While fixing standard costs, the fundamental principle to be observed is that the set standards are attainable so that these are taken as yardsticks for measuring the efficiency of actual performances. Along with this, standard costs help to identify any production costs that need to be controlled. The $240 variance is favorable since the company paid $0.08 per yard less than the standard cost per yard x the 3,000 yards of denim. Generally, management does not useideal standards because ideal standards do not allow for normalrepairs to machinery or rest periods for workers. Since planning underideal standards is unrealistic, managers rarely use ideal standardsin budgeting. Instead, management uses practical standards inplanning because these standards are more realistic, allowing formachinery repairs and rest periods for workers.
Classification and Codification of Accounts
During the period, 45,000 direct labor hours were worked and $832,500 was paid for direct labor wages. Rather than assigning the actual costs of direct materials, direct labor, and manufacturing overhead to a product, some manufacturers assign the expected or standard costs. This means that a manufacturer’s inventories and cost of goods sold will begin with amounts that reflect the standard costs, not the actual costs, of a product. Since a manufacturer must pay its suppliers and employees the actual costs, there are almost always differences between the actual costs and the standard costs, and the differences are noted as variances. Actual manufacturing data are collected after the period under consideration is finished.
Standard Costs
A cost driver, typically the production units, drives the variable component of manufacturing overhead. As with any variable cost, the per unit cost is constant, but the total cost depends on the quantity produced or another cost driver. The focus of this section is variable manufacturing overhead since it has both a quantity and price standard. Companies use standard costs for budgeting because the actual costs cannot yet be determined.
Variable manufacturing overhead rate variance
- Standard costs are estimates used for totals in some of the line items in that budget, as they related to manufacturing costs.
- Cost control helps management achieve greater profitability and improve budgeting and forecasting accuracy.
- The direct labor rate per hour variance is calculated as the projected standard direct labor rate of $18 per hour, less the actual direct labor rate of $18.50, which yields a $(0.50) unfavorable per hour rate variance.
- Total standard quantity is calculated as standard quantity per unit times actual production or 0.25 direct labor hours per unit times 150,000 units produced equals 37,500 direct labor hours.
Standards for variable manufacturing costs include both quantity and price standards. The quantity standard establishes how much of an input is needed to make a product or provide a service. These standards can be used to make financial projections and to evaluate performance by comparing the standards to actual performance at the end of the period. Any discrepancy between the standard and actual costs is known as a variance. Standard variances are considered a red flag for management to investigate and determine their cause.
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This process often includes time and motion studies to ensure that the labor standards are realistic and achievable. By setting these standards, businesses can monitor labor efficiency and identify areas for improvement. whos included in your household Standard costing has different applications in business, including budgeting and cost control. For this reason, many small businesses outsource standard costing to small business accounting experts.
Variance Analysis
A budget is always an estimate, later compared to the actual amounts spent, so that the creation of the following year’s budget is more accurate. In this way, assuming there are not significant product or manufacturing changes year after year, the sizes of the variances can decrease. It is not always considered practical or even necessary to calculate and report on variances, unless the resulting information can be used by management to improve the operations or lower the costs of a business. The preceding list shows that there are many situations where standard costing is not useful, and may even result in incorrect management actions.
For example, if the cost formula for supplies is $3 per unit ($3Q), it is also considered the standard cost for supplies. Managers can use the standard cost formula to make projections about supplies expense or to evaluate the actual amount spent on supplies. The standard costing method assumes there will be little changes in the budgeted amounts in the foreseeable future. However, if a product is unexpectantly discontinued or a new one introduced, or there are new efficiencies or deficiencies in the production process, this can result in significant variances from the estimates. Taking the time to continuously update actual costs means a lot of number adjustments for a company’s accountant.
In this manner, clear records are also maintained, which is useful while planning for funding through loans or equity for growth and expansion. The above is a very detailed and unique process that helps business to decide how much cost is incurred for each type of product lines and whether it is possible to reduce them. This will help in using the financial resources in areas where they are actually required.
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