Various writers have forecast a decline in the use of standard costing due to changing manufacturing technology and new thinking on costing. The Drury survey found that only 11 per cent of respondent manufacturing companies had stopped using standard costing systems in the last 10 years and 76 per cent were still using such systems.
Further reading
Drury, C (2004) Management and Cost Accounting, Thomson Learning, Stamford, CT.
Gowthorpe, C (2005) Management Accounting for Non Specialists, Thomson Learning, Stamford, CT.
Self-check questions
1. What is a standard hour?
2. Define the activity ratio.
3. Name some management techniques, which may be used when setting a standard cost specification.
4. Variances are either favourable or ...?
5. Define and give the formula for the labour efficiency variance.
6. The standard cost specification for a product is as follows:
Selling price £31
Less: Factory costs:
Direct material – 12 kg at £0.50 £6 Direct labour – 2 hours at £6.00 £12 Variable overhead per product £2 Fixed overhead per product £5
£25
Standard profit per product £ 6
KKK Ltd budgeted to produce and sell 1,100 products last week.
Actual production and sales was only 900 and other information is as follows:
Selling price – £32
Direct material – 12,600 kg at £0.55 Direct labour – 1,600 hours at £6 Variable overheads £2,100 Fixed overheads £5,700
Produce a statement reconciling the budgeted profit with the actual profit by disclosing all possible variances.
7. The standard material cost of fabric specified for a particular garment is £4.50, comprising three metres at £1.50 per metre. Last week, 1,000 garments were made using 3,200 metres of fabric bought in at £1.40 per metre. Calculate the total material cost variance and analyse further the material price variance and material usage variance.
Standard costing
Budgetary control
INTRODUCTION
We need to distinguish revenue budgetingfrom capital budgeting. Revenue budgets are concerned with forecasts of sales revenue and operating costs going into the budgeted profit and loss account. This applies to all organizations, of all sizes, in any sector, and is the focus of this chapter. A capital budget is concerned with plans for capital expenditure on indi- vidual projects or specific assets, which need to be included in the budgeted balance sheet. This budget is again applicable to all organiza- tions, but may be inextensive in some, and is discussed in Chapter 17.
Similarity of budgeting with standard costing
There are many similarities between a system of budgetary control and the standard costing technique discussed in Chapter 14. They are both concerned with planning and control involving the setting of targets and the later comparison with actual results. Differences called variances, arising from comparisons of target with actual, are identified so that corrective action can be taken if necessary.
Much detailed preparatory work is common to both budgetary control and standard costing as they are both concerned with detailed operating costs and revenues. Where the two systems differ is in the unit and scale of application. A standard cost specifies the selling price
15
and cost of a product while a budget is prepared for an organizational unit called a financial responsibility centre. Budgets and budgetary control are applicable in all organizations, whether manufacturing or service industries, whether profit-seeking or not.
Purpose of budgetary control
The main purpose of budgetary control is to plan and control the firm’s activities. Corporate and strategic planning are concerned with the long-term broad objectives of the firm, possibly stretching five years ahead. Budgetary control, however, is an expression of short-term financial plans to meet objectives in the coming accounting year. The short-term objective may be to earn a specified rate of return on capital, or to achieve a certain level of turnover or market share. In some organi- zations the objective may simply be not to overspend, but to keep spending within a grant or budget allocation. Although budgets are plans for activity in the very near future, they must be compatible with what the firm is trying to achieve in the longer term.
Using a system of budgetary control, senior management can practise the principle of management by exception. They delegate responsibility for activities, functions and departments to middle managers, allowing them- selves time to concentrate solely on deviations from plans and future strat- egy. This avoids them getting overwhelmed by involvement in day-to-day activities, the vast majority of which are probably running to plan. Put more formally, budgetary control is a classic example of a control cycle.
Control cycle
There are six sequential stages to the control cycle, as illustrated in Figure 15.1.
SETTING NEW DEFINING MEASURING
BUDGET PERFORMANCE ACTUAL
MEASUREMENTS PERFORMANCE
TAKING ACTION EXAMINING COMPARING
IF NECESSARY VARIANCES ACTUAL
WITH BUDGET Figure 15.1 Budgetary control cycle
Budgetary control
Stage 1. Setting new budget– this starts the control cycle off and is the original budget set in the manner described later, dependent on the size of the organization.
Stage 2. Defining performance measurements– these are the means by which the budget holder’s performance is going to be measured. Typical performance measures include a set return on capital; a specified sales target or market share; a profit target; keeping costs within budget.
Stage 3. Measuring actual performance – once performance measure- ments have been set then actual performance can be recorded. This is made possible by the use of cost centre numbers (and capital job numbers) when inputting financial transactions to the financial database.
Stage 4. Comparing actual with budget – measuring actual performance is insufficient by itself without a yardstick with which to make compari- son. The original budget, or a later revised budget, is that yardstick.
Stage 5. Examining variances– differences between actual and budget items are called variances and significant ones need to be identified and their causes investigated. Significance here may be defined as an absolute sum of money or a specified percentage variation from budget.
Stage 6. Taking action if necessary– there is no point to the previous stages if this does not happen. Information may be gleaned that helps avoid future mishaps or repeats a benefit that can be transferred else- where. Every attempt should be made to get back on target if this is real- istically possible.
Stage 1. Setting new budget again– this starts the cycle off again but there is no point in setting a new budget after each monthly review as future comparisons may become meaningless. Some organizations keep the original budget fixed, get budget holders to forecast the outcome at the end of the budget year quarterly, and for the remainder of the year make comparisons against both original budget and latest forecast.