Standard Costing And Variance Analysis

Chapter 13

Standard Costing

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Standard costing is a technique which is used in many industries, where production is of repetitive nature.

Standard costing is developed due to the shortcomings of historical costing.

CIMA, London, defines standard costing ‘as the predetermined cost based on technical estimates of materials, labour and overheads for selected period of time and for the prescribed set of working conditions’.

Standard costing is that technique in which the standard cost is determined before starting the production.

Standard cost is a predetermined cost and such cost indicates what a product should cost.

Standard cost is calculated by considering all the situations ideal in nature.

Standard costs have been defined as the normal costs for normal production efficiency at normal level of output.

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Standard

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The word standard means a criterion (principle,measure).A standard figure is one against which one can measure an

actual figure to see the deviation.

Standard Cost

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Standard cost is ‘a predetermined cost which is compared in advance of production on the basis of specifications of all the factors affecting costs and used in standard costing.’

In other words, standard cost is a predetermined cost that should be attained under a given set of operating conditions.

Objectives Of Standard Costing

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To establish controlTo set standards for various elements of costTo fix responsibilityTo make budgetary control more effective

Establishing A System Of Standard Costing

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• Setting up cost centers• Classification of accounts• Determination of size of the standard– Current• Ideal• Expected

– Basic• Setting up of standard• Standard cost card

Need For Standards

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Cost controlPricing decisionsPerformance AppraisalCost awarenessManagement by objective

Application Of Standard Costing

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Process industriesService industriesEngineering industriesTextile industriesExtraction industries

Advantages Of Standard Costing

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• Formulation of price and production policies• Comparison and analysis of data• Management by exception• Delegation of authority and responsibility• Cost consciousness• Better capacity to anticipate• Better economy, efficiency, and productivity• Preparation of periodical financial statements• Facilities budgeting

Limitations Of Standard Costing

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high degree of technical skillsegregation of variances into controllable and non-

controllable factorsduplication in recording,either too strict or too liberal.

Variance Analysis

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• The deviation of actual from standard is called variance.• When the actual cost is less than standard cost or actual

result is better than standard set, it is known as favourable variance.

• On the other hand, when actual cost exceeds standards cost or actual result is not up to standard, it is known as unfavourable or adverse variance.

Classification Of Variances

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Functional BasisMeasurement BasisResult BasisControllability Basis

Functional Basis

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Measurement Basis

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Absolute variance: Difference between the standard cost and the actual cost in terms of money is known as absolute variance.

Relative variance: difference is expressed as a percentage of the standard cost, it is known as relative variance.

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Result basis

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Material cost varianceMaterial cost variance = (Standard quantity of input for

actual production × SP) – (Actual quantity of input × AP)

Material cost variance = Material price variance + Material usage variance

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Material price variance

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This is that portion of the material cost variance which is due to the difference between the standard price specified and the actual price paid.

If the actual price is higher than the standard price, it would result in adverse price variance and if the actual price is lower than standard price, the result is favourable price variance.

Material price variance = Actual quantity (Standard price – Actual price)

Material Usage Variance

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This is that portion of material cost variance which is due to the difference between the standard quantity of actual production and the actual quantity used.

Formula:

Material Usage Variance = Standard price (Standard quantity – Actual quantity)

Material Mixture Variance

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This is that portion of usage variance which is due to the difference between the standard and actual composition of mixture.

Formula:Material Mixture Variance = Standard price [Actual quantity in

standard mix (i.e. RSQ) – Actual quantity]

Revised Standard quantity = Total actual quantity consumed ×

Material Yield Variance

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When there is a loss in process industries, the material yield variance can be calculated.

This variance arises due to the difference between the standard yield specified and actual yield obtained.

This is also a portion of the material usage variance.

Formula:Material yield variance = [(Standard loss in terms of

actual input) – (Actual loss on actual input)] × (Average standard price)

Material yield variance = Material usage variance – Material mix variance

Material Sub-usage Variance

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When a product is produced from a mixture of two or more kinds of material, there may arise material sub-usage variance.

There can be two possibilities:

(a)Total quantity of material consumed and standard quantity are not equal, and mix ratios are also different.

(b)Total quantity of material consumed and standard quantity are not equal, but mix ratios are equal.

• It should be noted that material sub-usage variance is calculated only when the 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 as material revised usage variance or material quantity variance.

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Formula:Material sub-usage variance = (SQ – RSQ) × SP

It can be seen from this formula that material sub-usage variance is the analysis of variance in basic standard quantity of each material.

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Labour Rate Variance This is that portion of the labour cost variance which is

caused by the use of actual wage rate other than predetermined.

Labour rate variance = Actual labour time (Standard wage rate – Actual wage rate)

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Labour Efficiency VarianceIt is the difference between the standard time and the actual

time spent multiplied by standard wage rate.

Labour efficiency variance = Standard wage rate (Standard labour time – Actual labour time)

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Labour Idle Time VarianceIt is that portion of labour cost variance which is due to the

abnormal idle time of workers.While calculating labour efficiency variance, abnormal idle time

is deducted from the actual time spent to determine the real efficiency of the workers.

Idle time variance = Abnormal idle time × Standard wage rate

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Labour Yield Variance It is computed on the basis of the increase or decrease in

the actual yield or output when compared to the standard.

Labour Yield Variance = [Standard yield in units expected from the actual hours worked – actual yield] × Standard labour cost per unit

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Labour Mix VarianceThis variance arises due to the change in the composition or

mix of a group of workers as compared to the standard composition or mix.

It can be calculated in the following two situation:

(a)When the totals of standard labour mix and actual labour mix are same, but the two mix ratios are different.

(b)When the totals of standard labour mix and actual labour mix are different, and the two mix ratios are also different.

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Situation ALabour mix variance = (Standard time mix – Actual

time mix) × Standard rate per hour

Situation BLabour mix variance = (Revised standard time – Actual

time) × Standard rate per hourHere, RST= Total actual time ×

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Variable overhead variance Difference between the standard variable overheads and

absorbed variable overheads is called variable overhead variance.

If variable overhead absorbed to actual output is more or less than its standard variable overhead, this variance is created.

Overhead variance is the difference between the amount calculated at standard rate of variable overhead and the amount calculated at actual rate of variable overhead on the on the actual output.

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Variable overhead variance = AO (SR – AR)

= (AO × SR) – (AO × AR)

= SVO – AVO

Here, AO = Actual output, SR = Standard rate,

AR = Actual rate,

SVO = Standard variable overhead, and

AVO = Actual variable overhead

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Net or overall variable overhead varianceVariable overhead variance =

[Standard hours × Standard variable overhead rate per hour] – [Actual hours × Actual variable overhead rate per hour]

= [SH × SVOR] – [AH × AVOR]

This net variable overhead variance can be decomposed into following two variances:

(a)Variable overhead spending variance

(b)Variable overhead efficiency variance

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Variable overhead spending variance (VOSV) VOSV = (Actual hours × Standard variable

overhead rate per hour) - (Actual hours × Actual variable

overhead rate per hour)

Variable overhead efficiency variance (VOEV) :The difference between the actual hours used to complete a

job and the standard hours allowed to do it indicates the efficiency or inefficiency.

It measures the extent of cost saved or excess cost incurred due to efficient or inefficient performance.

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VOEV = (Standard hours allowed for actual volume or output –

Actual hours taken for actual volume) × Standard variable overhead rate per hour

= (Actual output hours × Standard per unit) – (Actual hours × Standard variable overhead

recovery rate)

The variable overhead can be attributed to the causes which are responsible for the labour efficiency variance.

Factors such as workers’ personal problems, incentive plans, work process, frequency and quantity of machine repairs, materials quantity, etc. will cause variable overhead efficiency variance.

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Variable overhead expenditure varianceVariable overhead expenditure variance =

Budgeted variable overheads – Actual variable overheads

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Fixed overhead varianceFixed overhead variance is mainly concerned with over –

absorption or under – absorption on fixed overheads.As the fixed overheads are not affected by the volume of

output, its absorption is done on actual output the predetermined rate only.

Fixed overhead variance is caused due to the difference between standard fixed overhead and actual fixed overhead on actual output.

Fixed overhead variance = TSC – TAC

[AO × SFO] – [ AO × AFO]

TSO – TAO

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Here, TSC = Total standard cost for actual output,

TAC = Total actual cost, AO = Actual output SFO = Standard fixed overhead AFO = Actual fixed overhead TSO = Total standard overhead TAO = Total actual overhead

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Expenditure Variance The difference between the amount actually spent during a

certain period as fixed overhead and the amount of fixed overhead budgeted for the period is expressed by this variance.

This part of fixed overhead cost variance shows whether the actual amount of fixed overhead is less or more than the amount budgeted for it.

Expenditure variance =

Budgeted fixed overhead – Actual fixed overhead

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Volume varianceVolume variance is caused mainly due to the

difference between budgeted output and actual output.

To calculate this variance, the difference of budgeted output and actual output is multiplied by the budgeted standard absorption rate.

Volume variance = SC (AQ – BQ)Where, SC = Standard cost per unit of fixed overheads AQ = Actual output in actual hours worked BQ = Budgeted standard output in budgeted

standard hours44

Efficiency variance

This variance gives information about the efficiency of workers because it arises due to their being less or more efficient.

It also arises due to the change in production process or quality of material and efficiency of the machinery, plant, and workers.

Efficiency variance = SC (AQ – SQ)Here, SQ means the quantity produced during actual

working hours at the standard rate.

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Capacity variance Capacity is expressed in terms of average direct labour

hours per day.If capacity is utilized to a level less or more than the

planned standard, variance arises.Use of plant and instruments less or more than their

capacity affects the efficiency due to which this variance arises.

Capacity variance = SC (SQ – BQ)

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Calendar variance If the number of actual working days during a certain

period is different from the standard number of working days during the same period, then it is called calendar variance.

Calendar variance = SC (RBQ – BQ)Here, RBQ = Budgeted quantity of output for actual

working days.

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Note:If the calendar variance is being calculated, capacity

variance should be ascertained using the formula given below:

Capacity variance = SC (SQ – RBQ)

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Sales Value Variance It is the difference between the standard value and the actual

value of sales affected during a period.

Sales value variance =

Actual value of sales – Standard value of sales

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Sales price variance It is the portion of the sales value variance which is due to

the difference between actual price and standard price specified.

Sales price variance =

Actual quantity sold × (Actual price – Standard price)

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Sales Volume VarianceIt is the portion of the sales value variance which is due to

the difference between actual quantity of sales and standard quantity of sales.

Sales Volume Variance = Standard price × (Actual quantity of sales – Standard quantity of sales)

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Sales mix variance : It is the part of the sales volume variance and it arises due to

the difference in the proportion in which various articles are sold and standard proportion in which various articles were to be sold.

Sales mix variance = Standard value of actual mix – Standard value of revised standard mix

Sales Sub – Volume Variance : This represents the difference between the budgeted sales. It

is also called as sales quantity variance.Sales Sub – Volume Variance = (Revised standard sales

quantity × Standard selling price) – (Standard sales quantity × Standard selling price)53

Variances Based On Profits

Total sales margin variance :This is an overall or composite variance made of other sub-

variances, and is represented by the difference between the standard margin appropriate to the quantity of sales budgeted for a period and the margin between standard cost and actual selling price of the sales affected.

Total sales margin variance =

Standard or Budgeted margin – Actual margin

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Sales margin variance due to the selling priceThis is that portion of total margin variance which is due to

the difference between the standard price on the quantity of sales affected and the actual price of those sales.

Sales price variance =

(Actual quantity of sales × Standard price) –

(Actual quantity of sales × Actual price)

orSales price variance =

Profit on actual sales at standard price and standard cost – Actual profit

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Sales margin variance due to the volume of sales

This is that portion of total margin variance which is due to the difference between the budgeted quantity and the actual quantity of sales.

The variance is composed of two sub-variances, due to change in the ratio of quantities of sales (mix variance) and actual being more or less than the budgeted sales (quantity variance).

Sales volume variance = Standard profit on standard quantity of sales – Standard profit on actual quantity of sales

orSales volume variance = Standard profit – profit on

actual sales at standard price and standard costs56

Sales margin variance due to sales mixture

This is that portion of total margin variance which is due to the difference between the budgeted and actual quantities of each product of which the sales mixture is composed, valuing sales standard net selling prices and cost of sales at standard.

Sales mixture variance = Standard margin × (Standard proportion for actual sales – Actual proportion)

orSales mixture variance = Standard sales unit ×

(weighted budgeted margin per unit – Margin of actual sales units at standard price)

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Sales margin variance due to sales quantities

This is that portion of the sales volume variance which arises due to the difference in the total actual and the budgeted sales.

Sales quantity variance = Standard margin × (Budgeted sales – Standard proportion for actual sales)

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Efficiency ratio Efficiency ratio is the standard hour’s equivalent to the

work produced, expressed as percentage of the actual hours spent in producing that work.

This is related to the labour efficiency and variable overheads/fixed overheads efficiency variance

Efficiency ratio = ×100

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Activity ratioActivity ratio is the number of standard hour’s

equivalent to the work produced, expressed as a percentage of the budgeted standard hours.

This ratio is related to the fixed overhead volume variance.

Activity ratio = × 100

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Calendar ratioCalendar ratio is the relationship between the number

of working days in a period and the number of working days in the relative budget period.

Calendar ratio =

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Capacity usage ratio Capacity usage ratio is the relationship between the

budgeted number of working hours and the maximum possible number of working hours in the budget period.

Capacity usage ratio =

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Capacity utilization ratioCapacity utilization ratio is the relationship between the

actual hours in a budget period and the budgeted working hours in a given period.

This ratio is related to fixed overhead capacity variance.

Capacity utilization ratio =

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