Standard Costing in the Gem and Jewellery Industry

Transcription

1 Chapter-4 Standard Costing in the Gem and Jewellery Industry Introduction Features of a Standard Costing System Determination of Standard Costs Types of Standard Costing Application of Standard Costing Computation and Control through Variance Analysis Setting of Standard Costing Standard Cost and Variance Analysis Surana Jewellers Classic Diamonds Gitanjali Gems Vaibhav Gems Rajesh Exports Advantage of Standard Costing Criticism and Limitations of Standard Costing

2 176 INTRODUCTION The word Standard represents a level of quality or achievement or something that is used in order to judge the quality of something else. It is a pre-determined estimate of quantities. The work standard mean benchmark as before. A standard may be defined as Pre-determined measurable quantity set in defined conditions against which actual performance may be compared, usually for an element of work, operation or activity. 1 Standard Costing Standard Costing is an important sub-topic of cost accounting. Standard costing is associated with a manufacturing company. It is used to set a pre-determined estimation of cost for comparison with actual cost. It is used to fix a target cost to be obtained. Standard costs are estimated through identifying relation between specified inputs and expected outputs. Standard costing for one unit of output is the budgeted production cost for that unit. There is a difference between standard cost and standard costing system. Standard cost is a component in a Standard Costing System. They are targeted costs that should be incurred under efficient operation conditions. Standard costs are developed from historical data analysis or from time and motion studies. It is a technique, widely used for controlling 1. Ask U., Ax C. and Jonsson S. (1996), Cost management in Sweden: from modern to post-modern, in Bhimani, A. (ed.) Management Accounting: European Perspectives, Oxford, Oxford University Press,

3 177 costs. Standard costs are often used in preparing budgets because they are anticipated income costs under normal conditions. 2 Definition of Standard Costing The CIMA, London has defined standard cost as a predetermined cost which as calculate form Managements standards of efficient operations and the relevant necessary expenditure. They are the predetermined cost on technical estimate of material labour and overhead for a selected period of time and for a prescribed set of working conditions. In other words, a standard cost is a planned cost for a unit of product or service rendered. Standard costing is a control method involving the preparation of detailed cost and sales budget. Such budgets are then compared with the actual results for a specific account period and any significant variances between the actual and the budgeted results are investigated. Unexpected trends are corrected if they are not acceptable or they cannot be accommodated. Standard costing is an important sub-topic of cost accounting. Standard costs are usually associated with a manufacturing companies cost of direct material, direct labour, overhead. 3 FEATURES OF A STANDARD COSTING SYSTEM (a) Flow of Information: Cost information flows in standard costing system from the stage of acquiring of raw materials 2. Kaplan R.S. and Cooper R. (1998), Cost and Effect: Using Integrated Systems to Drive Profitability and Performance, Harvard Business School Press, p Ibid.

4 178 till the stage of final Production (finished goods), each activity is properly accounted for various systematically and even such various or analysed written off against the cost of sales account. Cost information flows smoothly and perfectly under standard costing system. (b) (c) (d) Role of Actual Cost: Actual cost have no role to play in a standard costing system. Actual cost are not at all to be taken into account. In this system, no actual product cost are generated. The main thrust in this system, is on the number of products manufactured. Performance Measurement: A standard costing reports the performance by responsibility centers. It acts as an apt basis for measuring the actual performance. It is a suitable criterion of performance measurement. Suitable for Repetitive Nature of Firms: the standard costing system is suitable for firms which produce identical goods in large number. In such manufacturing concerns activities are standard and repetitive in nature. 4 PROCESS OF DETERMINING THE STANDARDS The ideal standards for better controlling can be determined with following steps: 1. Determination of Cost Center According to J. Betty, A cost center is a department or part of a department or an item of equipment or machinery or a person or a group 4. Merchant K.A. (2008), Modern Management Control Systems: Text and Cases, Prentice-Hall, New Jersey, p.115.

5 179 of persons in respect of which costs are accumulated, and one where control can be exercised. post centers are necessary for determining the costs. If the whole factory is engaged manufacturing a product, the factory will be a cost center In fact, a cost center describes the product wh1ie cost is accumulated. Cost centers enables the determination of costs and fixation of responsibilities. 2. Current Standards A current standard is a standard which is established for use over a short period of time and is related to current condition. It reflects the performance that should be attained during the current period. The period for current standard is normally one year. It is presumed that conditions of production will remain unchanged. In case there is any change in price or manufacturing condition, the standards are also revised. 3. Ideal Standard This is the standard which represents a high level of efficiency. Ideal standard is fixed on the assumption that favorable conditions will prevail and management will be at its best. All the conditions, both internal and external, should be favorable and only then ideal standard will be achieved. Ideal standard is fixed on the assumption of those conditions which may rarely exist. 4. Basic Standards

6 180 A basic standard may be defined as a standard which is established for use for an indefinite period which may a long period. Basic standard is established for a long period and is not adjusted to the preset conditions. The same standard remains in force for a long period. These standards are revised only on the changes in specification of material and technology productions. It is indeed just like a number against which subsequent process changes can be measured basic standard enables the measurement of changes in cost. 5. Normal Standards As per terminology, normal standard has been defined as a standard which, it is anticipated, can be attained over a future period of time, preferably long enough to cover one trade cycle This standard is based on the conditions which will cover a future period of five years concerning one trade cycle If a normal cycle of ups and downs in sales and production is 10 years, then standard will be set on average sales and production which will cover all the years. The standard attempts to cover variance in the production from one time to another time. An average is taken from the periods of recession and depression. The normal standard concept is theoretical and cannot be used for cost control purpose. Normal standard can be properly applied for absorption of overhead cost over a long period of time. 6. Organization for Standard Costing

7 181 The success of standard costing system will depend upon the setting up of proper standards. For the purpose of setting standards, a person or a committee should be given this job in a big concern, a standard costing committee is formed for this purpose. The committee includes production manager, purchase manager, sales manager, personnel manager, chief engineer and cost accountant. The cost accountant acts as a co-coordinator of this committee. 7. Accounting System Classification of accounts is necessary to meet the required purpose, i.e. function, asset or revenue item. Codes can be used to have a speedy collection of accounts. A standard is a predetermined measure of material, labour and overheads. It may be expressed in quality and its monetary measurements in standard costs. 5 TYPES OF STANDARDS The two principal considerations affecting the classification of standards are: (i) attainability of standards, that is, the ease with which it is possible to achieve the standards, and (ii) frequency with which the standards are revised. On the basis of these two factors, it is possible to classify standards as ideal, normal, basic, current or expected actual standards Ideal, Perfect, Maximum Efficiency or Theoretic Standards 5. Friedman A.L. and Lynne S.R. (1995), Activity-based Techniques: The Real Life Consequences, Chartered Institute of Management Accountants, pp Drucker P.F. (1994), Cost control and management, in Management Controls: New Directions in Basic Research (eds C.P. Bonini, R. Jaedicke and H. Wagner), McGraw-Hill, p.215.

8 182 Ideal standards (costs) are the standards which can be attained under the most favorable condition possible. The level of performance under ideal standards would be achieved through the best possible combination of factors-the most favorable prices for materials and labour, highest output with best equipment and layout, and maximum efficiency in the utilisation of the production resources-in other words, maximum output at minimum cost. Such standards reflect only goals or targets without any hope of performance being currently achieved. These standards are extremely tight and do not provide for waste and inefficiency in any form; no material is wasted; no Units are spoiled; there are no idle hour operators work at predetermine speed; the available capacity is fully utilised. 2. Normal Standards Normal standards are the average standards which (it is anticipated) can be attained during a future period of time preferably long enough to cover one business cycle. These standards are not revised until the cycle has run its full course. This generally results in an incorrect valuation of inventories and consequent errors in the profit disclosed, as the inventories are understated in periods of high prices, and over-stated when prices are low. Normal standards are mainly used as a device to solve the problem of absorbing fixed overhead rather than in connection with material cost and wages Since these standards do not reflect the goals to be attained, they are not often used. 3. Basic Standards

9 183 The Institute of Cost and Management Accountants (UK) defines a basic standard as the standard which is established for use unaltered for an indefinite period which may be a long period of time. Basic standards are seldom revised or updated to reflect current operating costs and price level changes. 4. Currently Attainable or Expected Actual Standards Current standards are standards, which established for use over a short period of time, and are related to current conditions. They represent current costs to be expected from efficient operations. Currently attainable standards are formulated after making allowance for the cost of normal spoilage, cost of idle time due to machine breakdowns, and the cost of other events which are unavoidable in normal efficient operations. They take the place of actual cost and are recorded in account books and financial statements. Any deviation from these standards reflects inefficiencies in the production activities, unless the variances have occurred due to uncontrollable factors. These standards are most accurate and very useful to management in product costing, inventory valuations; estimates, analyses, performance evaluation, planning, employee motivation, and for managerial decision-making and external financial reporting. APPLICATION OF STANDARD COSTING Standard costs are usually associated with a manufacturing company s costs of direct material, direct labour, and manufacturing

10 184 overhead. Rather than assigning the actual costs of direct material, direct labour, and manufacturing overhead to a product, many manufacturers assign the expected or standard cost. This means that a manufacturer s inventories and cost of goods sold will begin with amounts reflecting the standard costs, not the actual costs, of a product. Manufacturers, of course, still have to pay the actual costs. As a result there are almost always differences between the actual costs and the standard costs, and those differences are known as variances. Standard costing and the related variances is a valuable management tool. If a variance arises, management becomes aware that manufacturing costs have differed from the standard (planned, expected) costs. If actual costs are greater than standard costs the variance is unfavourable. An unfavorable variance tells management that if everything else stays constant the company s actual profit will be less than planned. If actual costs are less than standard costs the variance is favourable. A favourable variance tells management that if everything else stays constant the actual profit will likely exceed the planned profit. As soon as the accounting system reports a variance, the management can direct its attention to the difference from the planned amounts Rangrajan K., Kennedy H. and Murti M., Management Megatrends, Allied Publishers Private Ltd., 2010, p.293.

11 185 COMPUTATION AND CONTROL THROUGH VARIANCE ANALYSIS Cost variance has been defined as the difference between a standard cost and the comparable actual cost incurred during a period. Variance analysis has been defined as the analysis of the cost variances into its components parts and the explanation of variances. Thus variance analysis is a part of the process of control and involves the calculation of variance and the interpretation of results so as to localise the different factors that are responsible for the variance. It leads us to ascertain the magnitude of each of the variances and the causes thereof so that corrective action may be taken. Variances may be broadly classified under the following heads according to the main types of cost:- 1. Material, 2. Labour, and 3. Overheads There are three distinct groups of variances that arise in costing. They are:- 1. Variances of Efficiency: These include variances because of efficiency or inefficiency in the use of material or labour, ascertained by the comparing actual quantities with pre-determined quantities of material and labour hours and from special allowances for surplus material and labour cost. 2. Variances of Price Rates: These include variances resulting from changes in unit material prices, standard labour hour rates and standard allowances for indirect costs.

12 Variances due to Volume: These represent the effect of difference between the actual activity and the level of activity assumed when the standard was set. The purpose of standard costing report is to investigate the reasons for significant variances so as to identify the problems and to take corrective action. Variances are mainly of two types:- 1. Controllable Variances 2. Uncontrollable variances Price variance is normally regarded as uncontrollable if the price increase is due to fluctuations of prices in the market. It becomes uncontrollable if the production controller has failed to place orders in time and urgent purchase was made at an extra cost. In the former case, no responsibility is attached to any one whereas the departmental head has the responsibility for loss in the latter case. The annual financial reports of the Gems and Jewellery companies in India contain the total material cost, total labour cost, and total manufacturing overheads, during each financial year. This information along with the average trading price of gold at MCX during a given financial year is used to calculate the material equivalent gold used by the sampled companies. Further, we assume that each of these companies manufacture homogenous product which uses 100 grams of gold. This information is used to estimate the number of units produced by each firm during a given financial year. The per unit material cost,

13 187 labour cost, and manufacturing overheads is estimated using the financial data and number of units produced by each firm during a given financial year. The standard cost (material, labour, manufacturing expenses) for each company is calculated as the average of direct material cost, direct labour cost, and manufacturing overheads. Further, the cost variance (material, labour and manufacturing overheads) is estimated as the difference in the direct cost (which is also the actual cost) and the standard cost. 8 SETTING OF STANDARD COSTING Normally, setting up standards is based on the past experience. The total standard cost includes direct materials, direct labour and overheads. Normally, all these are fixed to some extent. The standards should be set up in a systematic way so that they are used as a tool for cost control. There are various elements which influence the Setting of Standards. These are briefly described here Setting Standards for Direct Materials There are several basic principles which should be appreciated in setting standards for direct materials. If material is used for a product, it is known as direct material. On the other hand, if the material cost cannot be assigned to the manufacturing of the product, it will be called indirect material. Therefore, it involves two things: Quality of material 8. Ask U., Ax C. and Jonsson S., op.cit., p Friedman A.L. and Lynne S.R., op.cit., p.167.

14 188 Price of the material When a material is purchased, the quality and quantity should be determined. The standard quality to be maintained should be decided. The quantity is determined by the production department. This department makes use of historical records, and an allowance for changing conditions will also be given for setting standards. The second step in determining direct material cost will be a decision about the standard price. The procedure for purchase of materials, minimum and maximum levels for various materials, discount policy and means of transport are the other factors which have bearing on the materials cost price. It includes the following: Cost of materials Ordering cost Carrying cost The purpose should be to increase efficiency in procuring and store keeping of materials. The type of standard used ideal standard or expected standard also affects the choice of standard price. 2. Setting Direct Labour Cost To engage a labour force for manufacturing a product or a service, it is necessary to pay some amount, called wages. If the labour is engaged directly to produce the product, this is known as direct labour. The second largest amount of cost is of labour. The benefit derived from the workers can be assigned to a particular product or a process. If the

15 189 wages paid to workers cannot be directly assigned to a particular product these will be known as indirect wages. Standard labour time for producing Labour rate per hour Standard labour time indicates the time taken by different categories of labour force which are as under: Skilled labour Semi-skilled labour Unskilled labour For setting a standard time for labour force, we normally take in to account previous experience, past performance records, test run result, work-study etc. The labour rate standard refers to the expected wage rates to be paid for different categories of workers past wage rates and demand and supply principle may not be a safe guide for determining standard labour rates. 3. Setting Standards of Overheads The next important element comes under overheads. The very purpose of setting standard for overheads is to minimize the total cost. Standard overhead rates are computed by dividing overhead expenses by direct labour hours or units produced. The standard overhead cost is obtained by multiplying standard overhead rate by the labour hours spent or number of units produced. STANDARD COST AND VARIANCE ANALYSIS OF THE COMPANIES UNDER STUDY

16 190 Surana Jewellers The results in Table 4.1 summarize the standard cost and variance analysis for Surana Jewellers.

17 191 Table 4.1 Standard Cost and Variance Analysis for Surana Jewellers (Amount in Rupees) Particulars Direct Material Cost (per Unit) Direct Labour Cost (per Unit) Manufacturing Overheads (per Unit) Standard Direct Material Cost (per Unit) Standard Direct Labour Cost (per Unit) Standard Manufacturing Overheads (per Unit) Variance in Direct Material Cost (per Unit) Variance in Direct Labour Cost (per Unit) Variance in Manufacturing Overheads (per Unit) 122, , , , , , , , , , ,260 48,260 18,160 (48,140) (96,540) 24 (29) 16 (25) 15 (114) (201) Source: Annual Reports and Accounts of the company from to As can be seen from Table 4.1, for Surana Jewellers, direct material cost had an increasing trend throughout the period. It was Rs. 122,300 in which increased to Rs. 152,300 in , Rs. 182,400 in , Rs. 248,700 in and reached up to Rs. 297,100. The standard direct material cost per unit was Rs. 2,00,560 for all the firms during the period under study from to It is clear from this analysis that during first three years of study period, the firms direct material cost was less than standard direct material cost whereas in last two years, it was more than standard cost.

18 192 In other words, it can be said that material cost variance analysis for Surana Jewellers indicates that the variance in direct material cost is favourable during financial years , , and ; and unfavourable during financial years , and Direct labour cost showed a fluctuating trend during the study period. It was Rs. 122 in which increased sharply to Rs. 175 in but decreased to Rs. 130 in Then it increased again to Rs. 171 in the year but came down to Rs. 131 in the final year The standard direct labour cost per unit was Rs. 146 for Surana Jewellers during the period under study. Hence, with respect to variance in direct labour cost, the unfavourable years are and whereas favourable years are , and The manufacturing overheads per unit had an increasing trend throughout the period under study except in the year Initially in , it was Rs. 400 per unit which decreased and came down to Rs. 175 in Then, it increased to Rs. 181 in , Rs. 187 in and reached up to 487 in the year The standard manufacturing overheads per unit was Rs. 286 for the firm during the period under study from to Hence, the variance in manufacturing overheads was unfavourable in and whereas favourable during , and

19 193 The adverse or unfavourable variance shows the inefficiency of the budgetary department. The management of the firm should try to find out the reasons of unfavourable variances and make efforts to overcome these reasons so that the standards are estimated effectively. The management should try to maintain the favourable variances. Classic Diamonds Table 4.2 summarizes the results of the standard cost and variance analysis for Classic Diamonds. Table 4.2 Standard Cost and Variance Analysis for Classic Diamonds (Amount in Rupees) Particulars Direct Material Cost (per Unit) Direct Labour Cost (per Unit) Manufacturing Overheads (per Unit) Standard Direct Material Cost (per Unit) Standard Direct Labour Cost (per Unit) Standard Manufacturing Overheads (per Unit) Variance in Direct Material Cost (per Unit) Variance in Direct Labour Cost (per Unit) Variance in Manufacturing Overheads (per Unit) 1,22,300 1,52,300 1,82,400 2,48,700 2,97,100 6,228 5,000 5,820 5,750 6,044 10,666 5,473 2,422 3,422 4,629 2,00,560 2,00,560 2,00,560 2,00,560 2,00,560 5,768 5,768 5,768 5,768 5,768 5,322 5,322 5,322 5,322 5,322 78,260 48,260 18,160 (48,140) (96,540) (460) 768 (52) 18 (276) (5344) (151) Source: Annual Reports and Accounts of the company from to

20 194 Table 4.2 shows that for Classic Diamonds, direct material cost had an increasing trend throughout the period. It was Rs. 122,300 in which increased to Rs. 152,300 in , Rs. 182,400 in , Rs. 248,700 in and reached up to Rs. 297,100. The standard direct material cost per unit was Rs. 2,00,560 during the period under study from to It is clear from this analysis that in first three years of study period, the firms direct material cost was less than standard direct material cost whereas in last two years, it was more than standard cost. In other words, it can be said that cost variance analysis for Classic Diamonds indicates that the variance in direct material cost is favourable during financial years , , and ; and unfavourable during financial years , and Direct labour cost for Classic Diamonds showed a fluctuating trend during the study period. It was Rs in which decreased sharply to Rs in but increased to Rs in Then it decreased again to Rs in the year but inclined up to Rs in the final year The standard direct labour cost per unit was Rs for Classic Diamonds during the period under study. Hence, in the years and , direct labour cost variance was favourable as it was less than standard direct labour cost whereas in , and , it was higher than standard rate so unfavourable variance for the business.

21 195 The manufacturing overheads per unit had a decreasing cum increasing trend during the period under study. Initially in , it was Rs per unit which decreased and came down to Rs in and further decreased to Rs in Then, it increased to Rs in and reached up to 4629 in the year The standard manufacturing overheads per unit was Rs for the firm during the period under study from to Hence, the variance in manufacturing overheads was favourable during the last three years of the study period whereas unfavourable during an It is further suggested that the unfavourable variance should be avoided as it denotes the inefficiency of the management, hence should be controlled. Gitanjali Gems The results in Table 4.3 summarize the standard cost and variance analysis for Gitanjali Gems.

22 196 Table 4.3 Standard Cost and Variance Analysis for Gitanjali Gems (Amount in Rupees) Particulars Direct Material Cost (per Unit) Direct Labour Cost (per Unit) Manufacturing Overheads (per Unit) Standard Direct Material Cost (per Unit) Standard Direct Labour Cost (per Unit) Standard Manufacturing Overheads (per Unit) Variance in Direct Material Cost (per Unit) Variance in Direct Labour Cost (per Unit) Variance in Manufacturing Overheads (per Unit) 1,22,300 1,52,300 1,82,400 2,48,700 2,97, , ,354 1,127 6,208 6,002 6,977 10,307 14,109 2,00,560 2,00,560 2,00,560 2,00,560 2,00,560 1,003 1,003 1,003 1,003 1,003 8,720 8,720 8,720 8,720 8,720 78,260 48,260 18,160 (48,140) (96,540) 397 (9) 87 (351) (124) (1587) (5389) Source: Annual Reports and Accounts of the company from to As can be seen from Table 4.3, for Gitanjali Gems, direct material cost had an increasing trend throughout the period. It was Rs. 122,300 in which increased to Rs. 152,300 in , Rs. 182,400 in , Rs. 248,700 in and reached up to Rs. 297,100. It is clear from this analysis that during first three years of study period, the firms direct material cost was less than standard direct material cost hence favourable variance whereas in last two years, it was more than standard cost so unfavourable variance for the firm.

23 197 Direct labour cost showed a fluctuating trend during the study period. It was Rs. 606 in which increased sharply to Rs in but decreased slightly to Rs. 916 in Then, it increased again to Rs in the year but came down to Rs in the final year The standard direct labour cost per unit was Rs for Gitanjali Gems during the period under study. Hence, with respect to variance in direct labour cost, and years can be said favourable due to less value of direct labour cost in comparison to standard cost. On the other hand, remaining three years of the study period, it was unfavourable for the firm due to higher than standard values. The manufacturing overheads per unit had an increasing trend throughout the period under study except in the year Initially in , it was Rs per unit which decreased and came down to Rs in Then, it increased to Rs in , Rs in and reached up to in the year The standard manufacturing overheads per unit was Rs for the firm during the period under study from to Hence, the variance in manufacturing overheads was favourable in , and due to its less values whereas unfavourable during and due to its higher than standard value. It is suggested that the management of the firm should try to locate the reasons of unfavourable variance and try to control the adverse

24 198 variance as it denotes the inefficiency of management towards setting of standards. Vaibhav Gems The results in Table 4.4 summarize the standard cost and variance analysis for Vaibhav Gems Limited. Table 4.4 Standard Cost and Variance Analysis for Vaibhav Gems (Amount in Rupees) Particulars Direct Material Cost (per Unit) Direct Labour Cost (per Unit) Manufacturing Overheads (per Unit) Standard Direct Material Cost (per Unit) Standard Direct Labour Cost (per Unit) Standard Manufacturing Overheads (per Unit) Variance in Direct Material Cost (per Unit) Variance in Direct Labour Cost (per Unit) Variance in Manufacturing Overheads (per Unit) 1,22,300 1,52,300 1,82,400 2,48,700 2,97,100 9,062 12,486 21,817 34,105 36,924 7, ,953 15,322 27,779 31,516 2,00,560 2,00,560 2,00,560 2,00,560 2,00,560 22,879 22,879 22,879 22,879 22,879 42,788 42,788 42,788 42,788 42,788 78,260 48,260 18,160 (48,140) (96,540) (11226) (14045) (89165) Source: Annual Reports and Accounts of the company from to As can be seen from Table 4.4, for Vaibhav Gems, direct material cost had an increasing trend throughout the period. It was Rs. 122,300 in which increased to Rs. 152,300 in , Rs. 182,400 in

25 , Rs. 248,700 in and reached up to Rs. 297,100. The standard direct material cost per unit was Rs. 2,00,560 for all the firms during the period under study from to It is clear from this analysis that in first three years of study period, the firms direct material cost was less than standard direct material cost whereas in last two years, it was more than standard cost. In other words, it can be said that material cost variance analysis for Vaibhav Gems indicates that the variance in direct material cost is favourable during financial years , , and ; and unfavourable during financial years , and Direct labour cost showed an increasing trend during the study period. It was Rs om which increased to Rs in , Rs in , Rs in the year and reached up to Rs in the final year The standard direct labour cost per unit was Rs for Vaibhav Gems for the study period. Hence, with respect to variance in direct labour cost, the favourable years are , and whereas unfavourable years are and The manufacturing overheads per unit had an increasing trend throughout the period under study except in the year Initially in , it was Rs per unit which increased exceptionally and rose up to Rs in Then, it increased to Rs in , Rs in and reached up to in the year

26 200 The standard manufacturing overheads per unit was Rs for the firm during the period under study from to Hence, the variance in manufacturing overheads was favourable for the firm in all the years due to lower values except the year in which it was highest. However, it is suggested that the management of the firm should try to control the adverse variances. Rajesh Exports The results in Table 4.5 summarize the standard cost and variance analysis for Rajesh Exports. Table 4.5 Standard Cost and Variance Analysis for Rajesh Exports (Amount in Rupees) Particulars Direct Material Cost (per Unit) Direct Labour Cost (per Unit) Manufacturing Overheads (per Unit) Standard Direct Material Cost (per Unit) Standard Direct Labour Cost (per Unit) Standard Manufacturing Overheads (per Unit) Variance in Direct Material Cost (per Unit) Variance in Direct Labour Cost (per Unit) Variance in Manufacturing Overheads (per Unit) 1,22,300 1,52,300 1,82,400 2,48,700 2,97, , ,00,560 2,00,560 2,00,560 2,00,560 2,00, ,260 48,260 18,160 (48,140) (96,540) (130) (115) (577) 317 Source: Annual Reports and Accounts of the company from to

27 201 As can be seen from Table 4.5, for Rajesh Exports, direct material cost had an increasing trend throughout the period. It was Rs. 1,22,300 in which increased to Rs. 1,52,300 in , Rs. 1,82,400 in , Rs. 2,48,700 in and reached up to Rs. 2,97,100. It is clear from this analysis that in first three years of study period, the firms direct material cost was less than standard direct material cost Rs , whereas in last two years, it was more than the standard cost. In other words, it can be said that cost variance analysis for Rajesh Exports indicates that the variance in direct material cost is favourable during financial years , , and ; and unfavourable during financial years , and for the firm. Direct labour cost showed a fluctuating trend during the study period. It was Rs. 74 in which decreased to Rs. 55 in and further came down to Rs. 51 in Then, it increased to Rs. 69 in the year and reached up to Rs. 225 in the final year The standard direct labour cost per unit was Rs. 95 for Rajesh Exports during the period under study. Hence, with respect to variance in direct labour cost was favourable in first four years whereas unfavourable in the final year of the period under study which should be kept under control in future. The manufacturing overheads per unit had a decreasing trend throughout the period under study except in the year Initially in , it was Rs. 711 per unit which decreased to Rs. 513 in

28 202 and came down to Rs. 304 in Then, it increased to Rs in but declined sharply to Rs. 279 in the final year The standard manufacturing overheads per unit was Rs. 596 for the firm during the period under study from to Hence, the variance in manufacturing overheads was unfavourable in and whereas favourable during , and It is suggested that adverse variances should be kept in control by effective management of the firm. ADVANTAGE OF STANDARD COSTING Among many advantages, the most important may be listed as follows: 1. Managerial Planning: Planning is a process of using all resources in such a manner that maximizes business projects standard cost are more convenient than actual cost for budget preparation because the standard cost at different production levels and for different product. Mixes are readily built up into total cost as called for by the budget. On the other hand using actual cost requires a great deal of analysis and adjustment when extensive changes in product volume or product-mixes take place. 2. Efficiency Measurement: The comparison of actual cost with standard cost enables the management to evaluate performance of various cost centers. In the absence of standard costing system, actual cost of different period may be compared to measure efficiency. It is not

29 203 proper to compare cost of different period because circumstance of both the periods may be different still, a decision about base period can be made with which actual performance can be compared. 3. Co-Ordination: The establishment of standards coordinates all functions- manufacturing, marketing engineering, research of a common goal settings standards in all defining and communication targets so that they can work towards the attainment of the goal. 4. Finding of Variance: The performance variance are determined comparing actual cost with standard cost and place of inefficiencies. It can fix responsibility for deviation in performance. It is possible to take corrective measures at the earliest. A regular check on various expenditure is also ensured by standard cost system. Cost control and reduction are probably the most important aims of any costing system and standard costing gives due recognition objective of production of the required quality of the lowest cost attainable under existing conditions. Standards enable management to make periodic comparison of actual cost with standard cost in order to measure performance and to take action to maintain control over cost. 5. Right Decisions: It enables and provides useful information to the management towards taking important decisions for example, the problem created by inflating, rising prices. It can also be used to provide incentive plans for employees etc. Economical means of costing and record keeping: The use of standard cost can reduce clerical labour and

30 204 expense by avoiding the detailed record- keeping which is necessary when actual cost alone are used. Standards as incentives to Employees: If standards are reasonable and attainable they act like incentives to employees to improve their performances and to maintain the quality of the product. Standard motivate workers, supervisors and forman to work more efficiently in the accomplishment of their respective standards. 10 CRITICISM AND LIMITATIONS OF STANDARD COSTING Criticism 1. Aggregated and Untimely: Variances are too aggregated and arrive too late to be useful. Variances should focus on activities, specific product lines, production bathes. 2. Focuses on Less Important Production Factors: Variances focus too much on the cost and deficiency of labour, which is becoming relatively unimportant factor of production. 3. Less Stability of Manufacturing Environment: Standard cost rely on a stable production environment and flexible manufacturing systems have reduced the stability, with frequent switching among a variety of products on the same manufacturing line. 4. Much Focus on Costs rather than Quality: Standard focus too much on cost minimization and not enough on product quality, customer service and other contemporary issues Berliner C. and Brimson J.A. (1998), Cost Management for Today s Advanced Manufacturing, Harvard Business School Press, pp Rangrajan K., Kennedy H. and Murti M., op.cit., p.298.

31 205 Limitations 1. It cannot be used in those organizations where non-standard products are produced If the production is undertaken according to the customer specifications, then each job will involve different amount of expenditures. 2. The process of setting standard is a difficult task, as it requires technical skills. The time and motion study is required to be undertaken for this purpose. These studies require a lot of time and money. 3. There are no inset circumstances to be considered for fixing standards. The conditions under which standards are fixed do not remain static. With the change in circumstances, if the standards are not revised the same become impracticable. 4. The fixing of responsibility is not an easy task. The variances are to be classified into controllable and uncontrollable variances. Standard costing is applicable only for controllable variances. For instance, if the industry changed the technology then the system will not be suitable. In that case, we will have to change or revise the standards. A frequent revision of standards will become costly. *****