Costing

[pROJECT REPORT ON COSTIng][Type the abstract of the document here. The abstract is typically a short summary of the contents of the document. Type the abstract of the document here. The abstract is typically a short summary of the contents of the document.]

2012

UPKAR POLYMERS

NEERAJ JAIN

UNIVERSITY OF PUNE

PROJECT REPORT ON

COST ACCOUNTING IN MANUFACTURING INDUSTRYSTANDARD COSTING & VARIANCES

Bansilal Ramnath Agarwal Charitable Trust’s

Vishwakarma Institute Technology

PUNE – 411 037

UNDER THE GUIDANCE OF

PROF SHRIRAM M SANE

SUBMITTED BY

NEERAJ PC JAIN D-22BE INDUSTRIAL ENGINEERING

GR NO. 071154

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BANSILAL RAMNATH AGARWAL CHARITABLE TRUST`S

VISHWAKARMA INSTITUTE OF TECHNOLOGY (An Autonomous Institute Affiliated to University of Pune) PUNE-411037

CERTIFICATE

This is to certify that the PROJECT REPORT titled “Cost Accounting in manufacturing industry Standard Costing & Variances.”, submitted by Mr. Neeraj Jain GR No:- 071154

is record of bonafide work carried out by him, under the guidance of Mr. Shriram M Sane for

the partial fulfillment of the requirement for the award of the Degree of Bachelor of

Industrial/Production Engineering of University of Pune.

Prof. Shriram M Sane Prof. R. J. Dhake

(Guide) (Head of Department)

Examiner :

Place: Pune

Date:

3

TO WHOMSOEVER IT MAY CONCERN

This is to certify that Mr. Neeraj Jain, student of Bachelor in Engineering from Vishwakarma

Institute Of Technolgy ,has been pursuing his bachelor degree project under my guidance. As

a part of partial fulfillment of Bachelor Degree in Industrial Engineering, he has been doing the

project on topic “ Introduction to Cost Accounting Standard Cost & Variation” since August

2011. His behavior and preceedings throughout the project were found to be satisfactory.

I wish him all the best for his future endeavors.

Saurabh Jain

Managing Director

Upkar Polymers

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ABSTRACT

In recent years, numerous tools such as activity-based costing, the balanced scorecard

and target costing have gained prominence in the business community. Nonetheless,

traditional management accounting continues to be prevalent in practice. One example

is standard costing, which has been used on a wide front during the last century.

The purpose of this study is to examine the use and the relevance of the standard

costing system used at the manufacturing company UPKAR POLYMERS and to

provide recommendations on how the system can be improved.

In sum, the study shows that the standard costing system is widely used and that it is

perceived as relevant. However, some areas for improvement of the standard costing

system were identified, for example the communication within the organization and the

use of the guidelines regarding allocation bases.

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ACKNOWLEDGEMENT

I would like to express my gratitude to all those who have helped and inspired me

during my final year project.

I would like to take this opportunity to pay my profound gratefulness and express

my sincere gratitude to my guide, Prof. S.M. SANE for the valuable guidance in

preparation of this final year degree project report.

I am also thankful to Mr. SAURABH JAIN from Upkar Polymers for his guidance

and insights as regard to costing, who helped in my project.

NEERAJ JAIN

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CONTENTS

1. INTRODUCTION

1.1 Objective of study ……………………………………………….1

1.2 Scope of study……………………………………………………1

1.3 Outline of dissertation……………………………………………2

2. COMPANY PROFILE- UPKAR POLYMERS

2.1 Company profile………………………………………………….3

2.2 Process Of Manufacturing………………………………………

2.3 Plant Layout……………………………………………………..

2.4 Areas covered during study………………………………………6

3. THEORY AND LITERATURE SURVEY

3.1 Meaning Cost Accounting ……………….………………………7

3.2 Elements Of Cost ……………...……..………………………….11

3.3 Classification Of Cost…..……………………………………….19

3.4 Installation of costing System……………………………………27

4. METHODOLOGY

4.1 Standard Costing………….…………………………………….31

4.2 Meaning ,Advantages & Limitation …………………………....32

4.3 Process Of Standard Costing & Variances……………………..33

5. RESULTS

5.1 BPDS……………………………………………………………39

6. SUGGESTIONS FOR IMPROVEMENTS

6.1 suggestions for improvement at workplace…………………….54

6.2 Responsibility assignment- OISR sheet………………………..69

7. CASE STUDY

7.1 Standard Costing At Global Communication Ltd…..………….71

7.2 Company profile APIPL………………………………………..72

8. IMPLEMENTATION RESULTS/ SUGGESTIONS FOR

………………………………………………………………76

9. CONCLUSION…………………………………………………….84

REFERENCES…………………………………………………….

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INTRODUCTION

Accounting is the collection and aggregation of information for decision makers – including

managers, investors, regulators, lenders, and the public. Accounting systems affect behavior

and management and have affects across departments, organizations, and even countries.

Information contained within an accounting system has the power to influence actions.

Standard costing is a management tool for control. In the process, we have taken standards

as parameters for measuring the performance. Cost analysis and cost control is essential for

any activity. Cost includes material labor and overheads. Sometimes, we need to revise the

standards due to change in uses, raw material, technology, method of production etc. For a

proper organization, it is required to implement this under a committee for the activity. It is a

continued activity for the optimum utilization of resources. Even standards are also subjected

to change like the production method, environment, raw material, and technology.

Standards may need to be changed to accommodate changes in the organization or its

environment. When there is a sudden change in economic circumstances, technology or

production methods, the standard cost will no longer be accurate. Standards that are out of

date will not act as effective feed forward or feedback control tools. They will not help us to

predict the inputs required nor help us to evaluate the efficiency of a particular department. If

standards are continually not being achieved and large deviations or variances from the

standard are reported, they should be carefully reviewed. Also, changes in the physical

productive capacity of the organization or in material prices and wage rates may indicate that

standards need to be revised. In practice, changing standards frequently is an expensive

operation and can cause confusion. For this reason, standard cost revisions are usually made

only once a year. At times of rapid price inflation, many managers have felt that the high level

of inflation forced them to change price and wage rate standards continually. This, however,

leads to reduction in value of the standard as a yardstick. At the other extreme is the adoption

of basic standard which will remain unchanged for many years. They provide a constant base

for comparison, but this is hardly satisfactory when there is technological change in working

procedures and conditions.

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Meaning of Cost Accounting

Previously, cost accounting was merely considered to be a technique for the ascertainment of

costs of products or services on the basis of historical data. In course of time, due to

competitive nature of the market, it was realized that ascertaining of cost is not so important

as controlling costs. Hence, cost accounting started to be considered more as a technique for

cost control as compared to cost ascertainment. Due to the technological developments in all

fields, cost reduction has also come within the ambit of cost accounting. Cost accounting is,

thus, concerned with recording, classifying and summarizing costs for determination of costs

of products or services, planning, controlling and reducing such costs and furnishing of

information to management for decision making.

According to Charles T. Horngren, cost accounting is a quantitative method that accumulates,

classifies, summarizes and interprets information for the following three major purposes:

Operational planning and control

Special decisions

Product decisions

According to the Chartered Institute of Management Accountants, cost accounting is the

process of accounting for costs from the point at which its expenditure is incurred or

committed to the establishment of the ultimate relationship with cost units. In its widest sense,

it embraces the preparation of statistical data, the application of cost control methods and the

ascertainment of the profitability of the activities carried out or planned.

Cost accounting, thus, provides various information to management for all sorts of decisions.

It serves multiple purposes on account of which it is generally indistinguishable from

management accounting or so-called internal accounting. Wilmot has summarized the nature

of cost accounting as “the analyzing, recording, standardizing, forecasting, comparing,

reporting and recommending” and the role of a cost accountant as “a historian, news agent

and prophet.” As a historian, he should be meticulously accurate and sedulously impartial. As

a news agent, he should be up to date, selective and pithy. As a prophet, he should combine

knowledge and experience with foresight and courage.

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Objectives of Cost Accounting

The main objectives of cost accounting can be summarized as follows:

1. Determining Selling Price

Business enterprises run on a profit-making basis. It is, thus, necessary that revenue

should be greater than expenditure incurred in producing goods and services from

which the revenue is to be derived. Cost accounting provides various information

regarding the cost to make and sell such products or services. Of course, many other

factors such as the condition of market, the area of distribution, the quantity which can

be supplied etc. are also given due consideration by management before deciding upon

the price but the cost plays a dominating role.

2. Determining and Controlling Efficiency

Cost accounting involves a study of various operations used in manufacturing a product

or providing a service. The study facilitates measuring the efficiency of an organization

as a whole or department-wise as well as devising means of increasing efficiency.

Cost accounting also uses a number of methods, e.g., budgetary control, standard

costing etc. for controlling costs. Each item viz. materials, labour and expenses is

budgeted at the commencement of a period and actual expenses incurred are

compared with budget. This greatly increases the operating efficiency of an enterprise.

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3. Facilitating Preparation of Financial and Other Statements

The third objective of cost accounting is to produce statements whenever is required by

management. The financial statements are prepared under financial accounting

generally once a year or half-year and are spaced too far with respect to time to meet

the needs of management. In order to operate a business at a high level of efficiency, it

is essential for management to have a frequent review of production, sales and

operating results. Cost accounting provides daily, weekly or monthly volumes of units

produced and accumulated costs with appropriate analysis. A developed cost

accounting system provides immediate information regarding stock of raw materials,

work-in-progress and finished goods. This helps in speedy preparation of financial

statements.

4. Providing Basis for Operating Policy

Cost accounting helps management to formulate operating policies. These policies may

relate to any of the following matters:

o Determination of a cost-volume-profit relationship

o Shutting down or operating at a loss

o Making for or buying from outside suppliers

o Continuing with the existing plant and machinery or replacing them by improved

and economic ones

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CONCEPT OF COST

Cost accounting is concerned with cost and therefore is necessary to understand the meaning

of term cost in a proper perspective.

In general, cost means the amount of expenditure (actual or notional) incurred on, or

attributable to a given thing.

However, the term cost cannot be exactly defined. Its interpretation depends upon the

following factors:

The nature of business or industry

The context in which it is used

In a business where selling and distribution expenses are quite nominal the cost of an article

may be calculated without considering the selling and distribution overheads. At the same

time, in a business where the nature of a product requires heavy selling and distribution

expenses, the calculation of cost without taking into account the selling and distribution

expenses may prove very costly to a business. The cost may be factory cost, office cost, cost

of sales and even an item of expense. For example, prime cost includes expenditure on direct

materials, direct labour and direct expenses. Money spent on materials is termed as cost of

materials just like money spent on labour is called cost of labour and so on. Thus, the use of

term cost without understanding the circumstances can be misleading.

Different costs are found for different purposes. The work-in-progress is valued at factory cost

while stock of finished goods is valued at office cost. Numerous other examples can be given

to show that the term “cost” does not mean the same thing under all circumstances and for all

purposes. Many items of cost of production are handled in an optional manner which may

give different costs for the same product or job without going against the accepted principles

of cost accounting. Depreciation is one of such items. Its amount varies in accordance with

the method of depreciation being used. However, endeavor should be, as far as possible, to

obtain an accurate cost of a product or service.

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Elements of Cost

Following are the three broad elements of cost:

1. Material

The substance from which a product is made is known as material. It may be in a raw

or a manufactured state. It can be direct as well as indirect.

a. Direct Material

The material which becomes an integral part of a finished product and which can

be conveniently assigned to specific physical unit is termed as direct material.

Following are some of the examples of direct material:

All material or components specifically purchased, produced or

requisitioned from stores

Primary packing material (e.g., carton, wrapping, cardboard, boxes etc.)

Purchased or partly produced components

Direct material is also described as process material, prime cost material,

production material, stores material, constructional material etc.

b. Indirect Material

The material which is used for purposes ancillary to the business and which

cannot be conveniently assigned to specific physical units is termed as indirect

material. Consumable stores, oil and waste, printing and stationery material etc.

are some of the examples of indirect material.

Indirect material may be used in the factory, office or the selling and distribution

divisions.

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2. Labour

For conversion of materials into finished goods, human effort is needed and such

human effort is called labour. Labour can be direct as well as indirect.

a. Direct Labour

The labour which actively and directly takes part in the production of a particular

commodity is called direct labour. Direct labour costs are, therefore, specifically

and conveniently traceable to specific products.

Direct labour can also be described as process labour, productive labour,

operating labour, etc.

b. Indirect Labour

The labour employed for the purpose of carrying out tasks incidental to goods

produced or services provided, is indirect labour. Such labour does not alter the

construction, composition or condition of the product. It cannot be practically

traced to specific units of output. Wages of storekeepers, foremen, timekeepers,

directors’ fees, salaries of salesmen etc, are examples of indirect labour costs.

Indirect labour may relate to the factory, the office or the selling and distribution

divisions.

3. Expensesa. Direct Expenses

These are the expenses that can be directly, conveniently and wholly allocated to

specific cost centers or cost units. Examples of such expenses are as follows:

Hire of some special machinery required for a particular contract

Cost of defective work incurred in connection with a particular job or

contract etc.

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b. Indirect Expenses

These are the expenses that cannot be directly, conveniently and wholly

allocated to cost centers or cost units. Examples of such expenses are rent,

lighting, insurance charges etc.

4. Overhead

The term overhead includes indirect material, indirect labour and indirect expenses.

Thus, all indirect costs are overheads.

A manufacturing organization can broadly be divided into the following three divisions:

o Factory or works, where production is done

o Office and administration, where routine as well as policy matters are decided

o Selling and distribution, where products are sold and finally dispatched to

customers

Overheads may be incurred in a factory or office or selling and distribution divisions.

Thus, overheads may be of three types:

d. Factory Overheads

They include the following things:

Indirect material used in a factory such as lubricants, oil, consumable

stores etc.

Indirect labour such as gatekeeper, timekeeper, works manager’s salary

etc.

Indirect expenses such as factory rent, insurance, factory lighting etc.

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e. Office and Administration Overheads

They include the following things:

Indirect materials used in an office such as printing and stationery material,

brooms and dusters etc.

Indirect labour such as salaries payable to office manager, office

accountant, clerks, etc.

Indirect expenses such as rent, insurance, lighting of the office.

f. Selling and Distribution Overheads

They include the following things:

Indirect materials used such as packing material, printing and stationery

material etc.

Indirect labour such as salaries of salesmen and sales manager etc.

Indirect expenses such as rent, insurance, advertising expenses etc.

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Components of Total Cost

1. Prime Cost

Prime cost consists of costs of direct materials, direct labours and direct expenses. It is

also known as basic, first or flat cost.

2. Factory Cost

Factory cost comprises prime cost and, in addition, works or factory overheads that

include costs of indirect materials, indirect labours and indirect expenses incurred in a

factory. It is also known as works cost, production or manufacturing cost.

3. Office Cost

Office cost is the sum of office and administration overheads and factory cost. This is

also termed as administration cost or the total cost of production.

4. Total Cost

Selling and distribution overheads are added to the total cost of production to get total

cost or the cost of sales.

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Classification of Cost

Cost may be classified into different categories depending upon the purpose of classification.

Some of the important categories in which the costs are classified are as follows:

1. Fixed, Variable and Semi-Variable Costs

The cost which varies directly in proportion with every increase or decrease in the volume of

output or production is known as variable cost. Some of its examples are as follows:

Wages of laborers

Cost of direct material

Power

The cost which does not vary but remains constant within a given period of time and a range

of activity inspite of the fluctuations in production is known as fixed cost. Some of its

examples are as follows:

Rent or rates

Insurance charges

Management salary

The cost which does not vary proportionately but simultaneously does not remain stationary

at all times is known as semi-variable cost. It can also be named as semi-fixed cost. Some of

its examples are as follows:

Depreciation

Repairs

Fixed costs are sometimes referred to as “period costs” and variable costs as “direct costs” in

system of direct costing. Fixed costs can be further classified into:

Committed fixed costs

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Discretionary fixed costs

Committed fixed costs consist largely of those fixed costs that arise from the possession of

plant, equipment and a basic organization structure. For example, once a building is erected

and a plant is installed, nothing much can be done to reduce the costs such as depreciation,

property taxes, insurance and salaries of the key personnel etc. without impairing an

organization’s competence to meet the long-term goals.

Discretionary fixed costs are those which are set at fixed amount for specific time periods by

the management in budgeting process. These costs directly reflect the top management

policies and have no particular relationship with volume of output. These costs can, therefore,

be reduced or entirely eliminated as demanded by the circumstances. Examples of such

costs are research and development costs, advertising and sales promotion costs, donations,

management consulting fees etc. These costs are also termed as managed or programmed

costs.

In some circumstances, variable costs are classified into the following:

Discretionary cost

Engineered cost

The term discretionary costs are generally linked with the class of fixed cost. However, in the

circumstances where management has predetermined that the organization would spend a

certain percentage of its sales for the items like research, donations, sales promotion etc.,

discretionary costs will be of a variable character.

Engineered variable costs are those variable costs which are directly related to the production

or sales level. These costs exist in those circumstances where specific relationship exists

between input and output. For example, in an automobile

industry there may be exact specifications as one radiator, two fan belts, one battery etc.

would be required for one car. In a case where more than one car is to be produced, various

inputs will have to be increased in the direct proportion of the output.

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Thus, an increase in discretionary variable costs is due to the authorization of management

whereas an increase in engineered variable costs is due to the volume of output or sales.

2. Product Costs and Period Costs

The costs which are a part of the cost of a product rather than an expense of the period in

which they are incurred are called as “product costs.” They are included in inventory values.

In financial statements, such costs are treated as assets until the goods they are assigned to

are sold. They become an expense at that time. These costs may be fixed as well as variable,

e.g., cost of raw materials and direct wages, depreciation on plant and equipment etc.

The costs which are not associated with production are called period costs. They are treated

as an expense of the period in which they are incurred. They may also be fixed as well as

variable. Such costs include general administration costs, salaries salesmen and commission,

depreciation on office facilities etc. They are charged against the revenue of the relevant

period. Differences between opinions exist regarding whether certain costs should be

considered as product or period costs. Some accountants feel that fixed manufacturing costs

are more closely related to the passage of time than to the manufacturing of a product. Thus,

according to them variable manufacturing costs are product costs whereas fixed

manufacturing and other costs are period costs. However, their view does not seem to have

been yet widely accepted.

3. Direct and Indirect Costs

The expenses incurred on material and labor which are economically and easily traceable for

a product, service or job are considered as direct costs. In the process of manufacturing of

production of articles, materials are purchased, laborers are employed and the wages are

paid to them. Certain other expenses are also incurred directly. All of these take an active and

direct part in the manufacture of a particular commodity and hence are called direct costs.

The expenses incurred on those items which are not directly chargeable to production are

known as indirect costs. For example, salaries of timekeepers, storekeepers and foremen.

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Also certain expenses incurred for running the administration are the indirect costs. All of

these cannot be conveniently allocated to production and hence are called indirect costs.

4. Decision-Making Costs and Accounting Costs

Decision-making costs are special purpose costs that are applicable only in the situation in

which they are compiled. They have no universal application. They need not tie into routine-

financial accounts. They do not and should not conform the accounting rules. Accounting

costs are compiled primarily from financial statements. They have to be altered before they

can be used for decision-making.

5. Relevant and Irrelevant Costs

Relevant costs are those which change by managerial decision. Irrelevant costs are those

which do not get affected by the decision. For example, if a manufacturer is planning to close

down an unprofitable retail sales shop, this will affect the wages payable to the workers of a

shop. This is relevant in this connection since they will disappear on closing down of a shop.

But prepaid rent of a shop or unrecovered costs of any equipment which will have to be

scrapped are irrelevant costs which should be ignored.

6. Shutdown and Sunk Costs

A manufacturer or an organization may have to suspend its operations for a period on

account of some temporary difficulties, e.g., shortage of raw material, non-availability of

requisite labor etc. During this period, though no work is done yet certain fixed costs, such as

rent and insurance of buildings, depreciation, maintenance etc., for the entire plant will have

to be incurred. Such costs of the idle plant are known as shutdown costs.

Sunk costs are historical or past costs. These are the costs which have been created by a

decision that was made in the past and cannot be changed by any decision that will be made

in the future. Investments in plant and machinery, buildings etc. are prime examples of such

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costs. Since sunk costs cannot be altered by decisions made at the later stage, they are

irrelevant for decision-making.

7. Controllable and Uncontrollable Costs

Controllable costs are those costs which can be influenced by the ratio or a specified member

of the undertaking. The costs that cannot be influenced like this are termed as uncontrollable

costs.

The difference between controllable and uncontrollable costs is only in relation to a particular

individual or level of management. The expenditure which is controllable by an individual may

be uncontrollable by another individual.

8. Avoidable or Escapable Costs and Unavoidable or Inescapable Costs

Avoidable costs are those which will be eliminated if a segment of a business (e.g., a product

or department) with which they are directly related is discontinued. Unavoidable costs are

those which will not be eliminated with the segment. Such costs are merely reallocated if the

segment is discontinued. Certain costs are partly avoidable and partly unavoidable.

9. Imputed or Hypothetical Costs

These are the costs which do not involve cash outlay. They are not included in cost accounts

but are important for taking into consideration while making management decisions. For

example, interest on capital is ignored in cost accounts though it is considered in financial

accounts. In case two projects require unequal outlays of cash, the management should take

into consideration the capital to judge the relative profitability of the projects.

10. Differentials, Incremental or Decrement Cost

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The difference in total cost between two alternatives is termed as differential cost. In case the

choice of an alternative results in an increase in total cost, such increased costs are known as

incremental costs. While assessing the profitability of a proposed change, the incremental

costs are matched with incremental revenue.

11. Out-of-Pocket Costs

Out-of-pocket cost means the present or future cash expenditure regarding a certain decision

that will vary depending upon the nature of the decision made. For example, a company has

its own trucks for transporting raw materials and finished products from one place to another.

It seeks to replace these trucks by keeping public carriers. In making this decision, of course,

the depreciation of the trucks is not to be considered but the management should take into

account the present expenditure on fuel, salary to driveRs and maintenance. Such costs are

termed as out-of-pocket costs.

12. Opportunity Cost

Opportunity cost refers to an advantage in measurable terms that have foregone on account

of not using the facilities in the manner originally planned. For example, if a building is

proposed to be utilized for housing a new project plant, the likely revenue which the building

could fetch, if rented out, is the opportunity cost which should be taken into account while

evaluating the profitability of the project.

13. Traceable, Untraceable or Common Costs

The costs that can be easily identified with a department, process or product are termed as

traceable costs. For example, the cost of direct material, direct labor etc. The costs that

cannot be identified so are termed as untraceable or common costs. In other words, common

costs are the costs incurred collectively for a number of cost centers and are to be suitably

apportioned for determining the cost of individual cost centers. For example, overheads

incurred for a factory as a whole, combined purchase cost for purchasing several materials in

one consignment etc.23

Joint cost is a kind of common cost. When two or more products are produced out of one

material or process, the cost of such material or process is called joint cost. For example,

when cottonseeds and cotton fibers are produced from the same material, the cost incurred

till the split-off or separation point will be joint costs.

14. Production, Administration and Selling and Distribution Costs

A business organization performs a number of functions, e.g., production, illustration, selling

and distribution, research and development. Costs are to be curtained for each of these

functions. The Chartered Institute of Management accountants, ., has defined each of the

above costs as follows:

i. Production Cost

The cost of sequence of operations which begins with supplying materials, labor and

services and ends with the primary packing of the product. Thus, it includes the cost of

direct material, direct labor, direct expenses and factory overheads.

ii. Administration Cost

The cost of formulating the policy, directing the organization and controlling the

operations of an undertaking which is not related directly to a production, selling,

distribution, research or development activity or function.

iii. Selling Cost

It is the cost of selling to create and stimulate demand (sometimes termed as

marketing) and of securing orders.

iv. Distribution Cost

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It is the cost of sequence of operations beginning with making the packed product

available for dispatch and ending with making the reconditioned returned empty

package, if any, available for reuse.

v. Research Cost

It is the cost of searching for new or improved products, new application of materials, or

new or improved methods.

vi. Development Cost

The cost of process which begins with the implementation of the decision to produce a

new or improved product or employ a new or improved method and ends with the

commencement of formal production of that product or by the method.

vii. Pre-Production Cost

The part of development cost incurred in making a trial production as preliminary to

formal production is called pre-production cost.

Installation of Costing System

The installation of a costing system requires careful consideration of the following two

interrelated aspects:

Overcoming the practical difficulties while introducing a system

Main considerations that should govern the installation of such a system

Practical Difficulties

The important difficulties in the installation of a costing system and the suggestions to

overcome them are as follows:

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a. Lack of Support from Top Management

Often, the costing system is introduced at the behest of the managing director or some other

director without taking into confidence other members of the top management team. This

results in opposition from various managers as they consider it interference as well as an

uncalled check of their activities. They, therefore, resist the additional work involved in the

cost accounting system.

This difficulty can be overcome by taking the top management into confidence before

installing the system. A sense of cost consciousness has to be instilled in their minds.

b. Resistance from the Staff

The existing financial accounting staff may offer resistance to the system because of a feeling

of their being declared redundant under the new system.

This fear can be overcome by explaining the staff that the costing system would not replace

but strengthen the existing system. It will open new areas for development which will prove

beneficial to them.

c. Non-Cooperation at Other Levels

The foreman and other supervisory staff may resent the additional paper work and may not

cooperate in providing the basic data which is essential for the success of the system.

This needs re-orientation and education of employees. They have to be told of the

advantages that will accrue to them and to the organization as a whole on account of efficient

working of the system.

d. Shortage of Trained Staff

Costing is a specialized job in itself. In the beginning, a qualified staff may not be available.

However, this difficulty can be overcome by giving the existing staff requisite training and

recruiting additional staff if required.

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e. Heavy Costs

The costing system will involve heavy costs unless it has been suitably designed to meet

specific requirements. Unnecessary sophistication and formalities should be avoided. The

costing office should serve as a useful service department.

TECHNIQUES OF COSTING

Besides the above methods of costing, following are the types of costing techniques which

are used by management only for controlling costs and making some important managerial

decisions.

1. Marginal Costing

Marginal costing is a technique of costing in which allocation of expenditure to production is

restricted to those expenses which arise as a result of production, e.g., materials, labor, direct

expenses and variable overheads. Fixed overheads are excluded in cases where production

varies because it may give misleading results. The technique is useful in manufacturing

industries with varying levels of output.

2. Direct Costing

The practice of charging all direct costs to operations, processes or products and leaving all

indirect costs to be written off against profits in the period in which they arise is termed as

direct costing. The technique differs from marginal costing because some fixed costs can be

considered as direct costs in appropriate circumstances.

3. Absorption or Full Costing

The practice of charging all costs both variable and fixed to operations, products or processes

is termed as absorption costing.

4. Uniform Costing

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A technique where standardized principles and methods of cost accounting are employed by

a number of different companies and firms is termed as uniform costing. Standardization may

extend to the methods of costing, accounting classification including codes, methods of

defining costs and charging depreciation, methods of allocating or apportioning overheads to

cost centers or cost units. The system, thus, facilitates inter- firm comparisons, establishment

of realistic pricing policies, etc.

STANDARD COSTING

Standard costing is a system under which the cost of a product is determined in advance on

certain pre-determined standards. With reference to the example given in post costing, the

cost of product A can be calculated in advance if one is in a position to estimate in advance

the material labor and overheads that should be incurred over the product. All this requires an

efficient system of cost accounting. However, this system will not be useful if a vigorous

system of controlling costs and standard costs are not in force. Standard costing is becoming

more and more popular nowadays.

AN OVERVIEW OF A STANDARD COSTING SYSTEMStandard costing is most suitable in operations, where activities consist of a series of

common or repetitive operations. In manufacturing organisations the processes often are of a

repetitive nature and therefore standard costing is relevant in these kinds of organisations.

Standard costing procedures can be applied to non-manufacturing activities where operations

are of a repetitive nature. However, it cannot be easily applied to activities of a non-repetitive

nature, as there is no basis for observing repetitive operations and therefore standards cannot

be set. In organisations that produce many different products and the production consist of

series of common operations it is possible to apply a standard costing system (Drury, 1992).

In a standard costing system the standard costs for the actual output for a particular period

are traced to the managers of responsibility centres who are responsible for the various

operations. When it comes to the actual costs for the same period they are also charged to

the responsibility centres. The two costs, the standard and the actual, are then compared and

the variance between the two is reported . Managers need help in order to analyse where the 28

variances have arisen. Accountants may assist managers in doing this, but it is important they

do this together with the responsible managers in order to undertake an appropriate

investigation. By doing this together the reason for the variance will easily be such

comparisons can only be made after an event and the usefulness of the result is questioned.

However, argues that if people know in advance that their performance is going to be

measured it is more likely that they will perform better

Meaning of Standard

The word standard means a benchmark or yardstick. The standard cost is a predetermined

cost which determines in advance what each product or service should cost under given

circumstances.

In the words of Backer and Jacobsen, “Standard cost is the amount the firm thinks a product

or the operation of the process for a period of time should cost, based upon certain assumed

conditions of efficiency, economic conditions and other factors.”

Definition

The CIMA, has defined standard cost as “a predetermined cost which is calculated from

managements standards of efficient operations and the relevant necessary expenditure.”

They are the predetermined costs on technical estimate of material labor and overhead for a

selected period of time and for a prescribed set of working conditions. In other words, a

standard cost is a planned cost for a unit of product or service rendered.

The technique of using standard costs for the purposes of cost control is known as standard

costing. It is a system of cost accounting which is designed to find out how much should be

the cost of a product under the existing conditions. The actual cost can be ascertained only

when production is undertaken. The predetermined cost is compared to the actual cost and a

variance between the two enables the management to take necessary corrective measures.

The Purpose Of A Standard Costing System

29

Information is required in order to run an organisation successfully. The purpose of cost and

management accounting is to provide financial information to managers that will help them to

plan activities, control the activities for which they are responsible and see the financial

implications of any decisions they may take (Hussey & Hussey, 1999). Standard costing

systems provide cost data that can be used for many different purposes.

Ask and Ax (1997) have identified several fields of application when it comes to a standard

costing system. Their survey came up with the following reasons/purposes why a company

may use a standard costing system:

Product Costing 82.4 %

Inventory Valuation 64.8 %

Variance Analysis 56.0 %

Budgeting 45.1 %

Transfer Pricing 31.9 %

The Future Of Standard Costing

According to Cheatham and Cheatham (1996) many accountants in industry (as well as

academia) seem unaware of the fact that a redesigned standard costing system can provide

the important information that they need, and that updating their present system is an easier

process than adopting a new system. The same authors also point out that the standard

costing system coordinates managerial, financial and operations accounting, this makes it a

control system while many of its possible replacements only are cost accumulation systems.

Critics against the standard costing systems raise the question whether the system is really

useful in the manufacturing system of today. The fact is that it is still a widely used method,

due to the fact that it provides cost information for many different purposes in addition to cost

control. Many organizations have adapted their variance reporting system to report on those

variables particularly important to them, i.e. company specific variables. In companies where

an activity-based system is implemented, standard costing is important when it comes to

controlling the costs of unit-level activities. In many cases the criticism is concerned with the

fact that overemphasis is on price and efficiency, which would set quality aside. Attention is 30

also paid to the fact that volume variance to measure utilization of capacity ignores

overproduction and unnecessary build-ups of inventory. In this situation the fact that variance

analysis is not ‘locked in’ to a particular set of variables is ignored. Used variables can be

changed when the need arises.

To implement standards centred on the function of raw material ordering and inventory

levels, which give information about the effectiveness of suppliers. Since the goal is to have

orders delivered as placed, any variances are undesired. Price variances can be combined

with a quality variance, which prevents purchasing managers from just focusing on price

ignoring quality. Raw materials inventory variances indicate an inventory build-up, due to

more material purchased than used or an inventory decrease resulted, by reverted conditions.

This is in line with a just-in-time philosophy. Further criticism is concerned with the non-focus

of continuous improvement. However, static standards based on engineering studies or

historical data are not an essential part in a standard costing system since standards can be

adjusted to be dynamic or changing, by any of several methods. Examples of this will be

given below

Use last period’s results as standards. Important to remember when using this method is that

last period has to be representative; otherwise it needs to be revised. It is also possible to use

a base period with which comparisons are made. Benchmarking is a system where outside

companies are used as comparison. To compare with competitors or with the leader of the

industry provides motivation.

Another method is to use predetermined cost reductions, which means that the standard cost

is reduced for every period by a predetermined amount. This method favours constant

improvement.

Finally, the reporting system of the standard costing system has to be revised. In the

traditional way internal competition often arises. Instead, cooperation among workers,

managers and departments has to be encouraged.

Advantages

Standard costing is a management control technique for every activity. It is not only useful for

cost control purposes but is also helpful in production planning and policy formulation. It

31

allows management by exception. In the light of various objectives of this system, some of the

advantages of this tool are given below:

1. Efficiency measurement-- The comparison of actual costs with standard costs

enables the management to evaluate performance of various cost centers. In the

absence of standard costing system, actual costs of different period may be compared

to measure efficiency. It is not proper to compare costs of different period because

circumstance of both the periods may be different. Still, a decision about base period

can be made with which actual performance can be compared.

2. Finding of variance-- The performance variances are determined by comparing actual

costs with standard costs. Management is able to spot out the place of inefficiencies. It

can fix responsibility for deviation in performance. It is possible to take corrective

measures at the earliest. A regular check on various expenditures is also ensured by

standard cost system.

3. Management by exception-- The targets of different individuals are fixed if the

performance is according to predetermined standards. In this case, there is nothing to

worry. The attention of the management is drawn only when actual performance is less

than the budgeted performance. Management by exception means that everybody is

given a target to be achieved and management need not supervise each and

everything. The responsibilities are fixed and every body tries to achieve his/her

targets.

4. Cost control-- Every costing system aims at cost control and cost reduction. The

standards are being constantly analyzed and an effort is made to improve efficiency.

Whenever a variance occurs, the reasons are studied and immediate corrective

measures are undertaken. The action taken in spotting weak points enables cost

control system.

5. Right decisions-- It enables and provides useful information to the management in

taking important decisions. For example, the problem created by inflating, rising prices.

It can also be used to provide incentive plans for employees etc.

6. Eliminating inefficiencies-- The setting of standards for different elements of cost

requires a detailed study of different aspects. The standards are set differently for

32

manufacturing, administrative and selling expenses. Improved methods are used for

setting these standards. The determination of manufacturing expenses will require time

and motion study for labor and effective material control devices for materials. Similar

studies will be needed for finding other expenses. All these studies will make it possible

to eliminate inefficiencies at different steps.

Limitations of Standard Costing

1. It cannot be used in those organizations where non-standard products are produced. If

the production is undertaken according to the customer specifications, then each job

will involve different amount of expenditures.

2. The process of setting standard is a difficult task, as it requires technical skills. The time

and motion study is required to be undertaken for this purpose. These studies require a

lot of time and money.

3. There are no inset circumstances to be considered for fixing standards. The conditions

under which standards are fixed do not remain static. With the change in

circumstances, if the standards are not revised the same become impracticable.

4. The fixing of responsibility is not an easy task. The variances are to be classified into

controllable and uncontrollable variances. Standard costing is applicable only for

controllable variances.

For instance, if the industry changed the technology then the system will not be suitable. In

that case, we will have to change or revise the standards. A frequent revision of standards will

become costly.

Setting Standards

33

Normally, setting up standards is based on the past experience. The total standard cost

includes direct materials, direct labor and overheads. Normally, all these are fixed to some

extent. The standards should be set up in a systematic way so that they are used as a tool for

cost control.

Various Elements which Influence the Setting of Standards

Setting Standards for Direct Materials

There are several basic principles which sought to be appreciated in setting standards for

direct materials. Generally, when you want to purchase some material what are the factors

you consider. If material is used for a product, it is known as direct material. On the other

hand, if the material cost cannot be assigned to the manufacturing of the product, it will be

called indirect material. Therefore, it involves two things:

Quality of material

Price of the material

The second step in determining direct material cost will be a decision about the standard

price. Material’s cost will be decided in consultation with the purchase department. The cost

of purchasing and store keeping of materials should also be taken into consideration. The

procedure for purchase of materials, minimum and maximum levels for various materials,

discount policy and means of transport are the other factors which have bearing on the

materials cost price. It includes the following:

Cost of materials

Ordering cost

Carrying cost

34

The purpose should be to increase efficiency in procuring and store keeping of materials. The

type of standard used-- ideal standard or expected standard-- also affects the choice of

standard price.

Setting Direct Labor Cost

If you want to engage a labor force for manufacturing a product or a service for which you

need to pay some amount, this is called wages. If the labor is engaged directly to produce the

product, this is known as direct labor. The second largest amount of cost is of labor. The

benefit derived from the workers can be assigned to a particular product or a process. If the

wages paid to workers cannot be directly assigned to a particular product, these will be known

as indirect wages. The time required for producing a product would be ascertained and labor

should be properly graded. Different grades of workers will be paid different rates of wages.

The times spent by different grades of workers for manufacturing a product should also be

studied for deciding upon direct labor cost. The setting of standard for direct labor will be done

basically on the following:

Standard labor time for producing

Labor rate per hour

Standard labor time indicates the time taken by different categories of labor force which are

as under:

Skilled labor

Semi-skilled labor

Unskilled labor

35

For setting a standard time for labor force, we normally take in to account previous

experience, past performance records, test run result, work-study etc. The labor rate standard

refers to the expected wage rates to be paid for different categories of workers. Past wage

rates and demand and supply principle may not be a safe guide for determining standard

labor rates. The anticipation of expected changes in labor rates will be an essential factor. In

case there is an agreement with workers for payment of wages in the coming period, these

rates should be used. If a premium or bonus scheme is in operation, then anticipated extra

payments should also be included. Where a piece rate system is used, standard cost will be

fixed per piece. The object of fixed standard labor time and labor rate is to device maximum

efficiency in the use of labor.

Setting Standards of Overheads

The next important element comes under overheads. The very purpose of setting standard for

overheads is to minimize the total cost. Standard overhead rates are computed by dividing

overhead expenses by direct labor hours or units produced. The standard overhead cost is

obtained by multiplying standard overhead rate by the labor hours spent or number of units

produced. The determination of overhead rate involves three things:

Determination of overheads

Determination of labor hours or units manufactured

Calculating overheads rate by dividing A by B

The overheads are classified into fixed overheads, variable overheads and semi-variable

overheads. The fixed overheads remain the same irrespective of level of production, while

variable overheads change in the proportion of production. The expenses increase or

decrease with the increase or decrease in output. Semi-variable overheads are neither fixed

nor variable. These overheads increase with the increase in production but the rate of

increase will be less than the rate of increase in production. The division of overheads into

fixed, variable and semi-variable categories will help in determining overheads.

Determination of Standard Costs

36

1. Determination of Cost Center

According to J. Betty, “A cost center is a department or part of a department or an item of

equipment or machinery or a person or a group of persons in respect of which costs are

accumulated, and one where control can be exercised.” Cost centers are necessary for

determining the costs. If the whole factory is engaged in manufacturing a product, the factory

will be a cost center. In fact, a cost center describes the product while cost is accumulated.

Cost centers enable the determination of costs and fixation of responsibility. A cost center

relating to a person is called personnel cost center, and a cost center relating to products and

equipments is called impersonal cost center.

2. Current Standards

A current standard is a standard which is established for use over a short period of time and

is related to current condition. It reflects the performance that should be attained during the

current period. The period for current standard is normally one year. It is presumed that

conditions of production will remain unchanged. In case there is any change in price or

manufacturing condition, the standards are also revised. Current standard may be ideal

standard and expected standard.

3. Ideal Standard

This is the standard which represents a high level of efficiency. Ideal standard is fixed on the

assumption that favorable conditions will prevail and management will be at its best. The price

paid for materials will be lowest and wastes etc. will be minimum possible. The labor time for

making the production will be minimum and rates of wages will also be low. The overheads

expenses are also set with maximum efficiency in mind. All the conditions, both internal and

external, should be favorable and only then ideal standard will be achieved.

Ideal standard is fixed on the assumption of those conditions which may rarely exist. This

standard is not practicable and may not be achieved. Though this standard may not be

achieved, even then an effort is made. The deviation between targets and actual performance

is ignorable. In practice, ideal standard has an adverse effect on the employees.

37

4. Basic Standards

A basic standard may be defined as a standard which is established for use for an indefinite

period which may a long period. Basic standard is established for a long period and is not

adjusted to the preset conations. The same standard remains in force for a long period.

These standards are revised only on the changes in specification of material and technology

productions. It is indeed just like a number against which subsequent process changes can

be measured. Basic standard enables the measurement of changes in costs. The deviation

between standard cost and actual cost cannot be used as a yardstick for measuring

efficiency.

5. Normal Standards

As per terminology, normal standard has been defined as a standard which, it is anticipated,

can be attained over a future period of time, preferably long enough to cover one trade cycle.

This standard is based on the conditions which will cover a future period of five years,

concerning one trade cycle. If a normal cycle of ups and downs in sales and production is 10

years, then standard will be set on average sales and production which will cover all the

years. The standard attempts to cover variance in the production from one time to another

time. An average is taken from the periods of recession and depression. The normal standard

concept is theoretical and cannot be used for cost control purpose. Normal standard can be

properly applied for absorption of overhead cost over a long period of time.

6. Organization for Standard Costing

The success of standard costing system will depend upon the setting up of proper standards.

For the purpose of setting standards, a person or a committee should be given this job. In a

big concern, a standard costing committee is formed for this purpose. The committee includes

production manager, purchase manager, sales manager, personnel manager, chief engineer

and cost accountant. The cost accountant acts as a co-coordinator of this committee.

7. Accounting System

38

Classification of accounts is necessary to meet the required purpose, i.e. function, asset or

revenue item. Codes can be used to have a speedy collection of accounts. A standard is a

pre-determined measure of material, labor and overheads. It may be expressed in quality and

its monetary measurements in standard costs.

THE PROCESS OF STANDARD COSTING

Standard costs are pre-determined by using a careful analysis of production methods,

physical conditions and price factors. They represent achievable targets and help to build up

budgets, gauge performance and obtain product costs. The actual costs will vary from month

to month or even from day to day. The basic objective, therefore, of standard costing system

is to assist the departmental head by identifying and describing the variances over which he

has control. Thus, a set of standards developed under the standard costing system outlines

how a task must be accomplished and how much it should cost.

As work is done actual costs are recorded and compared with standard cost to determine the

VARIANCES

The variances, thus arrived at, are analyzed further with a view to discovering better ways of

adhering to standards or of altering the standards so as to accomplish the objectives.

Under this system, the cost is pre-determined for each element, namely, material, labour and

overhead and for each line of product manufactured or service rendered. It, therefore,

involves:

(a) The setting of standards,39

(b) Ascertainment of actual costs,

(c) Comparison of actual and standard costs to determine the variance, and

(d) Investigation of variances and taking appropriate action thereon wherever necessary.

TYPES OF VARIANCES

Controllable and un-controllable variances:

The purpose of the standard costing reports is to investigate the reasons for significant

variances so as to identify the problems and take corrective action. Variances are broadly of

two types, namely, controllable and uncontrollable. Controllable variances are those which

can be controlled by the departmental heads whereas uncontrollable variances are those

which are beyond their control.

For example, price variance is normally regarded as uncontrollable if the price increase is due

to fluctuations of prices in the market. It becomes controllable if the production controller has

failed to place orders in time and urgent purchase was made at extra cost. In the former case,

no responsibility is attached to any one whereas the departmental head has responsibility for

the loss in the latter case. As already explained, not all price variances are uncontrollable. If

the uncontrollable variances are of significant nature and are persistent, the standard may

need revision.

Computation of variances: Let us now proceed to study with illustrations the method of

computation of major variances. In all the problems illustrated in the following pages, ‘F’

means favourable variance and ‘A’ means adverse variance.40

Variances may be broadly classified under the following heads according to the main type of

cost. The categorization of variances is depicted

(a) Material – The two basic variances arising during material consumption are material

usage and material price variances. The former arises because of variations in the quantity of

material actually consumed when compared with what should have been consumed as per

the established standards and the latter because of the differences between the planned and

the actual material prices paid to the suppliers. Mathematically

(i)Material costs variance =

(Standard quantity x Standard Price) – (Actual quantity x Actual price)

MCV = (S × SP) – (A × AP)

(ii) Material price variance=

Actual quantity × (Standard price – Actual price)

MPV = A × (SP – AP)

(iii) Material usage variance = Standard price (Standard quantity – Actual quantity)

MUV = SP × (S –A )

Where

Revised standard quantity =Total of actual quantities of all materials

Total of standard quantitiets of all materials

Standard quantity of one material _Material revised usage variance =

(Standard quantity – Revised standard quantity) × Standard price

MRUV = (S – RS ) × SP

(ii) Material yield variance = (Actual yield – Standard yield) × Standard output price41

MYV = (AY – SY) × SOP

Note: Material revised usage variance is also known as material sub – usage variance.

In each case there will be only one variance either material yield or material revised usage

variance.

42

43

COMPANY PROFILE

Upkar Agencies has been incorporated in 1989. It started as a small trading firm and then

grew tremendously by expanding itself in various building materials. Some of these including

pvc pipes and fittings ,cement, water storage tanks ,suctions ,cement sheet etc.

Over the years, company has built up a very strong network, because of which it ensured

timely supply of inventory across the length and breadth of its market. Through its quality and

commitment it has succeeded in creating a high level of customer satisfaction which has

helped the company in gaining a respectable position in the market.

In 2011,Upkar Group started with its new division “UPKAR POLYMERS” for the

manufacturing of water storage tanks . It has procured recognition in the manufacturing, sales

,marketing industry under the brand name 'UPKAR'.

Upkar polymers manufacturing facilities are well equipped with high tech, and state of the art

roto-moulding machines. This has enabled the company’s product range to be at par with

international quality and superior finish. UPKAR range of water storage tanks are

manufactured to the highest quality standards and have stood the test of time with tanks in

the field for over years.

Upkar Group has always placed high emphasis on its marketing efforts. Our Main Office is

located in Sagar (MP). The company has steadily grown into a large entity having strong

network of 50+ dealers across Indore, Bhopal, Jabalpur, Katni, Sagar, Damoh, Tikamgarh,

Bina ,Raisen ,vidisha ,chattarpur district.

In the upcoming years, UPKAR aims to show its presence in the major cities of India. And

soon we are going to launch a new range products that will include PVC Pipes and Fittings ,

tubing pipe , Ghamela, which will satisfy every need of our discerning customers.

44

UPKAR POLYMERS

Plant Capacity:The production basis for a typical tiny unit would be as under:

Working hours/day : 12 (1 shift)

Working days in a month : 30

Monthly Production capacity : 500 ltrs. Tank : 1800 pcs.

The unit has been assumed to operate at 70%, 80% and 90% of its installed capacity

in the first, second and third year and onwards of its operation.

Raw Material:The main raw materials required for manufacturing water storage tank are

LDPE/LLDPE/HDPE, Master batch (carbon black and other colorants), hinges and

inserts.

Process of Manufacture:1) The LLDPE granules are mixed with granules of black colour concentrates.

2) These are extruded and strands are chopped as granules so as to achieve uniform

distribution of carbon black.

3) The granules are pulverized in a special pulverization system from 30 to 40- mesh

powder.

4) The rotational moulding process for manufacturing water storage tank consists of

the following major process steps:

• Loading of raw material

• Moulding of the part

• Cooling or curing

• Unloading of finished part

45

Cycle time generally varies from 15 to 20 minutes. Cycle as low as 10 minutes can be

achieved and extremely large part with heavy wall requires 20 minutes for each

moulding cycle. Tanks are generally made of up of doube layer or triple layer.

According to no. of layer for a finished product it will take 40-55 minutes for each arm

which has 4 moulds mounted on it.

MAJOR PROCESS STEPS:

Loading: Raw material in the form of powder (35 to 40 micron) or liquid state, is loaded into

the mould or cavities and mould halves are mechanically locked together. Loading is

generally accomplished before the machine has completed its previous cycle and ready to

accept the mould.

Moulding the part: The prepared mould is next placed in a closed chamber where it is

subjected to intense heat upto 400 C while rotating the mould bi-axially. Rotation is at low

speed generally in the range of 1 – 40 rpm on the minor axis and 1 – 12 rpm on the major

axis. A 4:1 rotation is common however both variable speeds and variable ratios are used for

moulding unusual configuration.

Cooling : The mould containing formed part is then transferred to a second enclosed chamber

where it is subjected to a combination of water spray and forced air cooling while continuing

to rotate biaxial. This causes the part to cure evenly and mould to reach handling

temperature.

Unloading: Like loading this can be accomplished manually by simply opening the mould and

physically removing the parts or automatically by using forced air to facilitate the ejection of

the part.

46

PLANT LAYOUT

47

48

Estimated Standard Cost in Rs.Capacity : ------1800 units of 500 ltrs tanks (per month)

Description Total Cost

Total FixedCost

Total Variable

Cost

Fixed CostPer Unit

VariableCost Per

Unit

TotalCostPerUnit

Bill of Material Cost

LLDPE(21600 in

kg)

2052000 2052000 1140 1140

Color granules

(450 kg)51750 51750 28.75 28.75

Fuel DIESEL(ltrs) 135450 135450 75.25 75.25Direct Labour 39600 39600 22 22

Screening & lids 97200 97200 54 54Manufacturing

overheads214750 88550 126200 49.14 70.11 119.25

Marketing and

administrative

overheads

65000 30000 35000 16.67 19.44 36.11

Total cost per unit 65.81 1409.55 1475.36Add desired profit( 15% 15%

Desired selling

price/unit1700

Standard Cost of 500 ltrs water storage tanks – Rs.1700/unit (or rs 3.40/ltr)

49

ACTUAL COST SHEETProduction of 500ltrs water storage tank

Actual production 70% of capacity 1260 units

Total cost Cost /unit1. Direct materialOpening Stock of Raw material

ADD: Material purchased during the period(16MT) 1504000 1193.65

ADD :Material parchased (315kg) 37800 30

LESS: Closing stock at the end (880 kg) -82720 -65.6

2.Direct wages 31500 25

3.Direct expenses 68040 54

(1+2+3)Prime Cost 1558620 12374.Work Expenses 151200 120

ADD :Indirect wages ,power ,maintenance of plant ,rent ,

Lighting & Insurance of Factory ,Depreciation of plant &

Building etc

Less :sale of scrap

5.ADD : Opening work-in-progress6.LESS: Closing work-in-progress

(prime cost +4+5-6)Work Cost 13577.Administrative ExpensesOffice salaries ,rent ,lighting ,insurance ,depreciation

Director’s fees , audit fees

1,15,523 91.68

(work cost + 7)Cost Of Production 1448.688.Opening stock of finished goods9.Closing stock of finished goods

50

(cost of production+8-9)Cost of goods sold10.Selling & Distribution exp. Carraige outwards ,commission ,advertisement ,bad debt…………..

72520 57.54

(cost of goods sold+10)Cost of Sales 1506.22ADD:Profit @15% 225.93Sales (Selling Price) 1732

Actual cost for 500ltr water storage tank Rs 1732/unit (3.46/ltr)

51

VARIANCE

The concerns of UPKAR POLYMERS furnish the following information:

BASIC CALCULATION

STANDARD FOR 1800 units Actual for 1260 units

Material

used(kg)

Rate(rs) Amount (rs) Material

used(kg)

Rate Amount

A 21600 1140 2052000 15120 1128 1421280

B 450 115 51750 315 120 37800

2103750 1459080

MATERIAL VARIANCE

Material usage variance,

Material price variance,

Material cost variance.

Std. cost of actual output = Rs.2103750 × (1260/1800) = Rs. 1472625.00

Calculation of Variances

1. Material Cost Variance = (SC of actual output – AC)

= (1472625.00 – 1459080.00) MCV = Rs.13545 (F)

2. Material Price Variance = (SP – AP) × A52

Material A = (1140 – 1128) × 15120 = Rs.181440.00 (F)

Material B = (115 – 120) × 315 = Rs. 1575.00 (A)

MPV = Rs. 179865.00 (F)

3. Material Usage Variance = (S for actual output – A ) × SP

Material A = (21600*(1800/1260)-15120)*1140 =Rs. 17940343.00(F)

Material B = (450*(1800/1260)-315)*115 =Rs. 37703.57 (F)

MUV= Rs.17678047 (F)

53

LABOUR VARIANCELabour – Similar to material usage variance, labour efficiency variance measures the

efficiency of labour by identifying the difference between the actual hours worked and the

hours which should have been worked as per the established standards.

Mathematically

Labour Cost variance =

(Std. hours for actual output x Std. rate per hour) – (Actual hours x Actual rate per hour)

LCV = (SH x SR) – (AH x AR)

Labour rate variance =

Actual time (Std. rate – Actual rate)

LRV = AH x (SR – AR)

Labour efficiency (or time) variance = Std. rate (Std. hours for actual output – Actual hours)

LEV = SR x (SH – AH)

Classification of Labour Efficiency VarianceLabour efficiency variance is further divided into the following variances:(i) Idle time variance(ii) Labour mix variance(iii) Labour yield variance (or Labour revised-efficiency variance)

(i) Idle time variance= Idle hours x Standard rate ITV = IH x SR(ii) Labour mix variance = (Revised std. hours – Actual hours) x Standard rate LMV = (RSH – AH) x SR Labour revised efficiency variance = (Std. hours for actual output – Revised std. hours) x Standard rate LREV = (SH – RSH) x SR(iii) Labour yield variance = (Actual yield – Std. yield from actual input) x Std. labour cost per unit of output

54

LYV = (AY – SY) x SLC

The standard and actual figures of the company are as under

Standard time for the job 252 hours

Standard rate per hour Rs. 110

Actual time taken 258 hours

Actual wages paid Rs. 31500

(a) Std. labour cost Rs.

(252 hours × Re. 110) 27720

(b) Actual wages paid 31500

(c) Actual rate per hour: Rs. 31500/258 hours 122

(i) Labour Rate variance = Actual time (Std. rate – Actual rate)

= 252 hours (Re.110 – Re.122) = Rs. 3054 (A)

(ii) Labour Efficiency variance = Std. rate per hr. (Std. time – Actual time)

= Re.110 (252 hrs. – 258 hrs.) = Rs.660 (A)

(iii) Total labour cost variance = Std. labour cost – Actual labour cost

=Rs 27720 –Rs 31500 = Rs 3780 (A)

55

OVERHEADS –

Normally, for several type of overhead expenses either a single recovery rate or two recovery

rates, one representing fixed overheads and the other representing variable overheads, will

be prepared. Refer to the ‘Estimated Standard Cost’

Overheads have been classified as both fixed and variable thereby giving a standard fixed

cost (overhead) per unit and standard variable cost (overhead) per unit. The recovery of the

fixed components of the estimated overheads depends upon capacity utilization.

In case a company produces less than the projected utilization it shall not be able to recover

all the budgeted fixed overheads. This unrecovered portion is known as production volume

variance.

The other variation is because of variations in actual spending when compared with both

estimated fixed and estimated variable overheads. Such a variance is known as Overhead

expenses variance.

The following detailed discussion shall help you have a clear understanding of these two

variances.

(1) Production Volume Variance:

The term fixed overheads implies that the element of cost does not vary directly in proportion

to the output. In other words fixed overheads do not change within a given range of activity.

However the unit cost changes even though the fixed overheads are constant in total within

the given range of output. So, higher the level of activity, the lower will be the unit cost or vice

-versa. The management is, therefore, faced with a costing difficulty because it requires a

representative rate for charging fixed overheads irrespective of changes in volume of output.

56

For example, if the fixed overheads are Rs. 10,000 and the output varies from 8,000 to

11,000 units, the cost per unit of output would be as under :

Fixed Output in Cost per

Overheads (Rs.) units unit of output (Rs.)

10,000 8,000 1.25

10,000 9,000 1.11

10,000 10,000 1.00

10,000 11,000 0.91

We have, however, seen that in standard costing, a predetermined rate of overhead recovery

is established for costing purposes. This involves the establishment of a predetermine

capacity. If we take, for example; 10,000 units as predetermine volume/capacity, the pre-

determined rate will be Re.1 per unit. If the factory produces only 8,000 units, there will be a

loss due to under-recovery which can be explained in two-ways:

(a) The actual cost will be Rs. 10,000/ 8,000 units = Rs. 1.25 per unit whereas the

absorbed cost is Re. 1 per hour. Since the cost is more by Re. 0.25 per unit, the total

loss is 8,000 units × Re. 0.25 or Rs. 2,000.

(b) Since the factory has produced only 8,000 units, the amount of overheads recovered is

8,000 units × Re.1 or Rs. 8,000. Since fixed overheads are constant, the amount which

should have been ideally incurred for the department is Rs.10,000. Hence there is a

difference of Rs 2,000 between the overheads recovered and the overheads estimated.

This variance is known as production volume variance.

This shows the cost of failure on the part of the factory to produce at the planned activity of

10,000 units. If the company produces 11,000 units, the variance will show the benefits of

operating at a level above the budgeted activity. If, however, the factory has produced 10,000

units, there will be no production volume variance because the actual activity equals what

was budgeted i.e. the production of 10,000 units.57

(2) Overhead Expenses Variance : As discussed above, the Production Volume Variance

analyses the unrecovered fixed overheads. Apart from this, there can be variations in the

actual spending of both fixed and variable overheads when compared to what was

established as a standard. Such variations can be accounted for by analyzing a Overhead

expenses variance.

The following illustration shows how overhead expense rates are computed and variance

analysed.

The analysis of overhead variances is different from that of material and labour variances. As

overhead is the aggregate of indirect materials, indirect labour and indirect expenses, this

variance is considered to be a difficult part of variance analysis. It is important to understand

that overhead variance is nothing but under or over-absorption of overhead. There is a

separate computation for overhead variances for fixed and variable overheads.

Basic terms used in the computation of overhead variance

Standard overhead rate (per hour) = Budgeted overhead

Budgeted hours Or Standard overhead rate (per unit) =

(Budgeted Overhead / Budgeted output in units)

Note: Separate overhead rates will be computed for fixed and variable overheads.

Basic calculations before the computation of overhead variances:

The following basic calculation should be made before computing variances.

(i) When overhead rate per hour is used:

(a) Standard hours for actual output (SHAO)

SHAO =( Budgeted hours × Actual output) / Budgeted output

(b) Absorbed (or Recovered) overhead =

Std. hours for actual output × Std. overhead rate per hour

(c) Standard overhead = Actual hours × Std. overhead rate per hour58

(d) Budgeted overhead = Budgeted hours × Std. overhead rate per hour

(e) Actual overhead = (Actual hours × Actual overhead rate per hour)

(ii) When overhead rate per unit is used

(a) Standard output for actual hours (SOAH)

SOAH = (Budgeted output (in units) × Actual hours)/ Budgeted hours

(b) Absorbed overhead = Actual output × Std. overhead rate per unit

(c) Standard overhead = Std. output for actual time × Std. overhead rate per unit

(d) Budgeted overhead = Budgeted output × Std. overhead rate per unit

(e) Actual overhead = Actual output × Actual overhead rate per unit

Overhead cost variance = Absorbed overhead – Actual overhead

OCV = (Std. hours for actual output × Std. overhead rate) – Actual overhead

Overhead cost variance is divided into two categories:

(i) Variable overhead (VO) variances

(ii) Fixed overhead (FO) variances

Variable Overhead (VO) Variances

V. O. cost variance = (Absorbed variable overhead – Actual variable overhead)

= (Std. hours for actual output × Std. variable overhead Rate) – Actual overhead cost

This variance is sub-divided into the following two variances:

(a) Variable overhead expenditure variance or spending variance or budget variance

(b) Variable overhead efficiency variance

V. O. expenditure variance = (Standard variable overhead – Actual variable overhead)

= (Actual hours × Std. variable overhead rate) – Actual overhead cost

V.O. efficiency variance = (Absorbed variable overhead – Standard variable overhead)

= (Std. hours for actual output – Actual hours) × Std. variable overhead rate

59

CALCULATIONS :

Company has established the following standards for factory overheads.

Variable overhead per unit: Rs. 89.55/-

Fixed overheads per month Rs. 1,18,550/-

Capacity of the plant. 1800 units per month.

The actual data for the month are as follows:

Actual overheads incurred Rs. 1,88,043/-

Actual output (units) 1260 units

Required:

Calculate overhead variances viz :

(i) Production volume variance

(ii) Overhead expense variance

Solution:

Unutilised capacity : 1800 units less 1260 units

= 540 units

Standard fixed overheads per unit = Rs. 65.86 per unit

Production volume variance = 540 units × Rs. 65.86

= Rs. 35,564.5 (Adverse)

Std variable overheads for actual production : Rs. 89.55 × 1260 units

= Rs. 1,12,833

Std fixed overheads = Rs. 118550

Total overheads on standards for actual production = Rs. 231383

Actual overheads incurred = Rs. 1,88,043

Overhead expense variance = Rs. 43,340

60

The following information was obtained from the records of a manufacturing unit using

standard costing system.

Standard Actual

Production 1800 units 1260 units

Working days 30 21.5

Fixed Overhead Rs.118550 Rs. 98,000

Variable Overhead Rs 161200 Rs 90,043

You are required to calculate the following overhead variance:

(a) Variable overhead variance

(b) Fixed overhead variances

(i) Expenditure variances

(ii) Volume variance

Solution:

(a) For Variable Overhead Variance:

Actual variable overhead = Rs.90, 043

Standard variable overhead for production (Budgeted output × Std. variable overhead

rate per unit) = (161200/ 1800) ×1260

= Rs.112,840

Variable overhead variance: Actual variable overhead – Standard variable overhead

= Rs.112840 – Rs.90043

= 22797 (A)

(b) For Fixed Overhead Variance:

Actual fixed overhead incurred = Rs. 98000

Budgeted fixed overhead for the period = Rs. 118550

Standard fixed overhead for production (Standard output for actual time × Standard Fixed

Overhead per unit)

= (Rs.118550/ 1800 units) × 1260 units

61

= Rs.82,985

Variances:

(i) Fixed Overhead Expenditure Variances:

Actual fixed overhead – Budgeted fixed overhead

= Rs.98000 – Rs.118550 = 20,550

(ii) Fixed Overhead Volume Variance : Budgeted fixed overhead – Standard fixed overhead

= Rs.118550 – Rs.82,985 = Rs.35565 (A)

(iii) Fixed Overhead Variance : Actual fixed overhead – Standard fixed overhead

= Rs.98000 – Rs.82985 = Rs.15, 015 (F)

Sales variances : Variances which arise due to a change in the actual selling price and the actual quantity of

units sold from that what was budgeted are known as sales variances.

These variances are computed on the basis of sales value. They provide the sales manager

an idea of the effect of various factors affecting sales such as prices, quantity and sales mix

on the overall sales value. The sales value variances are more or less similar to material cost

variances or labour cost variances.

Sales value variance: It is the difference between the budgeted sales and actual sales. The

variance can be bifurcated into sales price variance and sales volume variance.

(a) Sales price variance : Actual quantity of Sales (Actual price – Budgeted price) or Actual

sales minus actual quantity at budgeted prices.

(b) Sales volume variances: Budgeted price (Actual quantity – Budgeted quantity) or Actual

quantity at budgeted price minus budgeted sales.

62

Computation the sales variances from the following figures :-

Product Budget

Quantity

Quantity

Budgeted Price

Actual

Quantity

Actual

Price

Rs. Rs.

Upkar tank 1800 1700 1260 1732

Solution

Basic Calculation :

Product

price

Budgeted

price

Actual

price

Budgeted

Quantity

sales

Actual

Quantity

sales

Budgeted

sales

Actual

Sales at

Budgeted

price

Actual

sales

a b c d e = a*c f = (a*d) g = (b*d)

Upkar tank 1700 1732 1800 1260 3060000 2142000 2182320

Computation of Variances

Sales price variance = Actual quantity (Actual price – Budgeted price) = Actual sales – Standard sales = Rs. 2182320 – Rs. 2142000 = Rs. 40320(F)

Sales volume variance = Budgeted price (Actual quantity – Budgeted quantity)

= Std. sales – Budgeted sales = Rs. 26,000 – Rs. 25,000 = Rs. 1,000 (F)

Total variance = Actual sales – Budgeted sales = Rs. 2182320 – Rs. 3060000 = Rs.877680 (A)

63

SUMMARY

Standard Costing: A technique which uses standards for costs and revenues for the purposes of control through

variance analysis.

Standard Price:

A predetermined price fixed on the basis of a specification of a product or service and of all

factors affecting that price.

Standard Time: The total time in which task should be completed at standard performance.

Variance: A divergence from the predetermined rates, expressed ultimately in money value,

generally used in standard costing and budgetary control systems.

Variance Analysis: The analysis of variances arising in standard costing system into their

constituent parts.

Revision Variance: It is the difference between the original standard cost and the revised

standard cost of actual production.

Basic Standard: A standard fixed for a fairly long period.

Current Standard: A standard fixed for a short period.

Estimated Cost : An estimate of what the cost is likely to be during a given period of time.

Ideal Cost : A cost which should be incurred during a period under ideal conditions.

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Important Formulas

Material Variance :Material costs variance = (Std. qty x Std. Price) – (Actual qty x Actual price)

Material usage variance = Std. price (Std. Qty. – Acutal qty.)

Material price variance = Actual qty. (Std. price – Actual price)

Material cost variance = Material usage variance + Material price variance

Labour Variance : Labour cost variance = (Std. time x Std. Rate) – (Actual time x Actual rate

Labour efficiency variance = Std. rate (Std. time – Actual time)

Labour rate variance = Actual time (Std. rate – Actual rate)

Labour cost variance = Labour efficiency variance + Labour rate variance

Fixed Overhead Variances: F.O. cost Variance = Recovered Overhead – Actual Overhead

F.O. Expenditure Variance = Budgeted Overhead – Actual Overhead

F.O. Volume Variance = Recovered Overhead – Budgeted Overhead

Variable Overhead Variances V.O. Cost variance = Recovered Overhead – Actual Overhead

V.O. Expenditure Variance = Standard Overhead – Actual Overhead

V.O. Efficiency Variance = Recovered Overhead – Standard Overhead

Sales Variance :Sales price variance: Actual quantity of Sales (Actual price – Budgeted price)

Sales volume variances: Budgeted price (Actual quantity – Budgeted quantity)

65

CASE STUDY

STANDARD COSTING AT GLOBAL COMMUNICATION LTD.8.9.1 About Global Communications : Global Communication Ltd. (GCL), manufacturers of

Telephone Exchanges, had been incorporated in the early 90s and has since grown rapidly.

Today it is considered as one of the largest Telecom Company in the country. Till only a few

months back, being the only manufacturer of such products, GCL was enjoying monopoly and

huge Gross Profit Margins to its credit. Costing was hence not thought to be important, except

to facilitate statutory Financial Audits. However, the Telecom revolution changed the scenario

in no time, with more business houses venturing into Exchange production. Sensing

competition, the management had been quick to hire the services of Mr. Ravi Shankar in

order to help implement a relevant Costing System for its plant located at Kanpur. The system

was to be such, so as to fulfil the requirements of Material and Expenses Control, facilitate

Statutory Audit, help in Pricing Decisions and provide for the day-to-day requirements of

Excise, etc. Since the variable cost component within the production process was quite high a

Standard Costing System was thought off to be most appropriate.

The Manufacturing Process

GCL manufactures two types of Exchanges, viz.

1. Exch 007

2. Exch 009

Both the Exchanges are produced on separate Production Lines; however, the process of

manufacture is strikingly similar. Raw Material Cost comprises about 75% of the total

Product Cost and is the only identifiable Variable Cost.

Production is carried out by two departments – Assembly and Testing.

Raw material is issued in lots for 100 units of Finished Goods to the Assembly

department. Various electronic components are inserted into the Printed Circuit Boards

(PCBs) over here. About 40% of the insertions done by the Assembly department are

automated, the rest being done by hand. The inserted components are then soldered

manually. PCBs are plate shaped metallic sheets having tracks over the surface. These

66

tracks facilitate the electronic connectivity between various components inserted at

different parts of the sheets.

Thirty-six such populated PCBs are finally assembled in a Rack, which is transferred to

the Testing department for quality check and approval.

If found OK, the production is said to be complete.

In case there is any wastage on the floor (either in Testing or Assembly departments), the

material is replaced by the stores on receipt of a replacement slip duly signed by the

Assembly or Testing department’s supervisor. The defective component so replaced is

handed back to the stores. However there are no records maintained for such scrap

generated, as it does not carry any significant economic value.

The mechanics of the system as explained by Ravi :In due course, the system was designed

and presented in a meeting attended by almost all senior personnel’s of the Factory. Ravi

used an OHP to present a few slides, which have been shown as Exhibits below.

The mechanics of the system was described by Ravi as follows:

“A spread sheet for the components of cost for each of the 1800 Raw Materials shall be

drawn as shown in Exhibit 1.

A standard amount for each of these components of cost for every single raw material these

estimated cost components shall give ‘Standard Cost of each individual Raw

Material’ and would serve as an input for the estimated Raw Material cost (also known as

BOM cost i.e., ‘Bill of Material cost’) in the Standard Cost Sheet.

There shall be two cost sheets pertaining to the two exchanges being manufactured in

the factory. The cost sheets shall be drawn on the capacity available to the company and

not the budgeted production since the Company has frequently produced to capacity,

especially when nearing the close of the three previous financial years.

Hence, projections of overheads shall be done as if GCL would be attaining 100%

capacity utilization. The Bill of Material shall be extended to incorporate other columns as

shown in Exhibit 2.

This extended version of the BOM shall be known as Direct Material Control Statement

(DMCS) and shall be used to calculate net usage and net price variances. Two such

statements would be prepared, one each for the two Exchanges. The usage and price67

variances shall be calculated by using the rejection slips generated in the production

department/lines for identifying actual consumption (in quantity) of raw material during a

particular month. Since the Rejection Slips shall bear the production lot nos., the quantity

of raw material identified in them shall need to be added to the quantity estimated to be

consumed for that particular production lot no. actual price of each of the raw material

consumed shall be provided by the accounts department and shall be inserted manually in

column No.7 of the DMCS. Standard overheads on actual production for each of the two

exchanges shall be arrived at with the help of the projected figures of the respective Cost

Sheets (Exhibit 3). Such standard overheads on actual production shall be compared with the

factory trial balance in order to arrive at the overhead expense variance.

Standard fixed cost per unit as projected by the two cost sheets shall be utilized to calculate

the production volume variance. The sales price variance shall reflect the difference between

the actual and the standard selling price on actual sales.

Finally, adding all these five variances to the standard profit (The difference between the

estimated standard selling price and the estimated cost per unit of each of the two

exchanges) shall help arrive at the actual profit shall have to be established in the beginning

of the financial year. The sum total of all This profit shall then be reconciled with the financial

accounting profit as shown by the accounts department. The reporting pattern shall be as

shown below.

Period of reporting Type of report

Daily Production volume variance and daily standard profit based on daily production.

Monthly ∞ Statement of profit and loss based on standard profit adjusted with the above

mentioned five variances.

∞ Reconciliation of the costing profit with the financial accounting profit.

∞ Direct material control statement incorporating usage and material price variances

68

69

The Proposed System: A Critical Appraisal

The presentation being over, the dais was thrown open to suggestions. The system was appreciated

by one and all; however the following suggestions were made by the various functional managers.

Purchase cost to be loaded over, as a percentage of the raw material cost shall not help arrive at the

exact incidence of cost. According to the production manager, “in case I buy a Re. 1/- resistor and a

Rs. 5000/- IC from the same vendor at the same time, will it not be wrong to consider different

production overhead burden on the two concerned components?”

The mechanics of calculating the actual quantity of raw material consumed may not give accurate

results. Opined the finance manager “in case I use the rejection slips to understand the extra material

consumed, I shall not be sure of the exact figures. This shall necessitate the need of scrap

accounting, which at present does not exist”.

The purchase manager was sceptical about the mechanics of calculating the raw material purchase

price variance. “In case the usage variance is abnormal, a small adverse variance in the purchase

price shall be blown out of proportion”.

The accounts manager highlighted the need of an integrated accounting system rather than the

proposed use of the accounting trial balance as it existed on date, “without production accounting the

control of material is difficult. Year after year we are having problems reconciling purchases with the

stock. Since it is difficult to physically identify the WIP every month end, the only alternative left is an

integrated accounting system with an efficient cycle count (perpetual inventory check)”

Questions

1. The raw material price variance is calculated on the actual quantity of raw material consumed?

Suggest a modification to satisfy the concerns raised by the purchase manager.

2. How could an integrated accounting system be of help?

70

Standard Costing and Variance Analysis Case Study:

1. Case A: Effect of assumed standard levels

2. Case B: Factory overhead variance analysis

Case A:

Effect of Assumed Standard Levels:

Harden Company has experienced increased production costs. The primary area of concern

identified by management is direct labor. The company is considering adopting a standard cost

system to help control labor and other costs. Useful historical data are not available because detailed

production records have not been maintained.

To establish labor standards, Harden Company has retained an engineering consulting firm. After a

complete study of the work process, the consultants recommended a labor standard of one unit of

production every 30 minutes, or 16 units per day for each worker. The consultants further advised

that Harden's wage rates were below the prevailing rate of $ per hour.

Harden's production vice-president thought that this labor standard was too tight, and from

experience with the labor force, believed that a labor standard of 40 minutes per unit or 12 units per

day for each worker would be more reasonable.

The president of Harden Company believed the standard should be set at a high level to motivate the

workers and to provide adequate information for control and reasonable cost comparison. After much

discussion, management decided  to use a dual standard. The labor standard of one unit every 30

minutes, recommended by the consulting firm, would be employed in the plant as a motivation device,

while a cost standard of 40 minutes per unit would be used in reporting. Management also concluded

that the workers would not be informed of the cost standard used for reporting purposes. The

production vice-president conducted several sessions prior to implementation in the plant, informing

the workers of the new standard cost system and answering questions. The new standards were not

related to incentive pay but were introduced when wages were increased to $7 per hour.

The standard cost system was implemented on January 1, 19--. At the end of six months of

operation, these statistics on labor performance were presented to executive management:

71

 Januar

yFebruaryMarch April May June

Production (units) 5,100 5,000 4,700 4,500 4,300 4,400

Direct labor hours 3,000 2,900 2,900 3,000 3,000 3,100

Quantity Variances:            

Variance based on

labor standard (one unit

each 30 minutes)

$3150

U*

$2,800

U

$3,850

U $5,250U

$5,950

U

$6,300

U

Variance based on

cost standard (one unit each

40 minutes)

$2,800

F $3,033 F

$1,633

F -0- $933U

$1,167

U

*U = Unfavorable; F = Favorable

Materials quality, labor mix, and plant facilities and conditions have not changed to any great extent

during the six month period.

Required:

1. A discussion of the impact of different types of standards on motivations, and specifically the

likely effect on motivation of adopting the labor standard recommended for Harden Company

by the engineering firm.

2. An evaluation of Harden Company's decision to employ dual standards in its standard cost

system.

Answer:

1. Standards are often classified into three types - theoretical (tight), normal (reasonable), or

expected actual (loose). Standards which are too loose or too tight will generally have a

negative impact on workers motivation. If too loose, workers will tend to set their goals at this

low rate, thus reducing productivity below what is obtainable; if too tight, workers will realize

that it is impossible to attain the standard, become frustrated, and will not attempt to meet

the standard. An attainable or reasonable standard which can be achieved under normal 72

working conditions is likely to contribute to the worker's motivation to achieve the designated

level of activity.

If executive management imposes standards, workers and plant management will tend to react

negatively because they feel threatened. If workers and plant management participate in

setting the standard, they can more readily identify with it and it could become one of their

personal goals.

In Harden's case, it appears that the standard was imposed on the workers by management.

In addition, management used an ideal standard to measure performance. Both of these

actions appear to have had a negative impact on output over the first six months.

 Harden made a poor decision to use dual standards. If the workers learn of the dual

standards, the company's entire measurement system may may become suspect and

credibility will be lost. Company morale could suffer because the workers would not know for

sure how the company evaluates their performance. as a result, disregard for the present and

any future cost control system may develop.

Case B:

Factory Overhead Variance Analysis:

Strayer Company uses a standard cost system and budgets the following sales and costs for 19--

Unit sales 20,000

Sales $2,00,000

Total production cost at standard 130,000

Gross profit 70,000

Beginning inventories None

Ending inventories None

The 19-- budgeted sales level was the normal capacity level used in calculating the factory overhead

predetermined standard cost rate per direct labor hour.73

At the end of 19--, Strayer Company reported production and sales of 19,200 units. Total factory

overhead incurred was exactly equal to budgeted factory overhead for the year and there was under-

applied total factory overhead of $2,000 at December 31. Factory overhead is applied to the work in

process inventory on the basis of standard direct labor hours allowed for units produced. Although

there was a favorable labor efficiency variance, there was neither a labor rate variance nor materials

variances for the year.

Require: An explanation of the under-applied factory overhead of $2,000, being as specific as the

data permit and indicating the overhead variances affected. Strayer uses a three variance method to

analyze the total factory overhead.

Answer:

Under-applied factory overhead will arise when actual factory overhead incurred is larger than

the standard amount of factory overhead applied to work in process. The standard amount of factory

overhead applied to work in process is based on actual rather than on budgeted units of output.

Based on the information given, the sum of the factory overhead spending, efficiency, and idle

capacity variances resulted in an unfavorable total factory overhead variance of $2,000.

The factory overhead efficiency variance must be favorable because it is computed on the same

basis as the direct labor efficiency variance which was given as favorable.

Strayer would have an unfavorable idle capacity variance because the actual activity level for the year

was less than the capacity level used in calculating the standard cost rate for factory overhead.

As to the factory overhead spending variance, the balance would be unfavorable because actual

costs would have had to exceed the budgeted cost of the actual units produced since the budget

allowance for production of 19,200 units must be less than for 20,000 units and the actual costs were

exactly equal to the budget allowance for 20,000 units. The magnitude of the spending variance is

indeterminate from the information given.

74

REFRENCES

Arthur Hindmarch and Marry Simpsons (1991) Financial accounting.

Janet Brammer , David Cox ,Michael Fardon ,Aubrey Penning (2002) Active Accounting

Cost Accounting Vol1 The Institute Of Chartered Accountants Of India

Cost Accounting Vol 2 The Institute Of Chartered Accountants Of India

The Standard Costing System At SKF: A Case Study Of A Swedish Manufacturing Company

LINKS:

http://www.mccc.edu/~horowitk/documents/VanDerbeck15e_

www.accountingformanagement.com/standard_costing_variance_analysis_case_study

http://www.globusz.com/ebooks/Costing/00000011.htm

http://www.nos.org/srsec320newe/320el29a.pdf

http://www.globusz.com/ebooks/Costing/00000010.htm

http://www.slideshare.net/hemanthcrpatna/a-study-on-formulation-of-costing-system

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