by Standard Costing is a cost accounting method that involves setting predetermined, standard costs for direct materials, direct labor, and manufacturing overhead. It is used to establish a benchmark for comparing actual costs to expected costs and to identify any variances that may occur during production.
Under standard costing, costs are recorded in the accounting system at standard rates, and variances are identified and analyzed to understand the reasons for deviations from the standard. This information is then used to adjust future cost estimates and improve cost control.
Standard costing is commonly used in manufacturing industries where products are produced in large quantities and costs can be accurately predicted based on historical data and experience. It is also used in service industries where costs can be assigned to individual products or services.
Process of Standard Costing:
- Establishing standard costs for direct materials, direct labor, and manufacturing overhead
- Recording actual costs incurred during production
- Calculating and analyzing variances between actual and standard costs
- Investigating and explaining the reasons for variances
- Adjusting future cost estimates based on the information gathered from the analysis.
Advantages of standard costing:
- It helps to identify inefficiencies in production processes.
- It provides a framework for cost control.
- It enables management to identify areas for improvement.
- It facilitates the calculation of variances that can be used for performance evaluation.
- It provides a consistent basis for decision-making.
Disadvantages of Standard Costing:
- It can be time-consuming and expensive to set up.
- It may not accurately reflect the actual costs of production.
- It may not be suitable for businesses that operate in rapidly changing markets.
- It can lead to a focus on cost reduction at the expense of quality and customer service.
- It may not take into account non-financial factors that can impact production costs, such as employee morale and motivation.
The main formulas used in standard costing are:
- Standard Cost per unit = Direct materials standard cost per unit + Direct labor standard cost per unit + Manufacturing overhead standard cost per unit
- Total Standard cost = Standard cost per unit × Number of units produced
- Variance = Actual cost – Standard cost
- Material price variance = (Actual price – Standard price) × Actual quantity
- Material quantity variance = (Actual quantity – Standard quantity) × Standard price
- Labor rate variance = (Actual rate – Standard rate) × Actual hours
- Labor efficiency variance = (Actual hours – Standard hours) × Standard rate
- Overhead spending variance = (Actual overhead – Budgeted overhead) × Actual activity
- Overhead efficiency variance = (Actual activity – Standard activity) × Standard overhead rate.
Standard Costing example question with solution
ABC Ltd. produces and sells widgets. The company’s budgeted production for the year is 10,000 units, with a budgeted overhead of $50,000. The budgeted direct materials and direct labor cost per unit are $20 and $10 respectively. The budgeted fixed overhead per unit is $5. The standard overhead rate per direct labor hour is $5.
During the year, ABC Ltd. produced 9,800 units, and incurred actual overhead of $49,500. The actual direct materials cost was $195,000, while actual direct labor cost was $98,000.
Required:
- Calculate the standard cost per unit for direct materials, direct labor, and overhead.
- Calculate the total standard cost per unit.
- Prepare a standard cost card.
- Calculate the overhead variance and the overhead cost applied.
Solution:
- Calculation of standard cost per unit:
Direct materials cost per unit = Budgeted direct materials cost per unit = $20
Direct labor cost per unit = Budgeted direct labor cost per unit = $10
Variable overhead cost per unit = Standard overhead rate per direct labor hour * Budgeted direct labor hours per unit = $5 * 1 = $5
Fixed overhead cost per unit = Budgeted fixed overhead cost per unit = $5
Total standard cost per unit = Direct materials cost per unit + Direct labor cost per unit + Variable overhead cost per unit + Fixed overhead cost per unit
= $20 + $10 + $5 + $5 = $40
- Calculation of total standard cost per unit:
Total standard cost per unit = Standard cost per unit * Budgeted production per year = $40 * 10,000 = $400,000
- Preparation of standard cost card:
Direct materials: $20 per unit
Direct labor: $10 per unit
Variable overhead: $5 per unit
Fixed overhead: $5 per unit
Total: $40 per unit
- Calculation of overhead variance and overhead cost applied:
Actual overhead = $49,500
Actual direct labor cost = $98,000
Standard overhead rate per direct labor hour = $5
Budgeted direct labor hours = Budgeted production * Budgeted direct labor hours per unit = 10,000 * 1 = 10,000 hours
Overhead cost applied = Standard overhead rate per direct labor hour * Actual direct labor hours
= $5 * 9,800 = $49,000
Overhead variance = Actual overhead – Overhead cost applied
= $49,500 – $49,000 = $500 (favorable)
The favorable variance suggests that the company’s actual overhead cost was less than the overhead cost applied based on the standard rate.
Setting of Standard
Standard costing is a method of accounting that uses standard costs and variances to evaluate performance and control costs. In standard costing, a standard is set for each cost element, such as direct materials, direct labor, and overhead. The standard represents the expected cost for a unit of product or service, based on historical data or estimates.
Setting standards in standard costing is an important process that allows businesses to control costs and evaluate performance. By setting standards for each cost element, businesses can compare actual costs to expected costs and identify variances. Variances may be favorable (actual costs are lower than expected) or unfavorable (actual costs are higher than expected), and can provide insights into areas where cost control measures may be necessary. By analyzing variances and taking corrective action, businesses can improve their performance and profitability.
Steps in setting standards in standard costing:
- Identify cost elements:
The first step in setting standards is to identify the cost elements that will be included in the standard cost. This typically includes direct materials, direct labor, and overhead.
- Determine standard quantity and price:
For each cost element, the standard quantity and price are determined. The standard quantity is the amount of a cost element that is required to produce one unit of product or service, while the standard price is the expected cost per unit of the cost element.
- Establish standard costs:
The standard cost for each cost element is calculated by multiplying the standard quantity by the standard price. For example, if the standard quantity for direct materials is 2 pounds per unit and the standard price is $5 per pound, the standard cost for direct materials is $10 per unit.
- Review and update standards:
Standards should be reviewed and updated regularly to ensure they remain accurate and relevant. This includes considering changes in market conditions, technology, and production processes that may affect costs.
