Performance

Management

2012/13

STANDARD COSTING
What is a standard cost? A standard cost is a pre-estimated cost per unit. What are the uses of standard costing? Valuation of inventories. Control purposes. (Example: Variance Analysis)

STANDARD COST CARD A standard cost card show full details of the standard costs of each product. PROFORMA
Direct material Direct labor Direct expenses Standard direct cost Add: Variable prod OH Add: Fixed prod OH Std. full prod cost Add: V. admin OH Add: F. admin OH Std. full cost of sale Add: Std. profit Std. selling price

$
X X X X X X X X X X X X

Standard profit may be calculated using marginal or absorption costing.

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Performance Management STANDARD COSTING AS A CONTROL TECHNIQUE

2012/13

Standard costing is a technique which compares standard costs and revenues with actual results to obtain variances. Comparing actual results with the standard helps the organization exercise control. These variances are then used to improve performance. Differences between actual results and standards are known as variances. Variances can either be favorable or adverse. When actual results are better than expected it is a favorable variance or viceversa. Remember, unlike master budgets, standards are always based on the actual activity level. This makes the comparison like with like. Variances can be divided into two main groups. Cost Variances Sales Variances

COST VARIANCES
MATERIAL VARIANCES Total material variance: Actual material cost Standard material cost Material price variance: Actual qty purchased/consumed (A. price/kg Std. price/kg) Material usage variance: Std. price/kg (Actual qty consumed Std. qty allowed) o Std Quantity allowed: Std qty/unit LABOUR VARIANCES Total labor Variance: Actual labor cost Standard labor cost Labor rate variance: Actual hrs paid (Actual rate/hr std rate/hr) Labor efficiency variance: std rate/hr (Actual hours worked Std hours allowed) o Std hours allowed: Std hours/unit VARIABLE OH VARIANCES Total V.OH variance: Actual V.OH Standard V.OH V.OH expenditure variance: Actual V.OH Budgeted allowed at actual hours V.OH efficiency variance: Std V.OH rate/hr (Actual hrs worked std hrs allowed) o Std hours allowed: Std hours/unit Actual activity level Actual activity level Actual activity level

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Performance Management FIXED OH VARIANCES

2012/13

Total F.OH variance: Actual F.OH Absorbed F.OH. F.OH expenditure variance: Actual F.OH Budgeted F.OH F.OH volume variance: Std F.OH absorption rate/unit (budgeted units actual units) F.OH efficiency variance: Std F.OH absorption rate/hr (actual hrs std hrs allowed) F.OH capacity variance: Std F.OH absorption rate/hr (actual hrs budgeted hrs allowed) o Std hours allowed: Std hours/unit Actual activity level

SALES VARIANCES Sales price variance: Actual units sold (Actual S.P Std S.P) Sales volume profit variance: Std profit/unit (actual sales budgeted sales) Sales volume contribution variance: Std contribution/unit (actual sales budgeted sales)

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Performance Management

2012/13

Commenting on Variances
Organizations tend to investigate the most likely reasons of the variances. The possible reasons behind favorable or adverse variances should be stated within the answer with mere conclusions as to whether results were good or bad. Remember, drawing conclusions is a subjective activity. For example, an adverse material price variance could possibly arise due to poor negotiations with the supplier. Therefore, it may be concluded that management was not up to the mark. However, a student may go on to write that, management may have decided to buy good quality expensive material in order to ensure premium quality finished goods. Thus management performance seems good. Both styles of above written answers are correct. However it is very important to justify what you write! Whether to investigate variances or not? All variances may not be worthy of investigation. For example, there is no point of carrying out an investigation if the underlying factors are uncontrollable or the investigation is too costly. Thus, following factors shall be considered before investigation is carried out; Materiality: Only material (large) variances should be investigated. Controllability: Managers shall only be held accountable for controllable factors. Cost-benefit analysis: The cost of investigation should not exceed the benefits achieved. Interdependence between variances.

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Performance Management

2012/13

TYPES OF STANDARDS AND THEIR BEHAVIOURAL IMPLICATIONS

There are four types of standards: Ideal standards Attainable standards Current standards Basic standards

ATTAINABLE STANDARDS These are set according to practically possible scenarios. That is, some margin for inefficiency is incorporated. Such standards highly motivate employees since they can be achieved. BASIC STANDARDS These are standards that are fixed for a long period of time. They are used to show trends over long period of time. Such standards produce negative impacts on employee motivation. CURRENT STANDARDS What is currently being achieved is set as standard. Now since the standard does not require employees to put in more effort it has no impact on employee motivation. IDEAL STANDARDS These standards are set according to the perfectly possible scenario. It does not incorporate any margins for inefficiency, idle time, wastage, abnormal losses etc. Since the standards set are unlikely to be achieved, they have negative impact on employee motivation. Employees will often feel that the goals are unachievable and would not work hard. Such standards may be used in airline industry where no margins for error are bearable.

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