MAC3701 NOTES.
, STANDARD COSTING
KEY TERM
A standard cost is an estimated unit cost.
The standard cost of product 12345 is set out below on a standard cost card.
STANDARD COST CARD
Product : the Splodget, No. 12345
Cost Requirement
R R
Direct materials
A R2.00 per kg 6 kgs 12.00
B R3.00 per kg 2 kgs 6.00
C R4.00 per litre 1 litre 4.00
Others 2.00
24.00
Direct labour
Grade I R4.00 per hour 3 hrs 12.00
Grade II R5.40 per hour 5 hrs 27.00
39.00
Variable production overheads R1.00 per hour 8 hrs 8.00
Fixed production overheads R3.00 per hour 8 hrs 24.00
Standard full cost of production 95.00
Notice how it is built up from standards for each cost element: standard quantities of materials at standard
prices, standard quantities of labour time at standard rates and so on. It is therefore determined by
management’s estimates of the following :
The expected prices of materials, labour and expenses
Efficiency levels in the use of materials and labour
Budgeted overhead costs and budgeted volumes of activity
We will see how management arrives at these estimates later in the chapter.
But why should management want to prepare standard costs? Obviously to assist with standard costing, but
what is the point of standard costing?
2
,STANDARD COSTING
The uses of standard costing
Standard costing has two principal uses :
To value stocks and cost production for cost accounting purposes. It is an alternative method of
valuation to methods like FIFO and LIFO which you will have covered in your earlier studies.
To act as a control device by establishing standards (expected costs) and comparing actual costs with the
expected costs, thus highlighting areas of the organisation which may be out of control.
It can also be used in the following circumstances :
(a) To assist in setting budgets and evaluating managerial performance.
(b) To enable the principle of ‘management by exception’ to be practised. A standard cost, when
established, is an average expected unit cost. Because it is only an average, actual results will vary to
some extent above and below the average. Only significant differences between actual and standard
should be reported.
(c) To provide a prediction of future costs to be used in decision-making situations.
(d) To motivate staff and management by the provision of challenging targets.
(e) To provide guidance on possible ways of improving efficiency.
Standard costing as a control technique
KEY TERMS
Standard costing involves the establishment of predetermined estimates of the costs of products or services,
the collection of actual costs and the comparison of the actual costs with the predetermined estimates. The
predetermined costs are known as standard costs and the differences between standard and actual cost is
known as a variance. The process by which the total difference between standard and actual results is
analysed in know as variance analysis.
Question 1
What are the possible advantages for the control function of an organisation of having a
standard costing system?
Answer
(a) Carefully planned standards are an aid to more accurate budgeting.
(b) Standard costs provide a yardstick against which actual costs can be measured.
(c) The setting of standard involves determining the best materials and methods which
may lead to economies.
(d) A target of efficiency is set for employees to reach and cost-consciousness is
stimulated.
(e) Variances can be calculated which enable the principle of ‘management by
exception’ to be operated. Only the variances which exceed acceptable tolerance
limits need to be investigated by management with a view to control action.
(f) Standard costs and variance analysis can provide a way of motivation to managers
to achieve better performance. However, care must be taken to distinguish between
controllable and non-controllable costs in variance reporting.
3
, Where standard costing should be used
Although standard costing can be used in a variety of costing situations (batch and mass production, process
manufacture, jobbing manufacture (where there is standardisation of parts) and service industries (if a realistic
cost unit can be established)), the greatest benefit from its use can be gained if there is a degree of
repetition in the production process so that average or expected usage of resources can be determined. It
is therefore most suited to mass production and repetitive assembly work and less suited to organisations
which produce to customer demand and requirements.
Question 1
Can you think of a service organisation that could apply standard costing?
Answer
In an ACCA Students’ Newsletter article (December 1998), the examiner of the equivalent
paper under the old syllabus provided the example of restaurants which deal with standard
recipes for meals. If a large number of meals are produced, say, for conference delegates,
mass production systems will apply. Standards may not be calculated with the same
accuracy as in manufacturing environments, but the principles are still relevant. Other
examples are equally valid.
DERIVING STANDARDS
The responsibility for deriving standard costs should be shared between managers able to provide the
necessary information about levels of expected efficiency, prices and overhead costs.
Setting standards for materials costs
Direct materials costs per unit of raw material will be estimated by the purchasing department from their
knowledge of the following :
Purchase contracts already agreed
Pricing discussions with regular suppliers
The forecast movement of prices in the market
The availability of bulk purchase discounts
The quality of material required by the production departments
The standard cost ought to include an allowance for bulk purchase discounts, if these are available on all or
some of the purchases, and it may have to be a weighted average price of the differing prices charged for the
same product by alternative suppliers.
A decision must also be taken as to how to deal with price inflation. Suppose that a material costs R10 per
kilogram at the moment, and during the course of the next 12 months, it is expected to go up in price by 20% to
R12 per kilogram. What standard price should be selected?
(a) If the current price of R10 per kilogram were used in the standard, the reported price variance would
become adverse as soon as prices go up, which might be very early in the year. If prices go up
gradually rather than in one big jump, it would be difficult to select an appropriate time for revising the
standard.
(b) If an estimated mid-year price of, say, R11 per kilogram were used, price variances should be
favourable in the first half of the year and adverse in the second half, again assuming the prices go up
gradually. Management could only really check that in any month, the price variance did not become
excessively adverse (or favourable) and that the price variance switched from being favourable to
adverse around month six or seven and not sooner.
4
, STANDARD COSTING
KEY TERM
A standard cost is an estimated unit cost.
The standard cost of product 12345 is set out below on a standard cost card.
STANDARD COST CARD
Product : the Splodget, No. 12345
Cost Requirement
R R
Direct materials
A R2.00 per kg 6 kgs 12.00
B R3.00 per kg 2 kgs 6.00
C R4.00 per litre 1 litre 4.00
Others 2.00
24.00
Direct labour
Grade I R4.00 per hour 3 hrs 12.00
Grade II R5.40 per hour 5 hrs 27.00
39.00
Variable production overheads R1.00 per hour 8 hrs 8.00
Fixed production overheads R3.00 per hour 8 hrs 24.00
Standard full cost of production 95.00
Notice how it is built up from standards for each cost element: standard quantities of materials at standard
prices, standard quantities of labour time at standard rates and so on. It is therefore determined by
management’s estimates of the following :
The expected prices of materials, labour and expenses
Efficiency levels in the use of materials and labour
Budgeted overhead costs and budgeted volumes of activity
We will see how management arrives at these estimates later in the chapter.
But why should management want to prepare standard costs? Obviously to assist with standard costing, but
what is the point of standard costing?
2
,STANDARD COSTING
The uses of standard costing
Standard costing has two principal uses :
To value stocks and cost production for cost accounting purposes. It is an alternative method of
valuation to methods like FIFO and LIFO which you will have covered in your earlier studies.
To act as a control device by establishing standards (expected costs) and comparing actual costs with the
expected costs, thus highlighting areas of the organisation which may be out of control.
It can also be used in the following circumstances :
(a) To assist in setting budgets and evaluating managerial performance.
(b) To enable the principle of ‘management by exception’ to be practised. A standard cost, when
established, is an average expected unit cost. Because it is only an average, actual results will vary to
some extent above and below the average. Only significant differences between actual and standard
should be reported.
(c) To provide a prediction of future costs to be used in decision-making situations.
(d) To motivate staff and management by the provision of challenging targets.
(e) To provide guidance on possible ways of improving efficiency.
Standard costing as a control technique
KEY TERMS
Standard costing involves the establishment of predetermined estimates of the costs of products or services,
the collection of actual costs and the comparison of the actual costs with the predetermined estimates. The
predetermined costs are known as standard costs and the differences between standard and actual cost is
known as a variance. The process by which the total difference between standard and actual results is
analysed in know as variance analysis.
Question 1
What are the possible advantages for the control function of an organisation of having a
standard costing system?
Answer
(a) Carefully planned standards are an aid to more accurate budgeting.
(b) Standard costs provide a yardstick against which actual costs can be measured.
(c) The setting of standard involves determining the best materials and methods which
may lead to economies.
(d) A target of efficiency is set for employees to reach and cost-consciousness is
stimulated.
(e) Variances can be calculated which enable the principle of ‘management by
exception’ to be operated. Only the variances which exceed acceptable tolerance
limits need to be investigated by management with a view to control action.
(f) Standard costs and variance analysis can provide a way of motivation to managers
to achieve better performance. However, care must be taken to distinguish between
controllable and non-controllable costs in variance reporting.
3
, Where standard costing should be used
Although standard costing can be used in a variety of costing situations (batch and mass production, process
manufacture, jobbing manufacture (where there is standardisation of parts) and service industries (if a realistic
cost unit can be established)), the greatest benefit from its use can be gained if there is a degree of
repetition in the production process so that average or expected usage of resources can be determined. It
is therefore most suited to mass production and repetitive assembly work and less suited to organisations
which produce to customer demand and requirements.
Question 1
Can you think of a service organisation that could apply standard costing?
Answer
In an ACCA Students’ Newsletter article (December 1998), the examiner of the equivalent
paper under the old syllabus provided the example of restaurants which deal with standard
recipes for meals. If a large number of meals are produced, say, for conference delegates,
mass production systems will apply. Standards may not be calculated with the same
accuracy as in manufacturing environments, but the principles are still relevant. Other
examples are equally valid.
DERIVING STANDARDS
The responsibility for deriving standard costs should be shared between managers able to provide the
necessary information about levels of expected efficiency, prices and overhead costs.
Setting standards for materials costs
Direct materials costs per unit of raw material will be estimated by the purchasing department from their
knowledge of the following :
Purchase contracts already agreed
Pricing discussions with regular suppliers
The forecast movement of prices in the market
The availability of bulk purchase discounts
The quality of material required by the production departments
The standard cost ought to include an allowance for bulk purchase discounts, if these are available on all or
some of the purchases, and it may have to be a weighted average price of the differing prices charged for the
same product by alternative suppliers.
A decision must also be taken as to how to deal with price inflation. Suppose that a material costs R10 per
kilogram at the moment, and during the course of the next 12 months, it is expected to go up in price by 20% to
R12 per kilogram. What standard price should be selected?
(a) If the current price of R10 per kilogram were used in the standard, the reported price variance would
become adverse as soon as prices go up, which might be very early in the year. If prices go up
gradually rather than in one big jump, it would be difficult to select an appropriate time for revising the
standard.
(b) If an estimated mid-year price of, say, R11 per kilogram were used, price variances should be
favourable in the first half of the year and adverse in the second half, again assuming the prices go up
gradually. Management could only really check that in any month, the price variance did not become
excessively adverse (or favourable) and that the price variance switched from being favourable to
adverse around month six or seven and not sooner.
4
