The Standard Costing MNT Ltd - Assignment Example

Introduction Budgets are prepared with the intention of seeing to it that the affairs of an enterprise go along with projections which are, of always for a profit. No sane entrepreneur will engage in business to incur losses. Budget sets costs and expenses, as well as sales and earnings, which are desired to keep the entity economically viable. In sum, budgeted costs are expected or standard costs.1 Periodic review of the financial conditions and results of operations is made in order to check if the venture is gaining and, if not, to have information where deviations from budgets or standards originate. This approach explains the purpose of standard costing which relates to forecasting financial results. It aims to timely apply remedies in case the deviations or variances are unfavourable. In that way, the success of the business undertaking is determined beforehand as the risks are delineated and calculated from the start. Discussion of variance analyses In order to be cost-efficient, an ideal business entity prepares budgets for a prospective period in order to serve as guidelines geared toward desired outcomes.2 The scheme is applied or implemented among all cost centres on how expenses and expenditures are incurred in accordance with the standards as set forth and defined in the master budget. Every member of the organization is made responsible and accountable for any discrepancy that may occur between what has been budgeted and how much was actually spent. The concern of management becomes more important when actual costs are more than budgeted or standard costs. This kind of deviation is referred to as an unfavourable variance. Necessarily, if actual costs are lesser than budgeted ones, the variance is favourable. Variances in accounting are generally focused on costing analyses. There are therefore the materials cost variance, the labour cost variance and the overhead cost variance. However, variances may also apply to incomes or earnings. While it may be a misnomer to indicate a budget for earnings, these are likewise targeted. It means that goals can be set for income figures. For instance, the marketing department aims to generate sales of one million dollars for the coming quarter. The figure is considered the budgeted sales. Hence, if the amount of sales realized for that given quarter is only eight hundred thousand dollars, the difference of two hundred thousand dollars is an unfavourable sales variance. However, if sales reach one million one hundred thousand dollars for the projected three-month period, there is a favourable variance of one hundred thousand dollars. There are different types of variances and the more commonly used pertain to the costs of labour and materials. Both are pegged according to quantity and unit cost. To illustrate, Company X is in the construction business. For the window installation process of a certain building, it has budgeted one hundred glass panes at ten dollars each for materials. It will thus be a budget of one thousand dollars (100 x 10) for the cost of materials. Labour cost is pegged at one dollar per hour and it is estimated that a total five hundred hours is needed to finish installing the windows. That will be a total budgeted cost for labour in the sum of five hundred dollars (1 x 500). Total budgeted cost for both materials and labour needed to complete installing the windows is one thousand five hundred (1,000 + 500) dollars. In the illustration for Company X, if it actually used one hundred glass panes which were purchased at the budgeted amount of ten dollars per pane, the total actual cost for materials is one thousand dollars. This shows that costs for materials were incurred according to the forecast amount of one thousand dollars. There is no difference between projected and actual costs for materials. Otherwise stated, there is no variance as materials cost were exactly the same as projected. If Company X was able to use one hundred ten glass panes instead which were bought at ten dollars apiece, total actual cost for materials is one thousand one hundred dollars or one hundred dollars more than what was budgeted. In this case, there is an unfavourable materials cost variance of one hundred dollars. It is referred to as a materials quantity variance because the overspending resulted from the use of more materials than what was pegged or estimated. As an example of another type of variance, the material unit cost variance, presume that in the same example, Company X purchased one hundred glass panes to complete the window installation. It purchased the glass panes at twelve dollars each or for a total of one thousand two hundred dollars (100 x 12). The unfavourable variance here is two hundred dollars because the company spent two hundred dollars (1,200 – 1,000) more than what was budgeted. Since the discrepancy is attributed to the increase in unit cost, the variance is a unit cost variance. The third instance of a materials cost variance is one caused by both the quantity of materials used and by the unit cost. If Company X actually utilized one hundred twenty glass panes at a cost of twelve dollars per glass pane to completely install the windows, that will be a total cost of one thousand four hundred forty dollars (120 x 12) for materials. The total actual materials cost under this situation is four hundred forty dollars more than the budgeted amount of only one thousand dollars. This difference of four hundred forty dollars is an unfavourable materials cost variance which is both a quantity and unit cost variance as it resulted from quantity and unit cost variances. The same manners of computations stated above apply to labour cost variance. To summarize the variances for labour cost, the following samples may be helpful. It is to be recalled that the budgeted labour cost for Company X to finish the window installation is five hundred dollars (one dollar per hour for five hundred hours). Sample – labour cost – no variance Company X actually consumes total of five hundred hours to finish installing the windows at an actual cost of one dollar per hour. Total labour cost = five hundred dollars. Total budgeted labour cost = five hundred dollars Labour cost variance analysis variance: no variance. Sample – labour unit cost variance – unfavourable variance Actual labour consumption is five hundred hours to finish installing the windows at an actual cost of one dollar and twenty cents per hour. Total labour cost (500 x 1.20) = six hundred dollars Total budgeted labour cost = five hundred dollars Labour cost variance analysis: one hundred dollars (600 – 500) unfavourable variance Type of unfavourable variance: labour unit cost Sample – labour quantity variance – unfavourable variance Actual labour consumption is five hundred fifty hours to finish installing the windows at an actual cost of one dollar per hour. Total labour cost (550 x 1.00) = five hundred fifty dollars Total budgeted labour cost = five hundred dollars Labour cost variance analysis: fifty dollars (550 – 500) unfavourable variance Type of unfavourable variance: labour quantity Sample – labour unit cost and quantity variance – unfavourable variance Actual labour consumption is five hundred forty hours to finish installing the windows at an actual cost of one dollar and twenty five cents per hour. Total labour cost (540 x 1.25) = six hundred seventy five dollars Total budgeted labour cost = five hundred dollars Labour cost variance analysis: one hundred seventy five dollars (675 – 500) unfavourable variance Type of unfavourable variance: labour unit cost and quantity variance All the variances illustrated in the foregoing samples pertain to unfavourable variances. Favourable variances take place if the situation results into lesser actual cost compared to budgeted figures. In the case of Company X, presume that its actual material consumption was only ninety glass panes as it was not able to use the ten panes for breakage allowance. It purchased the materials at ten dollars each or for a total of nine hundred dollars (90 x 10). This shows a materials quantity favourable variance of one hundred dollars (one thousand dollars budgeted cost less nine hundred dollars actual cost). If the variance resulted from a lesser unit cost for the same number of glass panes, the variance is an example of materials unit cost favourable variance. This happens when, say, Company X was able to purchase the materials at a discount or for a lesser unit cost than what was projected. In the case of labour cost, favourable variances are determined in the same manner as illustrated in the foregoing computations and may be labour unit cost favourable variance or labour quantity favourable variance. The variance analyses referred to above are those for the general and common deviations. There are other variance analyses which specifically address particular concerns like efficiency and cost cutting some of which, at times, are not expressed in money terms but in other forms of reckoning like hours, stocks, etc. The choice of the type of the deviations method largely depends on the intention or purpose of the user. At any rate, variance analyses are management tools to measure performance levels in different dynamics and variables.3 Case problem In the problem given about MNT Ltd, the determination required is on its binding operations for August, 2008. The relevant computations and given data are set forth below. Standard direct labour time per binding operation: 2 minutes Standard direct labour rate per hour: RM 9.00 Actual number of binding operations during the month: 33,000 Actual number of minutes for the binding operations during the month: 66,000 (33,000 binding operations x 2 minutes) Actual number of hours of binding operations during the month: 1,100 (66,000 minutes divided by 60 minutes per hours) Actual direct labour cost (for 1400 hours): RM 11,700 Actual direct labour cost per hour: RM 8.357 (RM 11,700 divided by 1400 hours) Based on the above, the total standard or budgeted cost is RM 9,900 (RM 9.00 x 1,100 hours) while the actual cost is only RM 9,192.70 (RM 8.357 actual direct labour cost per hour multiplied by the actual number of hours of binding operations during the month. There is a labour cost favourable variance of RM 707.30 (RM 9,900 minus RM 9,192.70) for the month of August, 2008. For efficiency, there is a favourable variance of 11,400 binding operations computed, thus: Actual number of binding operations for the month of August, 2008 33,000 Number of minutes per month (60 x 24 x 30 days) 43,200 Divide by the number of minutes per standard binding operation 2 ---------- Presumed standard number of binding operations for one month 21,600 ---------- Favourable efficiency variance expressed in the number of binding operations 11,400 ====== For the other observations in the given problem, unforeseen repair work in the printing cost centre would not affect productivity in the binding operations because there is no direct connection between the two functions. However, if it can be shown that the works in the binding department are totally dependent on the supply of finished printed materials coming from the printing division, then it would be a different matter. In that latter case, any major unforeseen repair work in the printing cost centre will have adverse effects on the binding activities as will hinder productivity. In a situation where substandard binding materials are used, the productivity of the binding department will be naturally affected. The poor quality of the said substandard binding materials could slow down the pace of the binding process. For example, if the glue or adhesive elements of inferior class do not quickly bind the papers efficiently, more hours of work will be consumed in the process. Under that circumstance, production will be slow and higher labour cost will be incurred in the end as more time will be needed. Increases in salaries and wages always affect the budget as a matter of course. This is simply because the rate of pay will necessarily go higher. Even though the given problem logically indicates that the labour for binding cost is identified with the result of production, there are instances where time-and-motion studies bear to legislated wage increases. As a matter of fact, piece-work pay scales are usually raised when hourly wages are increased by law in order to avoid salary distortions and demoralization in the ranks. Conclusion and recommendations Generally, it is said that any endeavour needs planning in order to insure success. Albeit that cannot be absolutely true, plans and programs which are prepared ahead of any given activity calculate or pre-determine all possible factors and considerations that can arise during the actual event. Concentration is usually placed on probable negative scenarios. Taking the case of one who plans to put up a show, he has to anticipate the type and the number or population of the audience. If he believes that most of those who will come are children, he can be ready with things that children enjoy like balloons, multi-coloured barbecues and the like which kids always love and he does spend more on these items rather than waste money for things which are particularly for adults who are not likely to come. In short, because of planning, costs can be reduced and the expected performance will likely be realized. This is the very same thing in financial management. Plans and programs have to be set in the proper perspectives before the actual start of the business operations. Trends in demands have to be studied and based on the researches, price fluctuations of the materials needed must be anticipated even in estimates. There is not sense projecting for sales when the cost of materials will be relatively high in proportion to sales targets. Neither is it wise to take advantage of the low cost of a certain product when the prospective businessman does not see any quick demand for it in the market. There was one Japanese who visited the Philippine Islands and learned to like and love coconut juice sold almost all over. He was very impressed by the low cost of the beverage. In his country at that time, it was costing about twelve times. He brought a large volume of the product to Japan only to find out that his fellowmen did not care for the juice. Later studies revealed that the drink is humanly likeable ordinarily in places where the temperature is warm. The point here is that what good is a low price for a product a merchant wishes to sell when nobody buys during the actual sales campaign. Budgeting is a crucial segment of planning. As a matter of fact, budgeting or forecasting is a category of planning which gives emphasis on the statistics of income and expenses in the business. The usual items for cost budgeting are labour and materials, the possible reason and explanation being that these are the usual and most basic ingredients and elements of production. The projections for overhead costs are likewise considered although to a certain limited degree because overhead costs are sometimes indirectly related to production and can be dictated without minding the production process. For instance, the salary of a supervisor may be reduced and this will not likely affect production. Upon the other hand, if the price of the materials needed to produce a product abruptly rises unexpectedly, cuts in production may be possible and there can be serious repercussions. Sometimes, an economic debacle can happen. Budgeting helps the businessman from drifting in the direction of that disaster.4 Variance analysis is just a part of budgeting. Nonetheless, determination of variances plays a very significant role in the operations of any business. It points to the loopholes or sources of failures and lapses with the end in view of identifying the proper solutions and applying the same in a timely fashion. References Introduction to Standard Costing. AccountingCoach.com. [internet] Accessed October 19, 2009. Available at: < http://www.accountingcoach.com/online-accounting-course/30Xpg01.html> Kaelber, Henry V. Increase Your Wealth: Why Is Budgeting Important? Why Do I Need One? INVESTORGUIDE.com. [internet] Accessed October 19, 2009. Available at: Purpose of a Budget. [internet] Accessed October 19, 2009. Available at: < http://www.udel.edu/Budget/budgetclass/sld002.htm> Variance analysis. BusinessDictionary.com. [internet] Accessed October 19, 2009. Available at: < http://www.businessdictionary.com/definition/variance-analysis.html> Read More