Chapter 21: Standard Costing

Definition and Usefulness of Standard Costs 1. Standard Costs Definition • Standard costs are pre-determined costs for producing a product or providing a service under expected, normal conditions. These are applied for key expenses like: o Direct materials o Direct labor o Manufacturing overhead Standard costs are set by analyzing production needs and converting these into dollar amounts with the help of production managers, engineers, and accountants. 2. Benefits of Standard Cost Information • • • Variance Analysis: Comparing actual costs to standard costs helps management spot differences (variances), focusing on significant deviations that require action. Budgeting: Standard costs form the basis for budget preparation. For example, with a standard direct material cost of $2 per unit and expected production of 50,000 units, the budget for materials would be $100,000. Efficiency in Services: Service companies, like healthcare providers, use standard costs to ensure service quality while controlling operational costs, particularly in overhead. Setting Standard Costs 1. Methods for Setting Standards • • • Direct Labor Standards: Determined by analyzing the time required to complete tasks under typical conditions, accounting for necessary pauses (e.g., breaks, cleanup). Direct Materials Standards: Based on the required quantity, grade, and cost of materials, including allowances for normal waste or inefficiencies. Overhead Standards: Determined based on the production-support activities required, including costs like utilities and maintenance. Example - Setting Standards for Wooden Baseball Bats: • • • Direct Materials: Engineers at ProBat estimate that manufacturing each bat requires 2 pounds of wood. With allowance for normal waste, the standard requirement is adjusted to 2.2 pounds per bat. Direct Labor: Requires 2 hours per bat at a rate of $15/hour (including wages, taxes, and benefits). Overhead: Allocated at a rate of $5 per direct labor hour (DLH). Cost Variance Analysis 1. Understanding Cost Variances • A cost variance is the difference between actual and standard costs, labeled as either: o Favorable (F): When actual costs are lower than standard costs. o Unfavorable (U): When actual costs exceed standard costs. 2. Steps in Cost Variance Analysis (Exhibit 21.6 Process) • • • • Prepare a Standard Cost Performance Report. Compute and Analyze Variances: Use variances to identify where actual performance deviates from standards. Question and Answer: Ask targeted questions to understand the causes of variances. Take Corrective Actions: Implement strategies to address unfavorable variances and reinforce favorable ones. 3. Formula for Cost Variance (Exhibit 21.7) Cost Variance (CV)=(Actual Quantity (AQ)×Actual Price (AP))−(Standard Quanti ty (SQ)×Standard Price (SP)) Illustration of Standard Cost Application Example - G-Max Golf Club Manufacturing • • • Standard Costs: G-Max sets a $31 standard cost per unit for one of its clubheads. Budgeted Cost Calculation: If G-Max produces and sells 3,500 units in May, the budgeted cost is calculated as: 3,500 units×$31 per unit=$108,500 Variance Analysis: If actual production costs are $112,050, the cost variance is: $112,050−$108,500=$3,550 (Unfavorable)\$112,050 \$108,500 = \$3,550 This unfavorable variance indicates G-Max exceeded the budgeted amount, highlighting areas for cost control. Summary Standard costs facilitate budget preparation, variance analysis, and efficiency improvements. By enabling targeted corrective actions, standard costs contribute to both financial control and operational efficiency.