What are the major objectives of standards costing?
What are types of cost standards?
The standard is the level of attainment accepted by management as the basis upon which standard costs are determined. There are four different standards to consider which are current standard, ideal standard, basic standard and normal standard. 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. Current standard may be ideal standard and expected standard. However, ideal standard 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. The price paid for materials will be lowest and wastes etc. will be minimum possible. The labor time for making the production will be minimum and rates of wages will also be low. The overheads expenses are also set with maximum efficiency in mind. 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. This standard is not practicable and may not be achieved. Though this standard may not be achieved, even then an effort is made. The deviation between targets and actual performance is ignorable. In practice, ideal standard has an adverse effect on the employees. They do not try to reach the standard because the standards are not considered realistic. Third standard which is 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 conations. 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 costs. For example, if the basic cost for material is Rs. 20 per unit and the current price is Rs. 25 per unit, it will show an increase of 25% in the cost of materials. The changes in manufacturing costs can be measured by taking basic standard, as a base standard cannot serve as a tool for cost control purpose because the standard is not revised for a long time. The deviation between standard cost and actual cost cannot be used as a yardstick for measuring efficiency. The last one is normal standard. 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.
What are the advantages and disadvantages of standard costing system?
Standard costing have several advantages. First advantage of standard costing is as 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. Second advantage is standard costing is standards that are viewed as reasonable by employees can promote economy and efficiency. They provide benchmarks that individuals can use to judge their own performance. Besides that, standard costs can greatly simplify bookkeeping. Instead of recording actual costs for each job, the standard costs for materials, labor, and overhead can be charged to jobs. Last but not least, standard costs fit naturally in an integrated system of responsibility accounting. The standards establish what costs should be, who should be responsible for them, and what actual costs are under control. However, the use of standard costs can present a number of potential problems or disadvantages. Most of these problems result from improper use of standard costs and the management by exception principle or from using standard costs in situations in which they are not appropriate. 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. Besides that, 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 unfavorable labor efficiency variance. In the rush to produce output quality may suffer. In some cases, a “favorable” variance can be as bad as 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 an unsatisfied customer. Another problem of using standard costing, 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 supplemental performance measures 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. In sum, managers should exercise considerable care in their use of a standard cost system. It is particularly important that managers go out of their way to focus on the positive, rather than just on the negative, and to be aware of possible unintended consequences. Nevertheless standard costs are still found in the vast majority of manufacturing companies and in many service companies, although their use is changing. For evaluating performance, standard cost variances may be supplanted in the future by a particularly interesting development known as the balanced scorecard.
How standard costs are sets?
Standards should be set for the quantities and prices of materials, labour and services to be consumed in performing each operation associated with a product. Product standard costs are derived by listing and adding the standard costs of operations required to produce a particular product. Two approaches are used or setting standard costs. First, past historical records can be used to estimate labour and material usage. Secondly, standards can be set based on engineering studies. With engineering studies a detailed study of each operation is unedertaken under controlled conditions, based on high levels of efficiency, to ascertain the quantities of labour and materials required. Target prices are then applied based on efficient purchasing to ascertain the standard costs.
How a standard costing system operates?
Standard costing is most suited to an organization whose activities consist of a series of repetitive operations and the input required to produce each unit of output can be specified. A standard costing system involves the following:
The standard costs for the actul output are recorded for each operation for each responsibilty centre.
Actual costs for each operation are traced to each responsibility centre.
The standard and actual costs are compared.
Variances are investigated and corrective action is taken where appropriate
Standards are monitored and adjusted to reflect changes in standard usage and/or prices.
Variances What is the main purpose of variance analysis?
There are very few plans that turn out exactly as planned. Even when the overall objectives of the plan are achieved, some, if not all components of the performance will have varied from the sub-plans or standards that make up the overall picture. For example, a football team may win an important game, as planned, but within the team performance there may be many aspects that the manager will analyse during and after the match so that performance can be improved for next time. As in business, good points need to be encouraged, less positive aspects need to be discussed and corrected. In a game of football, a side may have won a high number of corner kicks, but conceded too many free-kicks in defending. There is little to be gained for the next match if we do not think about the last performance in detail.
Variance analysis provides a framework for business managers to breakdown the overall performance of an organisation, so that each individual element of the business can be isolated and analysed in turn.
What are the causes of labour, material, overhead, and sales margin variances?
Quantities cost variances arise because the actual quantity of resources consumed exceed actual usage or vice versa. Examples include excess usage of materials and labour arising from the usage of interior materials, careless handling of materials and failure to maintain machinery in proper condition. Price variances arise when the actual prices paid for resources exceed the standard prices or else. Examples include the failure of the purchasing function to seek the most efficient sources of supply or the use of a different grade of labour to that incorporation in the standard costs.
How to calculate material, labour, variable overhead, fixed overhead, and sales variances.
International Federation of Accountants Code of Ethics
Code of Ethics is essential for both accountants and auditors as they hold positions of expectation that the community rely on them and the capability. The Code of Ethics is regulated by International Federation of Accountants (IFAC) at international level. Due to the company failures such as Enron and Equitable life, ethical behavior and independence has become more important. The Enron case clearly demonstrates the value work of IFAC. (ACCA, 2002)
Therefore, IFAC’s Code of Ethic is broadly defined as code of conduct based on a set of moral principles or values that indicates how an individual should behave. (Velayutham, 2003) Through this, if an auditor is incompetent, the parties to the contract will place little or no value on the service provided. (Messier et al., 2007).Furthermore, auditors are required to be independence to apply unbiased judgment and objective consideration to establish facts in giving an opinion. It is essential because the users expect the auditor to have an unbiased viewpoint when forming opinion on the true and fairness of the financial statement. If the auditors are not independence, then the value of audit is lost. (Gomes, 2010) [Online].It is vital to provide assurance services as it can increase confidence of users of the information and to avoid conflicts of interests that may occur towards the auditor.
2.0 Main report 2.1 Critically evaluate of the role of IFAC’s Code of Ethics for professional accountants in strengthening independence of auditors. Over these years, IFAC has been revising a newer Code of Ethics to clarify requirements for all professional accountants and to enhance the independence of auditor. (IFAC, 2009) [Online].This Code of Ethics are follow up and practiced by its members until it becomes a system in the organization.(Ravendran,2006) [Online]. Principles-based approach is remained in the revised Code of Ethic and it establishes a conceptual framework for professional accountants and external auditor to follow. This is to make sure they are compliance with fundamental principles of professional ethics. It is important for fundamental of principle to remain the same, as it would be more flexible for all professional accountants and the external auditors. (Ward, 2006) [Online]
The IFAC Code of Ethic has constantly revised to meet the changing needs of the profession and the expectations of stakeholders in Malaysia. (MIA, 2006) [Online].Therefore IFAC Code of Ethic is set as a good example to follow because of its holistic approach that considers many aspects of the issue. (Gomes, 2009) [Online].External auditors to find out possible threats and evaluate how it could affect the audit are using conceptual framework. They have to apple safeguards on the identified threats to reduce them to an acceptable level. (MIA, 2006) [Online]
Furthermore, auditors play an important role to provide a high-quality financial statement because any loss in carrying out their work will give a bad impact on investor protection and confidence. For example, many auditors failed to give their opinion leading to compromising the shareholders of public listed companies. (Izma, 2009) [Online] .As a result, independence of auditors is affected. In solving this kind of situation, auditors will need to follow the fundamental of principles to reduce this threat. (MIA, 2005) [Online]
By applying a principle-based approach, it can also help to standardize the IFAC’s Code of Ethic globally. Through standardizing the international standards, the auditors will have high quality standards in auditing the financial statement. (Ward, 2006) [Online].If each country standardized the preparation of financial statements, making it flexible for cross-border securities listing globally. This will enable the company for a better flow of resources, using it systematically. (Kumar, Porwal, 2003) [Online] .Therefore opinion form by auditors will be more credible and reliable in ensuring auditors to be more independence.
On the other hand, the behavior of a human cannot be justified by just following the IFAC’s Code of Ethic. This is because personal behavior cannot be control and it depends on how they want to behave. (MIA, 2006) [Online].For example lack of ethical code, especially one client may jeopardized another client’s business due to the financial difficultly they faced.(Gomes, 2009) [Online] The reasons why auditors cannot control themselves, probably due to the characteristic of the auditors are self-centered, greedy and unprincipled, thus this will create a self- interest threat for the auditors.( Jackling et al., 2007)
As such, it is not good to understand the principle only, the knowledge of ethical code need to be apply. (Gomes, 2010) [Online].If not independence of auditor will be influence and then nobody would be able to trust them just like ‘Arthur Anderson’. Due to the cases like Enron or WorldCom, which ended up as a fraud, IFAC’s has revised stronger ethical code and stringent rules that a company must follow. However, the revised IFAC’s Code of Ethic cannot be perfect all the time. Somehow, loopholes can be found, as it may not fully capture the culture, belief and practice the code and it will make auditors to be unable to enhance independence. (ACCA, 2009) and external auditors may not adapt to this standards as there are changes to the ethical code.
It can also make mistakes as the environment is changing, so does the culture and the personality of the auditor as well. Therefore, without a proper guidance, certain parts of the organization may interpret the code differently and IFAC’s Code of Ethic cannot promise that very country or auditor may process the ethical code. For example as the culture in the world is changing so as the behavior of an auditor and for that auditor may do what they want, as the Code of Ethic is not included in the law system. In general, by maintaining the same code is not possible, as it has to change consistently. (Pflugrath et al., 2007)
2.2 Evaluate the important of maintaining principle-based approach in the Code of Ethics. Many corporation failures has shows the need of principle- based approach is essential. The suggested ways for IFAC’s Code of Ethic to strengthen the independence of auditors are by having a principle-based approach, as it is flexible and easy for the auditors and accountants to adapt. With a strong principle-based, this will enhance the auditor to perform a high quality standards of auditing in making decisions and the public would have more trust towards them (IFAC, 2009) [Online]. By having a principles- based approach, problems it maintaining will be reducibly and there are ways of resolving it. (MIA, 2008) [Online]
Furthermore, the IFAC’s body has agreed that principle-based are better compared to rules-based approach as threats and safeguards better serves the public interest, which cannot provide for all circumstances. (Bagshaw, 2006) [Online].As such, the Code of Ethic has been revised in principles- based approach primarily to encourage auditors to make a high quality judgment(MIA, 2006) [Online]. Therefore, assurance is critical in making sure that their judgments are ethical enough as the auditors and accountants holds these responsibilities. (Haron.H et al., 2010)
Other than that, a principles- based approach can adapt to the changes of the environment. This is because every country has a different culture and this culture will generally affect the behavior of that person. Therefore, with principle-based, it can minimize standards behavior for each auditor and accountant globally. (ACCA, 2009) and therefore it is important to maintain a principles-based in the IFAC’s Code of Ethic. Moreover, with the high quality of ethical code, auditors can make a good judgment and this will avoid them from having a financial scandal. (Ismail et al., 2010)
Somehow, some aspects that may considered as a threat towards a principle-based approach. External auditors and professional accountants that are use to comply with rules- based in Code of Ethics find themselves in a difficulty to switch to principles- based. The most important concern is whether a purely principle-based approach is strong enough to deal with a complicated transactions.(Yong, 2004) [Online].Due to the different culture in every country International codes such as the IFAC’s Code cannot fully comply with basic principles and practice. (ACCA, 2009)
The fact is that auditors and accountants will need to apply judgments according to the principles, which is impossible because Code of Ethic cannot include all situation and dilemmas and by applying judgments blindly, auditor’s independence are affected. (Gomes, 2009) [Online] Despite that, every now and then judgment are use to manipulate financial outcomes so a strong ethical behavior and commitment is required for the auditors to avoid temptations from resist client pressuring. (Yong, 2004)[Online]
Besides that, the lack of clarity in principle-based approach as ethical code can perceive to be to technical jargon. As such auditors will have a difficult time to understand certain parts especially when the ethical code is translated, auditors finds themselves that the meaning become weaker thus auditors will find it hard to revise the Code of Ethics and because of this ethical code may not be widely used all over the world. (MIA, 2005) [Online] (ICAEW, 2006) [Online].Therefore every country needs to adjust to have a simpler Code of Ethics.
2.3 Recommendation In general, all companies differs from one and another in terms of functional operations, its legal systems, institutional base works and cultures, therefore it is critical that every organization must have good corporate governance for survival. Hence corporate governance is another way to enhance the independence of auditors besides having Code of Ethics. The objectives are to make sure that company’s management is organized care and certain requirements that auditors and accountants must comply. Other than that, corporate governance systems are to make sure that threats to independence do not happen. (ICAEW, 2001) [Online]
As audit committee are parts of the corporate governance, it is important for them to monitor the external auditor’s work by checking the financial report. By doing so, external auditor’s assurance will be improved. Besides this, audit committee can give some opinions to external auditor especially when problems occur. (ACCA, 2009).Therefore, with the help of audit committee, financial report would be more reliable. Moreover, audit committee can also review the timing and nature of reports as well as the findings of the external auditors. (ACCA, 2009) Hence, this will be able to enhance the independence of auditors
Besides this, Continuing Professional Development (CPD) is another good substitute besides Code of Ethics. This program is great to ensure auditors and accountants are updated with the market developments and changes affecting the accountancy profession and the auditors. Further, it helps the auditors to maintain and raise standards to professional judgments thus this will give auditors to be more up to date in the Guide of Professional Ethics. Through CPD, auditors will have the advantage to improve the capacity to exercise the highest standards of professional judgement. (ICAEW, 2010) [Online]
CPD also provides information, support and guidance towards the auditor thus auditors are more confident in making a good decision without affecting the financial report. (ICAEW, 2010) [Online] By adopting this new approach, auditors will be able to follow up with current issue, which can affect their professional works, and to be committed in the job as they are responsible to the clients, stakeholders and the employers. (MIA, 2006) [Online].Finally, CPD will help them to be more knowledgeable and will enhance them to develop higher level of quality standards (MIA, 2007) [Online]
3.0 Conclusion Overall, it is important that IFAC’s Code of Ethics is revised every few years to make auditors and accountants are able to adapt with the changes made in the Code of Ethic. Ethical code is needed for the auditors and accountants as the public rely on them to perform the audit work efficient and effectively. Due to this, maintaining a principle-based is in need for every auditors and accountants as it is more flexible and thus it is globally used. However, there are still some negative aspects of ethical code, which auditor finds it difficult to comply with but somehow they manage to resolve it. As such, it is important that auditor and accountants knows when to apply the ethical code and not just understanding the principle only.
Nevertheless, by having a good judgment, auditors will be able to make a good decision without getting influence. Therefore, with a strong ethical behaviour, auditors will be able to give a reliable and credible financial report and as a result, independence of auditors can be enhanced.Apart from this, it is essential, that every country will be able to adopt the IFAC’s Code of Ethics, as it will give high quality standards in the financial statement. Ethical Code cannot guarantee ethical behavior or resolve all dispute ethical behavior should result from a personal commitment to engage in ethical practice. Audit committee and CPD can also help to enhance the independence of auditor’s.
Lastly, Ethical Code is an essential element of the surroundings in which auditors work and it is important that proper guidance to be given to them.