STANDARD COSTING

AND VARIANCE
ANALYSIS
 What is Standard Costing?
‘ a control technique that reports variances by comparing actual
costs to pre-set standards facilitating action through
management by exception ’
-CIMA .

Standard Costing and Budgets

• Standard cost: the standard cost of a single unit

• Budgeted cost: the cost, at standard, of the total

number of budgeted units
 Standard costing
• Standard costing is best suited to organizations with repetitive activities.
Mostly relevant to manufacturing organizations with repetitive
production processes.
• Standard costing cannot be applied easily to non-repetitive activities
because there is no clear basis for observing and recording operations.
It is difficult to determine a clear standard.
• Two commonly used approaches are used to set standard costs.
1. Past historical records can be used to estimate labour and material
usage.
2. Engineering studies can be used. This may involve a detailed study or
observation of operations in terms of material, labour and equipment
usage.
• The most effective control is achieved by identifying standards for
quantities of material, labour and services to be used in an operation,
rather than an overall total product cost. Variances from standard on all
component parts of cost should be reported to identify the cause – and
ultimate responsibility – for the variance from standard.
 Types of standards
Addresses the question of how demanding the standards should
be. i.e whether standards should represent ideal performance,
faultless performance or easily attainable performance.

Ideal standard
• Standards may be set at ideal levels, which make no allowance
for inefficiencies such as losses, waste and machine downtime.
This type of standard will almost always result in adverse
variances since a certain amount of waste, etc., is usually
unavoidable. This can be very demotivating for individuals who
feel that an adverse variance suggests that they have
performed badly
Types of standards
• Attainable standard
Standards may also be set at attainable levels which
assume efficient levels of operation, but which include
allowances for factors such as losses, waste and machine
downtime. This type of standard does not have the
negative motivational impact

• Current standard
Standards based on current performance levels (current
wastage, current inefficiencies) are known as current
standards. Their disadvantage is that they do not
encourage any attempt to improve on current levels of
efficiency.
A standard costing system consists of the
following four elements:
1. Setting standards for each operation.

2. Comparing actual with standard performance.

3. Analysing and reporting variances arising from

the difference between actual and standard
performance.

4. Investigating significant variances and taking

appropriate competitive action
Standard Costing and Variance Analysis
• The term standard cost refers to the cost that

management believes should be incurred to produce

a good or service under anticipated conditions.

• The primary benefit of a standard cost system is that

it allows for comparison of standard versus actual

costs.

• Differences are referred to as standard cost

variances and should be investigated if significant

 Variance Analysis
Variance analysis involves breaking down the total variance
to explain:
1. How much of it is caused by the usage of resources
differing from the standard
2. How much is caused by cost of resources differing from
the standard .Together;
• variances can help to reconcile the total cost difference by
comparing actual and standard cost.
• The main purpose of variances is to provide reasons for
off-standard performance. In this way, management can
improve operations, correct errors and deploy resources
more effectively to reduce costs.
Variances- Comparing standards with actual

• Points to consider in variance analysis

• - Although standards are set per unit, to identify the real
impact, variances are presented in total terms

• When comparing the standard with the actual, it must be

at the same activity level(we cannot compare if we
consider different activity levels)
Material Variance
• The cost of the materials used is determined by two
factors
• 1. Price paid for material
• 2. Quantity used in production

• Thus the actual could differ from the budget when

• - Actual quantity is different from standard quantity

• - Actual price/rate is different from standard price/rate
We can now compute
-Material price variance
-Material usage variance
Material price variance
• The difference between the standard price( SP) and the
actual price (AP) per unit, multiplied by the quantity of
materials purchased (QP)
= ( SP - AP) X QP
Having the difference in prices is not sufficient to
understand the consequences. Therefore the price
difference should be multiplied by the quantity to identify
the real impact.

The variance is then indicated as either favourable or

adverse
Possible causes
• Material price variance usually reflects the efficiency of the
purchasing department and it’s the purchasing department’s
responsibility
• E.g. an adverse variance may be due the purchasing
department failing to get the most advantageous source of
supply
• E.g a favourable price variance may be due to the purchasing
of an inferior material

• However it could be beyond the control of the purchasing

department
• E.g price increases due the market condition
• E.g Emergency purchase due to bad inventory control of the
stores department
Material Usage Variance
The difference between the standard quantity required for actual
production* and the actual quantity used, multiplied by the
standard material price.

=( SQ - AQ) X SP
* Note that standard quantity is based on the actual production and not budgeted production
because this facilitates accurate comparison and the responsible manager will be evaluated under
actual conditions she/he worked

Why multiply by standard price instead of actual price?

Material usage variance is normally controllable by the
production department. If actual material price is used, the
usage variance will be affected by the efficiency of the
purchasing department
Total material variance
• Difference between the standard material cost for actual
production and the actual cost

= SC-AC
The addition of the price variance and the usage variance
will also indicate the total material variance.

e.g. material price variance Rs.10100 favourable

material usage variance Rs.16500 adverse
Total material variance 6400 adverse
Labour variance
Labour rate variance = ( SR-AR) X AH
SR-standard labour rate per hour, AR= actual labour rate
per hour, AH=actual number of hours worked

Labour efficiency variance = (SH – AH)X SR

SH- standard labour hours for actual production
AH- actual hours worked, SR-standard rate

Total labour variance = SC- AC

SC- standard labour cost for the actual production
AC- actual labour cost
Variable overhead(VOH) variance
VOH rate variance = ( SR-AR) X AH
SR-standard variable overhead rate per hour, AR= actual
VOH rate per hour, AH=actual number of hours worked

VOH efficiency variance = (SH – AH) X SR

SH- standard VOH hours for actual production
AH- actual hours worked, SR-standard rate

Total Variable overhead variance = SC - AC

SC- standard variable overhead charged to production
AC- actual variable overhead incurred
Total Fixed overhead variance
= (O.A.R per unit X Actual no of units) – Actual fixed overhead

Also known as under/over absorption in absorption costing.

Activity
Rs. per unit
Direct material: 81 kg X Rs. 7 per kg 567
Direct labour: 97 hours X Rs. 8 per hour 776
Variable overhead: 97 hours X Rs. 3 per hour 291
1,634
During January, 530 units were produced and the costs incurred were as
follows:
Direct material: 42,845 kg purchased and used;cost Rs. 308,484
Direct labour: 51,380 hours worked; cost Rs. 400,764
Variable overhead: cost Rs. 156,709