Costing Eg

Standard Costing Example

SETTING STANDARD COSTS

A standard can be defined as a benchmark or "norm" for measuring performance.

The broadest application of the standard cost idea is found in manufacturing firms. Such firms often develop standards in detail for the materials, labour, and overhead cost of each separate product.

IDEAL VS. PRACTICAL STANDARDS

Ideal standards allow for no machine break-downs or work interruptions, and can be attained only by working at peak effort 100 percent of the time. Such standards often discourage workers and shouldn't be used for decision making.

Practical standards allow for "normal" machine down time, employee rest periods, and the like. Such standards are felt to motivate employees, since the standards are "tight but attainable". They are also useful for decision purposes, since variances from standard will contain only "abnormal" elements.

DIRECT MATERIAL STANDARDS

To illustrate the use of standard costs, consider Speeds, Inc. which manufactures a popular jogging suit. The company wishes to have standard costs developed for the suit in terms of material, labour, and variable overhead.

The standard price per unit for direct materials should be the final, delivered cost of materials. The standard price should reflect (1) specified quality of materials (2) transportation (freight) costs, and (3) receiving and handling costs.

Example: A material know as verilon is used in the jogging suits. The standard price for a yard of verilon is determined as follows:

Purchase price, grade A verilon....................$5.70

Freight, by truck...................................... .40

Receiving and handling............................. .10

Less purchase discount in 20,000 yard lots...... (.20)

Standard price per yard..............................$6.00

The standard quantity per unit for direct materials is the amount of material that should go into each finished unit of product. The standard quantity should reflect (1) engineered (bill of materials) requirements (2) expected spoilage of raw materials (3) unavoidable waste of materials in the manufacturing process and (4) materials in scrapped work in process (rejects).

Example: The standard quantity of verilon that goes into one jogging suit is computed as follows:

Bill of materials requirement.................2.8 yards.

Allowance for waste...........................0.6 yards.

Allowance for rejects..........................0.1 yards.

Standard quantity per jogging suit...........3.5 yards.

Once the price and quantity standards have been set, the standard cost of materials (verilon) for one unit of finished product can be computed:

3.5 yards per jogging suit x $6 per yard = $21 per jogging suit.

DIRECTOR LABOR STANDARDS

The standard rate per hour for direct labour should include all costs associated with direct labour workers. These costs reflect (1) hourly wage rates for each worker (2) fringe benefits (3) employment taxes.

Many companies prepare a single standard rate for all employees in a department, based on the expected mix of high and low rate employees. This procedure (1) simplifies the use of standard costs and (2) permits the manager to monitor the mix of employees in the department.

Example: The standard rate per hour for the expected labour mix is determined by using average wage rates, fringe benefits, and employment taxes as follows:

Average wage rate per hour...................$13

Average fringe benefits........................ 4

Average employment taxes.................... 1

Standard rate per direct labour hour...........$18

The standard hours per unit for direct labour specifies the amount of direct labour time required to complete one unit of product. This standard time should include (1) engineered labour time per unit (2) allowance for breaks, personal needs, and cleanup (3) allowance for setup and other machine downtime (4) allowance for rejects.

Example: The standard hours required to produce a jogging suit is determined as follows:

Basic labour time per unit.....................1.4 hours

Allowance for breaks and cleanup..........0.1 hours

Allowance for setup and downtime.........0.3 hours

Allowance for rejects.........................0.2 hours

Standard hours per jogging suit.............2.0 hours

Once the time and rate standards have been set, the standard cost of labour for one unit of product can be computed:

2.0 hours per jogging suit x $18 per hour = $36 per jogging suit.

VARIABLE OVERHEAD STANDARDS

There are usually standards for variable overhead, as well as for direct materials and direct labour. The standards are typically expressed in terms of a "rate" and "hours", much like direct labour.

The "rate" is the variable portion of the predetermined overhead rate.

The "hours" represent whatever base is used to apply overhead cost to products. Ordinarily, this would be direct labour hours or machine hours.

Example: Speed, Inc. applies overhead cost to products on the basis of direct labour hours. The variable portion of the predetermined overhead rate is $4 per direct labour hour. Using this rate, the standard cost of variable overhead for one unit of product is:

2.0 hours per jogging suit x $4 per hour = $8 per jogging suit.

After standards have been set for materials, labour, and overhead, a standard cost card can be prepared. The standard cost card indicates what the final, manufactured cost should be for a unit of product.

Example: Referring back to the standard costs computed for materials, labour, and