Standard costing

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Standard costing

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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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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)

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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

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Cost variance

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Cost variance

•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

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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 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) 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$ $


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 price variance


= ($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

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

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= ($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

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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)

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Calculation on overhead absorbed

Step 1

Step 2

POAR = Budgeted overheads

Budgeted activity level in standard hours

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

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= 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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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

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

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

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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

(33000+3000)/1000 units

$14000/1000 units

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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)

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Fixed overheads variance= Fixed overheads absorbed – Actual fixed overheads incurred

Fixed overheads expenditure varianceBudgeted fixed overheads – Budgeted overheads absorbed

Fixed overheads volume variance= Absorbed fixed overheads – Budgeted overheads absorbed

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Example

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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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Marginal costing

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Profit Reconciliation Statement$ $ $

Budgeted profit 14000Sales variances

Sales margin price 8000 FSales margin volume 3400 A 4600 F

Materials cost varianceMaterials price 480 AMaterial usage 2400 F 1920 F

Labour cost varianceLabour rate 3200 ALabour efficiency 4000 A 7200 A

Variable overhead varianceVO Expenditure 900 FVO Efficiency 1600 A 700 A

Fixed overhead expenditure variance 400F 980 AActual profit 13020

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Absorption costing

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Profit Reconciliation StatementBudgeted profit 14000Sales variances

Sales margin price 8000 FSales margin volume 2800 A 5200 F

Materials cost varianceMaterials price 480 AMaterial usage 2400 F 1920 F

Labour cost varianceLabour rate 3200 ALabour efficiency 4000 A 7200 A

Variable overhead varianceVO Expenditure 900 FVO Efficiency 1600 A 700 A

Fixed overhead varianceFO expenditure 400FFO Volume 600 A 200 A 980 AActual profit 13020

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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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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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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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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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Variable overheads efficiency variance– Both the variable overheads and direct labour cost

vary with the direct labour hours worked


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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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Fixed overhead volume variance– When the level of activity is higher than the

budgeted level, there is a favourable variance


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


Documents

Standard costing