Unit: 8 Standard Costing

Objectives:
 Meaning and calculation of Standard Costs
 Steps involved in Standard Costing
 Computation of Variances
 Material Variances
 Labor Variances
 Overhead Variances
 Sales Variances
 Preparation of Variance Reports

Learning Outcome:
Use standard costing system to understand the causes of labor, material, overhead, and
sales margin variances between standard and actual cost.

8.1 Introduction
The term "standard" refers to a "norm" or "criterion." Thus, standard cost is a benchmark
cost that can be utilized to assess how effectively actual cost has been incurred. A strategy
called standard costing makes use of predetermined expenses and revenues for the goal of
controlling variances. By establishing benchmarks for manufacturing costs and performance,
standard costing seeks to reduce waste and boost operational efficiency. Standard costing is
a control mechanism. It can be applied to any type of job, process, or product costing. All
costs are foreseen in this method. The difference between these predetermined prices and
the actual expense is known as variances, is then compared.

8.2 Concept – Standard Cost and Standard Costing

8.2.1 Standard Cost – CIMA London defines standard cost as, “the predetermined cost
which is calculated from management standard of efficient operation and relevant
necessary expenditure.”
The term Standard Costs refers to pre-determined costs. The words "standard" and "cost"
make into the term "standard cost." Standards can be established for items like labor and
material in quantity and quality. Cost is an expression of the standard that has been defined
by values.
8.2.2 Standard Costing - CIMA defines standard costing as “a control technique which
compares standard costs and revenues with actual results to obtain variances which are
used to stimulate improved performance”.
The standard costing method can be summed up as follows:
(1) Establishing appropriate standards for each cost component.
(2) Gathering information on actuals and application of standard costs.
(3) When actual costs are compared to Standard Costs, the deviations are known as
Variances.
(4) Analysis of Variances to identify Variances' causes.
(5) Making a report to the appropriate authorities so that appropriate measures can be
taken.
8.2.3 Advantages of Standard Costing

 Efficient Cost Control: Inventory Control: Standard costing facilitates inventory control
and simplifies inventory valuations. This ensures uniform pricing of stocks in the form of
raw materials, work‐in‐progress and finished goods.  
 Comparison of Forecasting and Outcomes: The employees are given an efficiency goal,
and cost awareness is encouraged. Since the standard costing approach enables an
evaluation to be done of employees, equipment, and working methods, existing
inefficiencies are brought to light and eliminated.
 Inventory Control: Standard costing makes it easier to manage inventory and value it.
This assures that supplies of raw materials, work-in-progress, and finished goods are
priced uniformly.
 Helpful in Budgeting: Budgets are prepared using standard costing. Standards that are
established for labor, supplies, and overheads are useful for preparing various budgets.
For example, flexible budget, sales budget, etc.
 Eliminates Waste: By establishing standards, some wastes are eliminated, such material
waste, idle time, wasted machine hours, etc.
 Aids in Policy Formulation: The management can use this method to help them set
prices and create production policies. When preparing cost estimates for the production
of new products, standard costing is used.
8.2.4 Limitations of Standard Costing

 Fixing Standards Could Be Difficult: It can be challenging to establish exact standards

costs in a circumstance that will match actual costs whenever operations are complete.
Standard costs are influenced by both historical performance and cost estimates based
on sophisticated statistical methods. Standards are therefore crucial to uncertainties.
 Constraint for Service Industry: Standard costing is used for planning and
controlling manufacturing costs, which is a limitation for the service sector. As a result, it
cannot be used in the service sector.
 Unsuited for Non-Standardized Products: Since job manufacturing companies produce
non-standardized goods like catering, tailoring, printing, etc., standard costing is
expensive and unsuitable for these industries.
 Consistency of Standard: It is challenging to consistently maintain and continue the same
standards because marginal costing standards change and vary throughout time.
 Employee and Worker Discouragement: When standards are set at a high level,
employees and workers can get dissatisfied. The unrealistically high expectations may
 have a negative impact on employee morale rather than serving as a motivator for
increased productivity.
 Inaccurate Results: Inaccurate and unreliable standards might lead to results that are
misleading, which could undermine users' trust in the system.

8.3 Calculation of Standard Costs

The steps stated below must be followed in order to determine the Standard cost:
1. Identify all of the direct expenses related to manufacturing; if these expenses are not
incurred, the manufacturing process will be affected.
2. Based on actual output, determine the standard quantity and standard hours.
3. Divide those expenses into three key categories: material, labor, and overhead, which can
then be further divided into fixed and variable overhead.
4. Add up the costs you determined in step 3 to get the overall standard cost for the
company.
Illustration: The summary taken from cotton manufacturing company BCA Ltd. is provided
below. 

Particulars Standard Actual

Cost per kg Rs.15 Rs.12.5
Quantity (kgs) 500 kgs 450 kgs
Hours 350 hours 400 hours
Rate per hour Rs.12 Rs.10.5
Output 250 units 220 units

You need to determine the overall Standard Cost.

Solution:

 Calculate Standard quantity for Actual output

= Standard Quantity/Standard output *Actual output
= (500 kgs/250 units) * 220 units = 440 kgs

 Calculate Standard hours for Actual output

= Standard Hours/Standard output *Actual output
= (350 hours/250 units) * 220 units = 308 hours

Particulars Standard Cost Total Standard Cost

Direct Material Cost (Standard quantity*Standard price) Rs.6600
= 440 kgs*Rs.15
Direct Labor Cost (Standard hours*Standard rate) Rs.3696
= 308 hours*Rs.12
Total Standard Cost Rs.10296
8.4 Steps involved in Standard Costing

The following steps are taken, in the process of Standard Costing:

 Fixing Standards: Setting the standards based on management's estimation is the

initial stage. Basically, production plans, prospective trends, and historical data are
taken into account when setting standards.
 Determining Actual Costs: The second step is to calculate the expenses for each
element, such as material, labor, and overhead, after the standards have been set.
 Comparison between actual and standard figures: The standards and actual costs will
be compared next to identify any variances.
 Variance analysis and reporting: Following the comparison, it is necessary to identify
any deviations and determine why they occurred in order to take appropriate
corrective action and to adjust the budget in order to make the standards more
realistic.
 Taking corrective action for the disposition of variances: The disposition of deviations
by moving them to the profit and loss account is the final stage.

8.5 Computation of Variances

The standard cost is a pre-determined cost that establishes in advance what each good or
service need cost in a particular situation.
Cost control and cost reduction are the goals of standard costing. The control system will
enable the comparison of performance targets with actual performances.
Variances are the differences between actual costs, profits, or sales and the standard costs,
profits, or sales. The difference could be either favorable or unfavorable (Adverse). The
variation is considered favorable if the actual cost is lower than the standard cost and the
actual profit or sales are higher than the standard profit or sales. Actual costs that are higher
than expected costs and actual profits or sales that are lower than expected profits or sales
should be reported as unfavorable, which is adverse. The favorable or positive variance is
represented by letter “F” and the unfavorable or adverse variance is represented by letter
“A”.
Illustration: Following is the information of the standard costs set and the actual costs
incurred during the period:

Particulars Standards Actuals

Material cost Rs. 300000 Rs. 285000
Labor Cost Rs. 155000 Rs. 180000
Overhead Cost Rs. 225000 Rs. 240000
Sales Rs. 800000 Rs. 860000
Profit Rs. 120000 Rs. 155000

Prepare a Variance Report.

Solution:
Variance Report

Particulars Standards Actuals Variances

Material cost Rs. 300000 Rs. 285000 (F) Rs. 15000
Labor Cost Rs. 155000 Rs. 180000 (A) Rs. 25000
Overhead Cost Rs. 225000 Rs. 240000 (A) Rs. 15000
Sales Rs. 800000 Rs. 860000 (F) Rs. 60000
Profit Rs. 120000 Rs. 155000 (F) Rs. 35000

8.6 Material Variance

It is also known as material cost variance. The cost of materials that have been actually
incurred differs from the standard cost of materials that should have been incurred for
producing the actual product, such variance is known as material variance.

 Material Cost variance

The difference between the standard cost set for material and the actual cost incurred for
actual production is known as Material cost variance.
Material Cost Variance (MCV)
= Total Standard Material Cost – Total Actual Material Cost
= (Standard Quantity*Standard Price) – (Actual Quantity*Actual price)
= (SQ*SP) – (AQ*AP)

 Material Usage Variance

The term "material usage variance" refers to the difference between the quantity of
material actually consumed and the quantity that should have been consumed. We have
to multiply this difference by the standard raw material price in order to put this loss into
monetary terms. The aim of establishing the materials utilization standard is to use
materials as efficiently as possible.
Material Usage Variance (MUV)
= (Standard quantity – Actual Quantity) *Standard Price
= (SQ – AQ) *SP

 Material Price Variance

This difference accounts for the portion of the overall material cost variance that results
from changes in the purchase price of the material. Comparing the standard purchase price
and the actual purchase price, it is possible to determine the loss or gain per unit purchased
or consumed. But the overall loss or gain depends on the actual quantity purchased or
consumed.
Material Price Variance (MPV)
= (Standard Price – Actual Price) *Actual Quantity
= (SP – AP) *AQ

 Material Mix Variance

The goal is to determine whether the actual raw material consumption is in compliance with
standards or has changed. This is the difference between the standard quantity required to
produce the actual output and the actual quantity consumed in production, taking into
consideration the standard material price.
Material Mix Variance (MMV)
= (Revised Standard quantity – Actual Quantity consumed) *Standard Price
 To calculate Revised Standard Quantity
= (Total Actual Quantity/Total Standard Quantity per unit) *Standard Quantity

 Material Yield Variance

This variation takes into consideration the portion of the consumption variance that results
from changes in the quantity of raw materials consumed, with the mix remaining constant.
Material Yield Variance (MYV)
= (Total Standard Cost/Total Standard Quantity) * (Actual Output – Standard Output)
Illustration:
For producing one unit of a product, the materials standard is:
Material Alpha: 4 kg. @ Rs.12 per kg.
Material Beta: 6 kg. @ Rs.8 per kg.
In a week, 1,000 units were produced, the actual consumption of materials was:
Material Alpha: 4600 kg. @ Rs.11 per kg.
Material Beta: 5600 kg. @ Rs.7.75 per kg.
Compute the various variances.
Solution:
Standard Cost of Materials for 1000 units:
Material Alpha: 1000 units*4kgs per unit = 4000 kgs
Material Beta: 1000 units*6kgs per unit = 6000 kgs
Total Standard Quantity = 10000 kgs
Total Standard Cost of Materials = (4000 kgs*Rs.12 + 6000 kgs*Rs.8) = Rs.96000
Actual Cost of Materials for 1000 units:
Material Alpha: 4600 kgs*Rs.11 per kg = Rs.50600
Material Beta: 5600 kgs*Rs.7.75 per kg = Rs. 43400
Total Actual Cost of Materials = Rs.94000
1. Material Cost Variance
= (Standard Quantity*Standard Price) – (Actual Quantity*Actual price)
= Total Standard Cost – Total Actual Cost
= Rs.96000 – Rs.94000
= Rs.2000 (F)
2. Material Usage Variance = (Standard quantity – Actual Quantity) *Standard Price
Material Alpha = (4000 kgs – 4600 kgs) *Rs.12
= (-) Rs.7200 (A)
Material Beta = (6000 kgs – 5600 kgs) *Rs.8
= Rs.3200 (F)
Material Usage Variance = (-) Rs.7200 + Rs.3200 = (-) Rs.4000 (A)

3. Material Price Variance = (Standard Price – Actual Price) *Actual Quantity

Material Alpha = (Rs.12 – Rs.11) *4600 kgs
= Rs.4600 (F)
Material Beta = (Rs.8 – Rs.7.75) *5600 kgs
= Rs.1400 (F)
Material Price Variance = Rs.4600 + Rs.1400 = Rs.6000 (F)

4. Material Mix Variance

= (Revised Standard quantity – Actual Quantity consumed) *Standard Price
Material Alpha = (4080 kgs – 4600 kgs) *Rs.12
= (-) Rs6240 (A)
Material Beta = (6120 kgs – 5600 kgs) *Rs.8
= Rs.4160 (F)
Total Material Mix Variance = (-) Rs.6240 + Rs.4160 = (-) Rs.2080 (A)
 To calculate Revised Standard Quantity
= (Total Actual Quantity/ Total Standard Quantity per unit) *Standard Quantity
Material Alpha = (10200/10) *4 = 4080 kgs
Material Beta = (10200/10) *6 = 6120 kgs

5. Material Yield Variance

= (Total Standard Cost/Total Standard output) * (Actual Output – Standard Output)
= Standard Cost per unit * (Actual Output – Standard Output)
= (Rs.96000/ 1000 units) * (1000 units – 1020 units)
 = Rs.96 * (- 20 units)
= (-) Rs.1920

 Actual Output = 1000 units

Standard Output = Revised standard quantity/Standard Quantity per unit
= 10200 units/10 kgs per unit
= 1020 units

8.7 Labor Variance

When actual labor costs deviate from standard labor costs, labor variance occurs.
Calculating labor variances involves taking into account differences in labor rates, time spent
working, idle time, and labor efficiency.

 Labor Cost Variance (LCV)

The difference between the actual direct wages paid and the standard direct wages required
to produce the output is known as the labor cost variance.
Labor Cost Variance = Total Standard Labor Cost – Total Actual Labor Cost incurred
= (Standard Labor Hours for actual ouput*Standard Rate per hour) – (Actual Labor
Hours*Actual Rate per hour)
= (SH * SR) – (AH * AR)

 Labor Rate Variance (LRV)

This is the portion of the wage variation that results from the difference between the hourly
standard rate and the actual rate. The difference is based on the change in the pre-
determined wage rate. Generally, factors beyond the personnel department's control, such
as the condition of the labor market, compensation paid, etc., influence salary rates.
Therefore, the majority of wage rate variations are uncontrollable variance.
Labor Rate Variance = (Standard Rate per hour – Actual Rate per hour) *Actual Hours
= (SR – AR) *AH

 Labor Efficiency Variance (LEV)

The portion of the direct wage variation that results from a difference between the specified
standard labor hours and the actual hours worked. Essentially, this difference offers a key to
managing labor costs and worker productivity. It is, in fact, a usage variance.
Labor Efficiency Variance = (Standard Hours – Actual Hours Worked) *Standard Rate
= (SH -AH) *SR

 LABOUR COST VARIANCE = LABOUR EFFICIENCY VARIANCE + LABOUR RATE VARIANCE

 = LEV + LRV

 Labor Idle-time Variance

It is the time that an employee gets paid for but does not work because of a power failure, a
scarcity of supplies, or a machine break down, among other factors. This is abnormal idle
hours. Due to the fact that it signifies a loss of time, it will always be in the unfavorable or
adverse. 
Labor Idle-time Variance = Idle Time x Standard Rate
 Idle-time hours = Actual Hours – Actual Hours Worked

 Labor Mix Variance (LMV)

This is a sub-variance which arises due to change in the composition of a standard gang or
combination of labour force.
Labor Mix Variance = (Revised Standard Labor Hour – Actual Hours Worked) *Standard Rate
= (RSH – AHW) *SR
 Revised Standard Labor Hours
= (Total Standard Hours/Total Actual Hours) *Standard Hours

 Labor Yield Variance (LYV)

This is due to the difference in the standard output specified and the actual output
obtained. Labor Sub Usage Variance (LSUV) is another name for Labour Yield Variance (LYV).
Actual yield or output will never change when computing the LYV, but standard yield or
output may. If the actual output is more than standard output, it is favourable variance and
vice versa
Labor Yield Variance
= (Total Standard Labor Cost/Total Standard Hours) *(Actual Output – Standard Output)
= Standard Labor Cost per unit *(Actual Output – Standard Output)
To calculate New Standard Yield or Output
= (Old Standard Output/Total Standard Hours) *Actual Hours Worked

Illustration:
The details of standard labour and the actual labour components used during the month are
given below:

Particulars Skilled Labor Unskilled Labor

Standard number of workers 60 20
 Standard Rate per hour Rs.15 Rs.10
Actual number of workers 64 18
Actual Rate per hour Rs.13.5 Rs.11
There are 50 working hours available in a week, the workers produced only 15400 hours
during the month. Calculate all the labor variances.
Solution:

Particulars Standard Cost Actual Cost

Hours Rate Total Hours Rate Total
Skilled Labor 12000 hrs Rs.15 Rs.180000 12800 hrs Rs.13.5 Rs.172800
Unskilled Labor 4000 hrs Rs.10 Rs.40000 3600 hrs Rs.11 Rs.39600
Total 16000 hrs Rs.220000 16400 hrs Rs.212400

 Standard Labor Cost for Actual Hours Produced

= Total Standard Cost/Standard Hours *Actual Hours
= Rs.220000/16000 hrs *15400 hrs = Rs.211750

 Labor Cost Variance

= (Standard Labor cost for Actual Output – Actual Labor cost)
= Rs.211750 – Rs.212400 = (-) Rs.650 (A)

 Labor Efficiency Variance

= Standard Rate* (Standard hours for Actual Output – Actual hours)
Skilled Labor = Rs.15 *(11550 hrs – 12800 hrs) = (-) Rs.18750 (A)
Unskilled Labor = Rs.10* (3850 hrs – 3600 hrs) = (+) Rs.2500 (F)
Total Labor Efficiency Variance = (-) Rs.16250 (A)
To calculate Standard Hours for Actual Output
= Standard hours/Total Standard hours *Total Actual hours
Skilled Labor = (12000 hrs/16000 hrs *15400 hrs) = 11550 hrs
Unskilled Labor = (4000 hrs/16000 hrs *15400 hrs) = 3850 hrs

 Labor Rate Variance

= Actual Hours (Standard Rate – Actual Rate)
Skilled Labor = (Rs.15 – Rs.13.5) *12800 hrs = (+) Rs.19200 (F)
Unskilled Labor = (Rs.10 – Rs.11) *3600 hrs = (-) Rs.3600 (A)
Total Labor Rate Variance = (+) Rs.15600 (F)

 Labor Mix Variance

= Standard Rate (Revised Standard Hours – Actual Hours)
Skilled Labor = (12300 hrs – 12800 hrs) *Rs.15 = (-) Rs.7500 (A)
Unskilled Labor = (4100 hrs – 3600 hrs) *Rs.10 = (+) Rs.5000 (F)
To Calculate Revised Standard Hours
Revised Standard Hours = Total Actual Hours/ Total Standard Hours *Standard Hours
Skilled Labor = 16400 hrs/16000 hrs *12000 hrs = 12300 hrs
Unskilled Labor = 16400 hrs/16000 hrs *4000 hrs = 4100 hrs

8.8 Overhead Cost Variance

It refers to the difference between the standard overhead cost for actual output and the
overhead incurred. In other words, overhead cost variance is the under or over absorption
of overheads.
Understanding the fundamental concepts involved in computing overhead variance:

 Standard overhead rate (per unit) = Budgeted Overhead/ Budgeted output (in units)
 Standard overhead rate (per hour) = Budgeted Overhead/ Budgeted hours
 Standard hours for actual output = Budgeted hours/ Budgeted output *Actual output
 Standard output for actual hours = Budgeted output/ Budgeted hours *Actual hours
 Budgeted overhead = Budgeted output × Std. overhead rate per unit
Or Budgeted hours × Std. overhead rate per hour
 Actual overhead = Actual output × Actual overhead rate per unit
Overhead cost variances can be classified as:
Variable overhead variance
Fixed overhead variance

8.8.1 Variable Overhead Variance

It is the difference between the actual variable overheads and the standard variable
overhead cost that is allowed for the actual output that was produced. The only factor that
can generate a fluctuation in variable overhead costs is a change in expenditure as they
fluctuate in proportion to production. Since variable overheads fluctuate according to
output and not according to time, there is only one variance.

 Variable Overhead Variance =

(Standard Variable Overhead Rate × Actual Output) - Actual Variable Overheads
 Or
(Standard Hours for Actual Output × Standard Variable Overhead Rate) – Actual Variable
Overheads
Or
(Standard Rate × Actual output) – (Actual Rate × Actual output)

 Variable Overhead Efficiency Variance

(Standard hours for Actual output × Standard Variable Overhead Rate per Hour) – Actual
Hours Worked × Standard Variable Overhead Rate per Hour).
Or
Standard Variable Overhead on Actual Production – Standard Variable Overhead for actual
time.
Or
Recovered Overheads – Standard Overheads
 Recovered Overhead
= Standard Rate per hour × Actual Output
Or standard rate per unit × standard hours for actual output
 Standard Overhead
= Standard output for actual hours × Standard overhead rate per unit
Or Actual hours × Standard overhead rate per hour
 It is preferable to calculate variation related to variable overhead using hours as
compared to units.

 Variable Overhead Expenditure Variance

(Actual Hours × Standard Variable Overhead Rate per Hour) – Actual Variable Overhead
OR
Actual Hours (Standard Variable Overhead Rate per Hour – Actual Variable Overhead Rate
per Hour)

8.8.2 Fixed Overhead Variance

All expenses that almost always remain constant regardless of the level of production or the
number of hours put in are referred to as fixed overhead.
The difference between the standard costs of fixed overhead allowed for the actual output
obtained and the actual fixed overhead cost incurred is known as the fixed overhead cost
variance.

 Fixed Overhead Cost Variance

= (Actual output × Standard fixed overhead rate) – Actual fixed overheads
OR
(Standard hours produced × Standard fixed overhead rate per hour) – Actual fixed
overheads
OR
Recovered fixed overhead – Actual fixed Overhead
Fixed overhead variance may broadly be divided into:
(i) Expenditure variance and
(ii) Volume variance.
 Fixed Overhead Expenditure Variance
This is also known as budget variance. This is obtained by comparing the total overhead cost
actually incurred against the budgeted overhead cost. This variation provides a
measurement of spending efficiency.
Fixed Overhead Expenditure Variance
= Budgeted fixed overhead – Actual fixed overhead
OR (Budgeted hours × Std. fixed overhead rate) – Actual fixed overhead

 Fixed Overhead Volume Variance

The difference between overhead absorbed on actual output and those on budgeted output
is termed as volume variance.
This variation demonstrates the over-absorption or under-absorption of fixed overheads
over a set period. The volume variance is favorable if the actual production exceeds the
standard output and there is an over-recovery of fixed overheads. If the actual output is less
than the standard output, the variance is adverse.
Volume Variance (FOVV)
= (Actual output × Standard rate) – Budgeted fixed overheads
OR
Standard rate (Actual output - Standard output)
OR
Standard rate per hour (Standard hours produced - Budgeted hours)
OR
(Absorbed overhead – Budgeted overhead)
 Standard hour produced refers to the number of hours that, according to the
predetermined standards, should have been required for the actual output.

The following variances can be added as subgroups of volume variance:

 Fixed Overhead Efficiency Variance
It results from the difference between the output that was actually produced and the
output that would have been produced given the hours actually worked. If the actual
production exceeds the standard production in terms of actual hours, this variance will be
favorable.
Fixed Overhead Efficiency Variance
= Standard Fixed Overhead Rate per hour (Standard Production – Actual Production)

 Fixed Overhead Capacity Variance

It is that portion of the volume variance which is due to working at higher or lower capacity
than the standard capacity. It is related to the under or over utilisation of plant and
equipment. If the capacity utilization is more than the budgeted capacity, the variance is
favourable, otherwise it will be adverse.
Fixed Overhead Capacity Variance
= Standard Fixed Overhead per hour (Actual hours – Budgeted hours)

 Revise Fixed Overhead Capacity Variance

Revised Capacity Variance is the difference that results from a change in this capacity
utilization. This variation shows the difference in capacity usage brought on by working less
or more days than anticipated.
Fixed Overhead Revised Capacity Variance
= Standard Rate (Standard Quantity – Revised Budgeted Quantity)

 Fixed Overhead Calendar Variance

It classifies that portion of the volume variance which is caused by the difference between
the number of working days in the budget period and the number of actual working days in
the period to which the budget is applied.
Fixed Overhead Calendar Variance
= Standard Overhead Rate per day (Actual days - Budgeted days)

8.9 Sales Variance

 Profit Method of Calculating Sales Variances:
 Sales Margin Variance
It is the difference between the actual profits earned and the budgeted profits or profits
estimated for the period.
Sales Margin Variance = Actual Profit – Budgeted Profit
or Actual Quantity of Sales x Actual Profit per unit- Budgeted Quantity of Sales x Budgeted
Profit per unit
 Sales Margin Volume Variance
It is that fraction of the total sales margin variance that results from more or fewer products
being sold than was budgeted for in terms of sales.
Sales Margin Volume Variance = Standard Profit per unit (Actual Quantity of Sales –
Budgeted Quantity of Sales)

 Sales Margin Price Variance

It is that portion of total sales margin variance which is due to the difference between the
actual price of quantity of sales effected and the standard price of those sales.
Sales Margin Price Variance = Actual Quantity* (Actual Selling Price per unit – Standard
Selling Price per unit).

 Value Method of Calculating Sales Variances:

The sales manager can determine the impact of the various sales efforts on the total sales
value by using sales variances determined using the value technique.

 Sales Value Variance

It is the difference between the standard value and the actual value of sales made during a
period.
Sales Value Variance = Actual Value of Sales – Budgeted Value of Sales.

 Sales Volume Variance

It is that portion of the sales value variance which arises due to difference between actual
quantity of sales and standard quantity of sales.
Sales Volume Variance = Standard Price (Actual Quantity of Sales – Budgeted Quantity of
Sales)

 Sales Price Variance

It is that portion of sales value variance which arises due to the difference between actual
price and standard price specified.
Sales Price Variance = Actual Quantity Sold (Actual Price – Standard Price)

8.10 Preparation of Variance Reports

In order for a standard costing system to be as beneficial to management, reports showing
deviations from standards for each cost element of each department and operation must be
promptly and efficiently given to the management. Additionally, it is crucial that
management take immediate actions to analyze deviations and, where appropriate, make
decisions to prevent the occurrence of unfavorable variations in the future.
Graphs and charts may be utilized when reporting the analysis of deviations to
management, or the analysis may be given in the form of statements and reports that
provide the essential information.
A Variance Report consists of columns to compare standards and actual figure with a
column for results so that management can easily see the factors that have contributed to
the change in the profit. A Reconciliation Statement should be prepared, staring with the
standard or budgeted profit, the various variances would be put in two columns, favourable
and unfavorable, and the net results added to or deducted from the standard profit, thus
arriving at the actual profit.

8.11 Conclusion
Standard costs are predetermined estimates of the cost of one or more units of a product or
service. Standard costing is a method of preparation of standards and their uses for
comparison with actual costs by variance analysis.

Use of the Standard Cost for:

• Cost-effective planning and management
• Pricing choices, such as submitting quotes and responding to tenders
• Determining and quantifying deviations from standards
• Creating systems for performance measurement

The installation of a standard costing system involves the following steps:

• To Set the predetermined standards for sales margin and production costs
• To ascertain and collect the actual results
• To compare the actual performance with pre-determined standards
• To determine the variances
• To analyse and investigate the variances
• To ascertain the causes of variance
• To take corrective action where necessary.
• To adjust the budget in order to make the standards more realistic

Valuation, planning, controlling is the main function of standard costing system. Variance is
the difference between standard cost and actual cost incurred.
Favourable variance is that variance which effect profit in a favourable manner which may
be due to reduction in cost.
It is better to compute variance related to variable overhead on the basis of hours rather then on the
basis of units.

8.12 Glossary
 Standard Cost: The Standard cost is a predetermined cost which is calculated from
management standard of efficient operation and relevant necessary expenditure.
 Standard Costing: A standard costing system is a method of cost accounting in which
standard costs are used in recording certain transaction and the actual costs are
 compared with the standard cost to learn the amount and reason for variations from the
standard.
 Variance: Variance means the deviation of the actual cost or actual sales from the
standard cost or profit or sales.
 Material cost variance: Material cost variance is the difference between standard cost
of direct material specified for output achived and the actual cost of direct material
used.
 Labour cost variance: Labor cost variance is the difference between the standard direct
wages specified for the activity achieved and the actual direct wages paid.
 Overhead cost variance: The total overhead cost variance is the difference between the
standard cost of overhead allowed for the actual output achieved and the actual
overhead cost incurred.
 Variable Overhead Variance: Variable overhead variance (VOV) is the difference
between the standard variable overhead cost allowed for the actual output achieved
and the actual variable overheads.
 Fixed Overhead Variance: Fixed overhead variance is the difference between the
standard costs of fixed overhead allowed for the actual output achieved and the actual
fixed overhead cost incurred.
 Favorable Variance: When actual cost is less than standard cost or profit is better than
the standard profit, it is known as ‘Favourable Variance’.
 Adverse Variance: Where the actual cost is more than standard cost or profit is better
than the standard profit, it is known as 'Unfavourable Variance' or 'Adverse'.

8.13 Self-Assessment Questions

1) What are the steps involved in the installation of Standard costing?
2) For material cost, how many standards must be developed? Explain their significance.
3) How is material usage variance different from the material mix variance?

8.14 Questions for discussion forum

1) The Management of Aqua ltd. decided on installation of Standard costing system for
accomplishing the objectives of cost reduction and control. Discuss the uses of standard
costing.
2)

8.15 Case Study

Altra Ltd. is rug manufacturing company. The company wants to analyse and investigate the
variances in fixed overheads so that corrective measures are taken on time and costs can be
controlled. Following is the information given:
Budget Fixed Overheads For the month is Rs.9500
Actual Fixed overheads incurred is Rs.11000
Budgeted Production: 1000 units
Actual production: 40 units per day
The factory operates for 28 days in a month, taking average or standard time of 10 hours to
produce one unit of the output. Actual hours worked in June 10640 hours.
Compute: (i) Fixed Overhead Cost Variance (ii) Expenditure Variance (iii) Volume Variance
(iv) Capacity Variance (v) Efficiency Variance

8.16 Multiple Choice Questions

1) Which of the following is an estimated cost that has been predetermined and can be
used to calculate a variance?
a) Actual Cost
b) Estimated Cost
c) Standard Cost
d) Product Cost
Explanation: CIMA London defines standard cost as, “the predetermined cost which is
calculated from management standard of efficient operation and relevant necessary
expenditure.”
2) A Standard Cost system can be valuable for top management in:
a) Planning and Decision-making
b) Cost Control and Cost Reduction
c) Analysis of Variances to identify Variances' causes.
d) All the above
Explanation: A Standard Cost system can be valuable for top management in planning and
decision-making, cost control, cost reduction, and analysis of Variances to identify
Variances' causes.
3) What is the correct sequence of the standard costing process?
i. Determining Actual Costs
ii. Variance analysis and reporting
iii. Fixing Standards
iv. Taking corrective action for the disposition of variances
v. Comparison between actual and standard figures
a) i, ii, iii, iv, and v
b) i, ii, iv, iii, and v
c) iii, i, v, ii, and iv
d) i, iii, iv, ii, and v
Explanation: The following steps are taken, in the process of Standard Costing:
i. Fixing Standards
ii. Determining Actual Costs:
iii. Comparison between actual and standard
iv. Variance analysis and reporting
v. Taking corrective action for the disposition of variances

4) Standard Costing is not applicable to:

 a) Transportation services
b) Glass manufacturing
c) Pipe manufacturing
d) Book publishing
Explanation: Standard costing is used for planning and controlling manufacturing costs,
which is a limitation for the service sector. As a result, it cannot be used in the service
sector.

5) Standard costs are influenced by:

a) Actual cost
b) Historical cost
c) Sunk cost
d) Opportunity cost
Explanation: Standard costs are influenced by both historical performance and cost
estimates based on sophisticated statistical methods.
6) Calculate Standard Quantity for actual output when:
Standard Quantity: 25000 kgs
Standard Output: 2000 units
Actual Output: 2250 units
a) 21285 kgs
b) 22815 kgs
c) 28125 kgs
d) 25185 kgs
Explanation: Standard Quantity/Standard output *Actual output
= (25000 kgs/2000 units *2250 units) = 28125 kgs

7) Variance is:
a) the differences between actual costs, profits, or sales and the standard costs,
profits, or sales.
b) The difference between the standard cost set for material and the actual cost
incurred
c) the difference between the quantity of material actually consumed and the
quantity that should have been consumed.
d) the difference between the standard quantity required to produce the actual output
and the actual quantity consumed
Explanation: Variances are the differences between actual costs, profits, or sales and the
standard costs, profits, or sales. The difference could be either favorable or unfavorable
(Adverse).

8) The variation is considered favorable:

a) Actual costs that are higher than expected costs
b) If the actual cost is lower than the standard cost
c) Actual profits or sales that are lower than expected profits
d) Represented by letter “A”.
Explanation: The variation is considered favorable if the actual cost is lower than the
standard cost and the actual profit or sales are higher than the standard profit or sales.
Case: Product P requires 5 kgs of material X at a rate of Rs.10 per kgs. The actual material
cost incurred is Rs.24000, where cost per kg paid being Rs.12 and consumed 4 kgs of
material per unit for production.
9) Case: Product P requires 5 kgs of material X at a rate of Rs.10 per kgs. The actual
material cost incurred is Rs.24000, where cost per kg paid being Rs.12 and consumed 4
kgs of material per unit for production.
Calculate Material Cost variance
a) (-) Rs.1000 (F)
b) (+) Rs.1000 (F)
c) (+) Rs.1000 (A)
d) No Variance
Explanation: Material cost variance
= Total standard material cost – Total actual material cost
= {[Rs.24000/ (12*4)] *5 kgs *Rs.10 per kg} – Rs.24000
= (+) Rs.1000 (F)

10) Case: Product P requires 5 kgs of material X at a rate of Rs.10 per kgs. The actual
material cost incurred is Rs.24000, where cost per kg paid being Rs.12 and consumed 4
kgs of material per unit for production.
Calculate Material Price Variance
a) (-) Rs.4000 (F)
b) (+) Rs.4000 (A)
c) (-) Rs.4000 (A)
d) No Variance
Explanation: Material Price Variance
= (Standard Price – Actual Price) *Actual Quantity
= (Rs.10 – Rs.12) *2000 units
= (-) Rs.4000 (A)

11) Case: Product P requires 5 kgs of material X at a rate of Rs.10 per kgs. The actual
material cost incurred is Rs.24000, where cost per kg paid being Rs.12 and consumed 4
kgs of material per unit for production.
Calculate Material Quantity Variance
a) (+) Rs.5000 (F)
b) (-) Rs.5000 (A)
c) (+) Rs.5000 (A)
d) No Variance
Explanation: Material quantity variance
= (Standard quantity – Actual Quantity) *Standard Price
= (2500 kgs – 2000 kgs) *Rs.10
= (+) Rs.5000 (F)
12) _________ variance takes into consideration the portion of the consumption variance
that results from changes in the quantity of raw materials consumed, with the mix
remaining constant.
a) Material Price
b) Material Quantity
c) Material Mix
d) Material Yield
Explanation: This variation takes into consideration the portion of the consumption variance
that results from changes in the quantity of raw materials consumed, with the mix
remaining constant.

13) It is the time that an employee gets paid for but does not work because of a power
failure, a scarcity of supplies, or a machine break down, among other factors.
a) Idle time
b) Normal Idle time
c) Abnormal Idle time
d) Overtime
Explanation: It is the time that an employee gets paid for but does not work because of a
power failure, a scarcity of supplies, or a machine break down, among other factors. This is
abnormal idle hours. 
14) Labor Efficiency Variance is equal to:
a) = (RSH – AHW) *SR
b) = (SH -AH) *SR
c) = (SR – AR) *AH
d) = (SH * SR) – (AH * AR)
Explanation: Labor Efficiency Variance = (Standard Hours – Actual Hours Worked) *Standard
Rate
15) Revised Standard Labor Hours is equal to:
a) (Standard Hours – Actual Hours Worked) *Standard Rate
b) Standard Labor Cost per unit *(Actual Output – Standard Output)
c) (Total Standard Hours/Total Actual Hours) *Standard Hours
d) Actual Hours – Actual Hours Worked
Explanation: Revised Standard Labor Hours
= (Total Standard Hours/Total Actual Hours) *Standard Hours

16) Budgeted Overhead/ Budgeted output (in units) is:

a) Overhead Rate per hour
b) Blanket Rate
c) Supplementary Rate
d) Overhead Rate per unit
Explanation: Standard overhead rate (per unit) = Budgeted Overhead/ Budgeted output (in
units)
17) Calculate Recovered Overhead when Standard rate per hour is Rs.10, Standard output is
1000 units and Actual output is 1200 units.
a) Rs.10000
b) Rs.12000
c) Rs.2000 (A)
d) Rs.2000 (F)
Explanation: Recovered Overhead
= Standard Rate per hour × Actual Output
= Rs.10 *1200 units
=Rs.12000

18) Calculate Labor Cost Variance when Labor rate variance is Rs.10000 (A) and Labor
Efficiency Variance is Rs.2000 (F).
a) (+) Rs.8000 (F)
b) (+) Rs.12000 (F)
c) (-) Rs.8000 (F)
d) (-) Rs.8000 (A)
Explanation: labour cost variance = labour efficiency variance + labour rate variance
= Rs.10000 (A) + Rs.2000 (F) = (-) Rs.8000 (A)
19) This is obtained by comparing the total overhead cost actually incurred against the
budgeted overhead cost.
a) Fixed Overhead Volume Variance
b) Fixed Overhead Efficiency Variance
c) Budget Variance
d) Recovered Overhead
Explanation: Fixed Overhead Expenditure Variance is obtained by comparing the total
overhead cost actually incurred against the budgeted overhead cost. This is also known as
budget variance.
20) The sales manager can determine the impact of the various sales efforts on the total
sales by using:
a) Sales Variance based on Value
b) Sales Variance based on profit
c) Sales Variance based on Quantity
d) Both (a) and (b)
Explanation: The sales manager can determine the impact of the various sales efforts on the
total sales by using sales variance based on value and profit margins.

Solution: (Case Study)

Calculate Overhead Rate
Fixed Overhead Rate per unit = Budgeted Overheads/Budgeted Output
= Rs.9500/1000 units = Rs.9.5 per unit
Fixed Overhead Rate per hour = Budgeted Overhead/Budgeted hours
= Rs.9500/10000 hour = Rs.0.95 per hour
1. Fixed Overhead Cost Variance
= (Actual output × Standard fixed overhead rate) – Actual fixed overheads
= [(40 units*28 days) *Rs.9.5 per unit] – Rs.11000
= (+) Rs.360 (F)
2. Fixed Overhead Expenditure Variance
= (Budgeted hours × Std. fixed overhead rate) – Actual fixed overhead
= (10000 hours*Rs.0.95 per hour) – Rs.11000
= (-) Rs.1500 (A)
3. Fixed Overhead Volume Variance
= Standard rate (Actual output - Standard output)
= Rs.9.5 per unit* [(40 units*28 days) – 1000 units]
= (+) Rs.1140 (F)
4. Fixed Overhead Capacity Variance
= Standard Fixed Overhead per hour (Actual hours – Budgeted hours)
= Rs.0.95 per hour* (10640 hours – 10000 hours)
= (+) Rs.608 (F)
5. Fixed Overhead Efficiency Variance
= Standard fixed overhead per hour (Standard hours for actual output – Actual hours)
= Rs.0.95 per hour (10000/1000*1120 hours – 10640 hours)
= (+) Rs.532 (F)