Standard costs for control:
Direct material and direct labour
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 Businesses are in control when operations proceed to plan and objectives are achieved
 Necessary requirements for control
 A predetermined or standard performance level
 A measure of actual performance; and
 A comparison between standard performance and actual performance
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 Standard costing is a part of the budgetary control system
 A predetermined or standard cost is developed
 A standard cost is a budget for the production of one unit of a product, either goods or services
 The actual cost incurred is measured
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 The actual cost is compared to the budgeted or standard cost, to form a standard cost variance
 Standard cost variances are used to evaluate actual performance and control costs
 Standard costs can be developed for direct material, direct labour and overheads
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 A variety of methods may be used to set cost standards
 Analysis of historical data
 Can provide a good basis for predicting future costs
 May need to be adjusted to reflect expected movements in price levels or technological changes into the product process
 Must be used with care as changes can make those costs irrelevant, and can include inefficiencies of the past continued
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 Engineering methods
 Rather than what did it cost in the past, the focus is on what should it cost in the future?
 Need to determine how much material should be required and how much direct labour should be used in the production process
 Time and motion studies may be conducted to ascertain how long it should take for workers to perform each step
 In practice both historical cost analysis and engineering methods may be used in combination
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 Participation in setting standards
 Standards should not be set by accountants alone
 People will usually be more committed to meeting standards and have greater confidence in their accuracy if they are allowed to participate in setting them
 Any manager who plays an integral part in an operation or process should participate in setting standards for that area continued
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 Perfection standards reflect minimum attainable costs under nearly perfect operation conditions
 Assumes peak efficiency, the lowest material and labour prices, the use of the best quality materials, and no production disruptions due to power failures or machine breakdowns
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 Perfection standards
 May motivate people to achieve the lowest cost possible, as the standard is theoretically attainable
 May discourage employees from workings hard as the standards are unlikely to be achieved
 May encourage employees to sacrifice quality to achieve low costs
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 Practical standards are the minimum attainable costs under normal operating conditions, with allowances made for downtime and wastage
 Factors in occasional machine breakdowns and normal amounts of raw material wastage
 May encourage more positive and productive attitudes among employees compared to perfection standards
 Some companies include allowances for idle time, material wastage or normal spoilage, which may encourage inefficiency and waste
 Other companies build continuous improvements into standards to make them more demanding continued
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 Benchmarking of costs may involve
 Identifying companies that have the best cost performance,
 Assessing their level of costs, and
 Identifying the cost performance gap that needs to be closed
 Cost standards may be formulated to achieve external performance standards over the medium to long term
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 Standard material quantity is the total amount of direct material required to produce one unit of product
 Standard material price is the total delivered cost of that material, less quantity discounts
 Based on ordering a specified supplier certain quality of material in specific order quantities from a
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 Standard direct labour is the number of labour hours normally needed to manufacture one unit of products
 Standard about rate is the total hourly cost of wages, including on-costs
 On-costs are extra salary-related costs that all
Australian companies have to pay, and usually treated as part of the cost of labour
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Direct material:
Standard direct material cost per pair of moleskins $38.75
Actual output
Total standard direct material cost
Direct labour:
X 2 000
$77 500
Direct labour cost per pair of moleskins
Actual output
Total standard direct labour cost
$25.20
X 2 000
$50 400
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 Direct material price variances
 The effect on cost of purchasing at a price that is different from standard
= PQ (AP – SP)
Where PQ= quantity purchased
AP= actual price
SP= standard price
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 Sometimes the direct material price variance is calculated using the quantity of materials used in production (AQ) rather than the quantity of material purchased
(PQ)
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 Direct material quantity variance
 The effect on cost of using a different quantity of material in production, compared with the standard quantity that should have been used for the actual production output
= SP (AQ - SQ)
Where SP= standard price
AQ= actual quantity used
SQ = standard quantity used, given actual output
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 Direct labour rate variance
 Effect on cost of paying a different labour rate, compared with standard
= AH (AR - SR)
Where AH= actual hours used
AR= actual rate per hour
SR= standard rate per hour
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 Direct labour efficiency variance
 Effect on cost of using a different number of direct labour hours, compared with the standard hours that should have been used for the actual production output
= SR (AH-SH)
Where AH= actual hours used
SH= standard hours allowed given actual output
SR= standard rate per hour
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 Management by exception
 Only reporting significant cost variances
 Significant variances
 Size of variance
 Recurring variances
 Trends
 Controllability
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 Favourable variances warrant similar investigation to unfavourable variances
 Investigating variances may include
 Talking with managers and employees familiar with the operations to find causes
 Written reports to explain significant variances and possible corrective actions
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 Variances may be caused by random fluctuations which may not require correction
 Statistical control charts plot standard cost variances across time and compares them with a statistically determined critical value to highlight the variances which should be investigated
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 Costs include
 Time spent investigating the problem
 Disruption to the production process as the investigation is conducted
 Corrective actions
 Benefits include
 Reduced costs if cause of variance is eliminated
 Causes of favourable variances may improve work practices
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 Standard costing can be used to evaluate the performance of employees and departments
 Comparing individuals’ performance with standards or budgets is used to determine salary increases, bonuses and promotions.
These can profoundly influence behaviour
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 Cost control is accomplished through the efforts of individual managers and employees
 It is important that managers held responsible for achieving certain cost standards
 Can control these outcomes
 Are involved in setting the standards
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 Interactions between variances may make it difficult to assign responsibility for particular variances
 Not all favourable variances are desirable
 Unfavourable variances do not always indicate a problem
 Source of the variance may lie in a different area of the firm than where the variance is being reported
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 Standard costing system
 All inventories are recorded at standard cost
 Variances are closed off at the end of accounting period
 To cost of goods sold expense, or
 Prorate between WIP, FG and COGS
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