GROUP 3

Hydrochem, Inc.
Actual v. Standard Cost Accounting Systems
 Introduction

Hydrochem Inc. processed oxide to make blank condutronic plates. The company maintained an actual process
costing system as the basis for cost of goods sold determination and inventory valuation. However, the company's new
controller, Mohini Dang, was considering adopting a standard costing system for management reporting purposes. She
believed a standard costing system would provide Hydrochem management with better information and would facilitate that
identification of any deviations from the plan. To test her hypothesis, Dang decided to compare Hydrochem's financial
statements for the month based on actual costs with those same financial statements based on standard costs.

Dang calculates the company's current standard cost per plate to be $21.65 and found that typically the company
produced and sold 70,000 plates each month at an average sales price of $27.00 per plate. Budgeted manufacturing overhead
for factory, rent, equipment depreciation, supervision, utilities, and other manufacturing-related costs was $311,500 per
month, or $4.45 per plate at a normal production volume. Of the amount $175,000 was considered to be fixed, and the
remainder varied primarily on the basis of machine hours. Each plate manufactured by Hydrochem required 1.5 machine
hours to produce.

In order to determine which would be a better system for Hydrochem, standard or actual, Dang decided to create two
sets of balance sheets and income statements so that she may analyze the results and determine an answer.

Literature Review

Companies that use process-costing systems produce masses of identical or similar units of output. In such
companies, it is fairly easy to set standards for quantities of inputs needed to produce output. Standard cost per input unit can
then be multiplied by input quantity standards to develop standard cost per output unit. Complex conditions are frequently
found, for example, in plants which manufacture rubber products, textiles, ceramics, paints, and packaged food products. In
each of these cases, the broad averaging procedure of actual process costing were used, the result would be inaccurate costs
for each product. Therefore, the standard-costing method of process costing is widely used in these industries.

Under the standard-costing method, teams of design and process engineers, operations personnel, and management
accountants work together to determine separate standard costs per equivalent unit on the basis of different technical
processing specifications for each product. Identifying standard costs for each product overcomes the disadvantage of costing
all products at a single average amount, as under actual costing.

A standard costing system is a costing system that traces direct costs to output produced by multiplying the standard
prices or rates by the standard quantities of inputs allowed for actual outputs produced and allocates overhead costs on the
basis of the standard overhead-cost rates that standard quantities of the allocation bases allowed for the actual outputs
produced.

Standard costs are usually associated with a manufacturing company's costs of direct material, direct labor, and
manufacturing overhead.

Rather than assigning the actual costs of direct material, direct labor, 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 unfavorable. 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 favorable. A favorable variance tells management
that if everything else stays constant the actual profit will likely exceed the planned profit.
The sooner that the accounting system reports a variance, the sooner that management can direct its attention to the difference
from the planned amounts.

An actual costing system is a job-costing system which traces direct costs to a cost object by using the actual direct-
cost rates times the actual quantities of the direct-cost inputs and allocates indirect costs based on the actual indirect -cost
rates times the actual quantities of the cost allocation bases.

Research Design & Methodology

In order to determine which costing system would be best for Hydrochem we will start by detailing each account and
the transactions that have occurred through the month for Hydrochem, Inc. After compiling this date will we create a
Statement of Financial Condition and a Statement of Net Income, under the actual costing system.

Once we have completed this we will repeat this process using a standard costing system and then analyze the results
and try to determine which system will lend itself better to Hydrochem, Inc and why.

Analysis

Actual Costing System, T accounts:

Presentation of Financial Statements using Actual Costing System:

Statement of Financial Condition

Liabilit
Assets ies
Accoun
ts
Payable
and $
accrued 891
264, expense ,65
Cash 000 s 0

Raw Other 140

Material 173, liabilitie ,00
s 200 s 0
$
Total 1,0
Finishe 575, Liabiliti 31,
d Goods 890 es 650
Account
s
Receiva 217,
ble 000
Other Equity
 668,
Assets 000
$
120
Capital ,00
Stock 0

Retaine 746
d ,44
Earnings 0
$
866
Total ,44
Equity 0

$ Total $
1,89 Liabiliti 1,8
Total 8,09 es and 98,
Assets 0 Equity 090
Statement of Income
Sa
les $ 1,617,000
Le
ss:
Co
st
of
G
oo
ds
So
ld (1,330,560)
Ne
t
In
co
m
e $ 286,440

Now we will show the T accounts under a Standard Costing System:

Standard Costing System Financial Statements:

Based on the information shown, there is no difference in the Net Income from using the Actual v. the Standard
costing system. This is due to the fact that no matter which system is implemented it does not change the amount of income
the company is receiving. Even though our Net Income totals were equal our balance sheet had different numbers.
 The difference in amounts on the balance sheets is due to the variance in the actual v. standard costs, in specific
direct labor, direct materials, price, volume and manufacturing overhead. Under the standard costing system the company
produces about 70,000 units per month, at a standard cost of 21.65 per plate, with a standard sales price of 27.00 per unit.
Under the actual we found that the company produced 80,000 units for the month, at an actual cost of 22.18 per unit and
actually sold for a price of 26.95. The variance in the cost per unit can be attributed to the variance in standard v. actual lbs of
raw material per unit needed. According to the standard system it takes 4 lbs of raw material per unit manufactured, if this
were true than if the company produced 80,000 units *4lbs they should have consumed 320,000 lbs of raw material, instead
they used 328,000; this created an unfavorable variance.

The unfavorable variance in the pounds of raw materials used is slightly offset by the direct labor charges. Under the
standard costing system it costs $12.00 per hour for direct labor, but it actually cost them $11.80; however under the standard
system it should take .6 hours to produce one unit, so 80,000*.6= 48,000; Hydrochem actually used 49,800 hours of direct
labor, creating another unfavorable variance.

For the manufacturing overhead charges under the standard costing system they stated manufacturing overhead at
311,500 per month, 175,000 in fixed and 136,500 in variable. The actual fixed costs were 174,000, creating a favorable
variance of 1,000. The actual variable costs amounted to 162,000 for the month, the reason for this is attributed to the
variance in machine hour costs shown in entry 5 in the standard costing system.

Conclusion

In summation we feel that the use of a standard costing system would benefit Hydrochem, Inc. because this type of
system lends itself to this type of manufacturing industry. Standard costing systems show the variances in items such as direct
labor, direct materials, and manufacturing overhead as they are incurred, this will help Hydrochem in determining where they
need to improve and adjust their figures.

While using an actual costing system will provide Hydrochem with an accurate Net Income, it does not show them
where they had variances throughout the month.

The following reasons are why Hydrochem should use a Standard Costing System:

1. Efficiency measurement-- The comparison of actual costs with standard costs

enables the management to evaluate performance of various cost centers. In the absence of
standard costing system, actual costs of different period may be compared to measure
efficiency. It is not proper to compare costs 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.
2. Finding of variance-- The performance variances are determined by comparing
actual costs with standard costs. Management is able to spot out the 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 expenditures is also ensured by standard cost system.
3. Management by exception-- The targets of different individuals are fixed if the
performance is according to predetermined standards. In this case, there is nothing to worry.
The attention of the management is drawn only when actual performance is less than the
budgeted performance. Management by exception means that everybody is given a target to be
achieved and management need not supervise each and everything. The responsibilities are
fixed and everybody tries to achieve his/her targets.
4. Cost control-- Every costing system aims at cost control and cost reduction. The
standards are being constantly analyzed and an effort is made to improve efficiency.
Whenever a variance occurs, the reasons are studied and immediate corrective measures are
undertaken. The action taken in spotting weak points enables cost control system.
5. Right decisions-- It enables and provides useful information to the management in
taking important decisions. For example, the problem created by inflating, rising prices. It can
also be used to provide incentive plans for employees etc.
6. Eliminating inefficiencies-- The setting of standards for different elements of cost
requires a detailed study of different aspects. The standards are set differently for
manufacturing, administrative and selling expenses. Improved methods are used for setting
these standards. The determination of manufacturing expenses will require time and motion
study for labor and effective material control devices for materials. Similar studies will be
needed for finding other expenses. All these studies will make it possible to eliminate
inefficiencies at different steps.