A COMPARITIVE STUDY OF STANDARD COSTING SYSTEM OF P&G AND

Definition and Explanation of Standard Costing

A standard cost is the predetermined cost of manufacturing a single unit or a number of product units during a specific period in the immediate future. It is the planned cost of a product under current and/or anticipated operating conditions. A standard cost has two components: a standard and a cost. A standard is like a norm and whatever is considered normal can generally be accepted as standard. For example, if a score of 72 is the standard for a golf course, a golfer's score is judged on the basis of this standard. In industry, the standards for making a desk, assembling a radio, refining crude oil, or manufacturing railway cars are based on carefully determined quantitative and qualitative measurements and engineering methods. A standard must be though of as a norm in terms of specific items, such as pounds of materials, hours of labor required, and percentage of plant capacity to be used. In many firms, a standard can be operative for a long time. A change is needed only when production or the products themselves have become obsolete or undesirable.

Advantages / Benefits of Standard Costing System:

Standard costingSystem has the following main advantages or benefits:

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The use of standard costs is a key element in a management by exception approach. If costs remain within the standards, Managers can focus on other issues. When costs fall significantly outside the standards, managers are alerted that there may be problems requiring attention. This approach helps managers focus on important issues. Standards that are viewed as reasonable by employees can promote economy and efficiency. They provide benchmarks that individuals can use to judge their ownperformance. Standard costscan greatly simplify bookkeeping. Instead of recording actual co0sts for each job, thestandard costsfor materials, labor, and overhead can be charged to jobs. Standard costsfit naturally in an integrated system ofresponsibility accounting. The standards establish what costs should be, who should be responsible for them, and what actual costs are under control.

Disadvantages / Problems / Limitations of Standard Costing System:

The use ofstandard costscan present a number of potential problems or disadvantages. Most of these problems result from improper use ofstandard costsand themanagement by exceptionprinciple or from usingstandard costsin situations in which they are not appropriate.

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Standard cost variance reports are usually prepared on a monthly basis and often are released days or even weeks after the end of the month. As a consequence, the information in the reports may be so stale that it is almost useless. Timely, frequent reports that are approximately correct are better than infrequent reports that are very precise but out of date by the time they are released. Some companies are now reporting variances and other key operating data daily or even more frequently. If managers are insensitive and use variance reports as a club, morale may suffer. Employees should receive positive reinforcement for work well done.Management by exception, by its nature, tends to focus on the negative. If variances are used as a club, subordinates may be tempted to cover up unfavorable variances or take actions that are not in the best interest of the company to make sure the variances are favorable. For example, workers may put on a crash effort to increase output at the end of the month to avoid an unfavorablelabor efficiency variance. In the rush to produce output quality may suffer. Labor quantity standards and efficiency variances make two important assumptions. First, they assume that the production process is labor-paced; if labor works faster, output will go up. However, output in many companies is no longer determined by hw fast labor works; rather, it is determined by the processing speed of machines. Second, the computations assume that labor is a variable cost. However, direct labor may be essentially fixed, then an undue emphasis on labor efficiency variances creates pressure to build excesswork in processandfinished goodsinventories. In some cases, a "favorable" variance can be as bad or worse than an "unfavorable" variance. For example, McDonald's has a standard for the amount of hamburger meat that should be in a Big Mac. A "favorable" variance would mean that less meat was used than standard specifies. The result is a substandard Big Mac and possibly a dissatisfied customer. There may be a tendency with standard cost reporting systems to emphasize meeting the standards to the exclusion of other important objectives such as maintaining and improving quality, on-time delivery, and customer satisfaction. This tendency can be reduced by using supplementalperformancemeasures that focus on these other objectives. Just meeting standards may not be sufficient; continual improvement may be necessary to survive in the current competitive environment. For this reason, some companies focus on the trends in the standard cost variances - aiming for continual improvement rather than just meeting the standards. In other companies, engineered standards are being replaced either by a rolling average of actual costs, which is expected to decline, or by very challenging target costs

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P&G
P&G company produces many products for household use. Company sells products to storekeepers as well as to customers. Detergent-DX is one of the products of P&G. It is a cleaning product that is produced, packed in large boxes and then sold to customers and storekeepers. P&G uses a traditional standard costing system to control costs and has established the following materials, labor and overhead standards to produce one box of Detergent-DX:

Direct materials: 1.5 pounds @ $12 per pound Direct labor: 0.6 hours $24 per hour Variable manufacturing overhead: 0.6 hours @ $5.00

$18.00 $14.40 $3.00 $35.40 -

During August 2012, company produced and sold 3,000 boxes of Detergent-DX. 8,000 pounds of direct materials were purchased @ $11.50 per pound. Out of these 8,000 pounds, 6,000 pounds were used during August. There was no

inventory at the beginning of August. 1600 direct labor hours were recorded during the month at a cost of $40,000. The variable manufacturing overhead costs during August totaled $7,200. Required:

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Compute materials price variance and materials quantity variance. (Assume that the materials price variance is computed at the time of purchase.) Compute direct labor rate variance and direct labor efficiency variance. Compute variable overhead spending variance and variable overhead efficiency variance.

Solution:
(1) Materials variances:

= (8,000 pounds $11.50) (8,000 pounds $12) = $92,000 $96,000 = $4,000 Favorable

= (6,000 pounds $12) (4,500 pounds $12) = $72,000 $54,000 = $18,000 Unfavorable (2) Labor variances:

= $40,000 (1,600 hours $24) = $40,000 $38,400 = $1,600 Unfavorable

= (1,600 hours $24) (1,800 hours $24) = $38,400 $43,200 =$4,800 Favorable (3) Variable overhead variances:

= (1,600 hours $4.5) (1,600 hours $5) = $7,200 $8,000 = $800 Favorable

= (1,600 hours $5) (1,800 hours $5) = $1,000 Favorable