Cyrus Jhun Ofrin - Engaging Activity B - Unit 4 Just in Time and Backflush Costing

COST ACCOUNTING
Cyrus Jhun A. Ofrin

2BSA1
Requirement: Standard Cost
NATURE AND RATIONALE OF STANDARD COST
The reason behind using standard costs is to help control expenses by comparing what
actually happened with what was expected to happen. Management wants to know not only
what costs were incurred but also if they reflect an efficient level of productivity. One way to
understand costs is by comparing them to what happened in the past. By comparing actual
costs to standard costs, we can see any differences and understand if things went as planned
or not. Standards act as benchmarks to measure success or failure.
Standard costs show what costs should be under reasonable, acceptable performance. They
don't represent what costs would be if everything went perfectly. Instead, they set a target for
the minimum acceptable costs. When actual operations go beyond these standards, the
differences, called variances, are usually looked into.
These standards relate to both the quantity and cost of inputs used in making goods or
providing services. Quantity standards tell us how much of things like labor, time, or raw
materials should be used for each unit of product or service. Cost standards tell us how much
these things should cost.
We compare the actual quantities and costs of inputs to these standards to see if operations
are within the limits set by management. If the actual quantities or costs exceed these limits,
management focuses on the differences to figure out what went wrong. This approach is
called management by exception, where attention is given to areas needing improvement
rather than everything being monitored all the time.
Benefits of Standard Costs:
1. Standard costs make managers and employees aware of costs because they compare
actual costs to expected costs. This encourages everyone to pay attention to cost
differences and figure out why they happened. By highlighting these differences,
standards act as a guide for improving performance.
2. They help with planning because they provide a set amount for budgeting. When
setting standards, managers carefully look at all the factors affecting costs and often
find ways to make operations better.
3. Standard cost systems bring together managerial, accounting, and engineering
functions. This encourages coordination because everyone in the organization is
working towards the same goal.
4. Although it might seem expensive to set up standard cost systems at first, using
standards can actually save money on data processing costs.
Limitations of Standard Costs:
1. It can be hard to decide which cost differences are important enough to investigate.
Some differences might not be significant, but it's not always easy to tell which ones
are worth looking into.
2. Focusing only on cost differences above a certain level might mean missing out on
other important information, like trends, that could be noticed early on.
3. Employees might hide or not report unfavorable differences, especially if they don't get
recognized for the good things they do. This can happen when management only
focuses on exceptions, leading to a culture of covering up problems.
4. Using the management by exception approach might make supervisors feel like they're
always focusing on problems and being critical of their team. This can affect their
morale and how they interact with their team.
In comparing the benefits and limitations of standard costs, it becomes evident that while
standard costs offer numerous advantages in terms of cost awareness, planning facilitation,
and organizational integration, they also present challenges such as difficulty in determining
material variances, potential oversight of other relevant information, and the risk of fostering
a culture of concealment among employees. Despite their potential drawbacks, the benefits of
standard costs, when effectively managed and implemented, generally outweigh their
limitations, making them a valuable tool for cost management and organizational
performance improvement.
EXPLAIN HOW STANDARDS ARE SET

Setting standard costs involves a blend of art and expertise, drawing on the insights and
knowledge of various individuals responsible for pricing and input quantities. In service and
trading firms, this process typically involves input from the controller, purchasing agent,
segment managers, and sales personnel. In manufacturing, additional contributors include the
industrial engineer, production supervisors, line managers, and production workers.
The managerial accountant plays a crucial role in kickstarting the standard-setting process by
providing data on past activities' cost characteristics. However, standards for the future must
go beyond simply projecting the past. They must be adjusted for changing economic
conditions, demand and supply dynamics, and evolving technology.
Decisions also need to be made about the capacity level used for setting standards. Ideal
standards, based on theoretical capacity, reflect maximum efficiency but are often
unattainable and can demoralize workers. On the other hand, practical standards, set at a less
demanding level, allow for normal inefficiencies like machine breakdowns and material loss.
Variances from practical standards signal deviations that warrant management attention,
distinguishing between normal and abnormal inefficiencies.
Throughout this process, the focus is typically on practical standards, balancing attainability
with efficiency, and providing valuable insights into deviations from expected performance.
SETTING DIRECT MATERIALS STANDARDS

Setting direct material standards involves two main aspects: standard quantity and standard
price. Industrial engineers determine the types and quantities of materials needed for
production, as outlined in operation schedules. Traditionally, quantity standards included
allowances for waste, but with the zero defect philosophy, waste allowances are omitted, and
any resource losses due to waste are directly charged to the responsible supervisor.
Collaboration between the engineering department, manufacturing supervisor, and
accountant establishes bills of material, forming the basis for setting material price standards.
Purchasing agents play a critical role in this process, considering market conditions, vendor
prices, and optimal purchase order sizes. Many companies adopt the just-in-time (JIT)
management philosophy to minimize inventories, reducing carrying costs and focusing on
quality. Standard prices account for factors such as cash discounts, material handling costs,
and quality specifications. Holding the purchasing department accountable for both price and
quality ensures balanced decision-making. While prioritizing inexpensive vendors may yield
favorable price variances, neglecting quality can result in unfavorable quantity and labor
efficiency variances due to manufacturing rework time.
SETTING LABOR STANDARDS

Setting labor standards encompasses two main aspects: standard time and standard labor
rate. To establish standard time, past payroll and production records are examined to
determine worker-hours on different jobs, supplemented by time reports from workers over a
limited period and, ideally, time and motion studies. These studies break down operating
cycles into distinct elements, aiding managers in accurately rating operations and employee
skills and efforts. As for standard labor rates, consideration is given to current rates and
competitive markets. Companies may set standard rates for specific jobs or individual
workers, or adhere to fixed wages dictated by labor contracts. In automated manufacturing
systems, labor costs may remain fixed despite hourly wage expressions, with average salary
figures derived from schedules detailing salaries, payroll taxes, and employee benefits
ensuring accurate cost estimation. These practices help companies effectively manage labor
costs and improve overall productivity.
SETTING OVERHEAD STANDARDS

Setting overhead standards involves allocating factory overhead to cost inventories for pricing
decisions and expense control. A standard cost system employs budgeted rates based on
standard hours or other cost drivers for actual production, while a non-standard cost system
relies solely on actual hours or another cost driver for overhead application. Standards are
applied to Work in Process Inventory using a selected capacity level, typically practical
capacity, as the volume basis. Volume-related bases like machine hours, direct labor-hours,
and units of production are commonly used for cost allocation, while non-volume related
activities such as production runs or inspections may be utilized in activity-based costing
systems. By estimating the factory overhead incurred at the chosen capacity level, companies
establish realistic and attainable standards, aiding in effective cost management and
performance evaluation.
The possible causes of materials price variance are as follows:
1. Fluctuations in market prices of materials.
2. Purchasing from distant suppliers, which results in additional transportation costs.
3. Failure to take cash discounts available.
4. Purchasing materials of substandard quality or in uneconomical lots.
5. Unfavorable purchase contract terms.
The possible causes of materials quantity or usage variance are as follows:

1. Waste and loss of material in handling and processing.
2. Substitution of defective or nonstandard materials.
3. Spoilage or production of excess scrap because of inexperienced workers or poor
supervision.
4. Lack of proper tools or machines.
5. Variation in yields from materials.
The possible causes of labor rate variance are as follows:

1. Inexperienced workers hired.
2. Change in labor rate particularly peak season that has not been incorporated in standard
rate.
3. Use of an employee having a wage classification other than that assumed when the
standard for a job was set.
4. Use of a greater number of higher-paid employees in the group than anticipated
The possible causes of labor efficiency variance are as follows:

1. Good or poor training of workers
2. Poor materials or faulty equipment
3. Good or poor supervision and scheduling of work
4. Experience or lack of experience on the job
5. Inefficient equipment
6. Machine breakdown
7. Nonstandard materials being used
The possible causes of variable overhead spending or price / controllable variance

are as follows:
1. Actual costs, for example, machine power, materials handling, supplies were different from
those expected because of fluctuations in market prices or rates.
2. Increase in energy costs.
3. Waste in using supplies.
4. Avoidable machine breakdowns.
5. Wrong grade of indirect material and indirect labor.
6. Lack of operators or tools.
The possible causes of variable overhead efficiency variance are as follows:

This is attributable to efficiency in using the base on which variable overhead is applied. So
that if the basis of the variable overhead application is direct labor hours, the causes of the
labor efficiency variance will also be the causes of the variable overhead efficiency variance.
The possible causes of capacity or volume variance are as follows:

1. Poor production scheduling.
2. Unusual machine breakdowns.
3. Storms or strikes.
4. Fluctuations over time.
5. Decrease in customer demand.
6. Excess plant capacity.
7. Shortage of skilled workers.
Give Example the Variances between the actual cost and standard costs (Computation of
Variances and entries to record variances.
The following events took place at Certified Containers, Inc. during the month of December:
1. Produced and sold 50,000 plastic water containers at a sales price of P10
each. (Budgeted sales were 45,000 units at P10.15).
2. Standard variable cost per unit:
Direct materials: 2 lbs. at P1 P2.00
Direct labor: 0.10 hours at P15 1.50
Variable manufacturing overhead: 0.50
0.10 hours at P5
4.00/unit
3. Fixed manufacturing overhead cost: P80,000
Monthly
4. Actual production costs
Direct materials purchased: 240,000
Direct materials used: 132,000
Direct labor: 84,000
Variable OH 28,000
Fixed OH 83,000
Direct materials price variance 240,000

Actual materials purchased 200,000
Less: Actual Quantity at Standard 40,000
price
Direct materials efficiency variance 110,000

Actual quantity used at standard price 100,000
Less: Standard quantity at standard 10,000
price
Direct labor rate variance 84,000

Actual labor cost (90,000)
Less: Actual hours at standard rate (6,000)
Direct labor efficiency variance 90,000

Actual hours at standard rate 75,000
Less: Standard hours at standard rate 15,000
Variable overhead spending variance 28,000

Actual variable overhead 30,000
Less: Actual hours at standard (2,000)
variable
Variable overhead efficiency variance 6,000

Actual hours 5,000
Less: Standard hours 1,000

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COST ACCOUNTING

Cyrus Jhun A. Ofrin

NATURE AND RATIONALE OF STANDARD COST

Benefits of Standard Costs:

EXPLAIN HOW STANDARDS ARE SET

SETTING DIRECT MATERIALS STANDARDS

SETTING LABOR STANDARDS

SETTING OVERHEAD STANDARDS

The possible causes of materials quantity or usage variance are as follows:

The possible causes of labor rate variance are as follows:

The possible causes of labor efficiency variance are as follows:

The possible causes of variable overhead spending or price / controllable variance

The possible causes of variable overhead efficiency variance are as follows:

The possible causes of capacity or volume variance are as follows:

Direct materials price variance 240,000

Direct materials efficiency variance 110,000

Direct labor rate variance 84,000

Direct labor efficiency variance 90,000

Variable overhead spending variance 28,000

Variable overhead efficiency variance 6,000

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