Question

Q1. What are ideal and practical standards? Which do you think is better?

Q2. How are standard costs developed? Take one of the standards and tell how it is developed.

Q3. What is the difference between a standard costing and a budget?

Answer 1

Q1.

In a standard costing system, standards are normally categorized as ideal standards and practical standards

Ideal standards are standards that do not allow for normal wastage and work interruption due to breakdown of machinery, employees’ rest periods, shortage of raw materials or any other reason. The achievement of such standards requires highly skilled and motivated workers and the best possible use of production facilities. In short, we can say that the ideal standards can only be achieved under the best and perfect work circumstances

Practical standards are standards that are challenging but achievable through the use of efficient and motivated workers under normal working conditions. They allow for work interruptions because of machine breakdowns, workers’ rest periods and other conditions that are considered normal in a particular work environment.

Most of the companies using standard costing system set practical standards rather than ideal standards. So the better category of standard is practical standard.

Q2.

Standard costs should be established by the authority or management so that the same may be acceptable. Establishment of standards may not be a simple task, depending on the nature of the product and the intricacies involved in its manufacture. In developing standards, the following should be taken into consideration:

1. The basic cost factors - physical and monetary. The physical factor relates to the unit of measurement of the cost elements involved in the production process, like the number of lumber units that are utilized to finish the boxes. The monetary factor relates to the amount paid for the physical factors, which in our illustration is the price per unit of lumber.

A formula is thereby formed from these cost factors:

Cost = Physical Factor multiplied by the Monetary Factor

Such formula will later be understood by presenting the data for Dollar Company.

2. Specification of the Product - this is necessary to determine the physical and monetary factors needed in the computation of the manufacturing elements, such as materials, labor, and factory overhead.

The following specifications are set up for BENGR:

Size of the Product: 2' x 2' x 2' (2 feet long, 2 feet wide and 2 feet high)

Color : walnut (varnish)

The cost accountant therefore should remember that in creating standards for the elements of costs (direct material, direct labor and factory overhead) the two most important things are considered: the physical aspect (units of materials, number of hours worked) and the monetary factor (price per unit material and the labor rate per hour).

Using the physical and monetary factors above, let us illustrate the application of these theories We will utilize the costing of the new product of the Dollar Company BENGR.

Direct Materials:

In producing a quality wooden box, for example, based on the research department of the company, 6 pieces of plywood are used. Hence, the standard physical factor for materials, or the standard quality, is 6 pieces of plywood.

The standard monetary factor, or the standard price, can be established by determined the prevailing market prices. For product BENGR, let us assume that the standard price per piece of plywood has been set at $20.

Now that we have the data for standard quality and price, the standard cost of materials for this product can be computed as follows:

Standard Cost = physical factor multiplied by monetary factor

Standard Cost = Standard quantity multiplied by standard price

For BENGR: Standard cost = 6 pieces lumber multiplied by $20/material

Standard Cost = $120 unit of BENR – means that to finish one unit of BENGR, there is a need to use spend $120 for materials.

Q3.

Differences between Standard Costs and Budgets

(1) A standard costing system can operate without any comprehensive budgeting system. But budgets in absence of standard costs will only be fair estimates and cannot provide a reasonable base against which the actual results can be compared.

(2) The objectives of budgeting are different from standard costing. A budget is a profit plan reflecting anticipated financial inflows and outflows. It is comprehensive in nature and covers several business activities, such as production, purchase, selling and distribution, research and development. Budgets include both income and expenditure, but standards are set usually for expenses only. Standard costs are developed only for the production and related manufacturing cost.

(3) Budgets project the volume of business and levels of costs which should be maintained. That is, they reflect cost ceilings which should not be exceeded if the budgeted profit is to be attained. Standard costs emphasize the cost levels to which cost should be reduced. If costs reach this level, profit will be increased. Standards are minimum targets which are to be attained by actual performance at specific efficiency.

(4) Budgets covering the entire business present the forecasted profit and loss account and sometimes balance sheet also. Therefore, budgets act as guides for operating the business on a defi­nite course of action. Standards are frequently used only in labour operation and do not represent expected costs but the cost that should be in a certain assumed conditions of performance.

(5) The term “standard” is a unit concept and the term budgeted cost is a total concept. It may be helpful to think of a standard as a budget for the production of a single unit of output.

(6) Budgets if achieved by the organisation do not usually involve much variance analysis. The achievement of budget targets point out the efficiency attained and therefore no analysis on a large scale is needed unless circumstances have considerably changed. Under standard costing detailed variance analysis is carried out to find out deviations so that corrective action may be taken.

(7) Review and revision of budgets is more frequently based on the changing circumstances than those of standard costs. Standard costs are more static and subject to less change.

(8) Budgets are equally important for planning, organisation, coordination and control func­tions of management. Standard costs contribute relatively more to the control function than other managerial function although standards are used for all business functions.

(9) Budgeting may be applied in such businesses which are of a jobbing nature, but standard costing is difficult to apply because of the dissimilar nature of different jobs. Jobs are better con­trolled through predetermined budget and cost for different jobs are ascertained historically. In those businesses where manufacturing is done under conditions of continuous processing or under mass production methods, standard costing is applied.