Developing Unit Input Standards
Although flexible budget variances provide significant information for control, developing standards for input prices and input quantities allows a more detailed understanding of the sources of these variances. Price standards specify how much should be paid for the quantity of the input to be used. Quantity standards specify how much of the input should be used per unit of output. The unit standard cost is defined as the product of these two standards: Standard price x Standard quantity (SP x SQ).
Although flexible budget variances provide significant information for control, developing standards for input prices and input quantities allows a more detailed understanding of the sources of these variances. Price standards specify how much should be paid for the quantity of the input to be used. Quantity standards specify how much of the input should be used per unit of output. The unit standard cost is defined as the product of these two standards: Standard price x Standard quantity (SP x SQ).
For example, an ice cream company may decide that 25 ounces of yogurt should be used for every quart of frozen yogurt produced (the quantity standard) and that the price of the yogurt should be $0.02 per ounce (the price standard). The standard cost of the yogurt per quart of frozen yogurt is then $0.50 ($0.02 x 25). The standard cost of yogurt per quart can be used to predict what the total cost of yogurt should be as the activity level varies; it thus becomes a flexible budget formula. If 20,000 quarts of frozen yogurt are produced, the total expected cost of yogurt is $10,000 ($0.50 x 20,000); if 30,000 quarts are produced, the total expected cost of yogurt is $15,000 ($0.50 x 30,000). Standard costs, therefore, facilitate budgeting, but the input price and quantity standards will also allow us to obtain a more detailed analysis of the flexible budget variance.
Establishing Standards
Developing standards requires significant input from a variety of sources. Historical experience, engineering studies, and input from operating personnel are three potential sources of quantitative standards. Historical experience should be used with caution because relying on input-output relationships from the past may perpetuate operating inefficiencies. Engineers and operating personnel can provide valuable insights concerning efficient levels of input quantities. Similar comments can be made about input price standards. Price standards are the joint responsibility of operations, purchasing, personnel, and accounting. Operations determines the quality of the inputs required; personnel and purchasing have the responsibility to acquire the input quality requested at the lowest price. Market forces, trade unions, and other external forces limit the range of choices for price standards. In setting price standards, purchasing must consider discounts, freight, and quality; personnel, on the other hand, must consider payroll taxes, fringe benefits, and qualifications. Accounting is responsible for recording price standards and for preparing reports that compare actual performance to the standard.
Standards are often classified as either ideal or currently attainable. Ideal standards are standards that demand maximum efficiency and can be achieved only if everything operates perfectly. No machine breakdowns, slack, or lack of skill (even momentarily) are allowed. Currently attainable standards can be achieved under efficient operating conditions. Allowance is made for normal breakdowns, interruptions, less than perfect skill, and so on. These standards are demanding but achievable. One cautionary observation about standards should be made. If standards are too tight and never achievable, workers become frustrated, and performance levels decline. However, challenging but achievable standards can lead to higher performance levels particularly when the individuals subject to the standards have participated in their creation.
Kaizen Standards
Establishing Standards
Developing standards requires significant input from a variety of sources. Historical experience, engineering studies, and input from operating personnel are three potential sources of quantitative standards. Historical experience should be used with caution because relying on input-output relationships from the past may perpetuate operating inefficiencies. Engineers and operating personnel can provide valuable insights concerning efficient levels of input quantities. Similar comments can be made about input price standards. Price standards are the joint responsibility of operations, purchasing, personnel, and accounting. Operations determines the quality of the inputs required; personnel and purchasing have the responsibility to acquire the input quality requested at the lowest price. Market forces, trade unions, and other external forces limit the range of choices for price standards. In setting price standards, purchasing must consider discounts, freight, and quality; personnel, on the other hand, must consider payroll taxes, fringe benefits, and qualifications. Accounting is responsible for recording price standards and for preparing reports that compare actual performance to the standard.
Standards are often classified as either ideal or currently attainable. Ideal standards are standards that demand maximum efficiency and can be achieved only if everything operates perfectly. No machine breakdowns, slack, or lack of skill (even momentarily) are allowed. Currently attainable standards can be achieved under efficient operating conditions. Allowance is made for normal breakdowns, interruptions, less than perfect skill, and so on. These standards are demanding but achievable. One cautionary observation about standards should be made. If standards are too tight and never achievable, workers become frustrated, and performance levels decline. However, challenging but achievable standards can lead to higher performance levels particularly when the individuals subject to the standards have participated in their creation.
Kaizen Standards
Another type of standard known as a kaizen standard is also possible. Kaizen standards are continuous improvement standards. Kaizen standards reflect a planned improvement and are a type of currently attainable standard. Kaizen standards by their very nature have a cost reduction focus and because of their emphasis on continuous improvement are constantly changing.
Standards and Activity-Based Costing
Standards also play an important role in activity-based systems. An activity’s cost is determined by the amount of resources consumed by each activity. To avoid measuring the amount of resource consumption on an ongoing basis for literally hundreds of activities, standard consumption patterns are identified based on historical experience. The purpose of standards in this case is to facilitate cost assignments.
Read usage of standard costing systems
Standards and Activity-Based Costing
Standards also play an important role in activity-based systems. An activity’s cost is determined by the amount of resources consumed by each activity. To avoid measuring the amount of resource consumption on an ongoing basis for literally hundreds of activities, standard consumption patterns are identified based on historical experience. The purpose of standards in this case is to facilitate cost assignments.
Read usage of standard costing systems
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