costs to production to value inventory,to control overhead
spending and to measure and evaluate the use of production capacity with respect to the incurrence of fixed
overhead costs.
variance tracking is a key to project management and needs logical approach.The project managers identify
the variance thresholds and develop a plan.variance is a measurable change from a known standard or
baseline.In other words,variance is the difference between what is expected and what is actually
accomplished. variance analysis is the quantitative investigation of the difference between actual and planned
behaviour.This analysis is used to maintain control over a business.
LIMITATIONS OF STUDY
Information can be out of date or inaccurate as it is presented by using secondary data.
The data is limited only upto one company.
Administrative data,which is not originally collected for research,may not be available in the usual research
formats or may be difficult to access to.
The documents or data collected may lack authenticity.
The way things are measured may change over time,making historical comparisons difficult.
SIGNIFICANCE OF TOPIC
Variance analysis aids efficient budgeting activity as management wishes to have lower deviations
from the planned budgets. Wanting a lower deviation usually leads managers to make detailed and
forward-looking budgetary decisions.
Variance analysis acts as a control mechanism. Analysis of large deviation on key items helps the
company in knowing the causes and it helps management look into possible ways of how such
deviation can be avoided.
Variance analysis facilitates assigning responsibility and engages control mechanism on departments
where it is required. For example, if labour efficiency variance is seen to be unfavourable or
procurement of raw material cost variance is unfavourable, the management can enhance control of
these departments to increase efficiency.
Standard costing is an important subtopic of costaccounting. Standard costs are usually associated
with a manufacturing company's costs of direct material, direct labor, and manufacturing overhead. ...
If actual costs are greater than standard costs the variance is unfavorable.
In accounting, a standard costing system is a tool for planning budgets, managing and controlling
costs, and evaluating cost management performance. A standard costing system involves estimating
the required costs of a production process.
Standard Costing one of the advance technique of cost accounting . With this manager calculates the
standard cost and compare it with actual cost and after calculating variance , improvement is done in
area of production . So Standard costing is so important for every type of business organisation . We
can explain its importance under following points
Account manager fixes the standard cost of direct material , labour and overheads and pre-
determined standard cost increases the efficiency of production , every worker produce goods
according to standard cost . After this actual cost is also compare with standard cost . With this
comparison , manager will succeed to increase the efficiency of worker for reducing cost.
Proper decisions
Standard costing is also helpful for taking proper decisions for deciding cost. There are large number
of expenses and there are many alternatives of these expenses . When standard cost is decided at
that time , best alternative from different expenses is chosen and it will reduce extra cost burden
Standard costing can also use in budgetary control . We know that budgetary control is the part of
management and in controlling , it can be used . In budgetary control , not only standard cost is
calculated but after comparing relative actions of improvement are taken . With standard costing ,
effective control of cost can be possible.
LITERATURE REVIEW
2.Standard costing in Japanese firms: Reexamination of its significance in the new manufacturing environment
Findings-The paper finds that standard costing is still being used by a large number of firms both in developing
and developed countries. Overall, the research suggests that the importance of standard costing has not declined
to such a low level despite the technological changes. In Japan standard costing is still used for different
purposes despite its apparent weaknesses.
Originality/value-The paper will be useful to researchers, cost accountants and others concerned with product
costing to understand the importance of standard costing. It is also expected that the current research will help
reveal whether or not one should continue teaching standard costing in the classroom.
3.Target costing in New Zealand manufacturing firms
Findings– A total of 12 of the 31 respondents use target costing. Findings on the use of target costing
that contrast with or add to prior studies include the following: target costing is being applied to
existing products; the manufacturing department is highly involved in target costing; the involvement
of suppliers in target costing is relatively low; considerable adjustments are made to the calculated
allowable costs, especially in order to assist sales of future products and to ensure the achievement
of target costs; and higher achievement of target costs is associated with higher firm performance.
The goals of target costing and the departments involved in the practice were similar to those in prior
studies.
Research limitations/implications– The sample size and minimal number of firms actually using target
costing has made it difficult to obtain statistically significant results. The survey method prevents
follow‐up questions and clarification of ambiguities. Single measures of performance and strategy
were used.
Originality/value– This survey provides academic researchers and teachers and firms implementing or
using target costing systems with a greater understanding of how target costing is being used by New
Zealand manufacturers, as well as adding to the scant research on target costing outside Japan.
Publisher:Emerald Group Publishing Limited
Citation:, Beverley R. Lord, Yvonne P. Shanahan, (2007) "Target costing in New Zealand manufacturing
firms", Pacific Accounting Review, Vol. 19 Issue: 1, pp.68-83, https://doi.org/10.1108/01140580710754656
Author(s):
Neil Robson (Bristol Business School, University of the West of England,Bristol, UK)
Purpose– The purpose of this paper is to trace the changes in accounting practice in UK
hospitals, focussing on costing, funding and budgetary control, and to place more recent
accounting changes in their historic context.
Design/methodology/approach– The paper is largely chronological and draws from previous
research by the author and other secondary sources, both of which are supplemented by
reference to government publications, accounting practitioner journals and public records.
Findings– The paper argues that contrary to many implicit assumptions in academic accounting
studies, our accounting ancestors promoted, and sometimes used, accounting data in pursuit of
similar objectives to those advocated in the twenty‐first century. But, although cost information
“evolved”, within its historical context, the process of establishing standard costs was slow and
sometimes controversial, and the use of such information for funding hospital activity was
avoided. In addition, the history of accounting reform in UK hospitals is one littered with
disappointing results.
Originality/value– The paper provides an historical context to more recent accounting reforms in
UK hospitals and suggests that the long history of “problems” documented in the paper may
provide some cautionary counsel to contemporary accounting reformers.
4.Budgeting and standard costing practices in New Zealand and the United Kingdom
Author links open overlay panelChrisGuilding∗DawneLamminmaki∗ColinDrury†
https://doi.org/10.1016/S0020-7063(98)90013-9Get rights and content
The findings of a survey of budgeting and standard costing practices in New Zealand (NZ) and United Kingdom
(UK) manufacturers are reported. The results suggest that some commentators' predictions of a demise in
standard costing and variance analysis are overstated. It has been found that standard costing systems continue
to be popular and that the majority of accountants surveyed do not envisage abandonment of standard costing
and variance analysis in advanced manufacturing technology environments. Comparisons between budgeting
and standard costing practices used in NZ and the UK reveal a high degree of consistency. In the case of the few
differences that have been observed, it appears that there is a greater lag behind prescribed practice amongst NZ
manufacturers. The main differences noted are: a greater proportion of performance reports used in NZ budget
centers fail to distinguish between controllable and non-controllable costs; NZ manufacturers are more reliant
on historic data when setting standard costs; when distinguishing between variable and fixed costs, there is a
greater tendency in NZ to simply treat direct costs as variable and overhead costs as fixed.
5.Standard costing and budgetary control in the British iron and steel industry: A study of
accounting change.
5.The Evolution of Standard Costing in the U.K. and U.S.: From Decision Making to
Control
Thomas N. Tyson
First published: 18 December 2002
Findings
Decision making and control are two fundamental components of industrial management that are aided by
accounting information. This article traces the evolution of standard costing in the U.K. and U.S. and describes
how it has served these two purposes over time. At the start of the industrial revolution, standard costing, in the
form of past actual costs, aided managers in make‐or‐buy, pricing, outsourcing and other routine and special
decisions. In the late nineteenth century, as the mass production of homogeneous products became more
common, predetermined, norm‐based standard costs were promoted as the means to control operations and
reduce waste. The use of predetermined costs was recommended by both academic and professional branches
well into the twentieth century. Since the mid‐1980s, norm‐based standards have come under fire for not
providing appropriate strategic signals in an era of global competition, continuous improvement and perpetual
cost reduction.
This article compares the nature of standard costing practices in the British Industrial Revolution with those that
evolved in the U.S. under scientific management. The enquiry is not limited to double‐entry systems and, like
Miller and Napier (1993), the domain is broadened to include other forms of cost‐keeping practices. We utilize
primary and secondary sources to argue that the environment and rationales for standard costs have changed
fundamentally over time. It is speculated that in the future standard costing will be used far less for individual
accountability or operational control, but will return to its decision‐making roots in the form of long‐run cost
targets that benchmark the success of continuous cost‐reduction efforts.