STANDARD COSTING

By SUPRIYA SEHGAL

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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

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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

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Motivation Notify the staff of the management’s expectations

Setting of selling price

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VARIANCE6

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)

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Profit variance

Selling and administrativeCost variance

Total production Cost variance

Total sales margin variance

Sales marginPrice variance

Sales margin volume variance

Materials costvariance

Labour Cost variance

Variable Overhead variance

Fixed Overhead variance

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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

COST VARIANCE11

COST VARIANCE

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•Cost variance = Price variance + Quantity varianceCost 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

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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EXAMPLE17

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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) 50000Less: Variable cost of goods sold

Direct materials ($3*4000) 12000Direct labour ($5*3000) 15000Variable overheads ($2*3000) 6000 33000

Budget contribution 17000Fixed overhead 3000Budget 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) 48000Less: Variable cost of goods sold

Direct materials ($3.2*2400) 12000Direct labour ($6*3200) 15000Actual Variable overheads 5500 32380

Contribution 15620Fixed overhead 2600Net profit 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

= (4*800 – 2400)*$3

= $2400 (F)

4000 units1000 units

MATERIAL COST VARIANCE Material price variance $480 (A)

Material usage variance $2400 (F)

Total Material cost variance $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

= $4000 (A)

3000 units1000 units

LABOUR COST VARIANCE

Labour rate variance $3200 (A)

Labour efficiency variance $4000 (A)

Total labour cost variance $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 VOBudgeted VO(SP * Actual hours worked

Absorbed VO(SP* standardhours for actualoutput

VO expenditure variance/VO spending variance

VO efficiency variance

Total VO variance(under-/over- absorbed)

CALCULATION ON OVERHEAD ABSORBED Step 1

Step 2

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POAR = Budgeted overheads

Budgeted activity level in standard hours

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

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 29

EXAMPLE30

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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) 50000Less: Variable cost of goods sold

Direct materials ($3*4000) 12000Direct labour ($5*3000) 15000Variable overheads ($2*3000) 6000 33000

Budget contribution 17000Fixed overhead 3000Budget 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) 48000Less: Variable cost of goods sold

Direct materials ($3.2*2400) 12000Direct labour ($6*3200) 15000Actual Variable overheads 5500 32380

Contribution 15620Fixed overhead 2600Net profit 13020

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POAR = Budgeted overheads

Budgeted activity level in standard hours

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

= $2 *3 hr per unit * 800 units

= $6000 3000

= $2

Standard hr per unit = 3000 hr /1000 units

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)34

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)

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Actual hour per unit = $3200 hr/800 units

VARIABLE OVERHEADS VARIANCE

Variable overheads expenditure variance $900 F

Variable overheads efficiency variance$1600 A

Total Variable overhead variance$400 A

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SALES VARIANCE37

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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

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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EXAMPLE41

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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) 50000Less: Variable cost of goods sold

Direct materials ($3*4000) 12000Direct labour ($5*3000) 15000Variable overheads ($2*3000) 6000 33000

Budget contribution 17000Fixed overhead 3000Budget 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) 48000Less: Variable cost of goods sold

Direct materials ($3.2*2400) 12000Direct labour ($6*3200) 15000Actual Variable overheads 5500 32380

Contribution 15620Fixed overhead 2600Net profit 13020

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)

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$33000/1000 units

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)

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$33000/1000 units

$17000/1000 units

SALES VARIANCE (MARGINAL COSTING) Sales margin price variance $8000 F

Sales margin volume variance $3400 A

Total sales variance $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

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

= (800-1000)*$14= $3400 A

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(33000+3000)/1000 units

$14000/1000 units

SALES VARIANCE (ABSORPTION COSTING) Sales margin price variance $8000 F

Sales margin volume variance $2800 A

Total sales variance $5200 F

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FIXED OVERHEAD VARIANCE

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Actual FO Budgeted FO

Absorbed VO(SP* standardhours for actualoutput

FO expenditure variance/FO spending variance

FO volume variance

Total FO variance(under-/over- absorbed)

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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EXAMPLE52

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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) 50000Less: Variable cost of goods sold

Direct materials ($3*4000) 12000Direct labour ($5*3000) 15000Variable overheads ($2*3000) 6000 33000

Budget contribution 17000Fixed overhead 3000Budget 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) 48000Less: Variable cost of goods sold

Direct materials ($3.2*2400) 12000Direct labour ($6*3200) 15000Actual Variable overheads 5500 32380

Contribution 15620Fixed overhead 2600Net profit 13020

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 A55

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

STATEMENT58

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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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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Reasons for variances