Standard Costing April 12 2008

Standard CostingAccounting 2020-Chapter 10

Prof. Richard McDermott

What is a Standard?

• A goal• A yardstick• A requirement• A criterion• Merriam-Webster says

– A definite rule, principle, or measure established by authority.

In Cost Accounting . . .

• A standard is a budgeted cost per unit of product.

• We have standard costs for:– Direct labor– Direct materials– Factory overhead

Taxonomy

• A way of classifying things.• How could you classify the marbles

in a large jar?– By size– By color– By material– Etc.

One Accounting Taxonomy

• Actual costing system• Normal costing system• Standard costing system

Actual Costing System• Debit work-in-process for

– Actual direct labor– Actual direct materials– Actual factory overhead

• Actual costing systems are rarely used because– One cannot establish product overhead

costs until the period is over– Fluctuations in monthly fixed overhead or

monthly production distorts product costs

Normal Costing System

• Debit work-in-process for– Direct labor– Direct materials– Overhead applied using an overhead

rate

• This is basically what you have been taught up to this point.

Standard Costing System

• Debit work-in-process for:– Standard direct labor– Standard direct materials– Standard factory overhead

• Standard variable overhead• Standard fixed overhead

• Calculate variances and debit or credit them to – Cost of goods sold if not material– WIP, Finished Goods & COGs if material

Standard Costing Reports:

• Standard Costs—what a product should cost.

• Actual Costs—what the actual actually cost

• Cost Variances—the difference between a standard cost and the actual cost.

Example

• The standard direct labor cost for a widget is $12.00.

• During January 2008 the actual cost to manufacture one widget was $11.50

• There was a favorable cost variance of $0.50.

Types of Standards

• Ideal Standards—represent optimum levels of performance under perfect operating conditions.

• Normal Standards—represent efficient levels of performance that are attainable under expected operating conditions.

Why Standard Costing?

• Facilitation of management planning.

• Make employees more cost conscious.

• Helpful in setting prices.

• Provides basis for evaluating management performance.

• Allows management by exception.

• Simplifies clerical costs and inventory costing.

What is best?

• Most managers believe it is best to use rigorous but attainable standards.

• We classify these as normal standards.

• In the remainder of this chapter we assume standard costs are set at a normal level.

Direct Materials Standard

• What the cost of direct materials should be to manufacture one unit.

• Standard direct material cost can include:

• Purchase price of materials• Freight• Receiving and handling

Direct Materials Standard

• Is broken into two sub-standards• Quantity Standard—how much

(ounces, pounds and so on) of the material one unit of the product should contain

• Price Standard—what the price per unit of material (ounce, pound, and so on) should be.

Direct Materials Variances

• Price Variance—the cost difference attributable to the difference between the standard price of one unit of material and the actual price of one unit of material.

• Quantity Variance—the cost difference attributable to the difference between the standard amount and the actual amount in one unit of the product during the period.

Calculation of Variances

AQ X AP = X1

AQ x SP = X2

SQ x SP = X3

Where:

AQ = actual quantityAP = actual priceSQ = standard quantitySP = standard price

Calculation of Variances

AQ X AP = X1

AQ x SP = X2

SQ x SP = X3

Price Variance

Quantity Variance

Example

• The standard material for one ingot is 2 pounds of copper at $2.00 per pound.

• During the period the company made 1,000 ingots.

• The company actually used 1,950 pounds of copper costing $1.75 per pound.

• What are the direct material variances?

Example

AQ X AP = X11950 x $1.75 = $3,412.50 AQ x SP = X21950 x $2.00 = $3,900.00

$487.50 Favorable Price

Example

AQ X AP = X11950 x $1.75 = $3,412.50 AQ x SP = X21950 x $2.00 = $3,900.00

SQ x SP = X32000 x $2 = $4,000.00

$487.50 Favorable Price

$100 Favorable Quantity

Direct Labor Variances

• The standard is based on current wage rates, adjusted for anticipated changes such as cost of living adjustments.

• The rate standard also generally includes employer payroll taxes, and fringe benefits such as paid holidays and vacations.

Direct Labor Variance

AH X AR = X1

AH x SR = X2

SH x SR = X3

Where:

AH = actual hoursAR = actual rateSH = standard hoursSR = standard rate

Note: This is essentially the same formula as for materials, exceptwe substitute hours for quantity, and rate for price.

Example

• The standard hours for one ingot is 1 hour at $10 per hour.

• During the period the company made 1,000 ingots.

• The company actually used 1,050 hours at a total labor cost of $10,237.50

• What are the direct labor variances?

Example

AH X AR = X11050 x $9.75 = $10,237.50 AH x SR = X21050 x $10.00 = $10,500.00

$262.50 Favorable Rate

Example

AH X AR = X11050 x $9.75 = $10,237.50 AH x SR = X21050 x $10.00 = $10,500.00

SH x SR = X31000 x $10.00 = $10.000.00

$262.50 Favorable Rate

$500 Unfavorable Efficiency

Manufacturing Overhead

• Similar to manufacturing overhead rate we learned about earlier.

• Applied using a base such as direct labor hours or dollars.

• Usually there are separate standards for fixed and variable overhead.

• Formula: Actual overhead – overhead applied = total overhead variance

Overhead Variance

• The total overhead variance can be broken into a controllable variance and a overhead volume variance.

• The formula is:• Actual OH – Budgeted OH =

Controllable variance• Fixed OH rate x (Normal capacity

hours – standard hours allowed) = overhead volume variance

Three Kinds of Overhead

• Budgeted overhead—number we came up with at the beginning of the year.– Use for one thing—to calculate rate for

the year (actually we use it for calculating variance)

• Actual overhead—this is what we actually spent, this number comes from the general ledger).

• Overhead applied—budgeted overhead rate x base.

Overhead Variance• The controllable variance tells

whether spending on individual overhead items was controlled or not.

• The volume variance relates to whether overhead was over or under applied due to differences in budgeted base and actual base.– i.e. did we us too many overhead hours

(if it is the base) or fewer than we estimated?

Overhead Variance

• There was not a problem assigned in the homework for overhead variances.

• You may be tested on the concept in Appendix 11B, however.

• We will work some example questions in class before taking the test.

Who is Responsible?

• Materials price variance—usually the purchasing agent

• Materials quantity variance—usually the production supervisor

• Labor rate variance—usually the personnel director

• Labor efficiency variance—usually the production supervisor

Who is Responsible?

• Overhead variances– Over or under spending on specific

overhead items– Use of more or less of the base than

anticipated. For example if the base is direct labor hours, then additional hours used incur additional fringe benefit costs, one component of the overhead pool.

Reporting Variances

• Report variances to appropriate levels of management as soon as possible.

• The form, content, and frequency of variance reports varies considerably among companies.

• In income statements prepared for management, cost of goods sold is stated at standard costs and the variances are disclosed separately.

Sales $60,000

COGS (at standard) 42,000

Gross profit (at standard) $18,000

Variances

Materials price $420

Materials quantity 600

Labor rate (420)

Labor quantity 1,000

Overhead 900

Total variances unfavorable 2,500

Gross profit (actual) 15,500

Selling and Administrative 3,000

Net Income $12,500

Book Example

Balanced Scorecard

• Based on the concept that accountants should report on more than just financial matters.

• The balanced scorecard should report on the key factors necessary to implement the company’s strategy.

Four Most Common Perspectives

• Financial Perspective—financial measures of performance used by most firms.

• Customer perspective—evaluates how well the company is performing from the viewpoint of the customer.

Four Most Common Perspectives

• Internal Growth Perspectiv2—evaluates the internal growth processes critical to success such as product development, production, delivery and after sales service.

• Learning and Growth Perspective—evaluates how well the company develops and retains its employees.

Brief Exercise 11-2

• Asaki Company accumulates the following data concerning raw materials in making one gallon of finished product:– Price—net purchase price $2.20, freight-

in $0.20, and receiving and handling $0.10.

– Quantity—required materials 2.6 pounds, allowance for waste and spoilage 0.4 pounds.

• Compute required variances.

Brief Exercise 11-2

• Standard direct materials price per gallon = $2.20 purchase price + $0.20 freight-in + $0.10 receiving and handling = $2.50.

• Standard direct materials quantity per gallon = 2.6 poundsquantity needed + allowance for spoilage 0.4 = 3.00 pounds.

Brief Exercise 11-2

• Standard direct materials cost per gallon = $2.50 x 3.00 pounds = $7.50.

Exercise 11-2

• Tony Rondeli manufactures and sells homemade wine, and he wants to develop a standard cost per gallon.

Exercise 11-2

• The following costs are required for a production of a 50 gallon batch.– 3,000 ounces of grape concentrate at

$0.40 per ounce– 54 pounds of granulated sugar at $0.35

per pound– 60 lemons at $0.60 each– 50 yeast nutrient tablets at $0.25 each– 50 nutrient tablets at $0.20 each– 2,500 ounces of water at $.004 per

ounce

Exercise 11-2

• Tony estimates that 4% of the grape concentrate is wasted, 10% of the sugar is lost, and 20% of the lemons cannot be used.

• Compute the standard cost of the ingredients for one gallon wine (carry computations to two decimal places).

Exercise 11-2

• Let’s start by figuring how much we have to buy of the ingredients to have the wastage and still have enough to make 50 gallons.

• Let’s start with the 4% waste of grape concentrate.

• This is not 4% of the concentrate that goes into the juice, but 4% of the purchased concentrate.

Exercise 11-2

• Grape Concentrate:• Let X = amount that must be

purchased before waste• For one gallon we need 60 0z• X - .04X = 60 (amount needed for 1

gallon_• .96 x = 60• X = 62.50 standard amount

purchased

Exercise 11-2

• Sugar:• Let X = amount that must be

purchased before waste• For one gallon we need 54/50 =

1.08 pounds of input• X - .10X = 1.08 pounds• .9X = 1.08 pounds• X = 1.2 pounds

Exercise 11-2• Lemons:• We need 60/50 lemons for 1 gallon = 1.20

lemons• X - .20X = 1.20• .8X = 1.20• X = 1.50 lemons

Now we are ready to calculate the total standard cost of materials.

Standard Materials

IngredientAmount

PerGallon

StandardWaste

StandardUsage

StandardPrice

StandardCost Per

Gallon

Grape concentrateSugar (54 ÷ 50)Lemons (60 ÷ 50)YeastNutrientWater (2,500 ÷ 50)

60* oz.1.08 lb.

1.21 tablet1 tablet

50 oz.

 4%10%20% 0% 0% 0%

62.5 oz.1.2 lb.

1.51 tablet1 tablet

50 oz.

$.04    .35    .60    .25    .20   

.004

$2.50  .42  .90  .25  .20  .20$4.47

Amount used

Amount Purchased

Standard

Cost

Exercise 11-3 (to be cont)

• Muhsin Co. has gathered the information shown on page 502 about its product.

• Direct materials: Each unit of product contains 4.5 pounds of materials.