Topic 5. Standard Cost

Topic 5. Standard Cost

Dr. Vera Butkouskaya

Content

1. Standard Cost: Concept, components and calculation

2. Types of Budgets3. Fixed and flexible budgets.4. Budgeting

2

Standard CostsConcept and usefulness

3

1

Usefulness of Cost Standards

A standard cost is described as a predetermined cost, an estimated future cost, an expected cost, a budgeted unit cost, a forecast cost, or as the "should be" cost.

▰ Used for: ▻ Planning▻ Benchmarking for predicting

performance▻ To simplify the accounting

system 4

Standards

Two schools of thought:1. Ideal standards (perfection standards): developed under the assumption that no obstacles to the operating process will be encountered.2. Attainable Standards: developed under the assumption that there will be occasional problems in the operating process.

5

Setting up standard costs.

Standard costs are developed in a variety of ways:a. Specified by formulas (if price and quantity of the input is known) .b. Developed from price lists provided by suppliers.c. Determined by time studies conducted by industrial specialists (leading indicators).d. Developed from analyses of past data.

6

Standard Cost: Unit Inputs

Each unit has standards for price (p) and quantity (q) of ▰ Direct Materials:

▻ Price - the cost of materials in each product/service▻ Quantity - amount used to make each product/service

▰ Direct Labour:▻ Price - wage rate for employee involved in making product/service ▻ Quantity - time used to make each product

▰ AND for ▰ Operational overhead for both

Variable Operational overheadFixed Operational overhead:▻ OH rate - the cost of the unit of indirect capacity ▻ Quantity - the amount of indirect capacity used (Quantity or Hours)

7

Standard cost: Total Input

The total standard cost of a product/service is the sum of the total standard costs of the inputs:

▰ Direct material (p*q)▰ Direct labor (p*q)▰ Overhead

Variable overheadFixed overhead

▻ OH rate*q

8

Standard Cost Example

In the Room department the following data is provided (per 1 night): Direct materials 4 euro/per room, direct labour 5 euro/per labour hour - per room , OH rate is 50 euro/per person. Make a calculation of the Standard Cost per 1 single room per night.

9

Type of Cost P (price) or OH Rate

x Q (quantity, hours, indirect capacity used)

= Standard Cost

Direct Materials 4 euro /room x 1 = 4

Direct Labour 5 x 1 = 5

Operational OH (indirect costs)

50 x 1 = 50

-- -- -- -- -- 59


In the Room department the following data is provided (per 1 night): Direct materials 3 euro/per person, direct labour 4 euro/per person, OH rate is 50 euro/per person. Make a calculation of the Standard Cost per 1 double room per night.

10



= Standard Cost

Direct Materials 3 euro/person

x 2 = 6

Direct Labour 4 x 2 = 8

Indirect (Operation OH) 50 x 2 = 100

-- -- -- -- -- 114

BudgetsConcept and usefulness

11

2

12Cost of operations

What is Budget?

A budget is a business plan, usually expressed in monetary terms. ▰ It is a projection of revenue (how much you

anticipate selling) and expenses (how much you anticipate spending).

13

Role of Budgets

The three main purposes of budgeting:

1. To provide organized estimates of future unit sales, sales revenues, expenses, net income, staffing requirements, or equipment needs, broken down by operating period and department.

2. To provide management with long-term and short-term goals. These goals can be used to plan future activities.

3. To provide information for control. This is important so that actual results can be evaluated against budget plans and adjustments, if necessary, can be made.

14

Types of budgets

There are a number of different kinds of budgets. 1. long-term and short-term budgets, 2. capital budgets, 3. operating budgets, 4. department budgets,5. master budgets, 6. and7. Fixed and flexible budgets.

15

Types of budgets (1)

▰ Short-term (even one day) / operationalFor ex., For a restaurant owner/operator, estimating how many customers will eat in the restaurant, and purchasing food and supplies to accommodate this need.▰ Long-term (up to 5 years) / strategic

For ex., In a large organization up to five years (such as for furniture and equipment purchases), as well as requiring day-to-day budgets (such as staff scheduling).

16


A capital budget is a plan for the acquisition of new (or replacement of existing) fixed assets.

For ex. a five-year replacement schedule for hotel room furnishings.

17


An operating budget concerns the ongoing projections of sales revenues and expense items that affect the income statement. ▰ For ex., a forecast of sales revenue for a

restaurant for a month is in an operating budget. ▰ Similarly, in a multi department hotel the forecast

of total payroll expense for the year is an operating budget. Or, the budget of daily spending on food in the hotel restaurant.

18


A department budget is prepared for a hospitality organization that has multiple sales revenue units (such as a restaurant complex with a dining room, and a bar, and a banquet area; OR hotel with a rooms operation, and dining room, and a bar, and spa).

A department budget for a revenue generating department

▰ total forecasted sales revenue (-)less operating expenses.

For supporting department (e.g., the maintenance department of a hotel),

▰ anticipated expenses in detail for an operating period.19


In the Room department the following data is provided (per 1 night): Direct materials 4 euro/per person, direct labour 6 euro/per person, OH rate is 50 euro/per room. Make a calculation of the Standard Cost per 1 Room department which includes 5 single rooms, 10 double-rooms and 7 suits (3 guest rooms).

20



= Standard Cost

Direct Material 4 euro/person

x 1*5+2*10+7*3=46 = 4*46 = 184

Direct Labour 6 euro/person

x 46 = 6*46 = 276

Operational OH 50 euro/room

x 5+10+7 = 22 = 50*22= 1100

-- -- -- -- -- 1100+276+184


A master budget is prepared for a year and

▰ includes a balance sheet for a year hence▰ all the departmental income and expense

statements for the next year.

21

Fixed and flexible budgetsConcept and usefulness

22

3


A fixed budget is based on a certain level of activity or sales revenue, and expense estimates are based on this level of sales.

A flexible (or variable) budget is prepared based on several levels of activity.

For ex., in rooms department sales revenue could be forecast for 60%, 70%, and 80% occupancy levels (or as many levels as are appropriate).

23


For fixed budget

▰ No attempt is made to introduce greater or lesser levels of sales revenue and, thus, different expense amounts in the budget.

For flexible (or variable) budget

▰ As the actual year progresses, it can be determined at which level the operation is going to fit best, and the appropriate expense levels will have already been determined for this level.

24

Fixed vs. Flexible Budget

25

Budgeting Concept and usefulness

26

3

THE BUDGET CYCLE

The budget cycle is a five-part process:

1. Establish attainable goals or objectives.

2. Plan to achieve these goals or objectives.

3. Compare actual results with those planned, and analyze the differences (variances).

4. Take required corrective action.

5. Improve the effectiveness of budgeting.

27

ESTABLISHING ATTAINABLE GOALS OR OBJECTIVES (1)

Limitation factors. Example - Volume of business Hotel cannot achieve more than 100% of room occupancy. If hotel achieve 100% of occupancy, how can it improve revenues? ▰ In the short run, if a hotel achieves 100% occupancy every

night, room rates would have to be increased for sales revenue to increase.

A restaurant is limited to a specific number of seats. How to increase revenues? ▰ in the short run, by increasing menu prices or seat turnover

(seat occupancy).BUT the are limits of customer sensibility towards price changing! 28

PLANNING TO ACHIEVE GOALS OR OBJECTIVES (2)

Example.

▰ At the departmental level, a restaurant manager must staff with employees skilled enough to handle the anticipated volume of business.

▰ A chef or purchaser must purchase food both in the quantities required to take care of anticipated demand and of a quality that meets the required standards established by management and expected by customers.

29

COMPARING ACTUAL RESULTS WITH THOSEPLANNED AND ANALYZING THE DIFFERENCES (3)

Comparing actual results with the budget allows one to ask questions:

▰ Our actual dining room sales revenue for the month of April was $60,000 instead of the budgeted $63,000.

▰ Was the $3,000 difference caused by a reduction in number of customers?

▰ If so, is there an explanation (e.g., are higher prices keeping customers away, or did a competitive restaurant open nearby)?

▰ Is the $3,000 difference a result of reduced seat turnover (is service slowing down)?

▰ Are customers spending less (a reduced average check, or customer spending, because of belt tightening by the customer)?

30

IF REQUIRED, TAKING CORRECTIVE ACTION (4)

The cause of a difference could be the result of:

▰ a circumstance that no one could foresee or predict (e.g., weather, a sudden change in economic conditions, or a fire in part of the premises).

▰ Decisions could be done incorrectly:▻ selling prices were not increased sufficiently to compensate for an inflationary cost

increase; or that▻ the budgeted forecast in occupancy of guest rooms was not sufficiently reduced to

compensate for the construction of a new, nearby hotel; ▻ or that staff were not as productive in the number of customers served or rooms cleaned

as they should have been according to predetermined standards.

31Variances between budget and actual figures should not be an argument

IMPROVING THE EFFECTIVENESS OF BUDGETING

The information provided from analyzing variances between actual and budgeted figures will be helpful. By improving accuracy in budgeting, the effectiveness of the entire organization is increased.

32

Sales Budget Concept and usefulness

33

4

Sales Budget

The following should be considered when making monthly sales revenue projections:■ Past actual sales revenue figures and trends■ Current anticipated trends (demand)■ Economic factors (customer price sensibility)■ Competitive factors (market share, occupancy rate, turnover)■ Limiting factors (number of rooms, or seats)

34

Sales Budget , Example

For example, the dining room sales revenue for the past three years for the month of January was as follows:

Year 1 $60,000

Year 2 $65,000

Year 3 $67,000Note. These increases were caused entirely by increases in number of customers. The size of the restaurant has not changed and no change in size will occur.

We plan an increase in Year 4 at the average level. Calculate the budgeted sales revenues for Year 4.

35


For example, the dining room sales revenue for the past three years for the month of January was as follows:

Year 1 $60,000

Year 2 $65,000 5000$ / 60000$ = 8.3% (Year2-Year 1)/Year 1

Year 3 $67,000 $2000/ 65000$ = 3% (Year3-Year 2)/Year2

Average (8.3%+3%)/ 2 = 5.65%Year 4 Year 3 + increase in 5.65% = 67000 + 5.65*67000 =

36


Year 1 $60,000

Year 2 $65,000 65000/60000 = 1.083 --- increase in 8.3%

Year 3 $67,000 67000/65000 = 1.03 --- increase in 3%

average (8.3%+ 3%)/2 = 5.65%

Year 4 $67,000+$67,000 *5.65% = $70 765

37

Purchases budget

A purchases budget contains the amount of inventory that a company must purchase during each budget period.Note., this calculations are most critical for restaurants and other service companies with inventory.

38

Purchases budget, Example

Example. Consider the following data available for the restaurant.

▰ Cost of products rested from the previous day 500 euro

▰ Purchased of the products in the beginning of the day 1500 euro

▰ Ending inventory 300 euro

Calculate the Cost of materials in goods sold (COGS). 39

Purchases budget

Example. Consider the following data available for the restaurant.

▰ Cost of products rested from the previous day 500 euro▰ Purchased of the products in the beginning of the day 1500 euro▰ Ending inventory 300 euro

Direct Materials used = 500+1500-300=1700 euro

40

Marketing and Administrative Expenses Planning

Marketing Expenses are expenses that DIRECTLY relate to the selling of a product or service. For ex., advertising expense, salesforce salaries, sales displays expense, brochure and pamphlet expense, sales promotion expense, and so on.

Administrative Expenses, on the other hand, are expenses that do NOT directly relate to the selling of a product or service; they are, however, necessary in operating the business. For ex., offices salaries expense, office supplies expense, office rent expense, insurance expense, utilities expense, delivery expense, maintenance expense, telephone expense, company registration expense, bank service charges expense, depreciation expense and so on.

41

Marketing and Administrative Expenses Planning, Example

For example, consider the following data.

During the low season the average period of stay decrease to 2 nights per guest. Also, these bookings are mainly happen on weekends. Thus, for the low season company put a sales promotion: “book 3 nights and get free breakfast (one)”. There are 10 single rooms, 15 double rooms and 3 suits. Price for the breakfast 12 euro per person.

Calculate the budgeted expenses related with this sales promotion.

42

Marketing and Administrative Expenses Planning, Example

For example, consider the following data.

During the low season the average period of stay decrease to 2 nights per guest. Also, these bookings are mainly happen on weekends. Thus, for the low season company put a sales promotion: “book 3 nights and get free breakfast (one)”. There are 10 single rooms, 15 double rooms and 3 suits. Price for the breakfast 12 euro per person.

Calculate the budgeted expenses related with this sales promotion.

588 euro

10*1+15*2+3*3= 49 persons

49*12 = 588 euro43

Cash budget

A cash budget is an estimation of the cash flows for a business over a specific period of time. This budget is used to assess whether the entity has sufficient cash to operate.

44

Cash budget

45

Questions

Documents

Topic 5. Standard Cost