A cost accounting system becomes more useful when· it includes the budgeted or expected amounts of manufacturing costs to serve as standards for comparison with the costs actually incurred. These budgeted amounts are called standard costs (or cost dastards).

An accounting system that accumulates product. service, or process costs using standard input prices and quantities is a standard cost system. Standard costs are used with both job order and process systems.

A standard cost is the per-unit cost expected to be incurred under normal (but efficient) operating conditions; Standard costs are estimated separately for the materials, direct labor, and overhead relating to each type of product that the company manufactures.

Comparison of the actual costs with these cost standards quickly directs management’s attention to situations in which actual costs differ from expected levels.

Differences between actual and standard input prices or quantities are called variances.

A variance is said to be favorable when actual input costs or quantities are less than standard. When actual input costs or quantities exceed the standard, the variance is said to be unfavorable. A standard cost system makes use offshoot actual and standard costs. The actual costs are recorded in the Materials, Direct Labor. and Overhead accounts in the manner described in prior chapters. However. the amounts charged to the work in process accounts are the standard costs for the number of units produced. Any differences between the actual costs incurred and the standard costs charged to the work in process accounts are.
recorded in special cost variance accounts.

A separate cost variance account is maintained for each type of cost variance. Thus the cost accounting system provides managers with detailed information as to the nature and
amount of the differences between ‘actual and expected (standard) manufacturing costs

How do standard costs and variance accounts .is  management in controlling costs? By quickly bringing differences in actual and expected costs to management’s attention. Otherwise, these cost differences might flow unnoticed into the Finished Goods Inventory
and· Cost of Goods Sold accounts.

Establishing and Revising Standard Dusts

Standard costs are established and revised each period during the budgeting process. Standard costs are continually reviewed and periodically revised if significant changes occur in production methods or in the prices paid for material. labor, and overhead .What should ‘the expectations of management be as they establish standard cost targets? This is an important question.

Under ideal conditions, management would leave no room for any inefficiencies in the production process-there would be no waste spoilage, fatigue, breakdowns, cost overruns, etc. However, ideal expectations are unrealistic and would result in cost standards impossible to achieve. Hence. management’s . level of expectation must be something less than ideal.

Assume you supervise. the production line for a product called Wingdings. Over several previous years, the average’ demand for Wingding has required. about 80% of production capacity, but recently demand has been very high and the production line has been running at 100% capacity.

Your production line has been designated as a responsibility cost center and you have the authority to make input-related declensions such as ordering raw materials, hiring ’employees to’ work on the production line, and maintaining the equipment,t used to produce Wingdings.

For the past several months, the plant manager has been questioning your management ability because the actual costs of producing Wingding are significantly higher than the expected standard costs. What could explain the significant difference between actual and standard costs of the recently produced Wingdings?

The level of production output plays an important role in determining cost standards. For instance, grossly underutilized production facilitate often experience varying degrees of cost inefficiency. Conversely, the stress and demands imposed on production facilities operating at full capacity can cause cost overruns. Thus, as previously stated, standards should correspond to what costs should he under normal operating conditions for a particular company. . Establishing realistic cost standards requires input from many different source soften including, people from outside of the business organization.

Standard cost systems are widely used throught the aerospace industry. At McDonnell Douglas, the development of accurate cost standards for aircraft and related products requires designee specifications from engineers material cost estimates from purchasing agents, capacity constraints from production managers. and timely updates from regulatory specialists regarding changes in FAA safety and design requirements.

Direct Material Standards

The first step in establishing standard costs for direct materials is identifying the specific materials required to produce each product. The setting of direct material standards involves both the cost the quantity of each material used. For example, assume that the standard cost of mozzarella cheese used in the production of frozen
pizzas is $2.40 per pound. If the standard quantity of cheese allowed per pizza is one quarter of a pound, the standard cost of cheese per pizza is $0.60 ($2.40 per pound times Y4 pound). The setting of direct material standards also involves assessing relationships among cost, quality, and selling prices. High-quality materials generally cost more than low quality materials. However, the use of High-quality materials often results in less waste, less spoilage, and fewer product-defects. In we pointed out that the cost and quality of materials used in production are key factors in determining selling prices, which. in turn, significantly influences customer demand. Issues relating to storage, availability, waste disposal, and shipping costs also should be taken into consideration.

Posted on November 24, 2015 in Standard Cost Systems

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