Application and use of the standard costing system

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Part A

Standard Costing

Financial control system is able to control and analyzed the budget in details, and more effective to measure the deviation in the budget. Standard costing is one of the tools in the financial control system. Standard cost can be evaluating the cost, such as labor, material, variable and fixed overheads. The technique of the Standard cost, it can help the organization to control the business operation and costs. The aims are to reduce the waste, and established the standard and formulate cost plan to enhance the more efficiency in performance.

Types of Standards:

The attainment level of standard is based on the management determined of which standard costs are accepted as basis. The four mainly standards as below:

1.Ideal Standard – attained under the most favorable conditions.

2.Expected Standard – achieved the actually expected budget.

3.Normal Standard –the average figure is according to the average performance of the past after taking into account the fluctuations caused by cyclical and seasonal changes.

4.Basic Standard – establishing basic standard are similar to use in the statistics when calculate the index number.

Standard Costing are appropriate to any type of organization?

The standard costing system can be offering more effective to any type and any size of the organization. The advantages of standard costing system as below:

  1. Measurement efficiency

Lack of the standard costing system, the actual costs may be compared with measure efficiency in different period. It is not allowed to compare the costs in different period; it was because the situation of both periods is not the same. Standard costing systems are comparing with standard costs and actual, it can be able to manage and estimate the performance of the various cost centers. Meanwhile, the standard costing system can be providing the cost control function. Comparing with standard costs and actual costs can be determined the variances. This function can be earliest to take the remedial action. The following example indicating the standard costing system enable to shown the actual cost for the output of the items.

Operation no. and

Standard costs
































Standard product cost (HK$)








  1. Cost consciousness

The most important for standard costing system can makes the employees to understanding the efficient operations so that attempt will be taken to decrease the costs to the minimize by collective efforts, it was because the important of standard costing system is more on cost variations, it make the whole organization cost conscious.

3.Management by exception

The exception indicates that each individual is fixed targets and employees are expected to achieve these given targets. For example, if everything is meeting the targets, management could not need to supervise everything. It will be avoid wasting the times.

4.Cost control

The standard costing system aims is cost reduction and cost control. The standards being continual analyzed and an attempt made the efficiency improvement. Whenever the variance appears, the reasons are investigate and immediately corrective the variance. Taken the action in weak points and use the cost control systems.

5.Right decision making

Management can make the important decisions through the standard costing system, because this system enables to provide the useful information. For example, if the rising or inflating prices affect the cost. These systems can able to providing the incentive plan for the employee.

6.Eliminating inefficiencies

The creating of standards for various elements of the cost requires detail study of various aspects. These standards are creative by administrative, manufacturing and selling expense. The methods improvement are using for creating these standard. For example, the manufacturing expenses should need a motion and time study for effective material and labor control devices for the equipment. This study can be needed for find other expenses and can make the possible to eliminate inefficiencies at various steps.

Variance analysis

The variances are meaning the different between expect results and actual results. The results of variance analyses which the total of different between actual results and standard results. If the actual results is higher than expected results, which is favorable variance. However, if the actual results are lower than expected results, which is an adverse.

Variance analysis is appropriate to any type of organization?

The variance analysis system can be offering more effective to any type and any size of the organization. The following example 1 can be explained the advantage of the variance analysis:

Example 1

ABC Company produces a LCD monitor products, which is known as 24” LCD monitor. The product requires a single operation, and the standard cost for this operation is presented as below:

Standard cost for product monitor(HK$)

Direct materials:

2 kg of A at HK$100 per kg200.00

1 kg of B at HK$150 per kg150.00

Direct labor (3 hours at HK$90 per hour)270.00

Variable overhead (3 hours at HK$20 per direct labor hour) 60.00

Total standard variable cost680.00

Standard contribution margin200.00

Standard selling price880.00

ABC Company plans to produce 20,000 units of monitor in the month of May, and the budgeted costs based on the information contained in the standard cost as below:

Budget based on the above standard costs and an output of 100,000 units


Sales (10,000 units of monitor at HK$880 per unit)8,800,000

Direct materials:

A: 20,000 kg at HK$100 per kg2,000,000

B: 10,000 kg at HK$150 per kg1,500,0003,500,000

Direct labor (30,000 hours at HK$90 per hour)2,700,000

Variable overheads (30,000 hours at HK$20 per

Direct labor hour) 600,0006,800,000

Budget contribution2,000,000

Fixed overheads1,200,000

Budgeted profit 800,000

Annual budgeted fixed overheads are HK$14,400,000 and are assumed to be incurred evenly throughout the year. The company uses a variable costing system for internal profit measurement purposes:

The actual results for May are:


Sales (9000 units at HK$900)8,100,000

A: 19,000 Kg at HK$110 per kg2,090,000

B: 10,100 kg at HK$140 per kg1,414,000

Direct labor (28,500 hours at HK$96 per hour)2,736,000

Variable overheads 520,0006,760,000


Fixed overheads1,160,000

Profit 180,000

Manufacturing overheads are charged to production on the basis of direct labor hours. Actual production and sales for the period were 9000 units.

1.Material variances

The components of materials costs in example 1 are determined by 2 basic factors (A & B). The cost paid for a material, that’s depending on the quantity of materials production. For calculating the material price variance is compare the actual price per unit with standard price per unit. The price of material A is HK$100 per kg, the price of actual price is HK$110. The price variance is HK$10 per kg. The formula for calculating the material price variance:

(Standard price SP Actual price AP) x Quantity of materials purchased QP

2.Material usage variance

For calculating the material usage variance is to compare to the usage of standard quantity with the usage of actual quantity. The most importance of excess usage is depending on materials cost. For example, if the price of material is HK$1 per kg then an excess usage of 1000 kg will not significant. However, if the price is HK$10 per unit then an excess usage of 1000 kg will be significant. The formula for calculating the material usage variance:

(Standard quantity SQ Actual quantity AQ) X Standard material price SP

3.Total material variance

The total material variance need to determine the actual of standard cost of materials should for actual production. In example 1 the standard material cost of material A is HK$200 per unit, the total standard material cost is HK$2,090,000; therefore the variance is HK$290,000 adverse. The price variance of HK$19,000 plus the usage variance of HK$100,000 agrees with the total material variance. Meanwhile, the total material variance of material B is HK$640,000; the favorable price variance of HK$10,100 and the adverse variance usage of HK$165,000. The formula for calculating the total material variance:

Standard material cost SC Actual cost AC

4.Wage rate variance

The labor cost is determined by the quantity of labor and the price paid for labor. Therefore, the quantity and price variance will arise for labor. In Example 1 the standard labor cost is HK$90 per hour and the actual labor rate is HK$96 per hour, the labor rate variance of HK$6 per hour. The formula for calculating the labor rate variance:

(Standard wage rate SR Actual wage rate AR) X Actual wage rate AR

5.Labor efficiency variance

The labor efficiency variance indicated the quantity variance for direct labor. The quantity of labor must be the usage of actual output is express in terms of standard hours produced. In Example 1 the standard time for production of 1 unit of monitor is 3 hours. Therefore, the actual production levels of 9000 units in an output 270,000 standard hours. The formula for calculating the labor efficiency variance:

(Standard labor hours SH Actual labor hours AH) X Standard wage rate SR

6. Variable overhead variances

The calculated for total variable overhead variance is in the same way as total material variances and total direct labor variances. In Example 1 the standard variable overhead cost is HK$60 per unit and the output is 9000 units. The production for standard cost is 9000 units for overheads is HK$540,000. The actual variable overheads are HK$520,000; therefore the favorable variance is HK$200,000. The formula for calculating the total variable overhead variance:

Standard variable overheads charged SC Actual variable overheads AC

Part B

Relevant costs

The decision are made, income and costs can classify that depends on whether the relevant to the particular decision. Relevant costs are meaning the future costs and income that will be change by the decision. However irrelevant costs and income are cannot affected by the decision.

Relevant income

Relevant incomes are the revenues suitable to definite management decision. Those future revenues will be affected by the decision taken. However, non-relevant revenues could not affected by the decision.

1.Shutting down or keeping open part of the business

In example 2, due to a lot of competitors in the LCD monitor market. ABC Company has not reported the profit for several years. The last year income statement as below:

Example 2(HK$)(HK$)


Less variable expenses:

Variable manufacturing costs1,200,000

Variable shipping costs 50,000

Commissions 750,0002,000,000

Contribution margin3,000,000

Less fixed expenses:

General factory overhead 600,000

Depreciation of equipment 500,000

Salary of product line manager 900,000

Rental (factory) 700,000

Product line advertising1,000,000

General administrative expense 300,0004,000,000

Net operating loss(1,000,000)

In example 3, if shutting down the LCD monitor business the ABC Company can able to avoid more fixed costs than loses in contribution margin, it should be better off if the LCD monitor product line is eliminated.

Example 3(HK$)(HK$)

Contribution margin lost if LCD monitor are shutting down3,000,000

Less fixed costs that can be avoided:

Salary of the product line manage 900,000

Product line advertising1,000,000

Rental (factory) 700,0002,600,000

Net disadvantage of shutting down the line (400,000)

The LCD monitor line should not shutting down, if it is shutting down, ABC Company will be HK$400,000 worse off in each year. The following reason as below:

a.Old equipment Depreciation should not relevant to the decision. It should be relates to the sunk cost.

b.The administrative and factory overhead expenses should allocate to the common cost that should not be avoid if LCD monitor line were shutting down. These costs should be allocated to other production line.

2.Pricing products or services

3.Product mix and limiting factor analysis

Product mix and limiting factor analysis are uses the limited resources to achieved the best effects, which mean two or more resources required to use linear programming to determine the best production mix. The mainly solution is how to best use the limited resource into the different products and make the maximize profit.

In example 4, ABC Company manufactures three different product lines, 24”, 32” and 40” monitor. ABC should be suitable the market demand exists for all models. The following each unit data apply:

Example 424 monitor32 monitor40 monitor


Direct materials 500 500 500

Direct labor ($50 per hour) 100 150 200

Variable overhead 50 100 100

650 750 800

In example 4, if the sales price per unit for 24” monitor is HK$1,500. 32”monitor is HK$3,500. And 40 monitor is HK$7,500. The available direct labor limited is 120,000 hours in May. The sales demand in May is expected to be 9,000 units for 24”, 12,000 units for 32”, and 20,000 units for 40”. Determine the profit-maximizing production levels, assuming that monthly fixed costs are HK$8,000,000 and that opening stocks of finished goods and work in progress are nil.

Confirm what the limiting factor as below:

24 monitor32 monitor40 monitor Total

Labor hours per unit2 hours3 hours4 hours

Sales demand9000 units12,000 units20,000 units

Labor hours needed18,000 hours36,000 hours80,000 hours134,000 hours

Less labor hours available120,000 hours

Shortfall 14,000 hours

Calculate the contribution earned by each product per unit of scarce resource.

24 monitor32 monitor40 monitor


Selling price150035007500

Variable cost 650 750 800

Unit contribution 200 150 150

Labor hours per unit2 hours 3 hours4 hours

Contribution per labor hour 100 50 50

Rank (3) (2) (1)

Work out the budgeted production and sales. Sufficient 40” monitor will be made to meet the full sales demand, and the remaining labor hours available will then be used to make 24” and 32” monitor.

RankProductHours requiredHoursTotal Contribution (HK$)

140” monitor80,00080,00012,000,000

(150 x 80,000 hours)

232” monitor36,00036,000 5,400,000

(150 x 36,000 hours)

324” monitor 18,000 4,000 622,222

(200 x 4,000) x 14,000 /

18,000 hours)

Total available134,000120,00018,022,222

Less fixed cost 8,000,000


4.Make of buy decisions

A decision-making always concerning whether the item should be purchased from supplier or produced internally.

In example 4, ABC Company is presently making a component that is used in one of the LCD monitor products. The unit of component cost as below:

Example 4(HK$)

Direct materials 90

Direct labor 50

Variable manufacturing overhead 10

Depreciation of special equipment 30

Supervisor’s salary 20

General factory overhead100

Total unit product cost300

In example 5, the costs are based on 200,000 parts produced each year. If supplier offering to provide 200,000 parts for HK$250 per part. The solutions to ABC Company make or buy decision as below:

Example 5Total differential costs of 200,000 units

Make Buy


Supplier purchase price5,000,000

Direct materials1,800,000

Direct labor1,000,000

Variable manufacturing overhead 200,000

Depreciation of equipment (not relevant)

Supervisor’s salary 400,000

General factory overhead (not relevant)

Total cost3,400,0005,000,000

In example 5, this solution assumes that none of factory overhead costs can be saved if the parts are purchased from the supplier; these costs should be allocated to other items made by the ABC Company.