1. Chapter 19 Standard Costs, Variable Costing Systems, Quality Costs, and Joint Costs

2. Standard & budgeted costs
Standard cost = a measure of how much cost should be = cost of one unit of product.
Budgeted cost = what the total costs of many units or of a time period should be.
Standard cost system = a product costing system that records standard costs either in addition to or instead of actual costs.

3. Standard cost sheet
Contains breakdown of standard cost of a unit of a particular product.
Bill of material:
Standard quantity of each item of material input needed to make one unit of output.
Standard price = current cost of each item of material input.
Routing = labor routing = bill of labor:
Various labor operations required to make the item.
Standard labor hours = Total of hours required to make a unit of product.

4. Standard cost
Standard quantity of materials * standard price of each material.
+ standard labor hours * standard labor rate
+ standard activity measure (e.g., standard labor hours) * predetermined overhead rate.

5. Favorable/Unfavorable variance
Standard cost - actual cost.
For materials, labor and overhead, separately or jointly.
Favorable variances are credit balances which:
Indicate costs were less than expected.
Are reductions of cost of goods sold (possibly some also allocated to inventory).
Unfavorable variances are debit balances which:
Indicate costs were higher than expected.
Are increases of cost of goods sold i.e., expenses (possibly some also allocated to inventory).

6. Total material variances
Actual cost - standard cost
= (act qty * act pr) - (Std qty * std pr)
= mat. price variance + mat. usage variance.
Materials price variance
= act qty * std pr - act qty *act pr
= (standard price -actual price) * actual quantity
= price * actual quantity.
Materials usage variance
= (std qty * std pr) - (act qty * std pr)
= (std qty - act qty) * standard price
= quantity * standard price.

7. Disposition of Production Cost Variances
Amount by which goods produced in an accounting period have been “miscosted”.
Alternative disposition of variances:
Proportionately between EOP inventory and COGS.
Best matching.
Debit or credit the expense cost of goods sold.
Expediency.
If amounts that should have been allocated to inventory are material, then this approach is not in compliance with GAAP.
Keep in an overhead clearing account.
Not GAAP. Should be zeroed out at year-end.

8. Variations in Standard Cost
In a standard cost system: some or all elements of cost are carried n an inventory account at standard.
A variance account is generated at the point that an element of cost is shifted from actual to standard.
Material can be shifted from actual to standard when received, when issued from Materials inventory or not at all.
Some companies use standard cost only for material or only for direct labor.

9. Uses of Standards Control. Decision making. More rational costs.
A starting point for measuring production and materials management performance is to compare actual costs with standards.
Decision making.
Pricing & alternative choice decisions.
More rational costs.
Identical costs for same products.
E.g., different production levels in month.
Recordkeeping savings.
Eliminates need to cost each requisition, or batch.
Standards changed infrequently (say, once every six months or a year).

10. Variable costing system
Up to now: full or absorption cost systems.
Variable and fixed production costs are assigned to product.
Required by GAAP and tax regulations.
Variable costing system.
Useful for management decision making.
Only variable production costs are included in inventory.
Fixed costs are treated as period costs.
Fixed costs = cost of maintaining capacity.
Sometimes mistakenly referred to as a direct costing system.

11. Advantages of variable costing
Simplifies accounting: no determination of overhead rate for fixed overhead.
Overhead variance is a pure spending variance.
Caused by actual overhead differing from costs based on a flexible budget.
Variances caused by volume differences are not reflected in variances.
Avoids confusion from overhead volume variance.
Management better focuses on differences arising from production cost variances other than volume.

12. Variable costing advantages (continued)
Allows management to control:
Variable costs on a cost-per-unit basis.
Fixed cost on a total-cost-per-period basis.
Useful for break-even and differential analysis.
Reported monthly income is related to the month’s sales volume.
Under absorption costing, reported monthly income is related to both sales and production volumes.
If production is higher (lower) than sales, absorption costing results in higher (lower) income than variable costing.

13. Overhead rates in the 2 systems
Variable costing system: overhead rate is essentially the same as accounting for direct material and direct labor, i.e., all 3 are variable.
Absorption costing system: In effect the sum of 2 rates:
To absorb variable overhead.
Slope of the flexible overhead budget line.
To absorb/allocate fixed overhead costs.
Determined by estimating standard volume over which fixed overhead costs are averaged.

14. Why use full costing?
Variable costing leads management to focus on contribution margin & not on fixed costs.
Makes costs tied up in inventory look smaller.
Mgmt thinks sales are more profitable.
Decomposing overhead costs into variable & fixed components may be difficult.
Needed for pricing, & financial & tax rptg.
Variable costing system would require maintaining 2 systems.
However, if management decomposes overhead into variable and fixed components, it can easily prepare reports in CM or full cost format.

15. Quality Costs Prevention costs: to prevent defects.
Supplier education and certification, product redesign, process improvement….
Quality appraisal (or detection) costs: to find defects before goods are delivered.
Inspection, testing….
Internal failure cost: to correct defects before good is delivered.
Scrap, rework…..
External failure costs: correcting defect after delivery.
Refunds, warranty costs for repairs and replacements, product liability,….

16. Joint-product costing
2 or more dissimilar end products.
Produced from same process/materials, e.g., steer, oil refining, timber processing, dairy.
Allocation of joint costs up to split-off:
Proportionately to sales value of end product less separate processing & marketing costs.
By-product costing:
Costed so that 0 profit reported for by-product.
Amount of joint cost=sales revenue-costs after split-off.

17. Joint Product Example Assume joint products Y & Z:
Joint processing costs = $1,100.
Sales value: Y=$2,200, Z=$600.
Costs beyond split-off: Y=$600, Z=$200.
Sales value-separate costs: Y=$1,600, Z=$400.
How much joint cost should be allocated to Y & to Z?
How much cost should be allocated to Y and Z, if Z is considered a by-product?

18. Difficulty of measuring indirect costs
Judgment calls:
Capitalization & depreciation policies.
Product or period cost?
DL identified or incl.in predetermined ov. rate.
Direct or indirect.
Cost driver used to allocate costs.
Allocating indirect costs of service depts.
Volume used to base standards.
Definition of cost centers.

19. Cost system design choices
Job order or process system?
Actual cost or standard cost system?
Absorption costing or contribution margin format?
How many cost centers?
How should volume be measured in each cost center?

20. Cost system design choices (Continued)
What is the step down cost order for allocating the costs of service centers to production cost centers?
Should labor related and material related costs be treated as direct costs or part of overhead?
Should the system be kept simple and supplement it with an activity based costing model?