Chapter 10
Standard costs for control: direct material and direct labour
Copyright ª 2006 McGrawHill Australia Pty Ltd 101
Controlling costs
• Businesses are in control when operations proceed to plan and objectives are achieved
• Control systems provide regular information to assist in control, which is an essential part of effective resource management
• Necessary requirements for control
– A predetermined or standard performance level – A measure of actual performance; and
– A comparison between standard performance and actual performance
continued
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
10-2
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
10-3
Controlling costs
• Standard costing is a part of the budgetary control system
1. A predetermined or standard cost is developed
– A standard cost is a budgeted cost of one unit of product – Includes cost of material, labour and overhead
1. The actual cost incurred in the product process is measured
2. The actual cost is compared to the standard cost to form a cost variance
continued
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
10-4
Controlling costs
• Standard cost variances are used to evaluate actual performance and control costs
• Standard costs can be developed for direct material, direct labour and overheads
• When cost variances are significant, the cause of the variance must be investigated
– May result in operations being changed to bring cost back in line with standards
– Management may reconsider whether the standard costs are appropriate benchmarks
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
10-5
Setting standards
• A variety of methods may be used to set cost standards
• Analysis of historical data
– Can provide a good basis for predicting future costs
– May need to be adjusted to reflect expected movements in price levels or technological changes in the product process
– Must be used with care as changes can make those costs irrelevant, and can include inefficiencies of the past
continued
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
10-6
Setting standards
• Engineering methods
– Rather than what it cost in the past, the focus is on what it should cost in the future
– Need to determine how much material should be required and how much direct labour should be used in the production process
– Time and motion studies may be conducted to ascertain how long it should take for workers to perform each step
• In practice, both historical cost analysis and engineering methods may be used in combination
continued
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
10-7
Setting standards
• Participation in setting standards
– Standards should not be set by accountants alone
– People will usually be more committed to meeting standards and have greater confidence in their accuracy if they are allowed to participate in setting them
– Any manager who plays an integral part in an operation or process should participate in setting standards for that area
continued
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
10-8
Setting standards
• Perfection standards reflect minimum attainable costs under nearly perfect operation conditions
– Assumes peak efficiency, the lowest material and labour prices, the use of the best quality materials and no production disruptions due to power failures or machine breakdowns
• Perfection standards
– May motivate people to achieve the lowest cost possible, as the standard is theoretically attainable
– May discourage employees from working hard as the standards are unlikely to be achieved
– May encourage employees to sacrifice quality to achieve low costs
continued
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
10-9
Setting standards
• Practical standards are the minimum attainable costs under normal operating conditions, with allowances made for downtime and wastage
– Includes occasional machine breakdowns and normal amounts of raw material wastage
– May encourage more positive and productive attitudes among employees compared to perfection standards
– Some companies include allowances for idle time, material wastage or normal spoilage, which may encourage inefficiency and waste
– Other companies build continuous improvements into standards to make them more demanding
continued
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
10-10
Setting standards
• Benchmarking of costs may involve
– Identifying companies that have the best cost performance
– Assessing their level of costs, and
– Identifying the cost performance gap that needs to be closed
• Cost standards may be formulated to achieve external performance standards over the medium to long term
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
10-11
Direct material standards
• Standard material quantity
– The total amount of direct material required to produce one unit of product
• Standard material price
– The total delivered cost of the material, less quantity discounts
– Based on ordering a certain quality of material in specific order quantities from a specified supplier
Copyright 2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith
10-12
Direct labour standards
• Standard direct labour
– The number of labour hours normally needed to manufacture one unit of products
• Standard labour rate
– The total hourly cost of wages, including on-costs
– On-costs are extra salary-related costs that all Australian companies have to pay; usually treated as part of the cost of labour