Standard Costing

1. Introduction to Standard Costing

• Standard Costing is a management accounting tool used to estimate costs and assess performance by comparing actual costs with predetermined standard costs.
• Standard Cost is the estimated cost of materials, labour, and overheads per unit of production.
• Businesses use standard costing to:
  • Improve cost control by identifying variances.
  • Aid budgeting and decision-making.
  • Increase efficiency in operations.
• Variances are differences between actual and standard costs, helping managers understand cost fluctuations and take corrective actions.
• Example: If the standard cost of producing a unit is $20 but actual costs are $22, there is an adverse variance of $2.

2. Setting Standards

• Standards should be realistic and periodically updated.
• Types of Standards:
  1. Ideal Standards: Achievable only under perfect conditions (e.g., no machine breakdowns, no idle time).
  2. Current Standards: Based on present performance but may not encourage efficiency.
  3. Attainable Standards: Allow for some inefficiencies but still motivate improvement.
• Example Calculation of Standard Cost:

  Standard Material Cost = Quantity Required × Cost per Unit
  Standard Labour Cost = Time Required × Wage Rate
  

3. Preparing Standard Costing Budgets

• Standard costing is a foundation for budgeting and budgetary control.
• Example Budgeted Profit Statement Calculation (for 3 desk sizes):
  

  Item	Small	Medium	Large	Total
  Revenue	20,000	45,000	80,000	145,000
  Materials	(8,000)	(18,000)	(32,000)	(58,000)
  Labour	(1,500)	(4,500)	(9,000)	(15,000)
  Overheads	(5,000)	(15,000)	(30,000)	(50,000)
  Profit	5,500	7,500	9,000	22,000

• This budget is based on pre-determined standard costs.

4. Advantages & Disadvantages of Standard Costing

Advantages

• Easier Budget Preparation – Since budgets are based on standard costs, they are more structured.
• Cost Control & Variance Analysis – Differences between standard and actual costs can be identified and corrected.
• Efficiency Measurement – Helps businesses identify waste and inefficiencies.
• Performance Benchmarking – Encourages employees to meet efficiency targets.

Disadvantages

• Time-Consuming to Set Up – Requires careful data collection and review.
• Need for Regular Updates – Standard costs can become outdated if not revised.
• May Not Reflect Reality – Actual conditions (e.g., price fluctuations, economic changes) may render standard costs inaccurate.

5. Flexible Budgeting & Standard Costing

• Fixed Budgets do not adjust for actual production levels.
• Flexible Budgets adjust based on actual output, making variance analysis more meaningful.
• Example of Flexible Budget Calculation:

  Flexible Revenue = Budgeted Revenue × (Actual Units / Budgeted Units)
  

6. Variance Analysis in Standard Costing

• Variance Analysis is a key feature of standard costing that helps businesses evaluate efficiency and cost control.
• Common Variances Include:
  • Sales Variance
  • Direct Material Variance
  • Direct Labour Variance
  • Overhead Variance
• Each variance is categorized as favourable (F) if it benefits the business or adverse (A) if it harms profitability.

7. Sales Variances

• Total Sales Variance = Difference between actual and budgeted sales revenue.
• Formula:

  Total Sales Variance = Actual Sales Revenue - Budgeted Sales Revenue
  

• Sales Volume Variance:

  Sales Volume Variance = (Actual Units Sold - Budgeted Units Sold) × Standard Selling Price
  

• Sales Price Variance:

  Sales Price Variance = (Actual Price - Standard Price) × Actual Units Sold
  

Example Calculation:

• Budgeted Sales Revenue: $640,000
• Actual Sales Revenue: $612,000
• Variance:

  $612,000 - $640,000 = ($28,000) Adverse
  

8. Direct Materials Variances

• Total Material Variance is caused by:
  • Material Usage Variance: Difference in material quantity used.
  • Material Price Variance: Difference in material cost per unit.

Formulas:

• Material Usage Variance:

  (Standard Material Quantity - Actual Material Quantity) × Standard Price per Unit
  

• Material Price Variance:

  (Standard Price - Actual Price) × Actual Quantity Purchased
  

Example:

• Standard material per unit = 1.25 kg at $4/kg.
• Actual material per unit = 1.10 kg at $4.15/kg.
• Price Variance Calculation:

  ($4.00 - $4.15) × 1.10 kg × 20,000 units = ($3,300) Adverse
  

9. Direct Labour Variances

• Labour Efficiency Variance: Measures whether workers took more or less time than expected.
• Labour Rate Variance: Measures whether wage costs were higher or lower than standard rates.

Formulas:

• Labour Efficiency Variance:

  (Standard Hours - Actual Hours) × Standard Wage Rate
  

• Labour Rate Variance:

  (Standard Wage Rate - Actual Wage Rate) × Actual Hours Worked
  

Example:

• Standard labour = 30 minutes per unit at $12/hour.
• Actual labour = 36 minutes per unit at $11/hour.
• Labour Rate Variance:

  ($12 - $11) × 36 minutes × 20,000 units = $12,000 Favourable
  

10. Fixed Overhead Variances

• Overhead variances help determine if overhead costs were effectively controlled.
• Formula for Overhead Volume Variance:

  (Standard Hours for Actual Output - Budgeted Hours) × Budgeted Overhead Absorption Rate
  

• Example Overhead Variance Calculation:
  • Budgeted Overhead Rate: $40 per direct labour hour.
  • Budgeted Hours: 9,000 hours.
  • Actual Hours: 10,000 hours.
  • Variance Calculation:

    (10,000 - 9,000) × $40 = $40,000 Favourable
    

11. Reconciling Standard Cost & Actual Cost

• A statement can be prepared to reconcile standard cost with actual cost by including all variances.

Example of Reconciliation Statement