Standard Costing

1. Standard Costing • Operation of a standard costing system • Definition of Standard Cost • Establishing cost standards • Types of Standard Cost • Why firms use standard cost system • Standard Setting and Learning Curve Theory • Strengths and Weaknesses of Standard Costing System

2. An overview of a standard costing system Std cost of actual Output recorded for each Responsibility centre Actual costs traced to each responsibility centre Std and actual costs compared and variances analysed And reported Variances investigated and corrective action taken Standards monitored and adjusted to reflect changes in standard usage and/or prices

3. Operation of a standard costing system • Most suited to firms whose activities consists of series of repetitive operations and input required to produce each unit output can be specified • Can be applied in service industries where output can be measured such as number of cheques or number of loans processed (i.e input-output relationship well defined.

4. Variance allocated to responsibility centres (RC) • Different RC responsible for each operation • Cost control requires that RCs be identified with the std cost for the output achieved • For effective control only compare total actual costs with the total std cost for each operation or RC

5. Detailed analysis of variances • Report a detailed analysis of variances • Variances for each RC can be identified for each element of cost and analysed according to price and quantity • Accountant role: assist managers to pinpoint where variances have arisen and investigate reasons for the variances

6. COST ASSIGNMENT APPROACHES

7. Standard costs • Standard cost are predetermined costs; they are target costs that should be incurred under efficient operating conditions • Not the same as budgeted costs. A budget relates to an entire activity/ operation. A standard provides same information on a per unit basis.

8. Standard cost (cont.) • Standard costs are benchmarks based on standards established in advance for (1) the quantity of resources that should be consumed by each product or other unit of output and (2) the price of these resources • The unit standard cost for a particular input = standard price x standard quantity

9. Establishing Cost Standards • Potential sources of quantitative standards include historical experience, engineering studies and input from operating personnel • Historical records to estimate labour and material usage • Historical experience should be used with caution because it may perpetuate operating inefficiencies • Engineering studies and input from operating personnel help determine the most efficient level of input quantities. The use of an engineering study approach may by itself produce standards that are too rigorous.

10. Direct material standards • Based on product specification • Materials quantity stds are recorded in bill of materials (describes and states the required qty of materials for each operation to complete the product • Std price from purchasing dept • Std material product cost = Qty x Price

11. Direct labour standards • Activities by different operations should be analysed • Time and motion study • Unavoidable delays included in the std time • Wage rate standards could be the result of negotiations between mgt and union (or company policy)

12. Responsibilities for establishing price standards • Operation managers determine the quality of inputs required • Purchasing and Personnel have the responsibility to acquire the input quality at the lowest price that is limited by market forces and trade unions. Purchasing must consider discounts, freight and quality. Personnel must consider payroll taxes, fringe benefits and qualifications and skill • Accounting is responsible for recording the price standards and for preparing reports

13. Why firms use a standard costing system? • Three main uses of standard cost systems: • Estimate product costs. Standards are developed for the consumption of direct materials, direct labour and support activity resources required by each product. Firms use the standard product costs to help set bid prices for customer s orders and evaluate product profitability

14. Why firms use a standard costing system? • Budget for Costs and Expenditures • Total costs can be estimated based on the standard quantity of consumption of an activity required to manufacture different products and the planned production levels • Control Costs relative to Standards • Managers can compare actual costs with standard costs. Differences between actual costs and standard costs known as cost variances

15. Usage of Standard Costing systems • Managing costs • Standards help managers understand what needs to be done to improve current and future performance • Kaizen standards help firm implement continuous improvement and cost reduction

16. Usage of Standard Costing systems • Improving planning and control • Unit standards are a fundamental requirement for a flexible budgeting system • Budgetary control systems compare actual costs with budgeted costs by computing variances • An overall variance can be decomposed into a price and usage

17. Usage of Standard Costing systems (cont.) • Facilitating decision making and product costing • Standard costing system uses standards for material , labour and overhead • Normal costing systems uses a predetermined rate for applying overhead but uses actual materials and labour costs

18. Advantages of a standard costing system • Provides readily available unit cost information that can be used for pricing decisions • Simplifies record keeping and also process costing. No need to compute unit costs for materials, transferred in costs and conversion cost categories. No need to distinguish between FIFO and weighted average

19. Purposes of Standard Costing • Provide a prediction of future costs that can be used for decision making purpose. Std costs can be derived fro either traditional or ABC system • Provide a challenging target which individuals are motivated to achieve. Research evidence suggests that the existence of a defined quantitative goal is likely to motivate higher levels of performance • Assist in preparing budgets and evaluating managerial performance

20. Purposes of Standard Costing (cont.) • Act a control device by highlighting those activities that do not conform to plan and thus alerting managers to situation that may be “out of control” and in need of corrective action • Simplify the task of tracing cost to products for profit measurements and inventory valuation purposes

21. Types of Standards • Ideal standards • Standards that demand maximum efficiency • Can only be achieved if everything operates perfectly • Minimum costs that are possible under the most efficient operating condition • Currently attainable standards • Can be achieved under efficient operating condition • These standards are demanding but achievable • Allowance is made for normal breakdowns, interruptions and differing skill levels

22. Types of Standards (cont.) • Basic standard • Constant standards that are left unchanged over long periods. Main advantage: a base is provided for a comparison with actual costs through a period of years with the same stand and efficiency trends can be established over time • Disadvantages: not very useful when changes occur in method so f production, price levels • Kaizen standards • Continuous improvement standards that reflect a planned improvement • Currently attainable and have a cost reduction focus

23. Standard Cost Sheets • Provides the standard costs and standard quantities of direct materials, direct labour and overhead that should be applied to a single product or service including: • a standard cost per unit i.e. the per unit cost that should be achieved given materials, labour and overhead standards • The quantity of each input that should be used to produce one unit of output

24. Standard Cost Sheet for Deluxe Strawberry Frozen Yogurt

25. Standard Setting and Learning Curve Theory • Need to set standard that are neither too slack (loose standard) nor too difficult • Slack standard (piawai yang longgar) lead to inefficient operations • Unattainable standards (very tight standard) cause employee frustration, demotivation and non-acceptability of the std set

26. Standard Setting and Learning Curve Theory • Management accountant should consider the effect of learning in setting standard such as direct labour standard • With the help of learning curve, the decision maker is able to predict how e. g. labour costs would change as the employees become more experienced in the performance of the task concerned

27. Learning Curve • The relationship between learning and output per labour hour or machine hour is shown in a graph known as learning curve

28. Standard Setting and Learning Curve Theory • A function that measures how labour hours per unit decline as units of production increases because workers are learning and becoming better at their jobs • In the manufacturing context, a learning curve is a cost function that shows how average labour cost per unit of output declines as cumulative production rises. Eg it may take 10 hours to knit the first scarf but only 15 hours to knit the first and second scarves

29. Standard Setting and Learning Curve Theory • Managers use LC to predict how labour hours or labour costs will increase as more units are produced • Learning has effect on efficiency (as workers become more familiar with their tasks , efficiency improves) • In certain tasks, the labour time required to perform certain tasks diminished as the employee becomes more experienced and familiar with the task. Eventually, a plateau level of performance is reached and no additional learning takes place

30. Cummulative Production No. of job lots Number of units Cumm. Average time per unit (min) Cummulative time (min) 1 10 10 100 2 20 10 x 0.8 = 8 160 4 40 8 x 0.8 = 6.4 256 8 80 6.4 x 0.8 = 5.12 409.6 16 160 5.12 x 0.8 = 4.096 655.36

31. Limitations of Standard Costing System • Traditional standard costing tend to focus too much on cost minimization rather increasing product quality or customer service. Standard costing system can cause dysfunctional behaviour in a JIT/FMS environment . e.g buying the least expensive material of a given quality in order to avoid a material price variance may result in using a vendor whose delivery capabilities are not consistent with JIT

32. Criticisms of Standard Costing • Variances calculated under std costing are at too aggregate a level and often come too late to be useful • One of the important conditions of standard costing is a stable production process. The introduction of flexible manufacturing system has reduced this stability (there’s frequent switching among a variety of products on the same product line)

33. Criticisms of Standard Costing (cont) • Traditional std costing system focus too much on the cost and efficiency on direct labour (becoming a relatively unimportant factor of production) • Traditional cost variances are also too aggregate i. e they are not tied to specific product lines, production batches . The aggregate nature of the variances makes it difficult for managers to determine their causes

34. Criticisms of Standard Costing (cont) • Shorter product life cycle means that the standard are relevant for only a short time. When new products are introduced, new standards must be developed • Traditional std costs are not defined broadly enough to capture various important aspects of performance ( e.g std direct material price do not capture all the cost of ownership which includes cost of ordering, receiving and inspecting, handling and storing.

35. Criticisms of Standard Costing (cont) • Automated manufacturing processes tend to be more consistent in meeting production specifications. Hence, variances from standards tend to be very small or nonexistent.