STANDARD COSTING & VARIANCE ANALYSIS

USES OF ACCOUNTING INFORMATION

Accounting information is quite useful to the Management in terms of arriving at a decision and also in planning, control and performance evaluation. Accounting information can be used for:

1. Projecting the profit level. 2. Analysing the impact of cost if sales volume drop by 10 %. 3. Measuring the efficiency of production. 4. Measuring the performance of each segment. 5. Designing performance measurement systems to encourage employees to participate for the betterment of the Organization

The answers to the above issues lie in the installation of a good accounting system encompassing an effective Budgetary control and STANDARD COSTING SYSTEM.Establishing a Standard costing system will be quite useful to the Management in both planning and control. In the planning stage, it can assist the Management with necessary data; at the control stage, it can be used to find the deviations between the actual vis-a-vis the standards. The measurement of such deviations is carried out through the technique of VARIANCE ANALYSIS.

What is Costing ?
Costing (or cost-benefit analysis) is the process of analyzing the costs and benefits of different options to determine what approach should be taken to a particular conflict. what solution or resolution should be chosen once various options are being considered.

Meaning of Standard
When you want to measure some thing, you must take some parameter or yardstick for measuring. We can call this as standard. What are your daily expenses? An average of $50! If you have been spending this much for so many days, then this is your daily standard expense. The word standard means a benchmark or yardstick. The standard cost is a predetermined cost which determines in advance what each product or service should cost under given circumstances. In the words of Backer and Jacobsen, Standard cost is the amount the firm thinks a product or the operation of the process for a period of time should cost, based upon certain assumed conditions of efficiency, economic conditions and other factors.

STANDARD COSTING
MEANING AND DEFINATION OF STANDARD COSTING TECHNIQUE A Standard Cost is a planned cost for a unit of product or service rendered. C.I.M.A (London) has defined standard cost as a pre-determined cost which is calculated from managements standard of efficient operations and the relevant necessary expenditure. It may be used as a basis for determination of prices and cost control through variance analysis According to C.I.M.A (London), standard costing is defined as The preparation and use of standard costs, their comparison with actual costs and the analysis of variances to their causes and point of incidence. Wheldon has defined it in the following words: Standard Costing is a method of ascertaining costs whereby statistics are prepared to show (a) The standard cost; (b) the actual cost; and (c) the difference between these costs, which is teremed as variance.

Classification of Standards
The two principal considerations for classification of standards are : Attainability of standards. Frequency with which the standards are revised.

Theoretic

Normal

Basic

Currently Attainable

Ideal standard
Ideal standard is fixed on the assumption of those conditions which may rarely exist. This standard is not practicable and may not be achieved. This is the standard which represents a high level of efficiency. Ideal standard is fixed on the assumption that favourable 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 labour time for making the production will be minimum and rates of wages will also be low. The overhead expenses are also set with maximum efficiency in mind. All the conditions, both internal and external, should be favourable and only then ideal standard will be achieved.

Basic
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. 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.

Normal
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. 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. 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.

Current
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. 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.

Revision of standards
We need to revise the standards which follow for better control. Even standards are also subjected to change like the production method, environment, raw material, and technology.

Standards may need to be changed to accommodate changes in the organization or its environment. When there is a sudden change in economic circumstances, technology or production methods, the standard cost will no longer be accurate.

STEPS IN STANDARD COSTING

Standard costing involves: The setting of standards Ascertaining actual results Comparing standards and actual costs to determine the variances Investigating the variances and taking appropriate action where necessary.

PRELIMINARIES IN ESTABLISHING A SYSTEM OF STANDARD COSTS

1. The establishment of cost centers with clearly defined areas of responsibility. 2. The classification of accounts, with provision for standard and actual costs with variances. 3. The type of standard to be operated. 4. The setting of standard costs for each element of cost.

Objectives of Standard Costing

To Establish Control. To Set Standard for various Elements of cost. To Fix Responsibility. To Make Budgetary Control more Effective.

The Need for Standards

Standards Are common in business Are often imposed by government agencies (and called regulations) Standard costs Are predetermined unit costs Used as measures of performance

Distinguishing Between Standards and Budgets

Standards and budgets are both Pre-determined costs Part of management planning and control A standard is a unit amount whereas a budget is a total amount Standard costs may be incorporated into a cost accounting system

Standard v/s Historical Costing

Standard Costing
It is a predetermined cost. It is an ideal cost. It is a future cost, it can be used for cost control. It is used for the measurement of operational efficiency of the enterprises. Historical costing It is recorded after production. It is an actual or incurred cost. It is related to past, cannot be used for cost control. It is used to ascertain the profit or loss incurred during a particular period.

Standard Cost v/s Estimated Cost

Standard Cost It is scientifically used & it is a regular system based upon estimation & survey. Its object is to ascertain, what the cost should be? It is used for effective cost control & to take proper action to maximize. It is continuous process of costing & take into account all the manufacturing process. It is used where standard costing is in operation. It is more accurate than estimated cost.

Estimated Cost It is used as statistical data and it is based on lot of guess work. Its object is to ascertain what the cost will be? Its purpose is planning and ascertainment of cost for fixing sale price. It is used for a specific use i.e. fixing sale price. It is used where standard costing is not in operation. It is not accurate as it is based on past experience.

Advantages of Standard Costing Technique

Increase in Efficiency. Detection of Efficient or Idle Centers. Ease in Managerial Decisions. Facilities Quality Control. Best use of Material. Facilities Budget Formation. Helps in Stock Valution. Knowledge of Workers Efficiency. Increase in Profits. Best use of Production capacity.

Standard costing is a management control technique for every activity. It is not only useful for cost control purposes but is also helpful in production planning and policy formulation. It allows management by exception. In the light of various objectives of this system, some of the advantages of this tool are given below: 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 every body 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.

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Limitation of Standard Costing

Determination by the Experts. Determination of Standard Cost is difficult in this age of inflation. Unsuitable in some Industries. Morale of Employees Lowered. Necessity of Budgetary Control. It cannot be used in those organizations where non-standard products are produced. If the production is undertaken according to the customer specifications, then each job will involve different amount of expenditures. The process of setting standard is a difficult task, as it requires technical skills. The time and motion study is required to be undertaken for this purpose. These studies require a lot of time and money. There are no inset circumstances to be considered for fixing standards. The conditions under which standards are fixed do not remain static. With the change in circumstances, if the standards are not revised the same become impracticable. The fixing of responsibility is not an easy task. The variances are to be classified into controllable and uncontrollable variances. Standard costing is applicable only for controllable variances. For instance, if the industry changed the technology then the system will not be suitable. In that case, we will have to change or revise the standards. A frequent revision of standards will become costly.

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Setting Standards
Normally, setting up standards is based on the past experience. The total standard cost includes direct materials, direct labor and overheads. Normally, all these are fixed to some extent. The standards should be set up in a systematic way so that they are used as a tool for cost control. Various Elements which Influence the Setting of Standards

Setting Standards for Direct Materials

There are several basic principles which ought to be appreciated in setting standards for direct materials. Generally, when you want to purchase some material what are the factors you consider. If material is used for a product, it is known as direct material. On the other hand, if the material cost cannot be assigned to the manufacturing of the product, it will be called indirect material. Therefore, it involves two things:

Quality of material Price of the material

When you want to purchase material, the quality and size should be determined. The standard quality to be maintained should be decided. The quantity is determined by the production department. This department makes use of historical records, and an allowance for changing conditions will also be given for setting standards. A number of test runs may be undertaken on different days and under different situations, and an average of these results should be used for setting material quantity standards. The second step in determining direct material cost will be a decision about the standard price. Materials cost will be decided in consultation with the purchase department. The cost of purchasing and store keeping of materials should also be taken into consideration. The procedure for purchase of materials, minimum and maximum levels for various materials, discount policy and means of transport are the other factors which have bearing on the materials cost price. It includes the following:

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Cost of materials Ordering cost Carrying cost

The purpose should be to increase efficiency in procuring and store keeping of materials. The type of standard used-- ideal standard or expected standard-- also affects the choice of standard price.

Setting Direct Labor Cost

If you want to engage a labor force for manufacturing a product or a service for which you need to pay some amount, this is called wages. If the labor is engaged directly to produce the product, this is known as direct labor. The second largest amount of cost is of labor. The benefit derived from the workers can be assigned to a particular product or a process. If the wages paid to workers cannot be directly assigned to a particular product, these will be known as indirect wages. The time required for producing a product would be ascertained and labor should be properly graded. Different grades of workers will be paid different rates of wages. The times spent by different grades of workers for manufacturing a product should also be studied for deciding upon direct labor cost. The setting of standard for direct labor will be done basically on the following:

Standard labor time for producing Labor rate per hour

Standard labor time indicates the time taken by different categories of labor force which are as under:

Skilled labor Semi-skilled labor Unskilled labor

For setting a standard time for labor force, we normally take in to account previous experience, past performance records, test run result, work-study etc. The labor rate

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standard refers to the expected wage rates to be paid for different categories of workers. Past wage rates and demand and supply principle may not be a safe guide for determining standard labor rates. The anticipation of expected changes in labor rates will be an essential factor. In case there is an agreement with workers for payment of wages in the coming period, these rates should be used. If a premium or bonus scheme is in operation, then anticipated extra payments should also be included. Where a piece rate system is used, standard cost will be fixed per piece. The object of fixed standard labor time and labor rate is to device maximum efficiency in the use of labor.

Setting Standards of Overheads

The next important element comes under overheads. The very purpose of setting standard for overheads is to minimize the total cost. Standard overhead rates are computed by dividing overhead expenses by direct labor hours or units produced. The standard overhead cost is obtained by multiplying standard overhead rate by the labor hours spent or number of units produced. The determination of overhead rate involves three things:

Determination of overheads Determination of labor hours or units manufactured Calculating overheads rate by dividing A by B

The overheads are classified into fixed overheads, variable overheads and semivariable overheads. The fixed overheads remain the same irrespective of level of production, while variable overheads change in the proportion of production. The expenses increase or decrease with the increase or decrease in output. Semi-variable overheads are neither fixed nor variable. These overheads increase with the increase in production but the rate of increase will be less than the rate of increase in production. The division of overheads into fixed, variable and semi-variable categories will help in determining overheads.

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Determination of Standard Costs

How should the ideal standards for better controlling be determined?

1. Determination of Cost Center

According to J. Betty, A cost center is a department or part of a department or an item of equipment or machinery or a person or a group of persons in respect of which costs are accumulated, and one where control can be exercised. Cost centers are necessary for determining the costs. If the whole factory is engaged in manufacturing a product, the factory will be a cost center. In fact, a cost center describes the product while cost is accumulated. Cost centers enable the determination of costs and fixation of responsibility. A cost center relating to a person is called personnel cost center, and a cost center relating to products and equipments is called impersonal cost center.

2. Current Standards
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.

3. Ideal Standard
This 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.

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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.

4. Basic Standards
A 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.

5. Normal Standards
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

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used for cost control purpose. Normal standard can be properly applied for absorption of overhead cost over a long period of time.

6. Organization for Standard Costing

The success of standard costing system will depend upon the setting up of proper standards. For the purpose of setting standards, a person or a committee should be given this job. In a big concern, a standard costing committee is formed for this purpose. The committee includes production manager, purchase manager, sales manager, personnel manager, chief engineer and cost accountant. The cost accountant acts as a co-coordinator of this committee.

7. Accounting System
Classification of accounts is necessary to meet the required purpose, i.e. function, asset or revenue item. Codes can be used to have a speedy collection of accounts. A standard is a pre-determined measure of material, labor and overheads. It may be expressed in quality and its monetary measurements in standard costs.

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What is variances??
If actual costs are greater than standard costs the variance is unfavourable. If actual costs are less than standard costs the variance is favourable. The difference between the actual costs and the standard costs 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.

Variance analysis involves two phases :

Computation of individual variances. Determination of the cause of each variance.

Classification of Variances

variances

Direct Material Variances

Direct Labour Variances

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Direct Material Variance

Direct Cost Variance (MCV)

Material Price Variance (MPV)

Material Usage Variance (MUV) Material Yield Variance (MYV)

Material Mix Variance (MMV)

Direct Labour Variance Direct Cost Variance

Rate Variance

Efficiency Variance

Idle Time Variance

Mix Variance

Yield Variance

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ABBREVATIVES used in Direct Material Variance

SP = Standard Price per unit of material. SQ = Standard Quantity of material to be used for actual output. AP = Actual Price per unit of material. AQ = Actual Quantity of material used. SQM = Standard Quantity Mix. AQM = Actual Quantity Mix. AY = Actual Yield. SY = Standard Yield from actual input. SR = Standard Rate per unit of material. TSC = Total Standard Cost for Actual Output TAC = Total Actual Cost. RSQ = Revised Standard Quantity.

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Direct Material Variance

The standard direct materials cost per unit is calculated as follows

Material Cost Variance - According to C.I.M.A., London Material cost variance is the difference between the standard cost of direct materials specified for the output achieved and the actual cost of direct material used.

MCV = ( SP * SQ ) ( AP * AQ ) or ( TSC TAC ) TSC = Actual Output * SR Material Price Variance - According to C.I.M.A., London Material price variance is that portion of the material cost variance which is due to the difference between the standard price specified and the actual price paid. MPV = ( SP AP ) * AQ Material Usage Variance - According to C.I.M.A., London Material usage variance is that portion of the material cost variance which is due to the difference between the standard quantity specified and the actual quantity used. MUV = ( SQ AQ ) * SP Varification - MCV = MPV + MUV

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 Material Mix Variance According to C.I.M.A., London Mix variance is the portion of the direct material usage variance which is due to the difference between the standard and actual composition of mixture. Any one of the following situations may be there as regards material mix: 1. When total quantity of materials actually used is equal to the total standard quantity, but the mixture ratio differs; 2. When total quantity of materials actually used is not equal to the total standard quantity, and also the mixture ratio differs; or 3. When total quantity of materials actually used is not equal to the total standard quantity, but mixture ratio is same. In the third case, as the mixture ratio is same, therefore material mix variance is not to be calculated. In the first and second cases only, material mix variance is calculated. First Situation : MMV = ( SQM AQM ) * SP Second Situation : MMV = ( RSQ AQ ) * SP RSQ ( Revised Standard Quantity) RSQ = Total Actual Qty. Consumed * Std. Qty. of Particular Material Total Std. Qty. of all the Materials Example 1- Calculate Material Mix Variance Standard Mix for one Unit of product X is: Material A 50 kg. @ Rs. 10 per kg. Material B 75 kg. @ RS. 20 per kg. 125 kg. Actual Mix used was

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Material A 60 kg. @ Rs. 12 per kg. Material B 65 kg. @ Rs. 18 per kg. 125 kg. SolutionMMV = ( SQM AQM ) * SP Here, SQM = Standard Quantity Mix & AQM = Actual Quantity Mix For Material A : ( 50 60 ) * Rs. 10 = Rs. 100 ( A ) For Material B : ( 75 65 ) * Rs. 20 = Rs. 200 ( F ) Rs. 100 ( F ) Here, (F) means Favorable (+) & (A) means Adverse (-) Example 2 - Calculate Material Mix Variance Standard Mix for one unit of Product X is : Material A 50 kg. @ Rs. 10 per kg. Material B 75 kg. @ Rs. 20 per kg. 125 kg. Actual Mix used was : Material A 60 kg. @ Rs. 12 per kg. Material B 70 kg. @ Rs. 18 per kg. 130 kg.

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Solution Here actual used (130 kg) & standard Mix (125 kg) are different also the actual mix ratio (6:7) differs from the standard mix ratio (2:3). In such case RSQ will be calculated as follows: MMV = ( RSQ AQ ) * SP RSQ = Total Actual Qty. Consumed * Std. Qty. of Particular Material Total Std. Qty. of all the Material RSQ for Material A = 130 kg * 50/125 = 52 kg. RSQ for Material B = 130 kg * 75/125 = 78 kg. MMV for Material A = ( 52 60 ) * Rs. 10 = Rs. 80 (A) MMV for Material B = ( 78 70 ) * Rs. 20 = Rs. 160 (F) Rs. 80 (F) Material Sub-usage Variance When a product is produced from a mixture of two or more kinds of material, there may arise material sub-usage variance. It should be noted that material sub-usage variance is calculated only when quantity of wastage or output is not given. When these quantities are given, this variance will be the same as material yield variance. This variance is also known Material Revised Usage Variance or Material Quantity Variance. There can be two possibilities : 1. Total quantity of material consumed and standard quantity are not equal, but mix ratios are also different; 2. Total quantity of material consumed and standard quantity are not equal, but mix ratios are equal. MSUV = ( SQ RSQ ) * SP

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 Material Yield Variance According to C.I.M.A., London Material yield variance is that portion of direct material usage variance which is due to the difference between the standard yield and the actual yield obtained MYV = ( AY SY ) * SR SR = Total cost of Standard Mix Net Standard Output Example- 3 Calculate Material Sub-usage Variance : Standard Mix Material A 100 kg. @ Rs. 5 per kg. Material B 150 kg. @ Rs. 10 per kg. 250 kg. Actual Mix 120 kg. @ Rs. 7 per kg. 180 kg. @ Rs. 9 per kg. 300 kg.

Solution Here total of standard mix (250 kg) and actual mix (300 kg) are different, but material mix ratio ( 2 : 3 ) is same. Therefore, RSQ for each material has been calculated as follows : Material Sub-Usage Variance = ( SQ RSQ ) * SP RSQ = Total Actual Mix * Particular Standard Mix Material / Total Standard Mix RSQ for Material A = 300 * 100 / 250 = 120 kg RSQ for Material B = 300 * 150 / 250 = 180 kg AQ and RSQ of each material is same. Therefore, MSUV for Material A = ( 100 120 ) * Rs. 5 = Rs. 100 (A) MSUV for Material B = ( 150 180 ) * Rs. 10 = Rs. 300 (A) Rs. 400 (A)

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Some authors use AQ in place of RSQ in the above formulate because RSQ and AQ are equal. Example 4 Calculate Material Variance from the following details availableStandard Material X 40 kgs. @ Rs. 6 Material Y 60 kgs. @ Rs. 4 Process Loss 20% Actual for 10 Mixes Material X 600 kgs. @ Rs. 4 Material Y 400 kgs. @ Rs. 6 Process Loss 30%

Solution - First of all standards will be set for 10 mixes as follows : Standard for 10 Mixes Material X : 40 * 10 * 6 = Rs 2400 Material Y : 60 * 10 * 4 = Rs 2400 Total Loss Output (i) 1000 kgs 200 kgs 800 kgs Rs 4800 Actual for 10 Mixes 600 * 4 = Rs 2400 400 * 6 = Rs 2400 1000 kgs Rs 4800 300 kgs 700 kgs

Calculation of Material Cost Variance (MCV) :

MCV = TSC TAC TSC = Actual Output * SR SR = Total Cost of Standard Mix / Net Standard output SR = 4800/800 = Rs. 6 per unit, TSC = 700 * 6 = Rs. 4200, TAC = Rs. 4800(given) (iv) Calculation of Material Mix Variance (MMV) MMV = ( SQM AQM ) * SP

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MMV for Material X = ( 400 600 ) * 6 = Rs. 1,200 (A) MMV for Material Y = ( 600 400 ) * 4 = Rs. Rs. 800 (F) 400 (A)

(v) Calculation of Material Yield Variance (MYV) MYV = ( AY SY ) * SR MYV = ( 700 800 ) * 6 = 600 (A) Verification : MCV = MPV + MMV + MYV 600 (A) = 400 (F) + 400 (A) + 600 (A)

Material Price
Possible causes

Inefficient buying or failure to make timely purchases Increase in market price Emergency purchases Bulk purchases Change in transport cost Non-availability of standard quality Loss of cash discount Change in the method of material collection

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Direct Labour Variance

The standard direct labor cost per unit is calculated as follows

Labour Cost Variance - According to C.I.M.A. London, Labour Cost Variance is the difference between standard cost of labour specified and actual cost of labour employed. LCV = ( Total Standard Labour Cost Total Actual Labour Cost ) Labour Rate Variance According to C.I.M.A. London, Labour Rate Variance is that portion of labour cost variance which is due to the difference between standard rate specified and actual rate paid. LRV = ( Standard rate per hour Actual rate per hour ) Labour Efficiency Variance - According to C.I.M.A. London, Labour Efficiency Variance is that portion of labour cost variance which is due to the difference between standard labour hours for output achieved and actual labour hours spent. it is also known as Labour Time Variance, Labour Quantity Variance, Labour Usage Variance, Labour Spending Variance, etc. LEV = ( Standard Time Actual Time ) * Standard rate per hour Here, Actual time means hours obtained on subtracting abnormal idle-time hours from labour hours actually paid for. Labour Idle Time Variance Idle time variance is that portion of labour cost which arises due to abnormal idle time of the workers specified. This idle time

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is possible due to many reasons, such as, workers sitting free because of machine break-down, power failure, etc. it should be noted that this variance always shows adverse position. LITV = ( Abnormal Idle Time * Standard rate per hour ) Varification - LCV = LRV + LEV + LITV Labour Yield Variance - When the actual yield is less or more than the standard yield, it gives rise to labour yield variance. LYV = ( Actual Yield Standard Yield ) * Standard rate per unit Here, Standard Yield = Total actual time * Std. yield from Std. mix Total standard time Standard rate per unit = Std. cost of standard mix / Std. yield from Std. mix Example 5 Calculate Labour Yield Variance from the following details : Standard Skilled 180 workers @ Rs. 3 per hour Actual 160 workers 140 workers

Unskilled 120 workers @ Rs. 1 per hour

Budgeted hours for one month 200. actual hours during the month 180; Budgeted production 5,000 units less standard loss 20%, Actual production 4,200 units. Solution - Standard production (yield) = 5,000 units 20% (1,000) = 4,000 units Actual production (AY) = 4,200 units Calculation of Standard Hours Calculation of Actual Hours

Budgeted hours No. of workers Total Hr Actual hour No. of worker Total Hr Skilled 200 * 180 * 120 = 36,000 = 24,000 180 180 * 160 * 140 = 28,800 = 25,200

Unskilled 200

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Total

300

60,000

300

54,000

Labour Yield Variance = ( AY SY ) * SR per unit Standard Yield (SY) = Total actual time * Std. yield from Std. mix Total standard time SY = 54,000 hours * 4,000 units / 60,000 hours = 3,600 units SR = Standard cost of standard mix / Standard yield from standard mixStandard Wages : Skilled workers = 36,000 hours * Rs. 3 = Rs. 1,08,000 24,000

Unskilled workers = 24,000 hours * Rs. 1 = Rs.

Total = Rs. 1,32,000 SR = Rs. 1,32,000 / 4,000 = Rs. 33 LYV = ( 4,200 3,600 ) * Rs. 33 = Rs. 19,800 (F) Labour Mix Variance - Different types of workers are generally required in a production, e.g., skilled, unskilled, men, women, children, etc. keeping in view the production efficiency of the factory and to control the labour cost, a standard mix ratio is specified for various type of workers. But in actual practice it is not possible to follow this standard because of some difficulties ( such as non-availability of desired type of workers, etc. ) Thus, labour mix variance arises. It is also known as Gang Composition Variance.

It can be calculated in following two situations : 1. When the totals of standard labour mix and actual labour mix are same but the two mix ratios are different. 2. When the totals of standard labour mix and actual labour mix are different but the two mix ratios are also different.

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When the totals of standard labour mix and actual labour mix are different but the two mix ratios are same, there will be no labour mix variance. First Situation LMV = ( Standard time mix Actual time mix ) * Std. rate per hour. Second Situation LMV = ( RST Actual Time ) * Standard rate per hour Here, RST ( Revised Standard Time ) RST = Total actual time * Standard time of particular labour Total standard time of all the labour Example 6 The budget of labour hours for the week ending June 30, 2011 is of 50 hours. The other details are as follows ; Standard Grade A 100 workers @ Rs. 3 per hour Grade B 200 workers @ Rs. 1 per hour Actual 120 workers @ Rs. 2.50 per hour 180 workers @ Rs. 1.50 per hour

The actual production is for 50 hours during the week. Calculate Labour Mix Variance. Solution Grade A workers Grade B workers Total Calculation of Standard Time 100 * 50 = 5,000 Hours 200 * 50 = 10,000 Hours 15,000 Hours Calculation of Actual Time 120 * 50 = 6,000 Hours 180 * 50 = 9,000 Hours 15,000 Hours

As the total of standard labour time mix (15,000 hours) and actual labour time mix (15,000 hours) is same, but standard labour mix ratio (1 : 2) and actual labour mix ratio (2 : 3) are different, therefore situation first is applicable Labour Mix Variance = ( Standard time mix Actual time mix ) * Std. rate per hour LMV for Grade A workers = ( 5,000 6,000 ) * Rs. 3 = Rs. 3,000 (A)

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LMV for Grade B workers = ( 10,000 9,000 ) * Rs. 1 = Rs. 1,000 (F) Total = Rs. 2,000 (A) Example 7 In above Example No. 6 let assumed that the actual number of grade B workers is 210 in place of 180. then calculate labour mix variance. SolutionCalculation of Standard Time Calculation of Actual Time 120 * 50 = 6,000 Hours 210 * 50 = 10,500 Hours 16,500 Hours

Grade A workers 100 * 50 = 5,000 Hours Grade B workers 200 * 50 = 10,000 Hours Total 15,000 Hours

As the totals of standard labour time mix (15,000 hours) and actual labour time mix (16,500 hours) are different, and standard labour mix ratio (1 : 2) and actual labour mix ratio (60 : 105) are also different, therefore second situation applicable Labour Mix Variance = ( RST AT ) * SR RST = Total actual time * Standard time of particular labour Total standard time of all the labour RST for Grade A workers = 16,500 * 5,000 / 15,000 = 5,500 hours RST for Grade B workers = 16,500 * 10,000 / 15,000 = 11,000 hours LMV for Grade A workers = ( 5,500 6,000 ) * Rs. 3 = Rs. 1,500 (A) 500 (F)

LMV for Grade B workers = ( 11,000 10,500 ) * Rs. 1 = Rs.

Total = Rs. 1,000 (A) Example 8 Calculate Direct Labour Variance from the following : Standard Workman A : 20 hours @ Rs. 3 = Rs. 60 Workman B : 20 hours @ Rs. 7 = Rs. 140 Actual 30 hours @ Rs. 4 = Rs. 120 25 hours @ Rs. 6 = Rs. 150

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40 hours

Rs. 200

55 hours

Rs. 270

In actual production, 3 hours (included in above) have been lost on account of machine breakdown. Solution (i) Labour Cost Variance = Total Standard labour Cost Total Actual Labour Cost LCV = ( Rs. 200 Rs. 270 ) = Rs. 70 (A) (ii) Labour Rate Variance = ( Std. rate per hr Actual rate per hr ) * Actual time LRV for A = ( Rs. 3 Rs. 4 ) * 30 hours = Rs. 30 (A) LRV for B = ( Rs. 7 Rs. 6 ) * 25 hours = Rs. 25 (F) Rs. 5 (A) (iii) Labour Efficiency Variance = ( Standard time Actual time ) * SR per hour LEV for A = ( 20 hours 27 hours ) * Rs. 3 = Rs. 21 (A) LEV for B = ( 20 hours 22 hours ) * Rs. 7 = Rs. 14 (A) Rs. 35 (A) (iv) Labour Idle time Variance = Idle time * Standard Rate per hour LITV for A = 3hours * Rs. 3 per hour = Rs. 9 (A) LITV for B = 3 hours * Rs. 7 per hour = Rs. 21 (A) Rs. 30 (A) Verification Labour Cost Variance = Labour rate Variance + Labour Efficiency Variance + Labour Idle time Variance Rs. 70 (A) = Rs. 5 (A) + Rs. 35 (A) + Rs. 30 (A)

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Labour Efficiency
Possible causes

Inefficient/Untrained workers Machinery breakdown Poor quality of material Inefficient supervision Hours lost in waiting, delay in routing material, tools, instructions and improper production scheduling Poor working conditions Change in design, quality standard of product.

Conclusion
A standard cost is a predetermined cost of manufacturing, servicing, or marketing an item during a given future period

It is based on current and projected future conditions The norm is also dependent on quantitative and qualitative measurements Standards may be based on engineering studies looking at time and motion. The formulated standard must be accurate and useful for control purposes.

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