ReSA The Review School of Accountancy R. Papa Cor. S. H. Loyola Sts. Sampaloc, Manila # Tel Nos. 734-39-89 & 735-98-07 ADVANCED FINANCIAL ACCOUNTING Cost Accounting - standard Costing & REPORTING Need for Standards Precise measurement requires standards. A standard is understood to be 2 rule of measurement by authority. It is like a norm. Whatever 1s considered normal can be generally accepted as standard. Management, in assigning responsibly for the actual results of operations, wants {o know that those results were measured accurately. But before there can be a fair judgment concerning 900d or poor performance, the measure of acceptable performance - a standard - must be applied to actual results. A standard cost, therefore, is a scientifically predetermined cost of manufacturing 2 unit or a specific quantity of product during a particular period of time. It is 2 measure of acceptable performance, estabished by management as a guide to certain economic decisions. It is in short, a reflection of what a management thinks a cost should ought to be. Standards are most frequently established for: 1. Raw materials used in making a product or one of its components. 2. Direct labor needed to perform a manufacturing operations. 3. Manufacturing overhead applied to a unit of output. Standard costs also have an important qualitative dimensions. For the moment, it will be assumed that a standard cost reflects the desired level of achievement with operating objectives. However, standards cannot be defined on any precise scale that reflects different degrees of success in achieving goals. As will be seen, accounting standards may be described variously as ideal, practical, tight, tight, loose, attainable, or current. Usefulness of Standard Costs A standard cost system may be used in connection with either the process or job order cost accumulation methods. Standard cost (s most readily adaptable to manufacturing environments, where production technology is relatively stable and the products manufactured are ‘homogenous within the cost accumulation unt, ie, the department or the job. Standard cost systems aid in planning and controlling operations and in gaining insights into the probable impact of managerial decisions on costs and profits. Standard costs are used for: 1. Establishing budgets 2. Cost control (management by exception) 3. Price setting 4, Cost awareness The Standard Cost Accounting System ‘The standard cost accounting system consists of three basic objectives, they are: 1, Standard setting 2. Accumulation of actual costs 3. Variance analysis, the difference between the actual costs incurred (2), and the standard setting. Development of Standards Developing standards can be rather large or detailed task, depending on the size of the company ‘or segment and the complexity and diversity of the product design and manufacturing operations, Before standards can be developed, a thorough understanding is needed for these things: 1. The fundamental factor of cost. 2. The design and material specifications of the product. 3. The nature of productive labor operations and their departmental locations. Who Set Standards ? Standards 1s to be set by duly constituted authority. In a small and medium-sized companies, {this authority would mean, top management. In lange companies, it is likely (0 be the general ‘manager of a division or a branch plant. itis seldom possible for busy top executives such as these to participate directly. in the establishment of standards, AFAR-17ADVANCED FINANCIAL ACCOUNTING & REPORTING page 2 Setting Standards The setting of standards and the estabishment of a standard cost system allow managers to follow the management by exception principle, which specifies that the manager will maximize his or her efficiency by concentrating on those operational factors vihich are deviations from the plan. Management by exception is especially effective in the area of cast control Events, rather than tiie, are the factors that determine when standards should be revised. These events may be classified as internal or external. Internal events such as technological advances, esign, revisions, method changes, izvur vate adjustments, and changes in physical facilities are to some degree controllable by management. In contrast, extemal events, such as price changes (including the impact of inflation), market trends, and specific customer requirements. Accumulation of Actual Cost When a company uses a standard cost accounting system, it does not mean there is no need for actual costs . Actual costs should likewise be recorded and accumulated. They should be made available for comparison with standard costs to determmne voy deviations. Therefore, a standard cost system should be used in conjunction with the other systems of cost accumulation methods like job order and process costing systems Variance Analysis The difference between standard cost and actual cost is called variance. The expression of this relationship is seen in the following simple formula: Actual Cost = Standard Cost + Variance By rearranging the terms in the formula, we can determine the variance if we know the standard cost and actual costs: Variance = Actus! Cost ~ Standard Cost ‘The word “variance” steraih’ means difference. Variance can be computed for all three cost elements of production ~ materials, labor and overhead. Variance can either be plus or minus, depending ‘on whether the actual cost is greater or lesser than standard. Since, standard cost is a measurement of what a particular cost should ought to be, any deviation from it can be interpreted as either good or bad = favorable or unfavorable to the attainment of company’s profit goal. Actually, variances is analyzed to know two things: 1. The difference between the a 2. The reasons for such fierence. and s J cost, and However, we should not be contensied to krow the amount of variance. But, itis more important to know the reasons for such variance, since this will be the management concern as @ basis for making economic decisions. Determination of standard cost is based on physical standards — they are of two types, basic and current. A basic standardis a yardstick against which both expected and actual performances are ‘compared. It is similar to an index number against which ali subsequent results are measured The current standards are of three types: 1. The theoretical standard is a sianiard set for an ideal or maximum level of operation and efficiency. Such standard constitute goals to be aimed for rather than performance that can be currently achieved. 2. ‘The expected actual standard ‘5 a standard set for 2 normal level of operation and efficiency. It is reasonably closed estimate of actuat result. 3. The normal standard 's a stancard set for normal ievel of operation and efficiency, instead to represent challenging yet attainable result. Determining Standard Cost Variances For each item of direct material, tor each fadur operations, and for departmentalized factory overhead actual costs are measurcd against standard costs, resulting in differences. The differences are analyzed and identified as specific types of standard cost variances. If the actual cost exceeds the ‘standard cost, the variance 1s referred £0 as “unfavorable” because the excess has an unfavorable effect on income. Conversely, f the standard cost exceeds the actuat cost, the variance referred to as “favorable” because - they have a favorable effect on income AFAR-17ADVANCED FINANCIAL ACCOUNTING & REPORTING page 3 I— Journal Entries: Variance Analysis ‘The Jubilee Corporation manufactures a product with the following standard costs: Direct materials ~ 20 yards at P1.35 per yard P27 Direct labor - 4 hours at P9 per hour - 36 Factory overhead ~ 4 direct labor hours at P7.50 per hour; ratio of variable to fixed factory overhead is 2:1, - 30 Total standard cost per unit of output. - 23 Standards are based on normal monthly capacity of 2,400 direct labor hours. The following information pertains to July: Units produced in July. 500 Direct materials purchased - 18,000 yards at P1.38 per yard, -P 24,840 Direct materials used - 9,500 yards Direct labor ~ 2,100 hours at P9.15 per hour 19,215 Actual factory overhead, - 16,650 Required: 1+ Compute the following vanances and indicated whether they ae favorable Or Unfavorable: Materials purchase price, price usage, and quantity variances. ator rate and emiengy vrionces ©. Factory overhead controllable and volume variances. Show the computation of variable and fixed factory overhead per direct labor hour and the total budgeted factory overhead into variable and fixed. 2. Prepare the entries for Number 1 above. (AICPA Adapted) 11 - Equivalent Production and Standard Cost Variance Analysis (With Solution) The Cross Company uses a standard process costing system ~ FIFO method in its one production department. Material A is added at the beginning of the process, and Material B is added when the units are 90% complete. Inspection take place at the end of the process, and all spoilage is expected to be abnormal. The standard cost of abnormal spoilage is charged to a current period expense account. Normal capacity is 7,800 labor hours per month. The standard cost per unit is as follows: Material A: 4 gallons at P1.20. .. P 4.80 Material B; 2 square feet at P.70 140 Direct labor: 1 hour at P11.50, 11.50 Variable factory overhead: 1 hour at P1.80 o 180 Fixed factory overhead: 1 hour at P5.00. 5.00 Total P24.50 Additional data for January are as follows: a. Beginning work in process inventory: 3.000 units (33 1/3% converted) b. Started in process during the month, 11,000 units. . Finished during January, 8,000 units. 4. Ending work in process inventory, 5,000 units (40% converted) . Actual costs incurred are as follows: Material A used. 50,000 gaitons at P1.00 Material B used. 18,000 sq, ft. at P.75 Direct labor. - 10,200 hours at P12.00 Factory overhead... = P60,100 Required: 1. Compute the January equivalent production for Material A, Material B, and for conversion costs, 2. Compute the materials price usage and quantity variances for each kind of material, the labor fate and labor efficiency variances, and the factory overhead controllable and volume variances. Indicate whether the variances are favorable or unfavorable. (CGA - Canada Adapted) AFAR-17ADVANCED FINANCIAL ACCOUNTING & REPORTING Solution to Problem II - Cross Company [Quantity Schedule: | Actual TWD - ice | Quantity | Total | P7100 | 50,000 50,000 | -_ 1.20 | *44,000 sz.800_| change fi OE some 2 con | “Standard materials per unit ic production (equivalent uni 4 gallons x 13,009 EUP - Mat A = 44,000 standard quantity MpUV = Change in Price x Actual Quy Used P(_20)F x 50,000 P( 10,000) F MQV = Change in Qiy.s Sid Price 6,000 U x P1.20. 2.200 u Material A Cost Variance 2.800) F 2:59 fl.x 9,000 EU>- Mat B = 18,000 standard quantity MpUV = Change in Price x Actual Qty Used =P05U x 18,000, P 900u MV = Change in Qly. x Sid. Price = -0- xP 70 |B Cost Variance alt —_2 _t Standard materisis per unit is based on actual production (equivalent units): 4 hour x 10,000 EUP — CC = 10,000 standard hours LRV = Change in Rate x Actual Hours P SOU x 10,200 P5.100U LEV = Change in Hours x Sid. DL Rate = 200 U xP1150 2,300_U Labor Cost Variance i P7400 U Factory Overhead: Controllable Variance: ‘Actual Factory Overhead (AFOH) 60,100 Less: Budgeted Allowed Based On Sid. Hrs.-10,000 hrs. (BASH) Fixed as Budgeted (PS x 7,809 Normal Capacity) .....P39,000 Variable (P1.80 x 15,000 hours) 18,000 _57,000 P 3,100U Volume Variance: Budgeted Allowed Based on Std. Hrs (BASH) P 57,000 Less: Std. FOH or Applied Factory Overnead (SH x SR). 10,000 hours x P6.80 68,000 (11,000) F Factory Overhead Variance ~ favorable. (7.900) F AFAR-17ADVANCED FINANCIAL ACCOUNTING & REPORTING Soll * Standard materials per unit is based on actual production (units) 20 yards x 500 units produced = 10,000 standard quantity Change in Price x Actual Qty. Purchased Materials Purchas Price Price Variance .03 U x 18,000. Materials: Materials Price = Change in Price x Actual Qty. Used Usage Variance = P.03F x 9,500.. NS quantity: Materials Quantity! = Change in Qty. x Standard Price Usage Variance = ( 500) Fx P1.38.. - (675) F Materials Cost Variance. (S20) Note: Change means Actual less Standard. Materials are recorded | ‘Materials are recorded ] | at Standard Price at Actual Price | (Price Variance determinedat the time | (Price Variance determinedat the time | t of purchase) | __ of issue/usage/requisition) _ t | Mat. @ Ack. Price (PT 38% 76 000). 24.840 ‘Accounts Pay. (Pt 38 * 18,000) i fo r a | | 15 (P1.35 x 10,000).13,500 | We. | MQV = fav. (500) fx 1.35}. 675 | MpUV— unf. (P.03 u x 9,500) 285 | Mat, @ Std. Price (P1.35 x 9,500) 12.825 MV fav. (500) fx P1.35}. 675 | |__Mat.. @ Act. Price (P1.38 x 9,500) 13.110 , 7 | ~ 1000 | P1215 0] * Standard Hours per unit is based on actual production (units) 4 hours per unit x 500 units produced = 2,000 standard hours “Efficiency may refer also to usage, time (hours). 15 U x 2,100...... 7, Rate : Labor Rate Variance = Change in Rate x Actual Hours Efficiency: Labor Efficiency! Usage/Time Variance = Change in Hours x Std. DL Rate =100U xP 9. 900 U P1215 U Labor Cost Variance. Note: Change means Actual less Standard. AFAR-17ADVANCED FINANCIAL ACCOUNTING & REPORTING Sol2 Journal Entries: Labor Incurrence: Payroll (at actual wisis) 19.215 ‘Accrued Payroll 19.215 Labor Distribution: Work-in-Process, @ Sid. Costs (P9 x 2,000) 18,000 Labor Rate Variance — unt (P. 16 « x 2,100). 315 Labor Efficiency Variance — unf (790 « PS). 900 Payroll 19,215 Factory Overhead: Std. Factory Overhead Rate Variable = P7 56 x 2:3 Ps Fixed = P7.50 x 1/3 2 Total Sid. Factory Overhead Rate B7 To determine standard factory overhead rate, the fonmuia would be Budgetes Fi tory Overhead (2) ao ne P7.50 Normal Capacity in H tours ~ 2.406 hours Budgeted Factory Overhead (BFOH) = P7.50 x 2,400 hours P16,900 Budgeted Variable Factory Overhead (7) - 5.00 Normal Capacity in Hours Budgeted Variable Factory © verheat (BVOH) = P5.00 x 2,400 hours Budgeted Fives Factory Overhead (7) ‘Normal Capacity in Hours — 2,400 hours Budgeted Fixed Factory Overhead (BFxOH) = P2 50 x 2,400 hours =P.6,000 Controllable Variance: ‘Aclval Factory Overnead (AFO}) 716.650 Less: Budgeted Allowed Based On Sid, Hrs -2.000 hrs. (BASH) Fixed as Budgeted. P 6,000 Variable (P5.00 x 2,000 hours) - 10,000 _16,000 P 650U Volume Variance: Budgeted Allowed Based on Std Hrs. (BASH). P 16,000 Less: Std. FOH or Applied Factcry Overhead (SH x SR). 2,000 hours x P7.50. 15,000 1,000 U Factory Overhead Variance — unf/underapplied. 1,650 U Journal Entries: Incurrence of Factory Overhead: Factory Overhead Control (actual costs) 16,650 Cash, Accumulated dep., Prepaia ins., Accounts Payable, etc. 16,650 Factory Overhead Applied to Production: Work-in-Process, @ Std. Costs (P7.50 x 2.000) a 15,000 Controliable Variance - unfavorable. 650 Volume Variance — unfavorable 1,000 Factory Overhead Coniro! 16,650 AFAR-17