STANDARD COSTING

By SUPRIYA SEHGAL

STANDARD COSTING SYSTEM

The management evaluates the performance of a company by comparing it with some predetermined measures Therefore, it can be used as a process of measuring and correcting actual performance to ensure that the plans are properly set and implemented

PROCEDURES OF STANDARD COSTING SYSTEM

Set the predetermined standards for sales margin and production costs Collect the information about the actual performance

Compare the actual performance with the standards to arrive at the variance
Analyze the variances and ascertaining the causes of variance

Take corrective action to avoid adverse variance

Adjust the budget in order to make the standards more realistic
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FUNCTIONS OF STANDARD COSTING SYSTEM

Valuation
Assigning the standard cost to the actual output

Planning
Use the current standards to estimate future sales volume and future costs

Controlling
Evaluating performance by determining how efficiently the current operations are being carried out

Motivation
Notify the staff of the managements expectations

Setting of selling price

VARIANCE
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VARIANCE ANALYSIS
A variance is the difference between the standards and the actual performance When the actual results are better than the expected results, there will be a favourable variance (F) If the actual results are worse than the expected results, there will be an adverse variance (A)

Profit variance
Selling and administrative Cost variance

Total production Cost variance

Total sales margin variance

Sales margin Price variance

Sales margin volume variance

Materials cost variance

Labour Cost variance

Variable Overhead variance

Fixed Overhead variance

Materials cost variance

Material Price variance

Material Usage variance

Labour cost variance

Labour rate variance

Labour Efficiency variance

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Variable Overhead variance

VO Expenditure variance

VO Efficiency variance

Fixed Overhead variance

Fixed Expenditure variance

Fixed Volume variance

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COST VARIANCE
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COST VARIANCE
Cost variance = Price variance + Quantity variance Cost variance is the difference between the standard cost and the Actual cost Price variance = (standard price actual price)*Actual quantity A price variance reflects the extent of the profit change resulting from the change in activity level Quantity variance = (standard quantity actual quantity)* standard cost A quantity variance reflects the extent of the profit change resulting from the change in activity level 12

THREE TYPES OF COST VARIANCE

Material cost variance Labour cost variance Variable overheads variance

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MATERIAL AND LABOUR VARIANCE

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MATERIAL COST VARIANCE

Material price variance

= (standard price actual price)*actual quantity

Material usage variance

= (Standard quantity actual quantity)* standard price = (Standard quantity for actual production actual quantity production) * standard price

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LABOUR COST VARIANCE

Labour rate variance

= (standard price actual price)*actual quantity

Labour efficiency variance
= (standard quantity actual quantity)*standard price = Standard quantity for actual production actual quantity used) * standard price

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EXAMPLE
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ABC Ltd. makes and sells a single product. The company uses a Standard marginal costing system. It plans to produce and sell 1000 units in May 2005. A budget statement is produced as follow: Budgeted income statement for the month ended 31 May 2005 $ $ Sales ($50*1000) 50000 Less: Variable cost of goods sold Direct materials ($3*4000) 12000 Direct labour ($5*3000) 15000 Variable overheads ($2*3000) 6000 33000 Budget contribution 17000 Fixed overhead 3000 Budget profit 14000

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The actual sales and production is 800 units. The actual income statement is shown as follows:

Income statement for the month ended 31 May 2005 $ Sales ($60*800) Less: Variable cost of goods sold Direct materials ($3.2*2400) Direct labour ($6*3200) Actual Variable overheads Contribution Fixed overhead Net profit $ 48000

12000 15000 5500 32380 15620 2600 13020

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Material cost variance

Material price variance = (standard price actual price)*actual quantity = ($3 - $3.2)*2400 = $480 (A) Material usage variance = (Standard quantity actual quantity)* standard price = (Standard quantity for actual production actual quantity production) * standard price 4000 units = (4*800 2400)*$3 1000 units = $2400 (F) 20

MATERIAL COST VARIANCE

Material price variance Material usage variance Total Material cost variance $480 (A) $2400 (F) $1920 (F)

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Labour cost variance

Labour rate variance

= (standard price actual price)*actual quantity = ($5 - $6)*3200 = $3200 (A)

Labour efficiency variance

= (standard quantity actual quantity)*standard price = Standard quantity for actual production actual quantity used) * standard price = (3* 800 3200)*$5 22 = $4000 (A)

3000 units 1000 units

LABOUR COST VARIANCE

Labour rate variance Labour efficiency variance Total labour cost variance $3200 (A) $4000 (A) $7200 (A)

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OVERHEADS VARIANCE
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OVERHEADS VARIANCE
Variable overheads variance Fixed overheads variance

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VARIABLE OVERHEADS VARIANCE

Variable overheads variance is the difference between the standard variable overheads absorbed into the actual output and the actual overheads incurred

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Actual VO

Budgeted VO (SP * Actual hours worked

Absorbed VO (SP* standard hours for actual output

VO expenditure variance/ VO spending variance

VO efficiency variance

Total VO variance (under-/over- absorbed)

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CALCULATION ON OVERHEAD ABSORBED

Step 1

Budgeted overheads POAR = Budgeted activity level in standard hours

Step 2

Overhead absorbed = POAR * Standard hours for actual number of units produced

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VARIABLE OVERHEADS VARIANCE

Variable overheads variance
= variable overheads absorbed actual variable overheads incurred

Variable overheads expenditure variance

= standard variable overheads for actual hours worked Actual variable overheads incurred

Variable overheads efficiency variance

= Standard variable overheads for standard hours of output Actual variable overhead absorbed = (standard hours for actual output Actual hours worked)* standard price
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EXAMPLE
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ABC Ltd. makes and sells a single product. The company uses a Standard marginal costing system. It plans to produce and sell 1000 units in May 2005. A budget statement is produced as follow: Budgeted income statement for the month ended 31 May 2005 $ $ Sales ($50*1000) 50000 Less: Variable cost of goods sold Direct materials ($3*4000) 12000 Direct labour ($5*3000) 15000 Variable overheads ($2*3000) 6000 33000 Budget contribution 17000 Fixed overhead 3000 Budget profit 14000

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The actual sales and production is 800 units. The actual income statement is shown as follows:

Income statement for the month ended 31 May 2005 $ Sales ($60*800) Less: Variable cost of goods sold Direct materials ($3.2*2400) Direct labour ($6*3200) Actual Variable overheads Contribution Fixed overhead Net profit $ 48000

12000 15000 5500 32380 15620 2600 13020

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Budgeted overheads POAR = Budgeted activity level in standard hours = $6000 3000 = $2 Overhead absorbed = POAR * Standard hours for actual number of units produced = $2 *3 hr per unit * 800 units Standard hr per unit = 3000 hr /1000 units
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VARIABLE OVERHEADS VARIANCE

Variable overheads variance = variable overheads absorbed actual variable overheads incurred = $4800 - $5500 = $700 (A)

Variable overheads expenditure variance

= standard variable overheads for actual hours worked Actual variable overheads incurred = ($2* 3200 hr) - $5500 = $900 (F)
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Variable overheads efficiency variance = Standard variable overheads for standard hours of output Actual variable overhead absorbed = (standard hours for actual output Actual hours worked)* standard price = (3 hr *800 units 4 hr *800 units)*$2 = $1600 (A)

Actual hour per unit = $3200 hr/800 units

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VARIABLE OVERHEADS VARIANCE

Variable overheads expenditure variance F Variable overheads efficiency variance $1600 A Total Variable overhead variance A $400 $900

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SALES VARIANCE
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Actual contribution

Budgeted contribution (Standard margin * Actual Volume)

Budgeted contribution (Standard margin* Standard volume)

Sales margin price variance

Sales margin volume variance

Total sales margin variance

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SALES VARIANCE (MARGINAL COSTING)

Total sales margin variance
= actual contribution budgeted contribution = [(Actual selling price Standard cost of sales )*Actual sales volume] Budgeted contribution

Sales margin price variance

= (Actual contribution per unit Standard contribution per unit) * Actual sales volume

Sales margin volume variance

= (Actual volume Budget volume)* Standard contribution per unit

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SALES VARIANCE (ABSORPTION COSTING)

Sales margin price variance
= (Actual profit margin per unit Standard profit margin per unit) * Actual sales volume

Sales margin volume variance

= (Actual volume Budget volume)* Standard profit margin per unit

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EXAMPLE
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ABC Ltd. makes and sells a single product. The company uses a Standard marginal costing system. It plans to produce and sell 1000 units in May 2005. A budget statement is produced as follow: Budgeted income statement for the month ended 31 May 2005 $ $ Sales ($50*1000) 50000 Less: Variable cost of goods sold Direct materials ($3*4000) 12000 Direct labour ($5*3000) 15000 Variable overheads ($2*3000) 6000 33000 Budget contribution 17000 Fixed overhead 3000 Budget profit 14000

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The actual sales and production is 800 units. The actual income statement is shown as follows:

Income statement for the month ended 31 May 2005 $ Sales ($60*800) Less: Variable cost of goods sold Direct materials ($3.2*2400) Direct labour ($6*3200) Actual Variable overheads Contribution Fixed overhead Net profit $ 48000

12000 15000 5500 32380 15620 2600 13020

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SALES VARIANCE (MARGINAL COSTING)

Total sales margin variance
= actual contribution budgeted contribution = [(Actual selling price Standard cost of sales )*Actual sales volume] Budgeted contribution = [($60 - $33)*800] - $17000 = $21600 - $17000 = $4600 (F)

$33000/1000 units

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SALES VARIANCE
Sales margin price variance

= (Actual contribution per unit Standard contribution per unit) * Actual sales volume = [($60 - $33) ($50 - $33)]*800 = $8000 F
Sales margin volume variance
= (Actual volume Budget volume)* Standard contribution per unit = (800 -1000)*$17 = $2800 (A)

$33000/1000 units

$17000/1000 units

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SALES VARIANCE (MARGINAL COSTING)

Sales margin price variance Sales margin volume variance Total sales variance $8000 F $3400 A $4600 F

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SALES VARIANCE (ABSORPTION COSTING)

Sales margin price variance
= (Actual profit margin per unit Standard profit margin per unit) * Actual sales volume

= [($60-$36) ($50-$36)]*800
= $8000 F

(33000+3000)/1000 units

Sales margin volume variance

= (Actual volume Budget volume)* Standard profit margin per unit = (800-1000)*$14 $14000/1000 units = $3400 A
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SALES VARIANCE (ABSORPTION COSTING)

Sales margin price variance Sales margin volume variance Total sales variance $8000 F $2800 A $5200 F

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FIXED OVERHEAD VARIANCE

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Actual FO

Budgeted FO

Absorbed VO (SP* standard hours for actual output

FO expenditure variance/ FO spending variance

FO volume variance

Total FO variance (under-/over- absorbed)

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FIXED OVERHEAD VARIANCE

Fixed overheads variance = Fixed overheads absorbed Actual fixed overheads incurred

Fixed overheads expenditure variance

Budgeted fixed overheads Budgeted overheads absorbed

Fixed overheads volume variance

= Absorbed fixed overheads Budgeted overheads absorbed
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EXAMPLE
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ABC Ltd. makes and sells a single product. The company uses a Standard marginal costing system. It plans to produce and sell 1000 units in May 2005. A budget statement is produced as follow: Budgeted income statement for the month ended 31 May 2005 $ $ Sales ($50*1000) 50000 Less: Variable cost of goods sold Direct materials ($3*4000) 12000 Direct labour ($5*3000) 15000 Variable overheads ($2*3000) 6000 33000 Budget contribution 17000 Fixed overhead 3000 Budget profit 14000

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The actual sales and production is 800 units. The actual income statement is shown as follows:

Income statement for the month ended 31 May 2005 $ Sales ($60*800) Less: Variable cost of goods sold Direct materials ($3.2*2400) Direct labour ($6*3200) Actual Variable overheads Contribution Fixed overhead Net profit $ 48000

12000 15000 5500 32380 15620 2600 13020

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FIXED OVERHEAD VARIANCE

Fixed overheads variance = Fixed overheads absorbed Actual fixed overheads incurred = ($1*3*800) - $2600 = $200 A Fixed overheads expenditure variance = Budgeted fixed overheads Budgeted overheads absorbed = $3000 - $2600 = $400 F Fixed overheads volume variance = Absorbed fixed overheads Budgeted overheads absorbed = ($1*3*800) - $3000 = $600 A
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FO VARIANCE IN MARGINAL AND ABSORPTION COSTING

In marginal costing:
Fixed overheads are charged as period costs instead of charging to product in marginal costing. It is assumed that the fixed overheads remain unchanged with the change in the level of activity. Single fixed overhead expenditure variance will be used

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In absorption costing
Fixed overheads are charged to the products and included in the valuation of closing stock. Total fixed overheads variance is divided into fixed overheads price variance and fixed overheads volume variance

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PROFIT RECONCILIATION STATEMENT

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PROFIT RECONCILIATION STATEMENT

Profit reconciliation statement is used to sum up all variances It can help the top management to explain the major reasons for the difference between budgeted and actual profits The sales margin variance and fixed overheads variance are different between absorption and marginal costing system

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REASONS FOR VARIANCES

Material price variance
Price changes in market conditions Change in the efficiency of purchasing dept. to obtain good terms from suppliers Purchase of different grades or wrong types of materials

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REASONS FOR VARIANCES

Materials usage variance
More effective use of materials/ wastage arising from the efficient production process Purchase of different grade or wrong types of materials Wastage by the staff Change in production methods

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REASONS FOR VARIANCES

Labour rate variance
Non-controllable market changes in the basic wage rate Use of higher/lower grade of workers Unexpected overtime allowance paid

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Reasons for variances

Labour efficiency variance
Purchase of different grade or wrong types of materials Breakdown of machinery High/low labour turnover Changes in production method Introduction of new machinery Assignment wrong type of worker to work Adequacy of supervision Changes in working condition Change in motivation methods

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Reasons for variances

Variable overheads expenditure variance
It may be caused by the non-controllable change in the price level of indirect wages or utility rates since the predetermined rate is set It is meaningless to interpret this kind of variance on its own. One should look various components of the fixed overheads

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Reasons for variances

Variable overheads efficiency variance
Both the variable overheads and direct labour cost vary with the direct labour hours worked

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Reasons for variances

Fixed overheads expenditure
It is meaningless to interpret this kind of variance on its own. It may be caused by the change in the price levels of rent, rates and other fixed expenses

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Reasons for variances

Fixed overhead volume variance
When the level of activity is higher than the budgeted level, there is a favourable variance

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Reasons for variances

Sales margin price variance
Change in the pricing strategies of the company Response to the change of pricing policies of its competitors Higher profit margin with growing demand for the product Lower profit margin for simulating sales

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Reasons for variances

Sales margin volume variance
Change in prices and demand Change in the market share of its competitiors

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