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ASSIGNMENT # 2

Mitra Ghadimi Khasraghy

0926110
The difference between actual costing and standard cost for material,
Labor and factory over head

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
a. Variable manufacturing overhead
b. Fixed manufacturing overhead

Usually there will be two variances computed for each input:

Input for Product Variance #1 Variance #2

Direct material Price (or cost) Usage (or quantity)

Efficiency (or
Direct labor Rate (or cost)
quantity)

Manufacturing overhead-
Spending Efficiency
variable

Manufacturing overhead-fixed Budget Volume

Standard costing values its manufactured products with a predetermined


materials cost, a predetermined direct labor cost, and a predetermined
manufacturing overhead cost. These standard costs will be used
for valuing the manufacturer’s cost of goods sold and inventories. If the
actual costs vary only slightly from the standard costs, the resulting
variances will be assigned to the cost of goods sold. If the variances are
significant, they should be prorated to the cost of goods sold and to the
inventories.

These standard costs will be used for valuing the manufacturer’s cost of
goods sold and inventories. If the actual costs vary only slightly from
the standard costs, the resulting variances will be assigned to the cost of
goods sold. If the variances are significant, they should be prorated to the
cost of goods sold and to the inventories.
Actual Costing

When you use actual costing, all goods movements within a period are valuated
preliminarily at the standard price. At the same time, all price and exchange rate
differences for the material are collected in the material ledger.

At the end of the period, an actual price is calculated for each material based on
the actual costs of the particular period. The actual price that is calculated is
called the periodic unit price and can be used to revaluate the inventory for the
period to be closed. In addition, you can use this actual price as the standard
price for the next period.

Material Quantity Variance

Difference between the actual quantity of materials used in production and the
standard quantity of materials allowed for actual production, multiplied by the
standard price per unit.

Materials quantity variance = (actual quantity - standard quantity) x standard


price per unit.

The variance is unfavorable if the actual quantity exceeds the standard quantity;
it is favorable if the actual quantity is less than the standard.

Labor Rate Variance

Any deviation from standard in the average hourly rate paid to workers:

Labor Rate = (Actual Rate - Standard Rate) x Actual Hours of Labor Used
Variance.

For example, assume that the standard cost of direct labor per unit of product A
is 2.5 hours x $14 = $35. Assume further that during the month of March the
company recorded 4500 hours of direct labor time. The actual cost of this labor
time was $64,800, or an average of $14.40 per hour. The company produced
2000 units of product A during the month. The labor rate variance is ($14.40 -
$14.00) x 4500 hours = $1800, which is unfavorable since the actual hourly rate
exceeded the standard rate. This may be the result of unavoidable increases in
labor rates, or it may reflect excessive labor costs due to use of higher skilled
labor commanding higher wages.
Factory overhead Variance

Factory overhead controllable variance is the difference between actual


expenses incurred and the budget allowance based on standard hours allowed for
work performed.
Factory overhead controllable variance is the responsibility of the department
managers to the extent that they can exercise control over the costs to which the
variances relate.

Controllable Variance = Actual factory overhead – Budgeted allowance based on


standard hours allowed

Volume Variance

Amount of under- or over applied fixed factory overhead. It is the difference


between budgeted fixed factory overhead and the amount applied based on a
predetermined rate and the standard input allowed for actual output. It measures
the use of capacity rather than specific cost outlays.

Controllable Variance

part of the total factory overhead variance not attributable to the volume variance
in two-way analysis.

Objective for calculating variance in manufacturing firms

1. Understand the difference between ideal & practical Standards

2. Calculate variances for direct labor, direct Materials and variable overhead

3. Calculate mix and yield variances for labor and


Materials

4. Understand and apply the models used in deciding whether or not to


investigate variances

5. Recognize the limitations of standard costing

6. Understand the role of the balance scorecard as a performance measurement


tool
Explain different type of elements of Cost

Raw materials are converted into finished products by a manufacturing concern


with the help of labor, plants etc. The elements that constitute the cost of
manufacturing are known as elements of cost. The elements of cost include the
following:

Material
Labor
Expenses

Each of these elements is again subdivided into direct and indirect material.
Direct material, direct labor and direct expenses are those which can be traced in
relationship with a particular process, job, operation or product. Indirect material,
indirect labor and indirect expenses are those which are of general nature and
cannot be traced in relationship with a particular process, operation, job or
product.

Fixed costing and variable costing, absorption and marginal costing

fixed costs are business expenses that are not dependent on the activities of
the business [1] They tend to be time-related, such as salaries or rents being paid
per month. This is in contrast to variable costs, which are volume-related (and
are paid per quantity).

In management accounting, fixed costs are defined as expenses that do not


change in proportion to the activity of a business, within the relevant period. For
example, a retailer must pay rent and utility bills irrespective of sales.
Along with variable costs, fixed costs make up one of the two components of total
cost. In the most simple production function, total cost is equal to fixed costs plus
variable costs.
A cost of labor, material or overhead that changes according to the change in the
volume of production units. Combined with fixed costs, variable costs make up
the total cost of production. While the total variable cost changes with increased
production, the total fixed cost stays the same.

ABSORPTION COSTING

Method of costing a product in which all fixed and variable costs (however
remote) are apportioned to cost centers where they are accounted for (absorbed)
using absorption rates. This method ensures that all incurred costs are recovered
from the selling price of a good or service, (assuming the final price is acceptable
to the customers). Also called full absorption costing. See also direct costing, and
marginal costing.

MARGINAL COSTING

Definition
Increase or decrease in the total cost of a production-run, from making one
additional unit of an item. It is computed in situations where breakeven point has
been reached: the fixed costs have already been absorbed by the already
produced items and only the direct (variable) costs have to be accounted for.
Marginal costs are variable costs comprising of labor and material costs, plus an
estimated portion of fixed costs (such as administration overheads and selling
expenses). In firms where average costs are fairly constant, marginal cost is
usually equal to average cost. However, in industries that require heavy capital
investment (automobile plants, airlines, mines) and have high average costs, it is
comparatively very low. The concept of marginal cost is of critical importance in
resource allocation because, for optimum results, the management must
concentrate its resources where the excess of marginal revenue over the
marginal cost is maximum. Also called choice cost, differential cost, or
incremental cost.

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