Bookkeeping8 1 Explain How and Why a Standard Cost Is Developed Principles of Accounting, Volume 2: Managerial Accounting

Classification or grouping of accounts is essential for standard costing. Standard costing techniques have been applied successfully in all industries that produce standardized products or follow process costing methods. The main purpose of standard cost is to provide management with information on the day-to-day control of operations. In ICMA’s definition of standard cost, the phrase “management’s standards of efficient operation” is important.

1. It assigns an average cost to labor, materials and overhead evenly so that managers can plan budgets, control costs and evaluate the performance of cost management.
2. Another situation in which a variance may occur is when the cost of labor and/or material changes after the standard was established.
3. Total variable overhead varies in direct
   proportion to the number of units produced.
4. Despite its limitations, it can be a helpful tool for manufacturing companies trying to improve their production processes.
5. The currently attainable standard is the most popular standard, and standards of this kind are acceptable to employees because they provide a definite goal and challenge to them.

Standard costs are commonly used to derive cost variances, particularly in regard to production and inventory costs. Any material unfavorable variances should be reviewed by management to see if any corrective grant writing fees actions can be taken. In some cases, they will find that the real problem is an incorrectly-derived standard cost that generates unfavorable variances even when there is no underlying problem.

Manufacturing companies use cost accounting for estimating various expenses including direct material, direct labor, or overhead. Standard costing assigns “standard” costs, rather than actual costs, to its cost of goods sold (COGS) and inventory. The standard costs are based on the efficient use of labor and materials to produce the good or service under standard operating conditions, and they are essentially the budgeted amount. Even though standard costs are assigned to the goods, the company still has to pay actual costs. Assessing the difference between the standard (efficient) cost and the actual cost incurred is called variance analysis.

Direct materials include all materials that can be easily and economically traced to the production of a product. For example, the direct materials necessary to produce a wood desk might include wood and hardware. Indirect materials are not easily and economically traced to a particular product. Examples of indirect materials are items such as nails, screws, sandpaper, and glue. Indirect materials are included in the manufacturing overhead category, not the direct materials category.

Along with this, standard costs help to identify any production costs that need to be controlled. By considering these expenses, management can
determine how much to charge for a product so that it can produce
the desired net income. As the business actually incurs these
expenses, management determines if the selling prices set are still
reasonable and, when necessary, considers some price adjustments
after taking competition into account.

Difficult to get information on specific units

The variable manufacturing overhead variances for NoTuggins are presented in Exhibit 8-10. Refer to the total variable manufacturing overhead variance in the top section of the template. Total standard quantity is calculated as standard quantity of the cost driver per unit times actual production, or 0.25 direct labor hours per unit times 150,000 units produced equals 37,500 direct labor hours.

Understanding Cost Accounting

The total amounts for direct materials actually purchased and used are reported on the following line. The actual quantity purchased and used to produce 150,000 units was 600,000 feet of flat nylon cord costing $330,000. The actual price of $0.55 per unit is not given in the actual data presented in Exhibit 8-1. However, it can be calculated by taking the total purchase price and dividing it by the total number of feet purchased.

In the NoTuggins example, the total standard direct materials allowed was 630,000 feet. However, they were able to produce the 150,000 units using less material, which is favorable. If the actual amount exceeds the standard amount, the variance is unfavorable (U) indicating they used or paid more than the standard amount, which is unfavorable. At the end of the year (or accounting period) if the standard costs are higher than the actual expenses, than the company is considered to have a favorable variance. If the company’s actual costs were higher, then the company would have an unfavorable variance.

Types of Costs in Cost Accounting

Cost accounting helps management plan for future capital expenditures, which are large plant and equipment purchases. Modern methods of cost accounting first emerged in the manufacturing industries, though its advantages helped it spread quickly to other sectors. While this data could still be useful, some of it may be irrelevant because several weeks have passed since the variance occurred. A currently attainable standard is one that represents the best attainable performance. It can be achieved with reasonable effort (i.e., if the company operates with a “high” degree of efficiency and effectiveness).

How to calculate standard costs

For example, if it’s taking workers longer than planned to produce a product, that could indicate they need more training, or something else is going on that’s slowing up their work. But it could be a sign the standard cost https://simple-accounting.org/ estimate for direct labor was too optimistic. Standard costs approximate actual costs, but they probably won’t be exactly the same. The difference between the standard cost and the actual cost is known as a variance.

They believe that there is no machine breakdown, worker tea break, or any error in the production process. Therefore, the production will be able to maximize their capacity which almost impossible to happen in real life. Direct materials are the raw materials that are directly traceable to a product. (In a food manufacturer’s business the direct materials are the ingredients such as flour and sugar; in an automobile assembly plant, the direct materials are the cars’ component parts). Even though cost accounting is commonly called a costing method, the scope of cost accounting is far broader than mere cost. Costing methods determine costs, while cost accounting is an analysis of the different types of costs a company incurs.

Variance analysis allows managers to see whether costs are different than planned. Once a difference between expected and actual costs is identified, variance analysis should delve into why the costs differ and what the magnitude of the difference means. Using the standard and actual data given for Lastlock and the direct materials variance template, compute the direct materials variances. The total price per unit variance is the standard price per unit of $0.50 less the actual price paid of $0.55 equals the price variance per unit of $(0.05) U. This is unfavorable because they actually spent more per unit than the standards allowed. Calculating inventory using standard costs is easier than using actual costs.

What Are Some Advantages of Cost Accounting?

The substandard material may have been more difficult to work with or had more defects than the proper grade material. In such a situation, a favorable material price variance could cause an unfavorable labor efficiency variance and an unfavorable material quantity variance. Employees who do not have the expected experience level may save money in the wage rate but may require more hours to be worked and more material to be used because of their inexperience. The total variances can be calculated in the last line of the top section of the template by subtracting the actual amounts from the standard amounts.