Lesson 279 of IEKC Industrial Engineering ONLINE Course Notes.
Lesson of Industrial Engineering Measurements - Online Course Module
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 pay the actual costs during transactions. As a result there can be differences between the actual costs and the standard costs. The differences are calculated and are known as variances. Standard costing and the related variances is a valuable management tool for control purpose. If a variance arises, management becomes aware that manufacturing costs have differed from the standard (planned, expected) costs that warrant careful attention.
Objectives of Standard Cost Development
a) Establishing budgets;
b) Controlling costs and motivating and measuring efficiencies;
c) Promoting possible cost reduction;
d) Simplifying costing procedures and expediting cost reports; and
e) Assigning costs to materials, work in process, and finished goods inventories
Regarding Standard Setting
The cost standard chosen should reflect the organization's objectives for using that cost standard and the variances that result from implementing it.
There are number of prerequisites for setting up standard costing via setting standards across different cost categories. These prerequisites may be pointed as below:
a) Define bills of material parameters;
b) Define resources;
c) Define the cost centre;
d) Assign resources to cost centre;
e) Define overheads and assign to cost centre;
f) Review routing and bill structures to confirm that costs will roll-up properly;
g) Control overheads by resource;
h) Confirm that the WIP parameters, Recognize Period Variance and Require Scrap
Account are set as required; and
i) Confirm that the Work in Process accounting classes and their valuations and accounts are properly set up.
It is very technical to set the standard materials quantity. How much unit of input materials and how many types of input materials is required for one unit of output is generally set out by the Product Development (PD) or Research & Development (R&D) or such technical department of an entity. They prepare a Bills of Material (BOM) or Recipe or formula of a product. The person (generally from Costing Department) assigned for calculating the unit standard cost of a product will collect the BOM or Recipe or formula and perform general review of the same, can be checked with previous trend to ensure the BOM or recipe is updated.
Special care should be given while setting the standard for material price. Generally, the price of any existing material can be collected from the historical information from the purchase department and then an average standard can be determined. In the case of new item, price can be collected through market survey, from the suppliers or indenters. For imported material, it is desirable to consider the variance resulting from exchange rate changes. The person assigned for setting the standard cost should collect this information and apply his professional judgment to ensure the accuracy of the cost price.
Setting the standard labor hour demands some technicalities. How much standard hour of labor is required for each unit/batch of production is usually fixed up by the production department. Time and motion study is a good tool to find out the standard labor hour. Time card and such other documents can be used to generate the data. Historical labor hour can also be considered to set the standard hour required for each unit/batch of output. Standard can be set for skilled, semi skilled and other categories of labor.
Special care should be given while setting the standard labor rate due to the involvement of human factor in it. The standard hourly labor rate can be set from the previous information of the Human Resources Department. Labor rate can be segregated as skilled, semi skilled and other categories. In the case of hourly standard rate, inflationary adjustment and minimum wages requirements of the country, if any should be considered.
The overhead rate can be segregated into fixed and variable categories. Activity based costing can be used for setting the standard. Historical information works as one of the base for setting such standard. Overhead rate can be applied either on the basis of direct labor hour or machine hour depending on the relevance or cause-effect analysis.
Perform cost rollup as appropriate to set initial standard costs. With the initial cost rollup/update, complete the setup of the manufacturing cost structure and begin normal processing, including purchase order receipts, material issues, job/schedule creation, shop floor moves, and so on. Later, analyze, report, and distribute costs through the period process.
Similar to work in process costing, the cost rollup does not cost the routings assigned to phantom assemblies. The bill of material phantom determines how the component is treated. If one is rolling up the phantom assembly, the cost of the routing is included in this level cost of the assembly. But, for the parent assembly, when the subassembly's supply type is Phantom, the routing costs from the lower level assembly are not included in the cost of the parent assembly. If one change the supply type and the subassembly is no longer a phantom, the parent assembly includes the lower level routing cost in the parent assembly's previous level costs.
Perform a cost update for manufacturing costing after rolling up assemblies. This revalues inventory and implements new costs.
A provision for normal loss (tolerable limit for variances) can be prescribed for guiding the variance analysis procedure to control any sort of undesirable outcome.
Standard cost accounting can hurt managers, workers, and firms in several ways. For example, a policy decision to increase inventory can harm a manufacturing manager's performance evaluation. Increasing inventory requires increased production, which means that processes must operate at higher rates. When (not if) something goes wrong, the process takes longer and uses more than the standard labor time. The manager appears responsible for the excess, even though s/he has no control over the production requirement or the problem. Thus, it supplements the application of 'Management by Exception' principle.
Journal Entries
Variances should be journalized in such a way that they facilitate variance analysis for evaluation and control purpose. When accountants use a standard costing system to record transactions, companies are able to quickly identify variances. In addition, inventory and related cost of goods sold are valued using standard cost information, which simplifies the bookkeeping process.
Two journal entries are needed to record transactions relating to direct materials that include these variances. The entry to record the purchase of direct materials and related price variance is -
Raw Materials Inventory Dr.
Materials Price Variance (UNF) Dr.
Trade Payables Cr.
The raw materials inventory account contains the actual quantity of direct materials purchased at the standard price. Payable reflects the actual cost, and the materials price variance account shows the unfavorable variance. Unfavorable variances are recorded as debits and favorable variances are recorded as credits. Variance accounts are temporary accounts that are closed out at the end of the financial reporting period.
The entry to record the use of direct materials in production and related quantity variance is Work in process Inventory Dr.
Materials Quantity Variance Cr.
Raw Materials Inventory Cr.
Work-in-process inventory reflects the standard quantity of direct materials allowed at the standard price. The reduction in raw materials inventory reflects the actual quantity used at the standard price and the materials quantity variance account shows the favorable variance.
Labor is not inventoried for later use like materials; thus, only one journal entry is needed to record transactions relating to direct labor. Again, many more journal entries would typically be made throughout the year for direct labor. For the purposes of this example, we will make one journal entry to summarize the activity for the year. The entry to record the cost of direct labor and related variances is - Work in process Inventory Dr.
Labor Rate Variance (UNF) Dr.
Labor Efficiency Variance (F) Cr.
Wages Payable Cr.
Work-in-process inventory reflects the standard hours of direct labor allowed at the standard rate. The labor rate and efficiency variances represent the difference between work-in-process inventory (at the standard cost) and actual costs recorded in wages payable.
The entry to record actual overhead expenditures is -
Manufacturing Overhead Dr.
Various Accounts Cr.
The credit goes to several different accounts depending on the nature of the expenditure. For example, if the expenditure is for indirect materials, the credit goes to accounts payable. If the expenditure is for indirect labor, the credit goes to wages payable.
Following entry will transfer manufacturing overhead to WIP Inventory -
Work in process Inventory Dr.
Manufacturing Overhead Cr.
The following entry is made to transfer the costs out of work-in-process inventory and into finished goods inventory -
Finished Goods Inventory Dr.
Work in process Inventory Cr.
When finished product is sold, the following entry is made:
Costs of Goods Sold Dr.
Finished Goods Inventory Cr.
Note that the entry shown previously uses standard costs, which means the cost of goods sold is stated at standard cost until the next entry is made.
Most commonly used method of disposal of variances is to adjust with the cost of goods sold. When accounts are closed out to cost of goods sold, after which point cost of goods sold will reflect actual manufacturing costs for the products sold during the period. The following entry is made to accomplish this goal:
Cost of Goods Sold Dr.
Materials Quantity Variance Dr.
Labor Efficiency Variance Dr.
Material Price Variance Cr.
Labor Rate Variance Cr.
However, there is a "Variance proration" method of variance disposition which allows apportionment of all variances among Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold. This accounting treatment reflects the impact of all unusual inefficiency or efficiency in all of the accounts through which the manufacturing cost flow.
The following three steps should be incorporated into a company's inventory accounting processes to assist in managing its standard cost: a) Review the company's capitalizable costs: When setting standard costs, have all appropriately capitalizable costs been considered, such as incoming freight for procured inventories or overhead for produced inventories? For instance, freight is subject to potentially significant variations due to factors such as the carrier or the quantities being ordered. b) Update standard costs regularly: Updating standard costs on an annual basis is a good start but is probably not frequent enough to ensure accurate inventory costing (not to mention the potential effects on the company's income statement every time inventory is expensed inaccurately). If the cost of procuring or producing a product has changed since the standard cost was last modified, inventory will be misstated accordingly. c) Maintain a "standard-to-actual" reserve in the balance sheet: Every time that any component of inventory is acquired or produced at a cost different than the assigned standard cost, that variance hits the income statement and inventory is misstated. If feasible, at the end of every reporting period an analysis of purchase and production costs for capitalizability should be performed. When complete, capitalizable variances should be recorded in a "standard-to-actual" reserve within inventory on the balance sheet with the remainder being appropriately expensed through the income statement. This reserve has the effect of adjusting the company's inventory balances to "actual," which is appropriate under accounting standard.
Standard cost card is an important document which needs to be developed, maintained, reviewed and complied.
Cost Reduction by Industrial Engineers
b) Update standard costs regularly:
Updating standard costs on an annual basis is a good start but is probably not frequent enough to ensure accurate inventory costing (not to mention the potential effects on the company's income statement every time inventory is expensed inaccurately). If the cost of procuring or producing a product has changed since the standard cost was last modified, inventory will be misstated accordingly.
Industrial engineers have the responsibility for cost reduction in the company. Whenever they conduct process improvement studies using process charts and operation analysis sheets, they have to set up new standards for material usage, machine usage, labor usage and expenses. These revised quantity standards are to be intimated to cost accounting departments to update standard cost cards at appropriate time. There is opportunity in accounting to report, deviations between old standard and new standard also for limited periods of time so that convergence of shop floor practices to new standard can be monitored.
Source:
BCAS 13: Standard Costing (Bangladesh)
STANDARD COSTING AND SCIENTIFIC MANAGEMENT
Rosalie C. Hallbauer
The Accounting Historians Journal
Vol. 5, No. 2 (Fall 1978), pp. 37-49 (13 pages)
Published by: The Academy of Accounting Historians
ABSTRACT
Many have suggested that scientific management had a direct influence on the development of standard costing. This paper examines the relationship between these concepts in broad terms. While it is concluded that no direct relationship exists between scientific management and standard costing, the existence of an indirect relationship is acknowledged. Scientific management does not require any specific type of accounting system and standard costing does not require a certain type of management organization to operate. However, certain reports developed for the scientifically managed enterprise, when added to the germs of standard costing that existed, expedited the evolution of standard costing.
No comments:
Post a Comment