Standard costing - new

Fundamentals of Responsibility Accounting and Standard Costing

  • Responsibility Accounting System:

    • Accumulates cost data for each individual responsibility centre.

    • Ensures that deviations from the budget for various items of expense can be assigned directly to the individual person in charge of that centre.

  • Standard Costing Overview:

    • Enables detailed analysis of deviations from the budget.

    • Facilitates effective cost control and provides a solid foundation for managerial planning.

    • Definition: Standard costing is a managerial control technique involving the establishment of predetermined target costs and prices, which are subsequently compared against actual operating results to determine variances. These variances serve to stimulate improved planning and operational performance.

    • Definition of Standard Cost: A predetermined target cost that ought to be incurred under efficient operating conditions.

  • Distinction Between Standard Cost and Budget Cost:

    • Budget: Relates to an entire activity, department, or overall operation, establishing overall aggregate cost expectations.

    • Standard: Presents cost expectations expressed strictly on a per-unit basis of activity or output.

    • Detailed Control: Establishing standard costs for each individual unit produced permits a granular analysis of differences between budgeted and actual performance, enabling precise cost control.

  • Setting Standard Costs:

    • A product standard cost is calculated by identifying, quantifying, and summing the standard costs of all required resource categories.

    • The core cost categories evaluated include:

      • Direct Materials

      • Direct Labour

      • Production Overheads

Standard Cost Setting Methods and Purposes

  • Methods of Establishing Standards:

    1. Historic Records: Uses past performance data of actual costs to project required future costs. Requires careful adjustment to historical figures to identify and eliminate past inefficiencies.

    2. Engineering Studies: Uses rigorous scientific and technical measurements to carefully establish exact standard specifications for direct materials, direct labour hours, and all other resources required per cost unit.

  • Behavioral Requirement in Standard Setting:

    • Like standard budget preparation, establishing standard costs requires the direct involvement of managers and operational personnel whose performance will be evaluated against those standards.

    • Participation fosters acceptance, ownership, and personal commitment to meeting the established standard targets.

  • Primary Purposes of Standard Costing:

    • Facilitating Management Planning: Directly assists in formulating operational plans and building master budgets.

    • Performance Evaluation: Provides a standard benchmark or yardstick to measure managerial and departmental performance.

    • Promoting Economy: Encourages cost consciousness among workers and operational leaders, reducing waste.

    • Control Mechanism: Employs management by exception by highlighting operational activities that do not conform to plan, thereby alerting managers to out-of-control operational areas requiring corrective action.

    • Cost Prediction for Decision Making: Generates accurate predictions of future unit costs necessary for strategic decisions such as product pricing.

    • Motivation: Serves as a challenging, attainable target that motivates individual employees to achieve higher efficiency.

Fundamentals of Variance Analysis

  • Definition of Variance:

    • The numerical difference between the predetermined standard cost and the actual cost incurred for actual output produced.

  • Variance Classification:

    • Favourable Variance (F\text{F}): Occurs when actual cost incurred is less than the predetermined standard cost (or actual revenue is higher than standard revenue).

    • Unfavourable / Adverse Variance (A\text{A}): Occurs when actual cost incurred exceeds the predetermined standard cost (or actual revenue falls below standard revenue).

  • Operational Objective of Variance Analysis:

    • It is insufficient merely to report numerical variance figures; management must trace the exact origin and root causes of variances to implement targeted remedial actions to eliminate or reduce operational inefficiencies.

Direct Material Variances: Formulas and Concepts

  • Reasons Actual Direct Material Cost Differs from Standard Material Cost:

    • The actual unit price paid for materials differs from the planned standard price per unit of material.

    • The actual physical quantity of materials consumed in production differs from the predetermined standard quantity allowed for the actual output.

  • Material Variance Formulas:

    • Material Price Variance (MPV\text{MPV}):         MPV=(Standard Price per Unit−Actual Price per Unit)×Actual Quantity Purchased\text{MPV} = (\text{Standard Price per Unit} - \text{Actual Price per Unit}) \times \text{Actual Quantity Purchased}         MPV=(SP−AP)×QP\text{MPV} = (\text{SP} - \text{AP}) \times \text{QP}

    • Material Usage Variance (MUV\text{MUV}):         MUV=(Standard Quantity for Actual Production−Actual Quantity Used)×Standard Price per Unit\text{MUV} = (\text{Standard Quantity for Actual Production} - \text{Actual Quantity Used}) \times \text{Standard Price per Unit}         MUV=(SQap−AQ)×SP\text{MUV} = (\text{SQ}_{\text{ap}} - \text{AQ}) \times \text{SP}

    • Total Material Variance (TMV\text{TMV}):         TMV=Standard Material Cost for Actual Production−Actual Material Cost Incurred\text{TMV} = \text{Standard Material Cost for Actual Production} - \text{Actual Material Cost Incurred}         TMV=SCap−AC\text{TMV} = \text{SC}_{\text{ap}} - \text{AC}

Direct Material Variance Calculations and Examples

  • Illustration: K plc

    • Standard Data:

      • Planned production: 9 000 units9\,000\text{ units} of product X2 per month.

      • Standard material per unit of X2: 4.5 kilos4.5\text{ kilos} at $2\$2 per kilo = $9.00\$9.00 per unit.

    • Actual Operating Data:

      • Actual production achieved: 8 000 units8\,000\text{ units} of X2.

      • Material purchased and used during the month: 40 000 kilos40\,000\text{ kilos} at $2.05\$2.05 per kilo, costing a total of $82 000\$82\,000.

    • Required Calculations:

      • a. Total Material Variance

      • b. Material Price Variance

      • c. Material Usage Variance

      • d. Reconciliation of standard material cost for actual production to actual cost.

  • Practice Question 1 (Product BS1):

    • Standard Data:

      • Standard direct material cost per unit: 2 kg2\text{ kg} at $0.50\$0.50 per kg = $1.00\$1.00

      • Budgeted monthly production: 20 000 units20\,000\text{ units}

    • Actual Operating Data:

      • Actual production achieved: 18 000 units18\,000\text{ units}

      • Material purchased and

Illustration: K plc
Standard Data:

  • Planned production: 9,000 units9,000\text{ units} of product X2 per month.

  • Standard material per unit of X2: 4.5 kilos4.5\text{ kilos} at $2\text{\$}2 per kilo = $9.00\text{\$}9.00 per unit.

Actual Operating Data:

  • Actual production achieved: 8,000 units8,000\text{ units} of X2.

  • Material purchased and used during the month: 40,000 kilos40,000\text{ kilos} at $2.05\text{\$}2.05 per kilo, costing a total of $82,000\text{\$}82,000.

Required Calculations:
a. Total Material Variance:
TMV=Standard Material Cost for Actual Production−Actual Material Cost Incurred\text{TMV} = \text{Standard Material Cost for Actual Production} - \text{Actual Material Cost Incurred}

  • Standard Material Cost for Actual Production:

  • Standard Material Cost=Standard material per unit×Actual production=9.00×8,000=$72,000\text{Standard Material Cost} = \text{Standard material per unit} \times \text{Actual production} = 9.00 \times 8,000 = \text{\$}72,000

  • Actual Material Cost Incurred:

  • Actual Material Cost=$82,000\text{Actual Material Cost} = \text{\$}82,000

  • Thus, Total Material Variance:

  • \text{TMV} = \text{\}72,000 - \text{\}82,000 = -\text{\$}10,000

    b. Material Price Variance (MPV):
    MPV=(Standard Price per Unit−Actual Price per Unit)×Actual Quantity Purchased\text{MPV} = (\text{Standard Price per Unit} - \text{Actual Price per Unit}) \times \text{Actual Quantity Purchased}

  • MPV:

  • MPV=(Standard Price per Unit−Actual Price per Unit)×40,000\text{MPV} = (\text{Standard Price per Unit} - \text{Actual Price per Unit}) \times 40,000

  • \text{MPV} = (\text{\}2 - \text{\}2.05) \times 40,000 = -\text{\$}2,000

    c. Material Usage Variance (MUV):
    MUV=(Standard Quantity for Actual Production−Actual Quantity Used)×Standard Price per Unit\text{MUV} = (\text{Standard Quantity for Actual Production} - \text{Actual Quantity Used}) \times \text{Standard Price per Unit}

  • Standard Quantity for Actual Production:

  • Standard Quantity=4.5×8,000=36,000\text{Standard Quantity} = 4.5 \times 8,000 = 36,000 kilos

  • Actual Quantity Used:

  • \text{MUV} = (36,000 - 40,000) \times \text{\}2 = -\text{\}8,000

    d. Reconciliation of Standard Material Cost for Actual Production to Actual Cost:

  • Starting with:

  • Standard Cost for Actual Production: $72,000\text{\$}72,000

  • Add MPV: −$2,000-\text{\$}2,000

  • Add MUV: −$8,000-\text{\$}8,000

  • Resulting in:

  • \text{\}72,000 - \text{\}2,000 - \text{\}8,000 = \text{\}62,000

  • This indicates the total costs incurred were $82,000\text{\$}82,000, confirming that all variances align with the actual cost incurred and the standard cost expectations.