All you'll ever need to know about standard costing! This is an in-depth summary, suitable for both undergraduate and honours. It provides a detailed background on what standard costing is and how it works, and provides extensive explanations about what variances are, how to calculate them and why ...
Standard Costing and Variance Analysis
Standard Costing is a financial control system that enables deviations from budget to be analysed in detail, thus enabling
costs to be controlled more effectively. Output can be measured and the input required to produce each unit of output can
be specified and therefore standard costing is generally applied to manufacturing activities,
Standard Costs are predetermined costs; they are target costs that should be incurred per unit under efficient operating
conditions whereas Budgeted Costs relate to an entire activity or operation. A standard therefore provides cost
expectations per unit of activity and a budget provides the cost expectation for the total activity.
Actual costs are not used for decision making because they represent past costs, whereas standard costs represent future
target costs. Actual costs must only be used for comparisons with standard costs.
Standard Costing is most suited when:
1. Products are made from a series of repetitive activities
2. Inputs are known (can be specified)
3. Consistent decision-making and inventory valuation exists within the organisation
4. IAS2 allows standard costing
Can also be applied to organisations that produce many different products, as long as production consists of a series
of common operations.
Standard Costing Process:
1. Set standards (per unit = usage x price)
2. Set budgets based on standards (activity level)
3. Measure actual results
4. Calculate variances (reconcile actual result with budget)
5. Identify material variances
6. Investigate variances
7. Take corrective action
Budgeted and Actual Information:
Static Budget Budgeted Units x Standard Cost per Unit
Flexible Budget Actual Units x Standard Cost per Unit
Actual Budget Actual Units x Actual Cost per Unit
Flexing – moving to flexible budget - makes info more comparable (apples with apples)
Standards are used for:
1. Decision-making: Standard costs can be derived for either traditional or ABC costing systems. Standard costs
represent future target costs based on elimination of avoidable inefficiencies and therefore they are preferable
to estimates based on past costs which may include inefficiencies (historical records)
2. Setting budgets: Helps with setting budgets because standard costing provides reliable and convenient data and
reduces preparation time because standard costs can be readily built into total costs.
3. Performance evaluations and control device: Highlights activities which do not conform to the plan by providing
feedback which allows areas where variances have arisen to be pinpointed, and alerts management to situations
which need corrective action
4. Simplifies inventory valuation and profit measurement: If actual costs are used a considerable amount of time is
required in tracking costs so that monthly costs can be allocated between COS and inventories in monthly
internal profit statements. Standard costing ensures that product costs are maintained, conversion to actual cost
is made by writing off all variances that arise during the period as a period cost.
5. Motivation: Individuals become motivated to achieve a defined quantitative goal or target.
Establishing Standard Costs
There are 2 approaches that can be used to set standard costs:
Historical Records: standards are set based on average past performance for the same or similar operations
(danger that past inefficiencies will be included)
Engineering studies: a detailed operation is undertaken based on careful specifications of materials, labour and
equipment and on controlled observations of operations
Standard cost for each operation = quantity of input that should be used per unit of output (quantity standard) x
amount that should be paid for each unit of input (price standard)
Created by: FENIX
, Types of Cost Standards
The determination of standard costs raises the problem of how demanding the standards should be. Should they symbolize
ideal or faultless performance or should they represent easily attainable performance? Standards are classified into 3
categories:
1. Basic Cost Standards: represent constant standards that are left unchanged over long periods. Provide a basis for
comparison with actual costs through a period of years with the same standard but when changes occur in
methods of production, price levels or other factors then basic cost standards aren’t very useful because they
don’t represent current target costs.
2. Ideal Standards: represent perfect performance. These costs are the minimum costs that are possible under the
most efficient operating conditions. These standards may have an adverse effect on employee motivation
because they are nearly unattainable.
3. Currently Attainable Standards: represent the costs that should be incurred under efficient operating conditions
and they are difficult, if not impossible to achieve. Some allowance is made for normal spoilage, machine break
downs and lost time (therefore include unavoidable costs so that standards aren’t unattainable). This standard
represents costs that can be attained under efficient conditions, and therefore provides the best norm to which
actual costs should be compared.
Variance Analysis
Note that standard quantities for material, labour and variable overheads variances (i.e. production variances) are derived
from determining the quantity that should be used for the actual production for the period. If the reason for the variance
is a permanent change, then the standards should be changed.
A. Material Variances
The total material variance is the difference between what your cost should have been (std. price x std.
quantity) for your actual level of production and what your cost actually was (cost price x actual quantity). This
total variance is broken down into a price variance and a usage variance.
Variance Formula Arises as a Result Of Other Comments
If raw materials are valued @
standard cost, use actual cost
of purchases. (better for
control)
If raw materials are valued @
actual cost, use actual cost of
issues. (Actual = FIFO, WAV,
(Actual price per unit of
etc.)
material – Standard price per Purchasing department
unit of material) x number of inefficiencies, changes in
Material Price Variances *If there is an OB of raw
units actually purchased/used market conditions, wastage due
materials then this must be
to using inferior materials, etc.
included in the material price
variance too. The easiest
method is to determine what
you should have paid for the
issued material and deduct this
from the amount you actually
paid for the issued material.
(= OB + Issued – CB)
Compare the standard quantity
that should have been used to
produce the manufactured
products (don’t use budgeted
production) with the actual
quantity that has been used.
(Actual quantity used –
Careless handling of materials,
standard quantity for actual Standard price must be used
purchasing inferior quality
Material Usage/Consumption production) x standard price because if actual material price
products, changes in production
Variances per unit of material is used, the usage variance will
methods, etc.
be affected by the efficiency of
the purchasing department,
since any excess purchase price
will be assigned to the excess
usage (price effects need to be
removed).
Created by: FENIX
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