STANDARD COSTINGBy SUPRIYA SEHGAL*

STANDARD COSTING SYSTEMThe management evaluates the performance of a company by comparing it with some predetermined measuresTherefore, 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 SYSTEMSet the predetermined standards for sales margin and production costsCollect the information about the actual performanceCompare the actual performance with the standards to arrive at the varianceAnalyze the variances and ascertaining the causes of varianceTake corrective action to avoid adverse varianceAdjust the budget in order to make the standards more realistic*

FUNCTIONS OF STANDARD COSTING SYSTEMValuationAssigning the standard cost to the actual outputPlanning Use the current standards to estimate future sales volume and future costsControlling Evaluating performance by determining how efficiently the current operations are being carried out *

MotivationNotify the staff of the managements expectationsSetting of selling price*

VARIANCE*

VARIANCE ANALYSISA variance is the difference between the standards and the actual performanceWhen 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 varianceSelling and administrativeCost variance Total production Cost varianceTotal sales margin varianceSales marginPrice varianceSales margin volume varianceMaterials costvarianceLabour Cost varianceVariable Overhead varianceFixed Overhead variance

*Materials cost varianceMaterial Price varianceMaterial Usage varianceLabour cost varianceLabour rate varianceLabour Efficiency variance

*Variable Overhead varianceVO Expenditure varianceVO Efficiency varianceFixed Overhead varianceFixed Expenditure varianceFixed Volume variance

COST VARIANCE*

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 costA quantity variance reflects the extent of the profit change resulting from the change in activity level

THREE TYPES OF COST VARIANCEMaterial cost varianceLabour cost varianceVariable overheads variance*

MATERIAL AND LABOUR VARIANCE*

MATERIAL COST VARIANCEMaterial price variance= (standard price actual price)*actual quantityMaterial usage variance= (Standard quantity actual quantity)* standard price= (Standard quantity for actual production actual quantity production) * standard price*

LABOUR COST VARIANCELabour rate variance= (standard price actual price)*actual quantityLabour efficiency variance= (standard quantity actual quantity)*standard price= Standard quantity for actual production actual quantity used) * standard price

*

EXAMPLE*

*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 soldDirect materials ($3*4000)12000Direct labour ($5*3000)15000Variable overheads ($2*3000)600033000Budget contribution17000Fixed overhead3000Budget profit14000

*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 soldDirect materials ($3.2*2400)12000Direct labour ($6*3200)15000Actual Variable overheads 550032380Contribution15620Fixed overhead2600Net profit13020

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

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

OVERHEADS VARIANCE*

OVERHEADS VARIANCEVariable overheads varianceFixed overheads variance*

VARIABLE OVERHEADS VARIANCEVariable overheads variance is the difference between the standard variable overheads absorbed into the actual output and the actual overheads incurred*

*

Actual VO

Budgeted VO(SP * Actual hours workedAbsorbed VO(SP* standardhours for actualoutputVO expenditure variance/VO spending varianceVO efficiency variance

Total VO variance(under-/over- absorbed)

CALCULATION ON OVERHEAD ABSORBEDStep 1

Step 2*POAR = Budgeted overheadsBudgeted activity level in standard hoursOverhead absorbed = POAR * Standard hours for actual number of units produced

VARIABLE OVERHEADS VARIANCEVariable overheads variance= variable overheads absorbed actual variable overheads incurredVariable overheads expenditure variance= standard variable overheads for actual hours worked Actual variable overheads incurredVariable 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

*

EXAMPLE*

*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 soldDirect materials ($3*4000)12000Direct labour ($5*3000)15000Variable overheads ($2*3000)600033000Budget contribution17000Fixed overhead3000Budget profit14000

*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 soldDirect materials ($3.2*2400)12000Direct labour ($6*3200)15000Actual Variable overheads 550032380Contribution15620Fixed overhead2600Net profit13020

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

VARIABLE OVERHEADS VARIANCEVariable 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)*

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

VARIABLE OVERHEADS VARIANCEVariable overheads expenditure variance$900 FVariable overheads efficiency variance$1600 ATotal Variable overhead variance$400 A*

SALES VARIANCE*

*Actual contribution

Budgeted contribution(Standard margin * Actual Volume)Budgeted contribution(Standard margin* Standard volume)Sales margin price varianceSales margin volume varianceTotal 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 contributionSales margin price variance= (Actual contribution per unit Standard contribution per unit) * Actual sales volumeSales margin volume variance= (Actual volume Budget volume)* Standard contribution per unit

*

SALES VARIANCE (ABSORPTION COSTING)Sales margin price variance= (Actual profit margin per unit Standard profit margin per unit) * Actual sales volumeSales margin volume variance= (Actual volume Budget volume)* Standard profit margin per unit

*

EXAMPLE*

*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 soldDirect materials ($3*4000)12000Direct labour ($5*3000)15000Variable overheads ($2*3000)600033000Budget contribution17000Fixed overhead3000Budget profit14000

*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 soldDirect materials ($3.2*2400)12000Direct labour ($6*3200)15000Actual Variable overheads 550032380Contribution15620Fixed overhead2600Net profit13020

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

SALES VARIANCESales 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

SALES VARIANCE (MARGINAL COSTING)Sales margin price variance$8000 FSales margin volume variance$3400 ATotal sales variance$4600 F*

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 FSales margin volume variance= (Actual volume Budget volume)* Standard profit margin per unit= (800-1000)*$14= $3400 A

*(33000+3000)/1000 units$14000/1000 units

SALES VARIANCE (ABSORPTION COSTING)Sales margin price variance$8000 FSales margin volume variance$2800 ATotal sales variance$5200 F*

FIXED OVERHEAD VARIANCE*

*

Actual FO

Budgeted FO

Absorbed VO(SP* standardhours for actualoutputFO expenditure variance/FO spending varianceFO volume variance

Total FO variance(under-/over- absorbed)

FIXED OVERHEAD VARIANCEFixed overheads variance= Fixed overheads absorbed Actual fixed overheads incurredFixed overheads expenditure varianceBudgeted fixed overheads Budgeted overheads absorbedFixed overheads volume variance= Absorbed fixed overheads Budgeted overheads absorbed

*

EXAMPLE*

*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 soldDirect materials ($3*4000)12000Direct labour ($5*3000)15000Variable overheads ($2*3000)600033000Budget contribution17000Fixed overhead3000Budget profit14000

*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 soldDirect materials ($3.2*2400)12000Direct labour ($6*3200)15000Actual Variable overheads 550032380Contribution15620Fixed overhead2600Net profit13020

FIXED OVERHEAD VARIANCEFixed overheads variance= Fixed overheads absorbed Actual fixed overheads incurred= ($1*3*800) - $2600= $200 AFixed overheads expenditure variance= Budgeted fixed overheads Budgeted overheads absorbed= $3000 - $2600= $400 FFixed overheads volume variance= Absorbed fixed overheads Budgeted overheads absorbed= ($1*3*800) - $3000= $600 A

*

FO VARIANCE IN MARGINAL AND ABSORPTION COSTINGIn 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*

In absorption costingFixed 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*

PROFIT RECONCILIATION STATEMENT*

PROFIT RECONCILIATION STATEMENTProfit reconciliation statement is used to sum up all variancesIt can help the top management to explain the major reasons for the difference between budgeted and actual profitsThe sales margin variance and fixed overheads variance are different between absorption and marginal costing system*

REASONS FOR VARIANCESMaterial price variancePrice changes in market conditionsChange in the efficiency of purchasing dept. to obtain good terms from suppliersPurchase of different grades or wrong types of materials *

REASONS FOR VARIANCESMaterials usage varianceMore effective use of materials/ wastage arising from the efficient production processPurchase of different grade or wrong types of materialsWastage by the staffChange in production methods *

REASONS FOR VARIANCESLabour rate varianceNon-controllable market changes in the basic wage rateUse of higher/lower grade of workersUnexpected overtime allowance paid *

Labour efficiency variancePurchase of different grade or wrong types of materialsBreakdown of machineryHigh/low labour turnoverChanges in production methodIntroduction of new machineryAssignment wrong type of worker to workAdequacy of supervisionChanges in working conditionChange in motivation methods

*Reasons for variances

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

*Reasons for variances

Variable overheads efficiency varianceBoth the variable overheads and direct labour cost vary with the direct labour hours worked*Reasons for variances

Fixed overheads expenditureIt 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

*Reasons for variances

Fixed overhead volume varianceWhen the level of activity is higher than the budgeted level, there is a favourable variance*Reasons for variances

Sales margin price varianceChange in the pricing strategies of the companyResponse to the change of pricing policies of its competitorsHigher profit margin with growing demand for the productLower profit margin for simulating sales*Reasons for variances

Sales margin volume varianceChange in prices and demandChange in the market share of its competitiors*Reasons for variances