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Category: Business and Industry
Date Submitted: 12/14/2011 10:23 AM
cause and effect
Standard costing is a control technique which compares standard costs and revenues with actual results to obtain variances which are used to stimulate improved performance. In order to stimulate improved performance, we need to understand the potential causes of variances. In general, variances have four causes. These are outlined below. Inappropriate standard If a standard is set at a level that does not reflect current conditions, then variances will be recorded even if the organisation is operating at the required level of efficiency. For example, if price standards have not been updated for inflation, an expenditure variance calculated against out-of-date price standards will result in an adverse variance – even when the organisation is purchasing efficiently. This type of variance is often dismissed in management meetings as ‘budget error’. Inaccurate recording of actual costs and revenues An organisation may be operating efficiently, but if costs are recorded inaccurately then variances may result. For example, if workers complete timesheets inaccurately some departments will be overcharged with labour hours and others undercharged. This will lead to adverse and favourable labour efficiency variances, even if the departments are operating at the standard level of efficiency. Random events Variances can sometimes be caused by random events which, by their very nature, are unlikely to occur again. For example, a freak accident may damage raw material stocks and cause adverse material usage variances. Operating efficiency If the three causes above can be eliminated, then the variance must be due to operating efficiency. Improving operating efficiency is the key 58 student accountant May 2006 to stimulating improved performance. Table 1 on page 60 gives some examples of causes of operating efficiency variances, both adverse and favourable. In a traditional standard costing system, the variances recorded are likely to be caused by a combination...