Download Chapter 10 Budgeting and standard costing

Chapter 10
• Standard costs
• Setting standards
Budgeting and
standard costing
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• Flexible budgets
• Principle of controllability
Syllabus learning outcomes
• Explain the use of standard costs.
• Outline the methods used to derive standard costs and
discuss the different types of cost possible.
• Explain and illustrate the importance of flexing budgets in
performance management.
• Explain and apply the principle of controllability in the
performance management system.
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Chapter overview
• In this chapter we will be looking at standard costs and
standard costing.
• You will have studied standard costing before and have
learned about the principles of standard costing and how
to calculate a number of cost and sales variances.
• We begin this chapter by reviewing the main principles of
standard costing as well as looking in some detail at the
way in which standard costs are set.
• Flexible budgets are vital for both planning and control and
we will look at how they are constructed and their use in
the overall budgetary control process.
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Summary
Purpose of
standards
Calculation of
standards
Bases of
standards
Budgeting and
standards costing
Controllability
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Standards and
budgets
Waste and
idle time
Tackling the exam
• The contents of this chapter may be examined via an MCQ
or as a discussion requirement in Section B.
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1 Standard costs 1/6
Purpose of standards
• Decision making
• Budgeting
• Control
• Performance evaluation
• Inventory valuation
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1 Standard costs 2/6
Calculation of standards
• Based on expected prices and expected usage or time
and wastage
• Greatest benefit arises if there is a large amount of
repetition in the production process
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1 Standard costs 3/6
• A standard is an estimated unit cost.
Example of a standard cost card for a cost unit
$/unit
Direct costs:
Direct materials
Direct labour
Indirect costs:
Variable overhead
Fixed overheads
Full product cost
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(5kg @ $3/kg)
(3 hrs @ $6/hr)
15.00
18.00
33.00
2.00
3.00
38.00
1 Standard costs 4/6
Uses of standard costing
• To act as a control device – variance analysis
• To value inventories and cost production
• To assist in setting budgets and evaluating managerial
performance
• To enable the principle of ‘management by exception’ to
be practised
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1 Standard costs 5/6
Uses of standard costing continued
• To provide a prediction of future costs for use in
decision-making situations
• To motivate staff and management by providing
challenging targets
• To provide guidance on possible ways of improving
efficiency
• Most suited to mass production and repetitive assembly
work
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1 Standard costs 6/6
• The responsibility for deriving standards should be shared
between managers
• They will be able to provide the necessary information
about levels of expected efficiency, prices and overhead
costs
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2 Setting standards 1/3
Types of performance standard
Ideal
• Perfect operating conditions
• Unfavourable motivational impact
Attainable
• Allowances made for inefficiencies and wastage
• Incentive to work harder (realistic but challenging)
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2 Setting standards 2/3
Types of standard continued
Current
• Based on current working conditions
• No motivational impact
Basic
• Unaltered over a long period of time
• Unfavourable impact on performance
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2 Setting standards 3/3
Standards and budgets compared
Similarities:
•Are very similar in terms of their motivation impacts on employees
•Standards generally form the basis for the budget
•Both used for control
Differences:
Standard cost
By unit
For areas of repetition
Financial & non-financial targets
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Budget
In total
All areas
Financial targets
Question: Standard cost and quantity
Required
What considerations will:
(a) The purchasing department take into account when
trying to establish the standard cost of material?
(b) The production department take into account when trying
to establish the quantity of material needed per unit?
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Answer: Standard cost and quantity
(a) Price discussions with suppliers
Anticipated inflation
Bulk discounts
Quality of material purchased
Quantity required
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Answer: Standard cost and quantity cont’d
(b) Anticipated quantity per unit based on specs
Whether required quality of material is available
Amount of wastage from material
Amount of rework required – need understanding of
skills/ training of labour force
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3 Flexible budgets 1/2
Flexible budgets
• Budgets which, by recognising different cost behaviour
patterns, change as activity levels change
• Flexible budgets can be drawn up to show the effect of
actual volumes of output and sales differing from
budgeted volumes
• At the end of a period, actual results can be compared to
a flexed budget
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3 Flexible budgets 2/2
Procedure
• Decide whether costs are fixed, variable or semi-variable
• Split semi-variable costs into their fixed and variable
components using the high-low method
• Flex the budget to the required activity level
• Many cost items in modern industry are fixed costs so the
value of flexible budgets is dwindling
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4 Principle of controllability
• Managers should only be held accountable for those items
that they can control ie: variable or discretionary fixed
costs.
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Question: Standards and motivation
Required
How do you think each of the bases of standard would
impact an employee's motivation?
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Answer: Standards and motivation
• Ideal – demotivates as impossible to achieve
• Attainable – best level to set for motivation of employees
– It is a target with stretch but it is do-able at a stretch
• Current – no incentive to do any more than is currently
being done
• Basic – often too out-of-date to be relevant and therefore
no positive impact – may even be adverse affects
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Question: Inflation
Required
If inflation is significant, would a standard be relevant?
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Answer: Inflation
• In times of inflation a decision needs to be made as to
what level to set the standard at.
• If it is at the inflated price, early in the year a favourable
variance due to price may be experienced.
• If mid point is chosen the variance may be favourable
early in the year and adverse later in the year.
• Setting a standard and evaluating performance against it
is therefore more difficult. However, inflation is measurable
and so its effects can be stripped out so that performance
can be measured.
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Inflation in different countries
• A corporation that has operations in different countries will
have to compare performance in those operations after
stripping out inflation.
• In November 2013 inflation in China was approximately
3% and in Indonesia inflation was approximately 9%.
• If a company had identical operations in each country and
each was judged only on the standards, the Indonesian
operations would be at a disadvantage, regardless of how
well they had done in ‘real’ terms.
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Question: Specimen exam
The following statements have been made about different
types of standards in standard costing systems:
(1) Basic standards provide the best basis for budgeting
because they represent an achievable level of
productivity.
(2) Ideal standards are short-term targets and useful for
day-to-day control purposes.
Which of the above statements is/are true?
A
1 only
C
Neither 1 nor 2
B
2 only
D
Both 1 and 2
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Answer: Specimen exam
C
A basic standard is a historical standard, and will often no
longer represent current levels of productivity. Ideal
standards are not achievable in the short term, but may be
longer-term targets.
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Summary
1 Standard costs
 Standard costs have many uses in performance management. These
include:
─ Performance evaluation
─ Control
─ Decision making
─ Budgeting
─ Inventory valuation
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Summary
2 Setting standards
 Standards are prepared taking into account future price rises,
efficiencies etc.
 The four bases are:
─ Ideal
─ Attainable
─ Current
─ Basic
 Standards should be set at an attainable level to drive the best
performance.
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Summary
3 Flexible budgets
 Budgets which, by recognising different cost behaviour patterns,
change as activity levels change
 Flexible budgets can be drawn up to show the effect of actual volumes
of output and sales differing from budgeted volumes
 At the end of a period, actual results can be compared to a flexed
budget
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Summary
4 Principle of controllability
 Managers should only be held accountable for those items that they
can control ie: variable or discretionary fixed costs.
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