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Standard cost
Is defined by the Institute of Cost and Management Accountants, London as the
predetermined cost based on technical estimate for materials, labor and overhead for a
selected period of time and for a prescribed set of working conditions.
Chartered Institute of Management Accountants England defines Standard costing as the
preparation and use of standard costs, their comparison with actual costs and the analysis
of variances of their causes and points of incidence.
The main objective of Standard costing is to ascertain the quotation and determination of
price policy
Types of Standard
Standard labor rates are established at this level where different wage rates are determined
for different labor categories.
Standard overheads are determined by dividing overhead expenses by direct labor hours
or units manufactured. The standard overhead cost is got by multiplying standard
overhead rate by the labor hours or number of units manufactured. Determining overhead
rates involves;
A. Determine overheads
B. Determine labor hours or units manufactured
C. Calculate overheads rate by diving A by B
Overheads may be classified as.
Fixed overheads. Overheads remain the same regardless of the level of production
Variable overheads. Overheads change in direct proportion to change in production
level
Semi-variable overheads. Expenses increase or decrease with increase or decrease in
production.
Variance is defined as the difference between standard cost and actual cost for each
element of cost incurred during a particular period.
Variance analysis may be defined as the process of analyzing variance by subdividing
the total variance in such a way that management can assign responsibility for off
standard performance.
The variance can be favorable or unfavorable whereby it’s favorable when the actual
performance is better than the standard whereas its unfavorable where the actual
performance is below the standard.
Variance analysis helps to fix the responsibility so that management can ascertain
(a) The amount of the variance
(b) The reasons for the difference between the actual performance and budgeted
performance
(c) The person responsible for poor performance
(d) Remedial actions to be taken
Types of Variances:
We analyze 3 variances under standard costs and variances.
1. Material Cost Variances
2. Labor Cost Variances
3. Fixed Overheads Cost Variances
It has 3 components;
Labor Rate Variance = Actual Hour (Standard rate – Actual rate)
Labor Efficiency Variance = Standard Rate (Standard Hour – Actual Hour)
Labor Idle Time Variance = Standard Rate * Idle time
Labor efficiency has 2 elements
Labor Mix Variance = Standard Rate (Revised S.H – Actual Hour)
Labor Yield Variance = Standard Rate (Standard Hour – Revised AH)
Unlike direct materials (which are obtained prior to being used) direct labor is obtained and used
at the same time.
This means that for the given good output, we can compute the following at the same time (when
goods are produced):
• Standard direct labor cost
• Direct labor rate variance
• Direct labor efficiency variance.
Direct labor rate variance measures the cost of the difference between the expected labor rate and
the actual labor rate. It is calculated by multiplying the difference between the standard rate and
actual rate by the actual number of hours.
Direct labor efficiency variance measures the cost of the difference between the expected number
of labor hours required for the operations and the actual number of labor hours required for the
operations.
If the variance demonstrates that the actual number of labor hours required was higher than
expected number of labor hours required, then consider the variance unfavorable. If the variance
demonstrates that the actual number of labor hours required was less than expected number of
labor hours required, then consider the variance favorable.
Using the following formula. A positive direct labor efficiency variance would be unfavorable
whereas a negative direct labor efficiency variance would be favorable.
Therefore; Direct labor efficiency variance = (Actual labor hours-standard labor hours)
*Standard labor rate
Example;
Rafiki ltd’standard cost sheet shows 1hour is required to produce a bar of soap each at 20,000/=.
During the month of October 2019, 25,000 bars of soap were produced in 21,000 hours with a
total amount of 35,700,000/=. Out of 21,000 production hours spent, employees used 1,000hours
as they waited for materials and tools.
Required; Compute
• Labor cost variance
• Labor rate variance
• Labor efficiency variance
• Idle time variance
S.R = 20,000
I bar = 1 hr
Month of October
AR ??
T.C = 35,700,000
Pdn = 25,000
Time used = 21000 Hrs
Pdn time = 1000 hrs
Actual time used = 20,000 hrs
Direct materials variance is the difference between the standard cost of direct materials
specified for production and the actual cost of direct materials used in production. Direct
materials are easily traceable raw materials that are employed in the production of goods
and make up a sizable portion of the final output. The quantity of materials utilized and
the cost of those materials may vary from the average expenses established at the start of
a period.
Material Variance informs management of the discrepancy which may either be less cost
or more cost incurred in relation to the standard cost. Hence, Variance Analysis helps
monitor the deviations from the standards set by a firm.
Material variance can be either favorable when positive or unfavorable when negative. It
is positive when the Standard Cost is higher than the Actual cost and vice negative when
vice versa.
Therefore, direct materials variances assess both the effectiveness and efficiency of the
company's use of materials. The direct materials price variance and the direct materials
quantity/usage variance, which both compare the actual price or amount utilized to the
standard amount, are the two halves of a direct materials variance.
Components of direct material variance;
i. Material Cost Variance
ii. Material price variance
iii. Material usage variance
iv. Material yield variance (MYV)
This is the sum of material usage variance and price variance. It is also viewed as the
difference between the standard cost of direct materials specified for production and the
actual cost of direct materials used in production is known as Direct Material Cost
Variance.
MCV is calculated as follows;
MCV = SC – AC
MCV = (SQ*SP) – (AQ*AC)
Material Price Variance is the difference between the standard price and the actual price
for the actual quantity of materials used for production. This can be caused by poor
purchasing procedures, changes in prices, deficiencies in price negotiation.
𝑀𝑃𝑉 = 𝐴𝑄(𝑆𝑃 − 𝐴𝑃)
Where;
MPV 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑃𝑟𝑖𝑐𝑒 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒
AQ 𝐴𝑐𝑡𝑢𝑎𝑙 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑈𝑠𝑒𝑑
SP 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑃𝑟𝑖𝑐𝑒
AP 𝐴𝑐𝑡𝑢𝑎𝑙 𝑝𝑟𝑖𝑐𝑒 𝑝𝑎𝑖𝑑
The actual amount of materials used and the standard amount that was anticipated to be
utilized to generate the actual units produced are compared using the direct materials
quantity variance. Therefore, Material Usage Variance is the difference between the
standard quantity for actual production and the actual quantity used at the standard
purchase price.
This can be caused by wastage, use of sub-standard, pilferage, and differences in material
quality,
𝑀𝑈𝑉 = 𝑆𝑃 (𝑆𝑄 − 𝐴𝑄)
Where;
MUV 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑢𝑠𝑎𝑔𝑒 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒
SP 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑃𝑟𝑖𝑐𝑒
SQ 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
AQ 𝐴𝑐𝑡𝑢𝑎𝑙 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑢𝑠𝑒𝑑
Material Yield Variances represents that portion of the direct materials usage variance which is due to
the difference between standard yield and the actual yield obtained.
Solution
Standard Actual
Quantity Rate Amount Quantity Amount
Material (SQ) (SP) (𝐴𝑆 × 𝑆𝑃) (AQ) Rate (AP) (𝐴𝑄 × 𝐴𝑃)
A 30 2000 60,000 20 1500 30,000
B 70 1000 70,000 60 500 30,000
Total 100 130,000 80 60,000
In most circumstances, as output rises, variable manufacturing overhead costs will also
rise overall. The price of the electricity required to run the equipment serves as one
example. The price of manufacturing supplies, which rises as production rises, is another
illustration and we will suppose that the amount of direct worker hours affects these
variable manufacturing overhead expenses.
Variable manufacturing overhead variance analysis includes two distinct variances, much
like direct materials and direct labor variances. That is,
The production expense information provided by the production department and the
projected labor hours to be worked, as estimated by the industrial engineering and
production scheduling staffs, based on historical and projected efficiency and
equipment capacity levels, are combined to form the variable overhead spending
variance.
There are a number of possible causes of a variable overhead spending variance. For
example:
• Misclassification of accounts. Numerous accounts are included in the variable
overhead category, some of which may have been mistakenly categorized and do
not appear to be included in variable overhead (or vice versa).
• Outsourcing. Some tasks that were formerly outsourced internally have now been
moved to a supplier, and vice versa.
• Prices from suppliers. The new standards have not yet been updated to reflect
supplier price changes.
When the production process is tightly controlled, as when mass quantities of identical
units are produced, the variable overhead spending concept is most useful.
The production expense information provided by the production department and the
projected labor hours to be worked, as estimated by the industrial engineering and
production scheduling staffs, based on historical and projected efficiency and equipment
capacity levels, are combined to form the variable overhead efficiency variance. It is
totally conceivable for an incorrectly determined standard number of labor hours to
produce a variation that does not accurately reflect an entity's performance. Therefore, an
evaluation of the reliability of the underlying standard should be included in the
investigation of the variable overhead efficiency variation.
Example
Innoplan limited has planned to absorb its variable overheads into production at a rate of 500 Ugx
per hour. Each unit is planned to take 0.5 hours to complete. During the period, 4,200 hours were
paid for with overheads absorbed being 2,520,000 Ugx. Output stood at 6,000 units.
Required. Compute variable overheads variances and analyze them.
Solution
Standard variable overhead absorption rate, SVOAR = 500 Ugx per labour hour
Standard hour, SH = 0.5 x 6,000
= 3,000 hours
Actual variable overhead absorption rate, AVOAR = 2,520,0004,200 = 600 Ugx per labour hour
Actual hours, AH = 4,200 hours
However, the following are the disadvantages of using standard costs in evaluation of
controls;
1. Reports of Standard cost variance are published every month and because of this, the data in
the reports could be so outdated that it is almost meaningless.
2. A "favorable" variation can occasionally be just as terrible as or even worse than a
"unfavorable" fluctuation. This often results into poor customer service.
Standard costing is applicable in a variety of circumstances and calls for the following;
https://gmuconsults.com/accounting/what-is-standard-costing/
https://www.scribd.com/document/288015225/Chapter-28-Standard-Costing-and-
Variance-Analysis
https://mymcqhub.blogspot.com/2021/03/cost-accounting-mcq-multiple-choice.html
https://accountlearning.com/limitations-or-drawbacks-of-standard-costing/
https://www.coursehero.com/file/p4vsm0o/2-Due-to-lack-of-technical-aspects-it-is-
difficult-to-establish-standards-3/
https://www.cimaglobal.com/Documents/ImportedDocuments/cid_tg_standard_costin
g_and_variance_analysis_mar08.pdf.pdf
https://www.yourarticlelibrary.com/cost-accounting/variance-analysis/variance-
analysis-meaning-classification-and-computation/62350