Standard Costing

CPA SPM Prior Learning Standard Costing Along with budgets, standard cost cards and variance reports are key management...

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CPA SPM Prior Learning

Standard Costing Along with budgets, standard cost cards and variance reports are key management accounting reports. A standard cost is a planned cost for a unit of product. A standard cost card lists the various planned expenses involved in manufacturing a unit of product. Below is an example of a standard cost card: ABC Ltd manufactures toys. One of its products is a wooden train set, which has the following standard costs per unit: Direct materials (wood and paint)

€5.50

Direct labour (cutting and painting)

€6.50

Prime cost

€12.00

Variable Overheads (heat and light)

€4.00

Marginal Cost

€16.00

Fixed Overheads (factory rent)

€5.00

Total Cost

€21.00

There are several key business decisions which this report can help a business to make. • • • • •

Pricing decisions – How much should we sell our products for in order to ensure we make a profit? Break-even analysis – Which products are profitable or loss-making? Is a new product worth producing? Can we sell enough units to cover the costs of making the product? Key factor analysis – should products be made in-house or should their manufacture be outsourced to somewhere cheaper? Investment appraisal – should a new machine be bought to replace an old machine? Should we begin a new project, such as launching a new product?

Standard costing is a control technique that reports variances from the standard expectation for each control period (normally monthly). It does so by comparing actual costs and revenues to pre-set standards. This helps facilitate management by exception as management can concentrate on acting on the most significant variances. Standard Cost Creation: Steps in standard costing: • Determine unit production costs (standard cost card) and finished goods and raw materials stockholding policy • Agree unit sales price • Estimate unit sales volume • Project profits for future period (typically monthly) • Record actual sales and costs • Report and reconcile actual and budgeted profit for each control period • Take appropriate corrective actions © Cenit Online 2016

CPA SPM Prior Learning There are a number of problems associated with standard setting including: • Deciding on how to incorporate inflation into planned unit costs • Agreeing on the performance standard expected for labour inputs e.g. attainable or ideal • Deciding on the quality of materials to be used • Estimating material prices where seasonal or commodity market variations may be significant Different types of standard which may be used include: Ideal standards: These standards are based on perfect operating conditions. If such standards were to apply there would not be any inefficiencies, wastage etc. As employees would rarely achieve such a standard the performance variances would continuously be adverse. Such a situation would have an unfavourable impact on employees’ motivation. Employees would not view the standards as legitimate and would cease attempting to attain the standard required. Current standards: These standards are based on current operating conditions, and may be used over a short period of time. Management, however, would hope to improve efficiency levels on current operating conditions. Attainable standards: These standards are based on normal operating conditions. Allowance is made for normal wastage and inefficiencies. Standards set on this basis should provide encouragement to employees to improve on existing efficiency. The standard must be realistic and attainable; otherwise it will have the same pitfalls as ideal standards. Standards are normally reviewed annually to see if any changes are required, e.g. prices, inflation, efficiency.

© Cenit Online 2016