Cambridge a level standard costing

Standard Costing
Candidates should understand the application of a system of standard costing to an organisation.
Candidates should be able to:
• calculate the following variances:
– direct material price and usage
– direct labour rate and efficiency
– fixed overhead expenditure, capacity, efficiency and volume
– sales price and volume
• reconcile standard cost to actual cost
• reconcile standard profit to actual profit
• explain the causes of the variances and their relationship to each other
• discuss how standard costing can be used as aid to improve the performance of a business
• discuss the advantages and disadvantages of a standard costing system.

1. Standard costing
1 Accounting with Sanjaya


Standard Costing




Sanjaya Jayasundara
B.Sc.(Finance) Sp.
University of Sri Jayewardenepura,
Investment Advisor,
International School Teacher

2. Standard costing
2 Accounting with Sanjaya
Content
Introduction.
Types of cost standard
Calculation of standard unit price
Standard hours
Variance analysis
Reconciliations
Extra readings
Past paper questions.
Model questions.
Summary


Syllabus according to Cambridge
2.3 Standard costing
Candidates should understand the application of a system of standard costing to an organisation.
Candidates should be able to:
• calculate the following variances:
– direct material price and usage
– direct labour rate and efficiency
– fixed overhead expenditure, capacity, efficiency and volume
– sales price and volume
• reconcile standard cost to actual cost
• reconcile standard profit to actual profit
• explain the causes of the variances and their relationship to each other
• discuss how standard costing can be used as aid to improve the performance of a business
• discuss the advantages and disadvantages of a standard costing system.

3. Standard costing
3 Accounting with Sanjaya
Introduction
Standard costing sets levels of costs and revenues that ought to be achievable when
reasonable levels of performance are attained, together with efficient working practices. In
order to achieve and efficient production process, budgets are prepared. They set the targets
for future performance. If a business does not achieve the standards set, managers will want
to find out why.
Can you remember?
Budget: a short –term financial plan prepared in advance and based on the objectives of
the business.

Types of cost standard
There are a number of ways of setting standards.
 Attainable standards are standards that are set so that they can be achieved under
generally efficient operations conditions. The CIMA defines an attainable standard as
one,
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They are most often used in practice as they are not too easy or too difficult to achieve.

 Basic standards remain unchanged over a number of years and are useful for
determining trends in efficiency. The danger is that such standards will become
outdated over time and so reveal variances that have little use for analysis purposes.
Therefore, basic standards are rarely used for control purposes.
 Ideal standards assume that production is carried out under the most favourable
conditions leading to perfect performance. The CIMA definition is,
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Calculation of standard unit price
Estimated costs for labour, materials and overheads are totaled to give the standard cost for
the product. The estimated costs are based on the costs that should be incurred under efficient
production conditions. Standard unit price is the total standard costs of all the factors of
production that make up one finished unit of production. Standard costs can be based on:
 Past data used to forecast likely usage of materials and labour.
 Detailed study of the processes involved in production.
Materials standards are based on the quantity of materials that will be necessary to complete
each unit of output. Labour standards are based on production methods and the hours
required by an average worker to complete each unit of output.
Standard hours
This output measure is used in departments that produce several different products and it
represents the work that can be done in an hour. Using such a measure, each production
department has a standard number of hours set for its output.

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Variance analysis
A variance is the difference between budgeted (standard) revenue and costs and actual
revenue and costs. It arises when actual results do not correspond with predicted results.
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Reference: https://www.slideshare.net/SanjayaJayasundara/standard-costing-amp-variances-
analysis
Direct materials variances
Total direct materials variance identifies the difference between the amount that managers
thought would be spent on direct materials (the standard/budgeted set) and the amount that
was actually spent.
An adverse total direct materials variance means that materials have cost the business more
than anticipated, which has reduced profits (profits affected adversely). A favourable total
direct materials variance means that materials have cost the business less than anticipated,
which has increased profits (a favourable effect on profits)
The difference in the cost of direct materials to a business could because of:
 more (adverse variance) or fewer (favourable variance) materials being used than
was expected
 an increase in the price of materials since the budget was prepared (adverse
variance) or a decrease in the price of materials since the budget was prepared
(favourable variance)
 a combination of a change in the use of materials and a change in prices.

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We can identify the causes of differences in budgeted and actual expenditure arising from
the above factors by calculating sub-variances.

Direct materials price sub-variance
A direct materials price sub-variance calculates differences between budgeted and actual
costs due to sub-variances that arise because of changes in the prices of the raw materials
used.
 An adverse price sub-variance arises when the cost of direct materials has risen.
 A favourable price sub-variance occurs when the cost of direct materials has fallen.

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Direct materials usage sub-variance
Direct materials usage sub-variance calculates the change in total expenditure caused by
changes in the quantity of materials used.
 An adverse usage sub-variance indicates that production used more materials than
anticipated (and therefore reduces predicted profits).
 A favourable usage sub-variance indicates that production used fewer materials than
anticipated (and therefore increases predicted profits)
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The calculation of sub-variances is relatively straightforward when only one variable is
considered

Direct labour variances
Direct labour variances identify the difference between the amount that managers thought
would be spent on direct labour costs and the amount that was actually spent. It is useful to
determine whether the total variance was
because of:
 workers being more or less efficient
 workers being paid more or less
 some combination of a change in efficiency and a change in wage rates
In order to calculate the sub-variances that make up the total direct labour variances we can
use the grid, but we do need to make some changes to our descriptions of the sub-
variances. Labour usage is referred to as labour efficiency and labour price is referred to as
wage rate or labour rate.

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Direct labour rate sub-variance
A direct labour rate sub-variance calculates differences between budgeted and actual costs
due to sub-variances that arise because of changes in the rates of the direct labour used.
 An adverse rate sub-variance arises when the labour rate has risen.
 A favourable rate sub-variance occurs when the labour rate has fallen.
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Direct labour efficiency sub-variance
Direct labour efficiency sub-variance calculates the change in total expenditure caused by
changes in the direct labour hours used.
 An adverse usage sub-variance indicates that production used more hours than
anticipated (and therefore reduces predicted profits).
 A favourable usage sub-variance indicates that production used fewer hours than
anticipated (and therefore increases predicted profits)
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The flexed budget
A standard costing system is used to identify problem areas in production so that remedial
action can be taken. The system also identifies areas of cost saving which may be copied in
other sections of the business. The variances by comparing standard costs and the costs that
have actually been incurred. It is important that any findings are made by comparing like with
like.
This principle should be applied when comparing standard costs with actual costs. If actual
activity differs from budgeted activity, budgets must be flexed to produce a
budget that reflects actual levels of activity.

Fixed overhead variances
Fixed overhead variances are not flexed since they do not vary with levels of production.
Remember that fixed costs do not change with levels of business activity.
Fixed overhead variances can be broken down into several sub-variances which help to
determine how the overall variance has arisen.
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7. Standard costing
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Reconciling standard cost to actual cost
The reasons why there may be a difference between the profit forecast in a budget and the
actual profit earned are shown in detail by comparing the budgeted cost and sales variances
with the actual costs and sales. The differences obtained form the basis of remedial action
where necessary.
The flexed variances are summarised; the total is then used to adjust standard costs for
materials, labour and overheads. The adjusted amount should total to the actual costs.
A total favourable variance is deducted from standard costs, since favourable variances
reduced the amount of expenditure incurred. A total adverse variance is added to the standard
costs.

Reconciling standard profit to actual profit
Changes in the cost structure of the factors of production as well as differences in the volume
of finished goods being produced and sold will change actual profit, making it different from
budgeted profit. A business may also change the selling price per unit to take into account
changes in the price that customers are willing to pay or the price competitors are charging.
Managers may prepare a statement reconciling the budgeted profit with the actual profit
earned. They can then identify the reasons why actual profit might differ from the profit forecast
in budgets. The cost and sales variances replace the expenses and incomes found in a
traditional income statement. Negative (adverse) variances allow management to identify
areas of the business that need some form investigation to determine if remedial action is
necessary; while the departments that produce positive (favourable) variances can be used
as examples of good practice to be used elsewhere in the business

Causes of sub variances
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9. Standard costing
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Past Paper Questions
October/ November 2019 – Variant 31

10. Standard costing
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October/ November 2019 – Variant 33

11. Standard costing
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May/ June 2019 – Variant 31/33

12. Standard costing
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From page no 14

13. Standard costing
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February/March 2019 – Variant 32

14. Standard costing
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October/ November 2018 – Variant 31


Please go to page no 12 for remaining parts of the question.

15. Standard costing
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May/ June 2018 – Variant 32

16. Standard costing
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February/March 2018 – Variant 32

17. Standard costing
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October/ November 2017 – Variant 31

18. Standard costing
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October/ November 2017 – Variant 33

19. Standard costing
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Notes
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20. Standard costing
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Chapter Summary
 Standard costs are predetermined and reflect possible levels of costs and revenues
that ought to be achieved under conditions of acceptable levels of efficiency.
 Standard costs are used to prepare budgets and may be used in pricing policies.
 Variances identify differences between standards set and actual performance. They
are composed of sub-variances.
 If actual performance is different from standard performance, the budget may have to
be flexed.
 Analysis of sub-variances is necessary in order to eradicate problems areas in
production or to copy good practice.
 A sub-variance in one area may cause a sub-variance in another connected area.




All the best children…!
I wish you an enjoyable learning session...!

Sanjaya Jayasundara

Study well and be a good citizen to motherland Sri Lanka…!