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It is the standard cost of difference between the actual hours paid and the actual hours worked. An ‘ideal’ standard is one which can be attained under the most favourable conditions. It represents the level of performance attainable with the ‘best’ or ideal set-up, i.e., best quality materials at favourable prices, highly skilled labour and best equipment. This standard focuses on maximum efficiency in the utilisation of resources, i.e., maximum output with minimum cost. While setting the expected standard, due allowance would be made for such contingencies as wastage, spoilage, lost time, etc. As such, the expected standard is realistic, capable of achievement and provides an incentive to operating personnel to improve performance.
Consequently, historical costs are computed by reference to source documents such as material requisition, job cards, time cards, etc. only after much time and clerical labour. Standard costs are pre-determined costs computed before commencement of production. The need for standard costs arises owing to the limitations or weaknesses of historical costs. While historical costs are ascertained after the completion of an activity or operation and, as such, can tell us what the costs actually are, standard costs are computed in advance of production. In a standard costing system, some favorable variances are not indicators of efficiency in operations. However, direct labor may be essentially fixed, and then an undue emphasis on labor efficiency variances creates pressure to build excess work in process and finished goods inventories.
Companies budget using standard costs since actual costs cannot yet be identified. This is because it is impossible to forecast a product’s demand or all of the variables that will affect its manufacturing costs during the manufacturing process. standard costing system It would be impossible to set a price for a product without the information provided by standard costing. This is because the pricing is based in part on the costs of creating those goods (including labor, materials, and overhead costs).
The components of this adjusting entry provide information about the company’s performance for the period, particularly about production efficiency and cost control. Using the standard and actual data given for Lastlock and the direct materials variance template, compute the direct materials variances. Another object of standard cost is to help the management in determining prices and formulating production policies. It also helps the management in the areas of profit planning, product-pricing and inventory pricing etc.
After the March 1 transaction is posted, the Direct Materials Price Variance account shows a debit balance of $50 (the $100 credit on January 8 combined with the $150 debit on March 1). A debit balance in any variance account means it is unfavorable. It means that the actual costs are higher than the standard costs and the company’s profit will be $50 less than planned unless some action is taken.
Overhead may produce a variance in expected fixed or variable costs, leading to possible differences in production capacity and management’s ability to control overhead. More specifics on the formulas, processes, and interpretations of the direct materials, direct labor, and overhead variances are discussed in each of this chapter’s following sections. Standard costs are established for the variable and fixed manufacturing overhead used in the manufacturing process. Manufacturing overhead includes all costs incurred to manufacture a product that are not direct material or direct labor. Variable manufacturing overhead is same amount per unit but the total amount depends on quantity. Fixed manufacturing overhead is the same in total regardless of quantity but the per unit amount changes depending on the quantity.
Subsequently, variances are recorded to show the difference between the expected and actual costs. There are certain factors that need to be considered before establishing a standard costing system. The first factor to consider is when setting standards within a standard costing system, the standards should be specific, measurable, achievable, relevant and time-based.
This is important since the standard costing system is to be built on the basis of the existing system of costing, budgeting and internal control procedures. The existing cost system should be reviewed with special reference to the existing cost system should be reviewed with special reference to the existing records and forms. (3) Comparison of actual performance and costs with standards and working out the variances i.e., the difference between the actual and the standards. (i) Ascertainment of various labour grades and requirement of their labour hours for each product.
While these standards are very likely attainable, they are difficult to compute, because of probable errors in predicting the extent and duration of cyclical effects. Methods, processes https://www.bookstime.com/articles/do-i-need-a-personal-accountant and operations should be capable of being standardised. (iv) Taking appropriate action on the basis of the nature of variances, i.e. controllable and non-controllable.
It contains quantity and price of each class of material used, grade of labour, labour rate and time and overhead rate for each product. Such limitations encouraged the development of a new costing approach, i.e., predetermined costs. It helps management to know costs before production starts and control inefficiency and waste at the source.
When new products are manufactured for sale, material quality requirements and labour skill requirements may not be accurately determined. Sometimes, it may become necessary to employ workers who have no experience in the job. Standards set on this basis are based on the past average performance. Such standards are generally less suitable compared to practical/normal standards.