Question

Describe how standard costs are determined by a manufacturing company. Describe 2 types of standard cost variances that are used by management to assess both the efficiency and effectiveness of comparing actual price to standard price.

Answer 1

A standard cost may be developed based on past prices, industry standards or the target cost the company want to achieve. Based on past prices the company can develop standards by challenging the actual material prices and giving cost control and cost reduction targets to each department. Based on Industry standards the company can develop standards to achieve cost leadership status. It needs study of cost structure of various companies. In target costing approach the company fixes the standard cost by deducting required margin on target selling price.

The 2 standard cost variances used by management to assess efficiency and effectiveness of comparing actual prices to standard prices are

· Price variance – Price variance is the difference between standard price and actual price multiplied by the actual quantity

· Efficiency variance – Efficiency variance is the different between standard input allowed for actual output and actual input used multiplied by the actual quantity