Group 10- Standard Costing
2011
Contents
Sr. no Topics Page. No Cost Accounting Introduction............................................................................... Definition................................................................................... The Main Objectives of Cost Accounting....................................... Elements of cost......................................................................... Classification of costs.................................................................3 Method of Costing.....................................................................3
1. 2. 3. 4. 5. 6.
2 2 2 3
7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23.
Standard Costing Introduction.....................................................................................5 Definition.........................................................................................5 What is Standard Costing? ..............................................................5 Standard Costing Diagram............................................................... 6 A simple example of standard costing.............................................6 Advantages of Standard Costing......................................................7 Limitations of Standard Costing........................................................8 Standard Cost Variances...................................................................8 Setting Standards.............................................................................10 Setting Standards for Direct Materials.............................................10 Setting Direct Labour Cost................................................................10 Setting Standards of Overheads.......................................................11 Determination of Standard Costs.....................................................12 Revision of Standards.......................................................................13 Summary..........................................................................................14 Case Study........................................................................................15 Multiple Choice Questions...............................................................16
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COST ACCOUNTING
Introduction-: Cost accounting information is designed for managers. Since managers are taking decisions only for their own organization, there is no need for the information to be comparable to similar information from other organizations. Instead, the important criterion is that the information must be relevant for decisions that managers operating in a particular environment of business including strategy make. Cost accounting information is commonly used in financial accounting information, but first we are concentrating in its use by managers to take decisions. The accountants who handle the cost accounting information generate add value by providing good information to managers who are taking decisions. Among the better decisions, the better performance of your organization, regardless if it is a manufacturing company, a bank, a non-profit organization, a government agency, a school club or even a business school. The cost-accounting system is the result of decisions made by managers of an organization and the environment in which they make them. Definition-: Cost Accounting is a method of accounting in which all costs incurred in carrying out an activity or accomplishing a purpose are collected, classified, and recorded. This data is then summarized and analyzed to arrive at a selling price, or to determine where savings are possible. The Main Objectives of Cost Accounting-: 1) Providing managers with information for decision making & planning. 2) Assisting managers in directing and controlling operations. 3) Motivating managers towards the organization’s goals. 4) Measuring the performance of managers and sub-units within the organization. In short, cost accounting is the process of accounting for cost, which begins with regarding and classifying of incomes and expenditures and ends with the preparation of periodical statements and reports for ascertaining and controlling costs. Elements of cost-: Material Labour
Direct material Direct labour Indirect material, Indirect labour, Maintenance & Repair, Supplies, Utilities, Other Variable Expenses, Overhead (Variable/Fixed) Salaries, Occupancy (Rent), Depreciation, Other Fixed Expenses
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Classification of costs Variable Costs
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Fixed Costs Direct Costs Indirect Costs/Overhead Costs Opportunity Costs Sunk Costs
Variable costs change in total in proportion to the level of activity. For example if a carmakers production increases by 5%, its tire costs will increase by about 5%. A fixed cost remains unchanged in total as the level of activity varies. For example, the property tax on a rental apartment is the same regardless of the number of building occupants. A direct cost is the cost of direct labour and material used in making the product or delivering the service. Indirect costs are costs of an activity which are not easily associated with the production of specific goods or services. The benefit that is sacrificed when the choice of one action precludes an alternative course of action. Costs that have been incurred in the past and cannot be changed by current actions.
Method of Costing-: The method of costing to be adopted depends on the nature of manufacturing activity. Different industries follow different methods for ascertaining cost of their products. The method to be adopted by business organisation will depend on the nature of the production and the type of output. There are various methods of costing. They are:
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Historical Costing - Historical cost is nothing but the actual cost. It is been collected after the cost had incurred. Standard Costing - Standard cost is the estimated cost of material, labour, overheads and other cost of each unit of production or purchase in a given accounting period. It is used as a benchmark against which cost variances and financial performances are measured, the valuation for inventory and basis of pricing. Marginal Costing - The Marginal Costing is the systematic examination of the relationship between selling prices, sales, production volumes, costs, expenses and profits. This analysis provides very useful information for decision-making in the management of a company. Job Costing - Job costing is concerned with the finding of the cost of each job or work order. This method is followed by these concerns when work is carried on by the customer’s request, such as printer general engineering work shop etc. under this system a job cost sheet is required to be prepared find out profit or losses for each job or work order. Batch Costing - A batch is a group of identical products. Under batch costing a batch of similar products is treated as a separate unit for the purpose of ascertaining cost. The total cost of a batch is divided by the total number of units in a batch to arrive at the costs per unit. This type of costing is generally used in industries like bakery, toy manufacturing etc
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2011
Contract Or Terminal Costing - Contract costing is applied for contract work like construction of dam building civil engineering contract etc. each contract or job is treated as separate cost unit for the cost ascertainment and control. Single Or Output Costing - Where there is only one product, output costing is adopted. A cost sheet or a production account is drawn, to show the cost of production of the product. Process Costing - This method is used in industries where production is carried on through different stages or processes before becoming a finished product. Costs are determined separately for each process. The main feature of process costing is that output of one process becomes the raw materials of another process until final product is obtained. This type of costing is generally used in industries like textile, chemical paper, oil refining etc. Operation Costing - This is suitable for industries where production is continuous and units are exactly identical to each other. This method is applied in industries like mines or drilling, cement works etc. Under this system cost sheet is prepared to find out cost per unit and profits or loss on production. Departmental Costing - With the help of this method of costing, the cost for each department or section is ascertained. Multiple Costing - It means combination of two or more of the above methods of costing. Where a product comprises many assembled parts or components (as in case of motor car) costs have to be ascertained for each component as well as for the finished product for different components, different methods of costing may be used. It is also known as composite costing. This type of costing is applicable to industries producing motor vehicle, aeroplane radio, T.V. etc. Service (Operating) Costing - This method is used in those industries which rendered services instead of producing goods. Under this method cost of providing a service is also determined. It is also called service costing. The organisation like water supply department, electricity department etc. are the examples of using operating costing.
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Standard Costing
Introduction: The most important objective in Cost accounting is “How to control Cost?” And to achieve that it has to have something which can compare with actual. That something can be standard. To actually understand standard costing we should know why standard costing is Important. If we don’t have standard costing the only other costing is Historical costing. Historical costing has its own limitations. We have to understand the historical costing and its limitation. Historical cost is nothing but the actual cost. It is been collected after the cost had incurred. 1. As Historical cost is actual cost and the costing is irreversible therefore insufficient in controlling the cost. 2. Historical cost does not help in reduction of the cost as there is nothing to compare with. 3. Historical cost does not provide any help to management in managing the task like budgeting, Planning and discussion making. We don’t have any standard than the previous record. But situation may vary from the previous situation. Therefore it is necessary to have standard costing against historical costing for better cost controlling. Standard cost will help in Budgeting, Planning and discussion making and ultimately will help in controlling the cost. Definition “Standard cost is a predetermined cost which is calculated from management’s standard of efficient operation and the relevant necessary expenditure. It may be use as a base for price fixing and for cost control through variance analysis”. Standard cost expresses what cost should be under attainable good performance. Small and simple definition A technique which uses standards for costs and revenues for the purpose of control through variance analysis What is Standard Costing? Standard costing has been used for over a 100 years. Early last century financial Accountants were interested in finding a better way of valuing stocks and work-in progress, important elements the calculation of profit and the concept of standard costing was born.
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Standard Costing is a valuable management tool, standard costing is part of cost accounting. Rather than using actual costs for direct material, labour and manufacturing overhead, standard costs are used to easily track variances and estimate profit. Though actual costs are still paid, standard costing is often used for inventories and cost of goods sold. The differences between standard and actual costs are known as variances. These variances are what make standard costing such a valuable practice for management. Management can quickly become aware of changes in budgeted costs by tracking the variances. Standard costs are usually associated with a manufacturing company's costs of direct material, direct labour, and manufacturing overhead. There are always differences between the actual costs and the standard costs, and those differences are known as variances. Variance: A divergence from the predetermined rates, expressed ultimately in money value, generally used in standard costing and budgetary control systems. Variance analysis: The analysis of variances arising in standard costing system into their constituent parts. Standard costing and the related variances is a valuable management tool. Below are the two statement shows how the variances are used in standard costing. 1. If actual costs are greater than standard costs the variance is unfavorable. An unfavorable variance tells management that if everything else stays constant the company's actual profit will be less than planned. 2. If actual costs are less than standard costs the variance is favorable. A favorable variance tells management that if everything else stays constant the actual profit will likely exceed the planned profit. Standard Costing Diagram Standard Costing Diagram
Historical Cost Historical Quantity Standard Cost Actual Quantity Standard Cost Standard Quantity
Price Price/Rate Variance
Usage Quantity/Efficiency Variance
Total Variance MMM-2011-2014 Page 6
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A simple example of standard costing
2011
A standard cost is a pre-determined cost of a product, product part, operational activity or service. An example of a standard cost for product Z is given below in Figure 1 for Scientific Lecture for Pharmaceutical Company.
Figure 1: Standard cost of product Z
Rs.per Unit Rs.per Unit
Raw material (Royalty) Raw material (Medical writer) Process 1 (Designing)
Process 2 (Printing) Process 3 (Transport)
7.00 2.75 _1.25______________ 11.00 10.25 _0.50______________ 10.75_ 21.75_
Advantages of Standard Costing Standard costing is a management control technique for every activity. It is not only useful for cost control purposes but is also helpful in production planning and policy formulation. It allows management by exception. In the light of various objectives of this system, some of the advantages of this tool are given below: 1. Efficiency measurement-- The comparison of actual costs with standard costs enables the management to evaluate performance of various cost centers. In the absence of standard costing system, actual costs of different period may be compared to measure efficiency. It is not proper to compare costs of different period because circumstance of both the periods may be different. Still, a decision about base period can be made with which actual performance can be compared. 2. Finding of variance-- The performance variances are determined by comparing actual costs with standard costs. Management is able to spot out the place of inefficiencies. It can fix responsibility for deviation in performance. It is possible to take corrective measures at the earliest. A regular check on various expenditures is also ensured by standard cost system. 3. Management by exception-- The targets of different individuals are fixed if the performance is according to predetermined standards. In this case, there is nothing to worry. The attention of the management is drawn only when actual performance
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is less than the budgeted performance. Management by exception means that everybody is given a target to be achieved and management need not supervise each and everything. The responsibilities are fixed and everybody tries to achieve his/her targets. 4. Cost control-- Every costing system aims at cost control and cost reduction. The standards are being constantly analyzed and an effort is made to improve efficiency. Whenever a variance occurs, the reasons are studied and immediate corrective measures are undertaken. The action taken in spotting weak points enables cost control system. 5. Right decisions-- It enables and provides useful information to the management in taking important decisions. For example, the problem created by inflating, rising prices. It can also be used to provide incentive plans for employees etc. 6. Eliminating inefficiencies-- The setting of standards for different elements of cost requires a detailed study of different aspects. The standards are set differently for manufacturing, administrative and selling expenses. Improved methods are used for setting these standards. The determination of manufacturing expenses will require time and motion study for labour and effective material control devices for materials. Similar studies will be needed for finding other expenses. All these studies will make it possible to eliminate inefficiencies at different steps. Limitations of Standard Costing 1. It cannot be used in those organizations where non-standard products are produced. If the production is undertaken according to the customer specifications, then each job will involve different amount of expenditures. 2. The process of setting standard is a difficult task, as it requires technical skills. The time and motion study is required to be undertaken for this purpose. These studies require a lot of time and money. 3. There are no inset circumstances to be considered for fixing standards. The conditions under which standards are fixed do not remain static. With the change in circumstances, if the standards are not revised the same become impracticable. 4. The fixing of responsibility is not an easy task. The variances are to be classified into controllable and uncontrollable variances. Standard costing is applicable only for controllable variances. For instance, if the industry changed the technology then the system will not be suitable. In that case, we will have to change or revise the standards. A frequent revision of standards will become costly. Standard Cost Variances A variance can be either a price variance or a quantity variance. A price variance arises when
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the cost to purchase an item differs from its standard price. A quantity variance occurs when the number of units actually required to build a product varies from the amount specified in the standard costing system. More specifically, here are the variances that you can calculate from a standard costing system (they are linked to more complete descriptions, as well as examples): ? Purchase price variance. The actual price paid for materials used in the production process, minus the standard cost, multiplied by the number of units used ? Labour rate variance. The actual price paid for the direct labour used in the production process, minus its standard cost, multiplied by the number of units used. ? Variable overhead spending variance. Subtract the standard variable overhead cost per unit from the actual cost incurred and multiply the remainder by the total unit quantity of output. ? Fixed overhead spending variance. The total amount by which fixed overhead costs exceed their total standard cost for the reporting period. ? Selling price variance. The actual selling price, minus the standard selling price, multiplied by the number of units sold. ? Sales volume variance. The actual unit quantity sold, minus the budgeted quantity to be sold, multiplied by the standard selling price. ? Material yield variance. Subtract the total standard quantity of materials that are supposed to be used from the actual level of use and multiply the remainder by the standard price per unit. ? Labour efficiency variance. Subtract the standard quantity of labour consumed from the actual amount and multiply the remainder by the standard labour rate per hour. ? Variable overhead efficiency variance. Subtract the budgeted units of activity on which the variable overhead is charged from the actual units of activity, multiplied by the standard variable overhead cost per unit. These variances track price, efficiency, and volume variances for the cost types noted in the following table: Variance Type Price Variance Efficiency Variance Volume Variance Material Yes Yes No Labou r Yes Yes No Variable Overhead Yes Yes No Fixed Overhead Yes No Yes
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Setting Standards
2011
Normally, setting up standards is based on the past experience. The total standard cost includes direct materials, direct labour and overheads. Normally, all these are fixed to some extent. The standards should be set up in a systematic way so that they are used as a tool for cost control. Various Elements which Influence the Setting of Standards Setting Standards for Direct Materials There are several basic principles which ought to be appreciated in setting standards for direct materials. Generally, when you want to purchase some material what are the factors you consider. If material is used for a product, it is known as direct material. On the other hand, if the material cost cannot be assigned to the manufacturing of the product, it will be called indirect material. Therefore, it involves two things: • • Quality of material Price of the material
When you want to purchase material, the quality and size should be determined. The standard quality to be maintained should be decided. The quantity is determined by the production department. This department makes use of historical records, and an allowance for changing conditions will also be given for setting standards. A number of test runs may be undertaken on different days and under different situations, and an average of these results should be used for setting material quantity standards. The second step in determining direct material cost will be a decision about the standard price. Material’s cost will be decided in consultation with the purchase department. The cost of purchasing and store keeping of materials should also be taken into consideration. The procedure for purchase of materials, minimum and maximum levels for various materials, discount policy and means of transport are the other factors which have bearing on the materials cost price. It includes the following: • • • Cost of materials Ordering cost Carrying cost
The purpose should be to increase efficiency in procuring and store keeping of materials. The type of standard used-- ideal standard or expected standard-- also affects the choice of standard price. Setting Direct Labour Cost If you want to engage a labour force for manufacturing a product or a service for which you need to pay some amount, this is called wages. If the labour is engaged directly to produce the product, this is known as direct labour. The second largest amount of cost is of labour. The benefit derived from the workers can be assigned to a particular product or a process. If
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the wages paid to workers cannot be directly assigned to a particular product, these will be known as indirect wages. The time required for producing a product would be ascertained and labour should be properly graded. Different grades of workers will be paid different rates of wages. The times spent by different grades of workers for manufacturing a product should also be studied for deciding upon direct labour cost. The setting of standard for direct labour will be done basically on the following: • • Standard labour time for producing Labour rate per hour
Standard labour time indicates the time taken by different categories of labour force which are as under: • • • Skilled labour Semi-skilled labour Unskilled labour
For setting a standard time for labour force, we normally take in to account previous experience, past performance records, test run result, work-study etc. The labour rate standard refers to the expected wage rates to be paid for different categories of workers. Past wage rates and demand and supply principle may not be a safe guide for determining standard labour rates. The anticipation of expected changes in labour rates will be an essential factor. In case there is an agreement with workers for payment of wages in the coming period, these rates should be used. If a premium or bonus scheme is in operation, then anticipated extra payments should also be included. Where a piece rate system is used, standard cost will be fixed per piece. The object of fixed standard labour time and labour rate is to device maximum efficiency in the use of labour. Setting Standards of Overheads The next important element comes under overheads. The very purpose of setting standard for overheads is to minimize the total cost. Standard overhead rates are computed by dividing overhead expenses by direct labour hours or units produced. The standard overhead cost is obtained by multiplying standard overhead rate by the labour hours spent or number of units produced. The determination of overhead rate involves three things: • • • Determination of overheads Determination of labour hours or units manufactured Calculating overheads rate by dividing A by B
The overheads are classified into fixed overheads, variable overheads and semi-variable overheads. The fixed overheads remain the same irrespective of level of production, while variable overheads change in the proportion of production. The expenses increase or decrease with the increase or decrease in output. Semi-variable overheads are neither fixed nor variable. These overheads increase with the increase in production but the rate of increase will be less than the rate of increase in production. The division of overheads into fixed, variable and semi-variable categories will help in determining overheads.
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Determination of Standard Costs How should the ideal standards for better controlling be determined?
2011
1. Determination of Cost Center According to J. Betty, “A cost center is a department or part of a department or an item of equipment or machinery or a person or a group of persons in respect of which costs are accumulated, and one where control can be exercised.” Cost centers are necessary for determining the costs. If the whole factory is engaged in manufacturing a product, the factory will be a cost center. In fact, a cost center describes the product while cost is accumulated. Cost centers enable the determination of costs and fixation of responsibility. A cost center relating to a person is called personnel cost center, and a cost center relating to products and equipments is called impersonal cost center. 2. Current Standards A current standard is a standard which is established for use over a short period of time and is related to current condition. It reflects the performance that should be attained during the current period. The period for current standard is normally one year. It is presumed that conditions of production will remain unchanged. In case there is any change in price or manufacturing condition, the standards are also revised. Current standard may be ideal standard and expected standard. 3. Ideal Standard This is the standard which represents a high level of efficiency. Ideal standard is fixed on the assumption that favourable conditions will prevail and management will be at its best. The price paid for materials will be lowest and wastes etc. will be minimum possible. The labour time for making the production will be minimum and rates of wages will also be low. The overheads expenses are also set with maximum efficiency in mind. All the conditions, both internal and external, should be favourable and only then ideal standard will be achieved. Ideal standard is fixed on the assumption of those conditions which may rarely exist. This standard is not practicable and may not be achieved. Though this standard may not be achieved, even then an effort is made. The deviation between targets and actual performance is ignorable. In practice, ideal standard has an adverse effect on the employees. They do not try to reach the standard because the standards are not considered realistic. 4. Basic Standards A basic standard may be defined as a standard which is established for use for an indefinite period which may a long period. Basic standard is established for a long period and is not adjusted to the preset conations. The same standard remains in force for a long period. These standards are revised only on the changes in specification of material and technology productions. It is indeed just like a number against which subsequent process changes can be measured. Basic standard enables the measurement of changes in costs. For example, if the basic cost for material is Rs. 20 per unit and the current price is Rs. 25 per unit, it will show an increase of
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25% in the cost of materials. The changes in manufacturing costs can be measured by taking basic standard, as a base standard cannot serve as a tool for cost control purpose because the standard is not revised for a long time. The deviation between standard cost and actual cost cannot be used as a yardstick for measuring efficiency. 5. Normal Standards As per terminology, normal standard has been defined as a standard which, it is anticipated, can be attained over a future period of time, preferably long enough to cover one trade cycle. This standard is based on the conditions which will cover a future period of five years, concerning one trade cycle. If a normal cycle of ups and downs in sales and production is 10 years, then standard will be set on average sales and production which will cover all the years. The standard attempts to cover variance in the production from one time to another time. An average is taken from the periods of recession and depression. The normal standard concept is theoretical and cannot be used for cost control purpose. Normal standard can be properly applied for absorption of overhead cost over a long period of time. 6. Organization for Standard Costing The success of standard costing system will depend upon the setting up of proper standards. For the purpose of setting standards, a person or a committee should be given this job. In a big concern, a standard costing committee is formed for this purpose. The committee includes production manager, purchase manager, sales manager, personnel manager, chief engineer and cost accountant. The cost accountant acts as a co-coordinator of this committee. 7. Accounting System Classification of accounts is necessary to meet the required purpose, i.e. function, asset or revenue item. Codes can be used to have a speedy collection of accounts. A standard is a pre-determined measure of material, labour and overheads. It may be expressed in quality and its monetary measurements in standard costs. Revision of Standards For effective use of this technique, sometimes we need to revise the standards which follow for better control. Even standards are also subjected to change like the production method, environment, raw material, and technology. Standards may need to be changed to accommodate changes in the organization or its environment. When there is a sudden change in economic circumstances, technology or production methods, the standard cost will no longer be accurate. Standards that are out of date will not act as effective feed forward or feedback control tools. They will not help us to predict the inputs required nor help us to evaluate the efficiency of a particular department. If standards are continually not being achieved and large deviations or variances from the standard are reported, they should be carefully reviewed. Also, changes in the physical productive capacity of the organization or in material prices and wage rates may indicate that standards need to be revised. In practice, changing standards frequently is an expensive operation and can cause confusion. For this reason, standard cost revisions are usually
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made only once a year. At times of rapid price inflation, many managers have felt that the high level of inflation forced them to change price and wage rate standards continually. This, however, leads to reduction in value of the standard as a yardstick. At the other extreme is the adoption of basic standard which will remain unchanged for many years. They provide a constant base for comparison, but this is hardly satisfactory when there is technological change in working procedures and conditions. Summary Basically, standard costing is a management tool for control. In the process, we have taken standards as parameters for measuring the performance. Cost analysis and cost control is essential for any activity. Cost includes material labour and overheads. Sometimes, we need to revise the standards due to change in uses, raw material, technology, method of production etc. For a proper organization, it is required to implement this under a committee for the activity. It is a continued activity for the optimum utilization of resources
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Case Study
2011
MEDICAL INDIA is a healthcare communication firm. They create scientific literature for doctors. Client has placed an order for scientific literature for their new product launch. Which they want to be packed in a special way. Booklet had to be tied with sateen ribbon and then to be placed in a polythene bag. There was a standard costing for the materials as shown in figure 3. Figure 3 Sr.no 1 2 3 4 5 6 Material Medical writer Designing Printing Packaging material Packaging Labour Transport Total Std cost per pcs 16 8 36 5 0.5 0.75 66.25
Based on the standard cost, the Selling price was given to client was Rs.73.00/- per pieces. Please find below actual costing for the production of the same input. In Figure 4. Figure 4 Act cost per pcs 17.5 8 36 5.5 0.5 2.5 70 Due to unavailability of sufficient data the medical team had to buy the additional text book Remains constant Remains constant Due to shortage of bags had to purchase at higher price Remains constant As there was a delay in getting the purchase bags it had to send on urgent bases due to which it had to send on courier than road transport
Sr.no
Material
1 2 3 4 5 6
Medical writer Designing Printing Packaging material Packaging Labour Transport Total
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Therefore the variance is as followed in figure 5 Figure 5. Standard cost per pcs 16 8 36 5 0.5 0.75 66.25 Actual cost per pcs 17.5 8 36 5.5 0.5 2.5 70
2011
Sr.no 1 2 3 4 5 6
Material Medical writer Designing Printing Packaging material Packaging Labour Transport Total
Variance 1.5 0 0 0.5 0 1.75 3.75
Conclusion: As in the above given case we can derive that there is major variance in Transport and medical writing. This gives an overall brief about the cost areas where it has to be managed. Transportation cost has increased by 200%, which has to be bought down with best alternate solution. Multiple Choice Questions 1.
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doc_920187966.docx
2011
Contents
Sr. no Topics Page. No Cost Accounting Introduction............................................................................... Definition................................................................................... The Main Objectives of Cost Accounting....................................... Elements of cost......................................................................... Classification of costs.................................................................3 Method of Costing.....................................................................3
1. 2. 3. 4. 5. 6.
2 2 2 3
7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23.
Standard Costing Introduction.....................................................................................5 Definition.........................................................................................5 What is Standard Costing? ..............................................................5 Standard Costing Diagram............................................................... 6 A simple example of standard costing.............................................6 Advantages of Standard Costing......................................................7 Limitations of Standard Costing........................................................8 Standard Cost Variances...................................................................8 Setting Standards.............................................................................10 Setting Standards for Direct Materials.............................................10 Setting Direct Labour Cost................................................................10 Setting Standards of Overheads.......................................................11 Determination of Standard Costs.....................................................12 Revision of Standards.......................................................................13 Summary..........................................................................................14 Case Study........................................................................................15 Multiple Choice Questions...............................................................16
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COST ACCOUNTING
Introduction-: Cost accounting information is designed for managers. Since managers are taking decisions only for their own organization, there is no need for the information to be comparable to similar information from other organizations. Instead, the important criterion is that the information must be relevant for decisions that managers operating in a particular environment of business including strategy make. Cost accounting information is commonly used in financial accounting information, but first we are concentrating in its use by managers to take decisions. The accountants who handle the cost accounting information generate add value by providing good information to managers who are taking decisions. Among the better decisions, the better performance of your organization, regardless if it is a manufacturing company, a bank, a non-profit organization, a government agency, a school club or even a business school. The cost-accounting system is the result of decisions made by managers of an organization and the environment in which they make them. Definition-: Cost Accounting is a method of accounting in which all costs incurred in carrying out an activity or accomplishing a purpose are collected, classified, and recorded. This data is then summarized and analyzed to arrive at a selling price, or to determine where savings are possible. The Main Objectives of Cost Accounting-: 1) Providing managers with information for decision making & planning. 2) Assisting managers in directing and controlling operations. 3) Motivating managers towards the organization’s goals. 4) Measuring the performance of managers and sub-units within the organization. In short, cost accounting is the process of accounting for cost, which begins with regarding and classifying of incomes and expenditures and ends with the preparation of periodical statements and reports for ascertaining and controlling costs. Elements of cost-: Material Labour
Direct material Direct labour Indirect material, Indirect labour, Maintenance & Repair, Supplies, Utilities, Other Variable Expenses, Overhead (Variable/Fixed) Salaries, Occupancy (Rent), Depreciation, Other Fixed Expenses
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Classification of costs Variable Costs
2011
Fixed Costs Direct Costs Indirect Costs/Overhead Costs Opportunity Costs Sunk Costs
Variable costs change in total in proportion to the level of activity. For example if a carmakers production increases by 5%, its tire costs will increase by about 5%. A fixed cost remains unchanged in total as the level of activity varies. For example, the property tax on a rental apartment is the same regardless of the number of building occupants. A direct cost is the cost of direct labour and material used in making the product or delivering the service. Indirect costs are costs of an activity which are not easily associated with the production of specific goods or services. The benefit that is sacrificed when the choice of one action precludes an alternative course of action. Costs that have been incurred in the past and cannot be changed by current actions.
Method of Costing-: The method of costing to be adopted depends on the nature of manufacturing activity. Different industries follow different methods for ascertaining cost of their products. The method to be adopted by business organisation will depend on the nature of the production and the type of output. There are various methods of costing. They are:
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Historical Costing - Historical cost is nothing but the actual cost. It is been collected after the cost had incurred. Standard Costing - Standard cost is the estimated cost of material, labour, overheads and other cost of each unit of production or purchase in a given accounting period. It is used as a benchmark against which cost variances and financial performances are measured, the valuation for inventory and basis of pricing. Marginal Costing - The Marginal Costing is the systematic examination of the relationship between selling prices, sales, production volumes, costs, expenses and profits. This analysis provides very useful information for decision-making in the management of a company. Job Costing - Job costing is concerned with the finding of the cost of each job or work order. This method is followed by these concerns when work is carried on by the customer’s request, such as printer general engineering work shop etc. under this system a job cost sheet is required to be prepared find out profit or losses for each job or work order. Batch Costing - A batch is a group of identical products. Under batch costing a batch of similar products is treated as a separate unit for the purpose of ascertaining cost. The total cost of a batch is divided by the total number of units in a batch to arrive at the costs per unit. This type of costing is generally used in industries like bakery, toy manufacturing etc
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2011
Contract Or Terminal Costing - Contract costing is applied for contract work like construction of dam building civil engineering contract etc. each contract or job is treated as separate cost unit for the cost ascertainment and control. Single Or Output Costing - Where there is only one product, output costing is adopted. A cost sheet or a production account is drawn, to show the cost of production of the product. Process Costing - This method is used in industries where production is carried on through different stages or processes before becoming a finished product. Costs are determined separately for each process. The main feature of process costing is that output of one process becomes the raw materials of another process until final product is obtained. This type of costing is generally used in industries like textile, chemical paper, oil refining etc. Operation Costing - This is suitable for industries where production is continuous and units are exactly identical to each other. This method is applied in industries like mines or drilling, cement works etc. Under this system cost sheet is prepared to find out cost per unit and profits or loss on production. Departmental Costing - With the help of this method of costing, the cost for each department or section is ascertained. Multiple Costing - It means combination of two or more of the above methods of costing. Where a product comprises many assembled parts or components (as in case of motor car) costs have to be ascertained for each component as well as for the finished product for different components, different methods of costing may be used. It is also known as composite costing. This type of costing is applicable to industries producing motor vehicle, aeroplane radio, T.V. etc. Service (Operating) Costing - This method is used in those industries which rendered services instead of producing goods. Under this method cost of providing a service is also determined. It is also called service costing. The organisation like water supply department, electricity department etc. are the examples of using operating costing.
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Group 10- Standard Costing
2011
Standard Costing
Introduction: The most important objective in Cost accounting is “How to control Cost?” And to achieve that it has to have something which can compare with actual. That something can be standard. To actually understand standard costing we should know why standard costing is Important. If we don’t have standard costing the only other costing is Historical costing. Historical costing has its own limitations. We have to understand the historical costing and its limitation. Historical cost is nothing but the actual cost. It is been collected after the cost had incurred. 1. As Historical cost is actual cost and the costing is irreversible therefore insufficient in controlling the cost. 2. Historical cost does not help in reduction of the cost as there is nothing to compare with. 3. Historical cost does not provide any help to management in managing the task like budgeting, Planning and discussion making. We don’t have any standard than the previous record. But situation may vary from the previous situation. Therefore it is necessary to have standard costing against historical costing for better cost controlling. Standard cost will help in Budgeting, Planning and discussion making and ultimately will help in controlling the cost. Definition “Standard cost is a predetermined cost which is calculated from management’s standard of efficient operation and the relevant necessary expenditure. It may be use as a base for price fixing and for cost control through variance analysis”. Standard cost expresses what cost should be under attainable good performance. Small and simple definition A technique which uses standards for costs and revenues for the purpose of control through variance analysis What is Standard Costing? Standard costing has been used for over a 100 years. Early last century financial Accountants were interested in finding a better way of valuing stocks and work-in progress, important elements the calculation of profit and the concept of standard costing was born.
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2011
Standard Costing is a valuable management tool, standard costing is part of cost accounting. Rather than using actual costs for direct material, labour and manufacturing overhead, standard costs are used to easily track variances and estimate profit. Though actual costs are still paid, standard costing is often used for inventories and cost of goods sold. The differences between standard and actual costs are known as variances. These variances are what make standard costing such a valuable practice for management. Management can quickly become aware of changes in budgeted costs by tracking the variances. Standard costs are usually associated with a manufacturing company's costs of direct material, direct labour, and manufacturing overhead. There are always differences between the actual costs and the standard costs, and those differences are known as variances. Variance: A divergence from the predetermined rates, expressed ultimately in money value, generally used in standard costing and budgetary control systems. Variance analysis: The analysis of variances arising in standard costing system into their constituent parts. Standard costing and the related variances is a valuable management tool. Below are the two statement shows how the variances are used in standard costing. 1. If actual costs are greater than standard costs the variance is unfavorable. An unfavorable variance tells management that if everything else stays constant the company's actual profit will be less than planned. 2. If actual costs are less than standard costs the variance is favorable. A favorable variance tells management that if everything else stays constant the actual profit will likely exceed the planned profit. Standard Costing Diagram Standard Costing Diagram
Historical Cost Historical Quantity Standard Cost Actual Quantity Standard Cost Standard Quantity
Price Price/Rate Variance
Usage Quantity/Efficiency Variance
Total Variance MMM-2011-2014 Page 6
Group 10- Standard Costing
A simple example of standard costing
2011
A standard cost is a pre-determined cost of a product, product part, operational activity or service. An example of a standard cost for product Z is given below in Figure 1 for Scientific Lecture for Pharmaceutical Company.
Figure 1: Standard cost of product Z
Rs.per Unit Rs.per Unit
Raw material (Royalty) Raw material (Medical writer) Process 1 (Designing)
Process 2 (Printing) Process 3 (Transport)
7.00 2.75 _1.25______________ 11.00 10.25 _0.50______________ 10.75_ 21.75_
Advantages of Standard Costing Standard costing is a management control technique for every activity. It is not only useful for cost control purposes but is also helpful in production planning and policy formulation. It allows management by exception. In the light of various objectives of this system, some of the advantages of this tool are given below: 1. Efficiency measurement-- The comparison of actual costs with standard costs enables the management to evaluate performance of various cost centers. In the absence of standard costing system, actual costs of different period may be compared to measure efficiency. It is not proper to compare costs of different period because circumstance of both the periods may be different. Still, a decision about base period can be made with which actual performance can be compared. 2. Finding of variance-- The performance variances are determined by comparing actual costs with standard costs. Management is able to spot out the place of inefficiencies. It can fix responsibility for deviation in performance. It is possible to take corrective measures at the earliest. A regular check on various expenditures is also ensured by standard cost system. 3. Management by exception-- The targets of different individuals are fixed if the performance is according to predetermined standards. In this case, there is nothing to worry. The attention of the management is drawn only when actual performance
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2011
is less than the budgeted performance. Management by exception means that everybody is given a target to be achieved and management need not supervise each and everything. The responsibilities are fixed and everybody tries to achieve his/her targets. 4. Cost control-- Every costing system aims at cost control and cost reduction. The standards are being constantly analyzed and an effort is made to improve efficiency. Whenever a variance occurs, the reasons are studied and immediate corrective measures are undertaken. The action taken in spotting weak points enables cost control system. 5. Right decisions-- It enables and provides useful information to the management in taking important decisions. For example, the problem created by inflating, rising prices. It can also be used to provide incentive plans for employees etc. 6. Eliminating inefficiencies-- The setting of standards for different elements of cost requires a detailed study of different aspects. The standards are set differently for manufacturing, administrative and selling expenses. Improved methods are used for setting these standards. The determination of manufacturing expenses will require time and motion study for labour and effective material control devices for materials. Similar studies will be needed for finding other expenses. All these studies will make it possible to eliminate inefficiencies at different steps. Limitations of Standard Costing 1. It cannot be used in those organizations where non-standard products are produced. If the production is undertaken according to the customer specifications, then each job will involve different amount of expenditures. 2. The process of setting standard is a difficult task, as it requires technical skills. The time and motion study is required to be undertaken for this purpose. These studies require a lot of time and money. 3. There are no inset circumstances to be considered for fixing standards. The conditions under which standards are fixed do not remain static. With the change in circumstances, if the standards are not revised the same become impracticable. 4. The fixing of responsibility is not an easy task. The variances are to be classified into controllable and uncontrollable variances. Standard costing is applicable only for controllable variances. For instance, if the industry changed the technology then the system will not be suitable. In that case, we will have to change or revise the standards. A frequent revision of standards will become costly. Standard Cost Variances A variance can be either a price variance or a quantity variance. A price variance arises when
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2011
the cost to purchase an item differs from its standard price. A quantity variance occurs when the number of units actually required to build a product varies from the amount specified in the standard costing system. More specifically, here are the variances that you can calculate from a standard costing system (they are linked to more complete descriptions, as well as examples): ? Purchase price variance. The actual price paid for materials used in the production process, minus the standard cost, multiplied by the number of units used ? Labour rate variance. The actual price paid for the direct labour used in the production process, minus its standard cost, multiplied by the number of units used. ? Variable overhead spending variance. Subtract the standard variable overhead cost per unit from the actual cost incurred and multiply the remainder by the total unit quantity of output. ? Fixed overhead spending variance. The total amount by which fixed overhead costs exceed their total standard cost for the reporting period. ? Selling price variance. The actual selling price, minus the standard selling price, multiplied by the number of units sold. ? Sales volume variance. The actual unit quantity sold, minus the budgeted quantity to be sold, multiplied by the standard selling price. ? Material yield variance. Subtract the total standard quantity of materials that are supposed to be used from the actual level of use and multiply the remainder by the standard price per unit. ? Labour efficiency variance. Subtract the standard quantity of labour consumed from the actual amount and multiply the remainder by the standard labour rate per hour. ? Variable overhead efficiency variance. Subtract the budgeted units of activity on which the variable overhead is charged from the actual units of activity, multiplied by the standard variable overhead cost per unit. These variances track price, efficiency, and volume variances for the cost types noted in the following table: Variance Type Price Variance Efficiency Variance Volume Variance Material Yes Yes No Labou r Yes Yes No Variable Overhead Yes Yes No Fixed Overhead Yes No Yes
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Group 10- Standard Costing
Setting Standards
2011
Normally, setting up standards is based on the past experience. The total standard cost includes direct materials, direct labour and overheads. Normally, all these are fixed to some extent. The standards should be set up in a systematic way so that they are used as a tool for cost control. Various Elements which Influence the Setting of Standards Setting Standards for Direct Materials There are several basic principles which ought to be appreciated in setting standards for direct materials. Generally, when you want to purchase some material what are the factors you consider. If material is used for a product, it is known as direct material. On the other hand, if the material cost cannot be assigned to the manufacturing of the product, it will be called indirect material. Therefore, it involves two things: • • Quality of material Price of the material
When you want to purchase material, the quality and size should be determined. The standard quality to be maintained should be decided. The quantity is determined by the production department. This department makes use of historical records, and an allowance for changing conditions will also be given for setting standards. A number of test runs may be undertaken on different days and under different situations, and an average of these results should be used for setting material quantity standards. The second step in determining direct material cost will be a decision about the standard price. Material’s cost will be decided in consultation with the purchase department. The cost of purchasing and store keeping of materials should also be taken into consideration. The procedure for purchase of materials, minimum and maximum levels for various materials, discount policy and means of transport are the other factors which have bearing on the materials cost price. It includes the following: • • • Cost of materials Ordering cost Carrying cost
The purpose should be to increase efficiency in procuring and store keeping of materials. The type of standard used-- ideal standard or expected standard-- also affects the choice of standard price. Setting Direct Labour Cost If you want to engage a labour force for manufacturing a product or a service for which you need to pay some amount, this is called wages. If the labour is engaged directly to produce the product, this is known as direct labour. The second largest amount of cost is of labour. The benefit derived from the workers can be assigned to a particular product or a process. If
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the wages paid to workers cannot be directly assigned to a particular product, these will be known as indirect wages. The time required for producing a product would be ascertained and labour should be properly graded. Different grades of workers will be paid different rates of wages. The times spent by different grades of workers for manufacturing a product should also be studied for deciding upon direct labour cost. The setting of standard for direct labour will be done basically on the following: • • Standard labour time for producing Labour rate per hour
Standard labour time indicates the time taken by different categories of labour force which are as under: • • • Skilled labour Semi-skilled labour Unskilled labour
For setting a standard time for labour force, we normally take in to account previous experience, past performance records, test run result, work-study etc. The labour rate standard refers to the expected wage rates to be paid for different categories of workers. Past wage rates and demand and supply principle may not be a safe guide for determining standard labour rates. The anticipation of expected changes in labour rates will be an essential factor. In case there is an agreement with workers for payment of wages in the coming period, these rates should be used. If a premium or bonus scheme is in operation, then anticipated extra payments should also be included. Where a piece rate system is used, standard cost will be fixed per piece. The object of fixed standard labour time and labour rate is to device maximum efficiency in the use of labour. Setting Standards of Overheads The next important element comes under overheads. The very purpose of setting standard for overheads is to minimize the total cost. Standard overhead rates are computed by dividing overhead expenses by direct labour hours or units produced. The standard overhead cost is obtained by multiplying standard overhead rate by the labour hours spent or number of units produced. The determination of overhead rate involves three things: • • • Determination of overheads Determination of labour hours or units manufactured Calculating overheads rate by dividing A by B
The overheads are classified into fixed overheads, variable overheads and semi-variable overheads. The fixed overheads remain the same irrespective of level of production, while variable overheads change in the proportion of production. The expenses increase or decrease with the increase or decrease in output. Semi-variable overheads are neither fixed nor variable. These overheads increase with the increase in production but the rate of increase will be less than the rate of increase in production. The division of overheads into fixed, variable and semi-variable categories will help in determining overheads.
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Group 10- Standard Costing
Determination of Standard Costs How should the ideal standards for better controlling be determined?
2011
1. Determination of Cost Center According to J. Betty, “A cost center is a department or part of a department or an item of equipment or machinery or a person or a group of persons in respect of which costs are accumulated, and one where control can be exercised.” Cost centers are necessary for determining the costs. If the whole factory is engaged in manufacturing a product, the factory will be a cost center. In fact, a cost center describes the product while cost is accumulated. Cost centers enable the determination of costs and fixation of responsibility. A cost center relating to a person is called personnel cost center, and a cost center relating to products and equipments is called impersonal cost center. 2. Current Standards A current standard is a standard which is established for use over a short period of time and is related to current condition. It reflects the performance that should be attained during the current period. The period for current standard is normally one year. It is presumed that conditions of production will remain unchanged. In case there is any change in price or manufacturing condition, the standards are also revised. Current standard may be ideal standard and expected standard. 3. Ideal Standard This is the standard which represents a high level of efficiency. Ideal standard is fixed on the assumption that favourable conditions will prevail and management will be at its best. The price paid for materials will be lowest and wastes etc. will be minimum possible. The labour time for making the production will be minimum and rates of wages will also be low. The overheads expenses are also set with maximum efficiency in mind. All the conditions, both internal and external, should be favourable and only then ideal standard will be achieved. Ideal standard is fixed on the assumption of those conditions which may rarely exist. This standard is not practicable and may not be achieved. Though this standard may not be achieved, even then an effort is made. The deviation between targets and actual performance is ignorable. In practice, ideal standard has an adverse effect on the employees. They do not try to reach the standard because the standards are not considered realistic. 4. Basic Standards A basic standard may be defined as a standard which is established for use for an indefinite period which may a long period. Basic standard is established for a long period and is not adjusted to the preset conations. The same standard remains in force for a long period. These standards are revised only on the changes in specification of material and technology productions. It is indeed just like a number against which subsequent process changes can be measured. Basic standard enables the measurement of changes in costs. For example, if the basic cost for material is Rs. 20 per unit and the current price is Rs. 25 per unit, it will show an increase of
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2011
25% in the cost of materials. The changes in manufacturing costs can be measured by taking basic standard, as a base standard cannot serve as a tool for cost control purpose because the standard is not revised for a long time. The deviation between standard cost and actual cost cannot be used as a yardstick for measuring efficiency. 5. Normal Standards As per terminology, normal standard has been defined as a standard which, it is anticipated, can be attained over a future period of time, preferably long enough to cover one trade cycle. This standard is based on the conditions which will cover a future period of five years, concerning one trade cycle. If a normal cycle of ups and downs in sales and production is 10 years, then standard will be set on average sales and production which will cover all the years. The standard attempts to cover variance in the production from one time to another time. An average is taken from the periods of recession and depression. The normal standard concept is theoretical and cannot be used for cost control purpose. Normal standard can be properly applied for absorption of overhead cost over a long period of time. 6. Organization for Standard Costing The success of standard costing system will depend upon the setting up of proper standards. For the purpose of setting standards, a person or a committee should be given this job. In a big concern, a standard costing committee is formed for this purpose. The committee includes production manager, purchase manager, sales manager, personnel manager, chief engineer and cost accountant. The cost accountant acts as a co-coordinator of this committee. 7. Accounting System Classification of accounts is necessary to meet the required purpose, i.e. function, asset or revenue item. Codes can be used to have a speedy collection of accounts. A standard is a pre-determined measure of material, labour and overheads. It may be expressed in quality and its monetary measurements in standard costs. Revision of Standards For effective use of this technique, sometimes we need to revise the standards which follow for better control. Even standards are also subjected to change like the production method, environment, raw material, and technology. Standards may need to be changed to accommodate changes in the organization or its environment. When there is a sudden change in economic circumstances, technology or production methods, the standard cost will no longer be accurate. Standards that are out of date will not act as effective feed forward or feedback control tools. They will not help us to predict the inputs required nor help us to evaluate the efficiency of a particular department. If standards are continually not being achieved and large deviations or variances from the standard are reported, they should be carefully reviewed. Also, changes in the physical productive capacity of the organization or in material prices and wage rates may indicate that standards need to be revised. In practice, changing standards frequently is an expensive operation and can cause confusion. For this reason, standard cost revisions are usually
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made only once a year. At times of rapid price inflation, many managers have felt that the high level of inflation forced them to change price and wage rate standards continually. This, however, leads to reduction in value of the standard as a yardstick. At the other extreme is the adoption of basic standard which will remain unchanged for many years. They provide a constant base for comparison, but this is hardly satisfactory when there is technological change in working procedures and conditions. Summary Basically, standard costing is a management tool for control. In the process, we have taken standards as parameters for measuring the performance. Cost analysis and cost control is essential for any activity. Cost includes material labour and overheads. Sometimes, we need to revise the standards due to change in uses, raw material, technology, method of production etc. For a proper organization, it is required to implement this under a committee for the activity. It is a continued activity for the optimum utilization of resources
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Group 10- Standard Costing
Case Study
2011
MEDICAL INDIA is a healthcare communication firm. They create scientific literature for doctors. Client has placed an order for scientific literature for their new product launch. Which they want to be packed in a special way. Booklet had to be tied with sateen ribbon and then to be placed in a polythene bag. There was a standard costing for the materials as shown in figure 3. Figure 3 Sr.no 1 2 3 4 5 6 Material Medical writer Designing Printing Packaging material Packaging Labour Transport Total Std cost per pcs 16 8 36 5 0.5 0.75 66.25
Based on the standard cost, the Selling price was given to client was Rs.73.00/- per pieces. Please find below actual costing for the production of the same input. In Figure 4. Figure 4 Act cost per pcs 17.5 8 36 5.5 0.5 2.5 70 Due to unavailability of sufficient data the medical team had to buy the additional text book Remains constant Remains constant Due to shortage of bags had to purchase at higher price Remains constant As there was a delay in getting the purchase bags it had to send on urgent bases due to which it had to send on courier than road transport
Sr.no
Material
1 2 3 4 5 6
Medical writer Designing Printing Packaging material Packaging Labour Transport Total
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Group 10- Standard Costing
Therefore the variance is as followed in figure 5 Figure 5. Standard cost per pcs 16 8 36 5 0.5 0.75 66.25 Actual cost per pcs 17.5 8 36 5.5 0.5 2.5 70
2011
Sr.no 1 2 3 4 5 6
Material Medical writer Designing Printing Packaging material Packaging Labour Transport Total
Variance 1.5 0 0 0.5 0 1.75 3.75
Conclusion: As in the above given case we can derive that there is major variance in Transport and medical writing. This gives an overall brief about the cost areas where it has to be managed. Transportation cost has increased by 200%, which has to be bought down with best alternate solution. Multiple Choice Questions 1.
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doc_920187966.docx