About Calculating Standard Cost

Many manufacturing companies select a valuation base of standard cost. This also applies to companies that perform light manufacturing, such as assembly and kitting. A standard cost system determines inventory unit cost based on some reasonable historical or expected cost. Studies of past and estimated future cost data can then provide the basis for standard costs. These costs are frozen until a decision is made to change them. The actual cost to produce a product may differ from the estimated standard costs. For management control, the actual cost is compared to the standard cost for a specific item and differences, or variances, are identified and analyzed. Standard costs can be maintained for items that are replenished through purchase, assembly, and production. For each replenishment method, standard costs can consist of the following elements.

Replenishment system Purchase Assembly Prod. Order

Standard cost elements Direct material cost and overhead material cost if it is required. Direct material cost, direct or fixed labor cost, and overhead cost.

Direct material cost, labor cost, subcontractor cost, and overhead c

Setting Up Standard Costs

Because the standard cost of a produced or assembled item can consist of multiple cost elements, including material, capacity (labor) and direct and overhead subcontractor costs, standard costs must be established for each of these elements. The accounting task for an item-processing company using standard costing is to: Estimate a standard cost of the finished item and set it up on the item card. Record and allocate the actual cost of the key cost elements and to account for variances.

To determine the direct cost of a finished item, all component costs must be totaled. An assembled or produced item can include subassemblies, which also consist of multiple components. The following key cost elements make up the total direct cost of a finished processed item: Material costs. Capacity cost. Subcontracting costs for produced items only.

Material Costs

Material costs are costs that are associated with subassemblies and purchased raw material. Material unit cost can consist of direct and indirect cost elements. Direct material cost represents an invoiced amount for purchased raw materials or the processing cost of a subassembly. Indirect material cost, or overhead, can represent elements such as inventory carrying costs for the finished item after it is produced.

The setup of the material cost for purchased items that affect direct and indirect cost depends on the costing method that you have selected for the specified item. You set up cost information for either costing method on the Invoicing FastTab of the item card. The cost of scrap (production only) is an additional factor to consider when you calculate the total material cost. When a certain amount of raw material is scrapped when you assemble or produce an item, it generally causes an increase in the quantity of components that are required to produce this item. This increases the material cost of the components that are consumed when producing a parent item. You set up scrap cost for materials on either the production BOM or routing. The material cost of a produced item can be represented in two ways that correspond to the following cost calculation bases.

Cost calculation basis Single level Rolled-up level or multilevel

Material cost calculation

Produced item is equal to the total cost of all purchased or subassembled items o

Produced item is the sum of the material cost for all subassemblies on that item's on that item's production BOM.

Capacity Costs
Capacity costs are the costs that are associated with internal labor and machine costs. You must set up these costs for each resource (in assembly management) and work or machine center on the routing (in production). As with materials, you can identify both direct and indirect elements of capacity cost. For example, the direct cost for a work center may be the established shop rate to perform a specific function. The indirect cost for a work center may represent some general factory expenses, such as lighting, heating, and so on. As with material costs, you can express capacity overhead as an indirect cost percentage or a fixed overhead rate. The setup of the capacity costs of assembled items consists of the following elements: Direct and indirect unit cost of the resource. Fixed or direct resource usage type.

The setup of the capacity costs of produced items consists of the following elements: Direct and indirect unit cost of the machine or work center. Time and lot size setup.

To calculate standard capacity cost, you have to establish the standard time rates that are required to perform operations on machine and work centers. The total time to complete an operation typically consists of setup, run time, and wait and move time. You set up the rates for each time type for each machine or work center on an individual routing.

Note

While run time rates apply for each item unit that is produced, the setup time rates apply for each lot. Th time for each operation over the lot size. You specify the lot size in the corresponding field on the Orde

To specify setup time on the routing for planning but not include this expense in the standard cost calculation, clear the Cost Incl. Setup field on the General FastTab in the Manufacturing Setup window. On a single-level basis, this is the labor cost that is required to produce the finished production item and is specified on the production item's routing. On a multi-level basis, this is the capacity cost that is specified for each individually produced item that is included in the parent item's BOM.

Subcontractor Costs
Subcontractor costs are the costs that are associated with services that are provided by a company's outside vendors or subcontractors. Similar to material and capacity, subcontractor costs can consist of both direct and overhead amounts. Direct subcontractor cost represents the actual charge for each unit of services that is provided. For example, overhead subcontractor cost can represent freight and handling costs that are incurred by the company with a subcontracted order. Because subcontracting is an outsourced capacity, you set up the cost of both direct and indirect subcontracting services on the work center card that represents the subcontracting operation.

Updating Standard Costs

To update or calculate the standard cost of assembly items, use the function from the item card. For more information, see How to: Calculate the Standard Cost of Assembly BOMs. The process of updating or calculating standard costs typically consists of the following tasks: 1. Updating costs at the component and capacity levels. For more information, see Suggest Item Standard Cost and Suggest Work/Mach Ctr Std Cost. Consolidating and rolling up the component and capacity costs to calculate the total manufacturing cost of the items. For more information, see Roll Up Standard Cost. Implementing the standard costs that are entered when you run the previous batch jobs. The standard costs do not take effect until they are implemented. For more information, see Implement Standard Cost Change.

2.

3.

4.

Implementing the changes to update the Unit Cost field on the item card and perform inventory revaluation. For more information, see Revaluation Journal.

CHAPTER 10: STANDARD COSTING Chapter Contents: Introduction Standard Costs Example of a Standard Cost Sheet Standard Costing Systems Standard Costing Systems and Flexible Budgeting ZFN Apparel Company, Standard Costing Example Reasons for Using a Standard Costing System Summary of Actual Costing, Normal Costing and Standard Costing Introduction: If you were to design a cost accounting system with no accounting education other than financial accounting courses, you would probably design an accounting system that collects, summarizes, and reports actual costs. This approach would be consistent with the implicit assumption throughout every financial accounting course that when financial statements report historical cost data, such as would normally be the case for cost-of-goods-sold and ending inventory, that the information reported represents actual costs. Therefore, it comes as a surprise to most students that the initial journal entries to record the production and movement of inventory in the costing systems of most manufacturing firms are not based on actual costs at all, but rather are based on budgeted per-unit costs.
In most manufacturing firms, the initial journal entries to debit work-in-process, finished goods and cost-of-goods-sold are based on the actual quantity of output produced, multiplied by budgeted data about the inputs necessary to produce those outputs, and the budgeted costs of those inputs. Then, at the end of the month (or possibly quarterly), an adjusting or closing entry is made to record in the inventory accounts the difference between actual costs incurred, and the budgeted information that has formed the basis for the journal entries during the month. The nature of this adjusting entry depends on the materiality of the amounts involved. If the differences between actual costs and budgeted costs are small, this adjusting entry might be made in an expedient manner, involving only cost-of-goods-sold, but if the

differences are large, the adjusting entry might also involve work-in-process and finished goods inventory accounts. The accounting system described above is called a standard costing system, and it is widely-used by companies in the manufacturing sector of the economy. This chapter describes standard costing systems, and explains why companies use them. But first we discuss a related concept, standard costs, which constitutes an important component of standard costing systems.

Standard costing: Standard Costs: Introduction: A standard, as the term is usually used in management accounting, is a budgeted amount for a single unit of output. A standard cost for one unit of output is the budgeted production cost for that unit. Standard costs are calculated using engineering estimates of standard quantities of inputs, and budgeted prices of those inputs. For example, for an apparel manufacturer, standard quantities of inputs are required yards of fabric per jean and required hours of sewing operator labor per jean. Budgeted prices for those inputs are the budgeted cost per yard of fabric and the budgeted labor wage rate.
Standard quantities of inputs can be established based on ideal performance, or on expected performance, but are usually based on efficient and attainable performance. Research in psychology has determined that most people will exert the greatest effort when goals are somewhat difficult to attain, but not extremely difficult. If goals are easily attained, managers and employees might not work as hard as they would if goals are challenging. But also, if goals appear out of reach, managers and employees might resign themselves to falling short of the goal, and might not work as hard as they otherwise would. For this reason, standards are often established based on efficient and attainable performance. Hence, a standard is a type of budgeted number; one characterized by a certain amount of rigor in its determination, and by its ability to motivate managers and employees to work towards the companys objectives for production efficiency and cost control. There is an important distinction between standard costs and a standard costing system. Standard costs are a component in a standard costing system. However, even companies that do not use standard costing systems can utilize standards for budgeting, planning, and variance analysis.

Definition: STANDARD COSTING may be defined basically as a technique of cost accounting which compares the standard cost of each product or service with the actual cost, to determine the efficiency of the operation, so that any remedial action may be taken immediately. The standard cost is a predetermined cost which determines what each product or service should cost under given circumstances. STANDARD COST: Definition:
An estimated or predetermined cost of performing an operation or producing a good or service, under normal conditions. Standard costs are used as target costs (or basis for comparison with the actual costs), and are developed from historical data analysis or from time and motion studies. They almost always vary from actual costs, because every situation has its share of unpredictable factors. Also called normal cost.
Objective of standard costing: Standard costing

is one of important technique of controlling the cost of company in which standard cost is determined for each department and each element of cost. After this, we use variance analysis for seeing whether our cost is less than our standard cost. If our actual cost is less than our standard cost, we have successful in our mission. So, all these things include in standard costing. Following points will explain the purposes of standard costing more deeply: 1.For Fixing the Responsibility If there is unfavorable variance after variance analysis in standard costing, we will fix the responsible of our employees. Suppose, if the standard cost of labor is less and actual cost of labor is more. It means, we have paid more to employees. This is our big loss. Who is responsible to pay salary to employees. That person has to give answer for this. 2. Management by Exceptions We can use management by exceptions easily with standard costing. Management by exception means to concentrate big projects of company instead of doing small and small supervision. In standard costing, we have made standard of our cost. Now, feel relax and happen what is happening and only check and compare results relating to material, labor and overhead cost. 3. Study of Time and Speed For calculating standard cost, we have to study of time and speed. When we study, we get knowledge of new ways to increase our speed at lowest time. So, standard costing promotes innovation.

4. Helpful in Production Policy Standard costing's one purpose is to help in production policy. We make only good standards if we know complete report of variance. That report can be available in standard costing technique.

5. Helpful in Planning Budget Planning budget may be also easy in standard costing.

6. Increase in Efficiency In standard costing technique, every employee will become alert. Because he know that if he will not bring performance, company may demote him. With this, efficiency of employee will increase. 7. Easy to Evaluate Stock To evaluate stock is very very easy in this technique. 8. Easy to Delegate Powers Delegation of powers is very easy in this technique because I will promote to that employee whose performance will be the best. How can I measure his performance. Just check the variance. Suppose, his duty is to buy material. If material cost variance shows positive variance and after investigation, we found that our actual material cost is very less due to the good buying strategy of that employee. We will make him the manager of purchase department by delegate our powers.
advantages: Standard Costing provides a valuable guidance to management in several management functions for example, formulating policies and determining prices. The standards set act as yardsticks against which actual costs are compared. Thus, standard costing facilitates effective cost control and provides the information required for cost reduction. Measurement and analysis of variances help detecting mistakes and inefficiencies, thereby enabling the management to investigate into their causes. It helps to apply the principle of management by exception that is, the management need not trouble itself with respect to those activities which proceed according to plans. It is only on the points of exceptions that they have to concentrate. It stimulates the cost consciousness of all executives because in variance analysis, the responsibility for favorable or unfavorable performances is indicated. Labour efficiency is promoted and they are destined to be cost conscious. Stock can be valued at standard cost and this, in turn, reduces the fluctuation of profits due to adoption of different methods for stock valuation. It helps in the prompt preparation of the profit and loss account for short periods, say, a week, a fortnight, a month, so as to apprise the management of the business trends. Once the system is

properly planned and introduced, it leads to savings in costs as much of the costing work can be avoided by simplifying the costing procedures. In standard costing, cost centre are defined clearly thus showing who is responsible for which cost centre. As a result, responsibilities are defined and executives are destined to be responsible.

Disadvantages The ascertainment of standards requires a high degree of technical skills is, therefore, costly. Therefore, small organizations may find it difficult to establish standard costing owing to their limited financial resources. But one should not lose sight of the fact that once the system is established, the gains that are achieved will be far in excess of the high initial costs. Executives can only be held responsible for variances if such variances arise from actions which can be controlled by them. This means that for fixing responsibilities, the controllable and noncontrollable portion of the variances should be separated. But the segregation of variances into controllable and non- controllable portion may often become a difficult task. Standard costing becomes ineffective in those industries which are subject to frequent changes in processes and technology, in the quality of material and character of labour. In these industries, if the benefits of standard costing are to be obtained, the standards have to be revised frequently so as to render them comparable with actual results.

PURPOSE OF STANDARD COSTING SYSTEMS OR METHOD

Standard costing system provides standard cost for budgeting purpose to plan future performance. Standards are established to communicate employees about economy and efficiency is required to achieve business objectives. It can be used to motivate employee to achieve desired level of performance (ideal standards). It provides some allowances for wastage and idle time (attainable standards), it recognizes the fact the labour are likely to waste some material and will become absent for various reasons like sickness. Standard costing provides standard costs for variance analysis to control business performance. Standards are compared with actual outcomes to find deviations and reasons for these deviations, so that corrective action can be taken. It helps in managing human resources by giving them signal that their performances are being measured, compared and analysed. Rewards can be given and Disciplinary action can be taken based on pre-defined criteria communicated to them, so that decisions regarding whatever action taken can be justified to avoid resentment among workforce.

STANDARD COSTING PROCESS OR PROCEDURE

Standard costing is used for recording of material, labour, overhead. Data presented in the financial statements are recorded at actual cost. Some business chooses to directly record Direct costs (material and labour) at actual costs and indirect cost (overheads)at standard or budgeted cost as per normal costing systems, while other businesses choose to record all Direct and indirect costs firstly at standard cost. At the end of the reporting period, when company performs variance analysis, these variances (differences) are adjusted to standard costs to arrive to actual cost. Whatever the approach may be chosen, it gives the same results.

Standard costs may need to be revised during the periods if circumstances changes which initially used in the determination of standard costs like inflation rate. Then this new standard cost will be used from the point circumstances are changed.

Total standard cost Standard direct material cost

Direct materials cost is the cost of direct materials which can be easily identified with the unit of [1] production. For example, the cost of glass is a direct materials cost in light bulb manufacturing. The manufacture of products or goods required material as the prime element. In general, these materials [2] are divided into two categories. These categories are direct materials and indirect materials. Direct materials are also called productive materials, raw materials, raw stock, stores and only materials without any descriptive title.

Standard quantity of material:

Direct material quantity variance is calculated to determine the efficiency of production department in converting raw material to finished goods. In order to improve efficiency, wastage of raw material must be reduced. A negative value of direct material quantity variance is unfavorable and it implies that more quantity of direct material has been used in the production process than actually needed. A positive value of direct material quantity variance is favorable implying that raw material was efficiently converted to finished goods. Standard quantity of actual output= standard quantity of material required to produce 1 unit of output x actual output Or = standard input/standard output x actual output

Standard mixture of materials:

When two or more materials are required to manufacture a product, the production engineer has to fix the standard ratio or mixture of each material. Thus, example, the engineer may determine that the standard mixture of raw material to manufacture 100units of output is material A-50units and material B-80units. Thus, Standard mixture of material A = standard input of A / standard input of all materials (A+B) The actual ratio of consumption of each material is compared with this standard ratio or mixture by working out the material mixture variance.

Standard price of materials Standard price of all materials is determined by the accounts manager with the co-operation of the purchase manager. The standard price may be fixed on the basis of historical prices or expected prices. The expected price should be fixed on the basis of the stocks in hand, the purchase orders placed, the price trends and so on. The actual prices of materials are compared with the Standard prices by working out the material price variance. Setting direct materials price standard means determining the expected price of a unit of material. It also includes expenses associated with it i.e., freight, handling charges and octroi duty etc. Every company has different type of expenses associated with materials to get it available for use. If some discount is allowed by the vendor, it is subtracted from the price to arrive at final standard price

STANDARD COSTING - DEFINITION STANDARD COSTING may be defined basically as a technique of cost accounting which compares the standard cost of each product or service with the actual cost, to determine the efficiency of the operation, so that any remedial action may be taken immediately. The standard cost is a predetermined cost which determines what each product or service should cost under given circumstances.