Labor Costs
At the end of each period, you compare the amount of
Labor costs, also known as direct labor costs, refer to any funding
given to workers who produce and build the products in question.
Examples of labor include assembly line workers, machine operators
and installation clerks. Indirect labor refers to individuals who are
working for the company but have indirect roles in the manufacturing
process. Indirect workers include janitors, supervisors and security
guards.
Material Costs
Material costs refer to the raw materials that actually create the product
in question. Raw materials cover anything from the finished product
itself to any bolts, nuts and wood that went into building the original
product. The final product is considered raw since it may be used as
raw materials for another product for another business. Material costs
also include direct materials that play a role in the manufacturing
process, such as tiny motors, buttons and light bulbs.
Overhead Costs
Overhead costs are those associated with the manufacturing process,
excluding the raw materials and labor funding. The machinery and
equipment used to build the products must undergo frequent
maintenance and funding must be available to complete repairs.
Overhead costs also cover any maintenance or rebuilding of the
manufacturing facilities, such as expanding the production line or
adding new lighting in the factory. Any expense or cost that does not fit
into direct material costs and labor costs may fall into the
manufacturing overhead category.
Nonmanufacturing Costs
Nonmanufacturing costs refer to any funding that is not directly
associated with creating a product but connect to the actual product in
terms of sales. In other words, nonmanufacturing costs refer to the
funding spent on marketing, sales associates, equipment maintenance
and automobile expenses. Salaries for marketers, accountants and
managers in various departments in the company also falls into this
category. Facility expenses, such as rent, light, heat and property
taxes, are also nonmanufacturing costs as they fall into general
operations costs.
Job-Order Costing
The most common cost-accounting system used by small-business
manufacturers is job-order costing. Job-order costing assigns costs to
products based upon production batches. For example, if your clothing
manufacturing business produces socks, jeans and shirts, you might
produce a batch of jeans, then a batch of socks, then some shirts.
Each production run of clothing is considered a batch or job. Under
job-order costing, you would account for the actual materials and labor
used during the job and assign these costs to products. You would
then allocate a portion of overhead costs, those manufacturing costs
not included as materials or labor, to each batch as well. If your
company produces different products via production batches, job-order
costing is probably the best choice for your company.
Process Costing
If your small business produces products where individual units of
product are indistinguishable from one another, then process costing
will probably be the best choice for your business. Products
manufactured under a process-costing system include orange juice,
ball bearings, petroleum products and milk. The process costing
system assigns costs to products based upon the department in which
the costs occur. For example, if your company produces orange juice,
you may have washing, peeling, juicing, pasteurizing and bottling
departments. Under process costing, you would allocate any materials
and labor related to washing the oranges in the washing department.
In addition, you would allocate any overhead costs related to the
products in this department. Once the product moves onto peeling, the
costs move on as well. In peeling, the same process occurs, with
materials, labor and overhead costs being added to the product cost.
This process repeats until the product is completed.
Standard Costing
Many small-business manufacturers use standard costing systems.
These systems start with the establishment of a standard cost. The
standard cost of a product is the estimated cost of production, provided
normal operations and a reasonably minimal amount of waste, defect
and spoilage.
materials, labor and overhead costs used in production to the
standard. If management deems the difference between the actual and
standard to be significant, the company will investigate the
differenceand attempt to correct operations to eliminate the difference
in the future. If not, the company accepts the difference and does not
change the process.
Activity-Based Costing
Companies use activity-based costing systems to obtain more-detailed
cost information. Because these systems are not allowed for external
financial reporting, activity-based costing is done in addition to process
or job-order costing. In an activity-based costing system, you
accumulate costs by activities that may include both manufacturing
and non-manufacturing costs. For example, if your company produces
custom riding saddles, you may incur costs during the ordering,
machinery setup, production, packing and post-sale customer service
processes. In an activity-based costing system, you assign ordering
costs, such as the costs of telephone operators and ordering system
computers, to products. Once the ordering process is complete, you
add costs of setup to the product's cost, and so on, until the product is
completed.
Introduction to Standard Costing
Standard costing is an important subtopic of cost accounting. Standard
costs are usually associated with a manufacturing company's costs of
direct material, direct labor, and manufacturing overhead.
Rather than assigning the actual costs of direct material, direct labor,
and manufacturing overhead to a product, many manufacturers assign
the expected or standard cost. This means that a manufacturer's
inventories and cost of goods sold will begin with amounts reflecting
the standard costs, not the actual costs, of a product. Manufacturers,
of course, still have to pay the actual costs. As a result there are
almost always differences between the actual costs and the standard
costs, and those differences are known as variances.
Standard costing and the related variances is a valuable management
tool. If a variance arises, management becomes aware that
manufacturing costs have differed from the standard (planned,
expected) costs.
If actual costs are greater than standard costs the variance
is unfavorable. An unfavorable variance tells management
that if everything else stays constant the company's actual
profit will be less than planned.
If actual costs are less than standard costs the variance is
favorable. A favorable variance tells management that if
everything else stays constant the actual profit will likely
exceed the planned profit.
The sooner that the accounting system reports a variance, the sooner
that management can direct its attention to the difference from the
planned amounts.
If we assume that a company uses the perpetual inventory system and
that it carries all of its inventory accounts at standard cost (including
Direct Materials Inventory or Stores), then the standard cost of a
finished product is the sum of the standard costs of the inputs:
1. Direct material
2. Direct labor
3. Manufacturing overhead
1. Variable manufacturing overhead
2. Fixed manufacturing overhead
Usually there will be two variances computed for each input:
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Sample Standards Table
Let's assume that your Uncle Pete runs a retail outlet that sells denim
aprons in two sizes. Pete suggests that you get into the manufacturing
side of the business, so on January 1, 2016 you start up an apron
production company called DenimWorks. Using the best information at
hand, the two of you compile the following estimates to use as
standards for 2016:
Standards Table for DenimWorks
The aprons are easy to produce, and no apron is ever left unfinished at
the end of any given day. This means that your company never
has work-in-process inventory.
When we make your journal entries for completed aprons (shown
below), we'll use an account called Inventory-FGwhich means Finished
Goods Inventory. (Some companies will use WIP Inventory or Work-in-
Process Inventory). We'll also use the account Direct Materials
Inventory. (Other account titles often used for direct materials are Raw
Materials Inventory or Stores.)
Direct Materials Purchased: Standard Cost and Price Variance
Direct materials refers to just thatraw materials that are directly
traceable into a product. In your apron business the direct material is
the denim. (In a food manufacturer's business the direct materials are
the ingredients such as flour and sugar; in an automobile assembly
plant, the direct materials are the cars' component parts).
DenimWorks purchases its denim from a local supplier with terms of
net 30 days, FOB destination. This means that title to the denim
passes from the supplier to DenimWorks when DenimWorks receives
the material. When the denim arrives, DenimWorks will record the
denim received in its Direct Materials Inventory at the standard cost of
$3 per yard (see standards table above) and will record the liability at
the actual cost for the amount received. Any difference between the
standard cost of the material and the actual cost of the material
received is recorded as a purchase price variance.
Examples of Standard Cost of Materials and Price Variance
Let's assume that on January 2, 2016 DenimWorks ordered 1,000
yards of denim at $2.90 per yard. On January 8, 2016 DenimWorks
receives 1,000 yards of denim and an invoice for the actual cost of
$2,900. On January 8, 2016 DenimWorks becomes the owner of the
material and has a liability to its supplier. On January 8 DenimWorks'
Direct Materials Inventory is increased by the standard cost of $3,000
(1,000 yards of denim at the standard cost of $3 per yard), Accounts
Payable is credited for $2,900 (the actual amount owed to the
supplier), and the difference of $100 is credited to Direct Materials
Price Variance. In general journal format the entry looks like this:
The $100 credit to the price variance account communicates
immediately (when the denim arrives) that the company is
experiencing actual costs that are more favorable than the planned,
standard cost.
In February, DenimWorks orders 3,000 yards of denim at $3.05 per
yard. On March 1, 2016 DenimWorks receives the 3,000 yards of
denim and an invoice for $9,150 due in 30 days. On March 1, the
Direct Materials Inventory account is increased by the standard cost of
$9,000 (3,000 yards at the standard cost of $3 per yard), Accounts
Payable is credited for $9,150 (the actual cost of the denim), and the
difference of $150 is debited to Direct Materials Price Variance as an
unfavorable price variance:
After the March 1 transaction is posted, the Direct Materials Price
Variance account shows a debit balance of $50 (the $100 credit on
January 2 combined with the $150 debit on March 1). A debit balance
in a variance account is always unfavorableit shows that the total of
actual costs is higher than the total of the expected standard costs. In
other words, your company's profit will be $50 less than planned
unless you take some action.
On June 1 your company receives 3,000 yards of denim at an actual
cost of $2.92 per yard for a total of $8,760 due in 30 days. The entry is:
Direct Materials Inventory is debited for the standard cost of $9,000
(3,000 yards at $3 per yard), Accounts Payable is credited for the
actual amount owed, and the difference of $240 is credited to Direct
Materials Price Variance. A credit to the variance account indicates that
the actual cost is less than the standard cost.
After this transaction is recorded, the Direct Materials Price Variance
account shows an overall credit balance of $190. A credit balance in a
variance account is always favorable. In other words, your company's
profit will be $190 greater than planned due to the favorable cost of
direct materials.
Note that the entire price variance pertaining to all of the direct
materials received was recorded immediately. In other words, the price
variance associated with the direct materials received was not delayed
until the materials were used.
Standard Costing one of the advance technique of cost accounting .
With this manager calculates the standard cost and compare it with
actual cost and after calculating variance , improvement is done in
area of production . So Standard costing is so important for every type
of business organisation . We can explain its importance under
following points
Increase the efficiency
Account manager fixes the standard cost of direct material , labour and
overheads and pre-determined standard cost increases the efficiency
of production , every worker produce goods according to standard cost
. After this actual cost is also compare with standard cost . With this
comparison , manager will succeed to increase the efficiency of worker
for reducing cost .
Effective utilization of resources

Standard costing is also helpful for effective utilization of resources .

We can explain this with small example
Suppose , A company purchase following raw material without setting
any standard cost .

Name of Item Actual Cost

x - material $ 40000
y - material $ 30000
z - material $ 20000

Because A company can not set the standard of quantity and rate of
raw material cost . It may possible .

Company has purchased raw material more than current

production and extra raw material is the waste of working capital .
Company does not research the market , it may possible that
one supplier can supply same raw material with following cost

Name of Item Actual Cost

x - material $ 35000
y - material $ 20000
z - material $ 15000

Now company will face the total loss due to not utilization his resources
effectively and standard costing is only way to effective utilization for
reducing cost .

Use in Budgetary Control

Standard costing can also use in budgetary control . We know that

budgetary control is the part of management and in controlling , it can
be used . In budgetary control , not only standard cost is calculated but
after comparing relative actions of improvement are taken . With
standard costing , effective control of cost can be possible .

Proper decisions

Standard costing is also helpful for taking proper decisions for deciding
cost. There are large number of expenses and there are many
alternatives of these expenses . When standard cost is decided at that
time , best alternative from different expenses is chosen and it will
reduce extra cost burden .