# Standard costing

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```					    Standard costing

1
Standard costing system

   The management evaluates the performance
of a company by comparing it with some
predetermined measures
   Therefore, it can be used as a process of
measuring and correcting actual performance
to ensure that the plans are properly set and
implemented

2
Procedures of standard costing
system
   Set the predetermined standards for sales margin and
production costs
   Collect the information about the actual performance
   Compare the actual performance with the standards to
arrive at the variance
   Analyze the variances and ascertaining the causes of
variance
   Take corrective action to avoid adverse variance
   Adjust the budget in order to make the standards more
realistic

3
Functions of standard costing
system

   Valuation
–   Assigning the standard cost to the actual output
   Planning
–   Use the current standards to estimate future sales
volume and future costs
   Controlling
–   Evaluating performance by determining how
efficiently the current operations are being carried
out

4
   Motivation
–   Notify the staff of the management’s expectations
   Setting of selling price

5
Variance

6
Variance analysis

   A variance is the difference between the
standards and the actual performance
   When the actual results are better than the
expected results, there will be a favourable
variance (F)
   If the actual results are worse than the
expected results, there will be an adverse
variance (A)

7
Profit variance

Selling and          Total production        Total sales margin variance
Cost variance

Sales margin      Sales margin
Price variance    volume variance

Materials        Labour           Variable                Fixed
variance         variance         variance                variance

8
Materials cost variance

Material Price variance       Material Usage variance

Labour cost variance

Labour rate                 Labour Efficiency
variance                    variance

9

VO Expenditure variance         VO Efficiency variance

Fixed Expenditure variance         Fixed Volume variance

10
Cost variance

11
Cost variance
•Cost variance = Price variance + Quantity variance
Cost variance is the difference between the standard cost and the
Actual cost

•Price variance = (standard price – actual price)*Actual quantity
A price variance reflects the extent of the profit change
resulting from the change in activity level

•Quantity variance = (standard quantity – actual quantity)*
standard cost
A quantity variance reflects the extent of the profit change
12   resulting from the change in activity level
Three types of cost variance

   Material cost variance
   Labour cost variance

13
Material and labour variance

14
Material cost variance

   Material price variance
= (standard price – actual price)*actual quantity
   Material usage variance
= (Standard quantity – actual quantity)* standard price
= (Standard quantity for actual production – actual
quantity production) * standard price

15
Labour cost variance

   Labour rate variance
= (standard price – actual price)*actual quantity
   Labour efficiency variance
= (standard quantity – actual quantity)*standard price
= Standard quantity for actual production – actual
quantity used) * standard price

16
Example

17
ABC Ltd. makes and sells a single product. The company uses a
Standard marginal costing system. It plans to produce and sell 1000
units in May 2005. A budget statement is produced as follow:

Budgeted income statement for the month ended 31 May 2005
\$     \$
Sales (\$50*1000)                                       50000
Less: Variable cost of goods sold
Direct materials (\$3*4000)               12000
Direct labour (\$5*3000)                  15000
Budget contribution                                    17000
Budget profit                                          14000

18
The actual sales and production is 800 units. The actual income
statement is shown as follows:

Income statement for the month ended 31 May 2005
\$      \$
Sales (\$60*800)                                            48000
Less: Variable cost of goods sold
Direct materials (\$3.2*2400)                12000
Direct labour (\$6*3200)                     15000
Contribution                                              15620
Net profit                                                13020

19
Material cost variance

  Material price variance
= (standard price – actual price)*actual quantity
= (\$3 - \$3.2)*2400
= \$480 (A)
 Material usage variance
= (Standard quantity – actual quantity)* standard price
= (Standard quantity for actual production – actual
quantity production) * standard price
4000 units
= (4*800 – 2400)*\$3
1000 units
20        = \$2400 (F)
Material cost variance

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

21
Labour cost variance
   Labour rate variance
= (standard price – actual price)*actual quantity
= (\$5 - \$6)*3200
= \$3200 (A)
   Labour efficiency variance
= (standard quantity – actual quantity)*standard price
= Standard quantity for actual production – actual
quantity used) * standard price
3000 units
= (3* 800 – 3200)*\$5
1000 units
22          = \$4000 (A)
Labour cost variance

   Labour rate variance       \$3200 (A)
   Labour efficiency variance \$4000 (A)
   Total labour cost variance \$7200 (A)

23

24

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   Variable overheads variance is the difference
absorbed into the actual output and the actual

26
Absorbed VO
Budgeted VO             (SP* standard
Actual VO            (SP * Actual            hours for actual
hours worked            output

VO expenditure variance/      VO efficiency variance
VO spending variance

Total VO variance
(under-/over- absorbed)

27

   Step 1
POAR = Budgeted activity level in standard hours

   Step 2

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

28

incurred
= standard variable overheads for actual hours worked – Actual
= Standard variable overheads for standard hours of output –
= (standard hours for actual output – Actual hours worked)*
standard price
29
Example

30
ABC Ltd. makes and sells a single product. The company uses a
Standard marginal costing system. It plans to produce and sell 1000
units in May 2005. A budget statement is produced as follow:

Budgeted income statement for the month ended 31 May 2005
\$     \$
Sales (\$50*1000)                                       50000
Less: Variable cost of goods sold
Direct materials (\$3*4000)               12000
Direct labour (\$5*3000)                  15000
Budget contribution                                    17000
Budget profit                                          14000

31
The actual sales and production is 800 units. The actual income
statement is shown as follows:

Income statement for the month ended 31 May 2005
\$      \$
Sales (\$60*800)                                            48000
Less: Variable cost of goods sold
Direct materials (\$3.2*2400)                12000
Direct labour (\$6*3200)                     15000
Contribution                                              15620
Net profit                                                13020

32
POAR = Budgeted activity level in standard hours

= \$6000
3000
= \$2
Overhead absorbed = POAR * Standard hours for actual
number of units produced
= \$2 *3 hr per unit * 800 units
Standard hr per unit = 3000 hr /1000 units
33

= variable overheads absorbed – actual variable
= \$4800 - \$5500
= \$700 (A)
= standard variable overheads for actual hours
worked – Actual variable overheads incurred
= (\$2* 3200 hr) - \$5500
= \$900 (F)
34
= Standard variable overheads for standard
hours of output – Actual variable overhead
absorbed
= (standard hours for actual output – Actual
hours worked)* standard price
= (3 hr *800 units – 4 hr *800 units)*\$2
= \$1600 (A) Actual hour per unit = \$3200 hr/800 units

35

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

36
Sales variance

37
Budgeted
Actual             Budgeted contribution         contribution
contribution       (Standard margin * Actual     (Standard margin*
Volume)                       Standard volume)

Sales margin price variance    Sales margin volume variance

Total sales margin variance

38
Sales variance (Marginal costing)
   Total sales margin variance
= actual contribution – budgeted contribution
= [(Actual selling price – Standard cost of sales )*Actual sales
volume] – Budgeted contribution
   Sales margin price variance
= (Actual contribution per unit – Standard contribution per unit) *
Actual sales volume
   Sales margin volume variance
= (Actual volume – Budget volume)* Standard
contribution per unit

39
Sales variance (Absorption costing)

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

40
Example

41
ABC Ltd. makes and sells a single product. The company uses a
Standard marginal costing system. It plans to produce and sell 1000
units in May 2005. A budget statement is produced as follow:

Budgeted income statement for the month ended 31 May 2005
\$     \$
Sales (\$50*1000)                                       50000
Less: Variable cost of goods sold
Direct materials (\$3*4000)               12000
Direct labour (\$5*3000)                  15000
Budget contribution                                    17000
Budget profit                                          14000

42
The actual sales and production is 800 units. The actual income
statement is shown as follows:

Income statement for the month ended 31 May 2005
\$      \$
Sales (\$60*800)                                            48000
Less: Variable cost of goods sold
Direct materials (\$3.2*2400)                12000
Direct labour (\$6*3200)                     15000
Contribution                                              15620
Net profit                                                13020

43
Sales variance (Marginal costing)

   Total sales margin variance
= actual contribution – budgeted contribution
= [(Actual selling price – Standard cost of
sales )*Actual sales volume] – Budgeted
contribution
= [(\$60 - \$33)*800] - \$17000
= \$21600 - \$17000
\$33000/1000 units
= \$4600 (F)

44
Sales variance

   Sales margin price variance
= (Actual contribution per unit – Standard contribution
per unit) * Actual sales volume
= [(\$60 - \$33) – (\$50 - \$33)]*800
= \$8000 F                           \$33000/1000 units
   Sales margin volume variance
= (Actual volume – Budget volume)* Standard
contribution per unit
= (800 -1000)*\$17       \$17000/1000 units
= \$2800 (A)
45
Sales variance (Marginal costing)

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

46
Sales variance (Absorption costing)
   Sales margin price variance
= (Actual profit margin per unit – Standard profit margin per unit) *
Actual sales volume
= [(\$60-\$36) – (\$50-\$36)]*800
= \$8000 F                               (33000+3000)/1000 units
   Sales margin volume variance
= (Actual volume – Budget volume)* Standard profit margin per
unit
= (800-1000)*\$14
= \$3400 A
\$14000/1000 units

47
Sales variance (Absorption costing)

   Sales margin price variance    \$8000 F
   Sales margin volume variance   \$2800 A
   Total sales variance           \$5200 F

48

49
Absorbed VO
(SP* standard
Actual FO             Budgeted FO             hours for actual
output

FO expenditure variance/       FO volume variance
FO spending variance

Total FO variance
(under-/over- absorbed)

50
incurred
absorbed
absorbed

51
Example

52
ABC Ltd. makes and sells a single product. The company uses a
Standard marginal costing system. It plans to produce and sell 1000
units in May 2005. A budget statement is produced as follow:

Budgeted income statement for the month ended 31 May 2005
\$     \$
Sales (\$50*1000)                                       50000
Less: Variable cost of goods sold
Direct materials (\$3*4000)               12000
Direct labour (\$5*3000)                  15000
Budget contribution                                    17000
Budget profit                                          14000

53
The actual sales and production is 800 units. The actual income
statement is shown as follows:

Income statement for the month ended 31 May 2005
\$      \$
Sales (\$60*800)                                            48000
Less: Variable cost of goods sold
Direct materials (\$3.2*2400)                12000
Direct labour (\$6*3200)                     15000
Contribution                                              15620
Net profit                                                13020

54
= (\$1*3*800) - \$2600
= \$200 A
= \$3000 - \$2600
= \$400 F
= (\$1*3*800) - \$3000
= \$600 A
55
FO Variance in marginal and
absorption costing

   In marginal costing:
–   Fixed overheads are charged as period costs
instead of charging to product in marginal costing.
–   It is assumed that the fixed overheads remain
unchanged with the change in the level of activity.
Single fixed overhead expenditure variance will be
used

56
   In absorption costing
–   Fixed overheads are charged to the products and
included in the valuation of closing stock.
–   Total fixed overheads variance is divided into fixed
volume variance

57
Profit reconciliation statement

58
Profit reconciliation statement

   Profit reconciliation statement is used to sum
up all variances
   It can help the top management to explain the
major reasons for the difference between
budgeted and actual profits
   The sales margin variance and fixed
absorption and marginal costing system

59
Marginal costing

60
Profit Reconciliation Statement
\$             \$        \$
Budgeted profit                                      14000
Sales variances
Sales margin price     8000 F
Sales margin volume 3400 A           4600 F
Materials cost variance
Materials price        480 A
Material usage         2400 F        1920 F
Labour cost variance
Labour rate            3200 A
Labour efficiency      4000 A        7200 A
VO Expenditure         900 F
VO Efficiency          1600 A        700 A
Fixed overhead expenditure variance         400F     980 A
Actual profit                                        13020
61
Absorption costing

62
Profit Reconciliation Statement
Budgeted profit                                      14000
Sales variances
Sales margin price     8000 F
Sales margin volume 2800 A           5200 F
Materials cost variance
Materials price        480 A
Material usage         2400 F        1920 F
Labour cost variance
Labour rate            3200 A
Labour efficiency      4000 A        7200 A
VO Expenditure         900 F
VO Efficiency          1600 A        700 A
FO expenditure                400F
FO Volume                     600 A         200 A    980 A
Actual profit                                        13020
63
Reasons for variances

   Material price variance
–   Price changes in market conditions
–   Change in the efficiency of purchasing dept. to
obtain good terms from suppliers
–   Purchase of different grades or wrong types of
materials

64
Reasons for variances

   Materials usage variance
–   More effective use of materials/ wastage arising
from the efficient production process
–   Purchase of different grade or wrong types of
materials
–   Wastage by the staff
–   Change in production methods

65
Reasons for variances

   Labour rate variance
–   Non-controllable market changes in the basic wage
rate
–   Use of higher/lower grade of workers
–   Unexpected overtime allowance paid

66
Reasons for variances
   Labour efficiency variance
–   Purchase of different grade or wrong types of materials
–   Breakdown of machinery
–   High/low labour turnover
–   Changes in production method
–   Introduction of new machinery
–   Assignment wrong type of worker to work
–   Changes in working condition
–   Change in motivation methods

67
Reasons for variances
–   It may be caused by the non-controllable change in the price
level of indirect wages or utility rates since the predetermined
rate is set
–   It is meaningless to interpret this kind of variance on its own.
One should look various components of the fixed overheads

68
Reasons for variances

–   Both the variable overheads and direct labour cost
vary with the direct labour hours worked

69
Reasons for variances

–   It is meaningless to interpret this kind of variance on
its own.
–   It may be caused by the change in the price levels
of rent, rates and other fixed expenses

70
Reasons for variances

–   When the level of activity is higher than the
budgeted level, there is a favourable variance

71
Reasons for variances

   Sales margin price variance
–   Change in the pricing strategies of the company
–   Response to the change of pricing policies of its
competitors
–   Higher profit margin with growing demand for the
product
–   Lower profit margin for simulating sales

72
Reasons for variances

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

73

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