STANDARD COSTING AND VARIANCE ANALYSIS

Standard costing and variance analysis are remarkably valuable tools in Cost and Management
Accounting. They play important roles in financial analysis and decision making by the
management of companies. When practical standards of performance are set, taking normal
losses into consideration, and the actual performance deviates positively or negatively from the
predetermined levels of performance, there will be a question of why there is a variance from
the plan (ICAN, 2006). The basic definition of variance is simply the difference between actual
costs incurred and standard or budgeted costs applied to an activity or service. The
management should realize that the variances are a starting point for investigation. And, for the
purpose of control, these variances should be measured as quickly as possible. The longer the
delay, the less useful the data would be and the lower the chances to correct the negative
variance or to further improve on the positive variance (Charles, 1978).

“The planned unit cost of the product, component or service produced in a period. The standard
cost may be determined on a number of bases. The main use of standard costs is in
performance measurement, control, stock valuation and in the establishment of selling prices.”
(CIMA, 2005)

Standard costing most suitable to organisations with recurring activities. It is likely very
important to manufacturing companies with repetitive production processes. Standard costing
may not be applied easily to non-recurring activities because there is no definite basis for
observing and recording operations. It is difficult to determine clear standard costs. (Stephanie,
2008). Common tools used to set standard costs are historical costs and detailed observation of
operations in terms of material, labour and equipment usage.

Effective standard costing systems provide a benchmark against actual costs, help to determine
the best materials and methods that lead to the efficient usage and effective performance.
Standard costing helps to stimulate cost consciousness and enables practicing the principle of
“Management by Exception”. (Mula et al, 2016). They also posit some limitations such as high
cost, lack of expertise, reverse motivation, difficulty of application to non-standardized products,
and reduction in efficiency due to frequent analysis.

“The evaluation of performance by means of variances, whose timely reporting should maximise
the opportunity for managerial action.” (CIMA, 2005).

Variance is the difference between an actual value and a planned or budgeted value. In
performance management and project management, variance is used to measure the difference
between actual costs and budgeted costs for materials, wages, and labour. Variance analysis is
the process of analyzing variances to identify the causes of the deviation and to take corrective
action when necessary. Analysis of Variance is an important tool for cost control and
performance evaluation.
Material price variance, material usage variance, wage rate variance, and labor efficiency
variance are key performance indicators (KPIs) used in cost accounting to measure the
difference between the actual and budgeted or standard costs for materials, wages, and labor.
The critical factors that cause these variances can be categorized into two groups: internal and
external factors.

In the case of Juniper Ltd, the management recorded a £3,500 adverse variance in the material
price. This could be owing to price fluctuations in the market. Changes in market prices for
materials and labor can lead to variances in material price. These changes are external to the
company and the management of Juniper Ltd may not have control over market outcomes.
(Khan, M. & Jain, P., 2016). Other external factors that may affect the price of materials is
inflation. This can lead to increased material and labor costs. (Edwards & Bell, 2007).

Juniper Ltd recorded an adverse variance in the material price but recorded a favourable £8,300
variance in the usage of the materials. It is suggested that the cause of the adverse variance in
price is a higher quality. This may have brought about the favourability in the materials usage.
Positive material usage variances are caused by efficiency in the production processes. The
Production Manager possibly used a good standard quantity of materials in the production
process. (Perera 2011).

Juniper Ltd’s production manager possibly less manpower than planned. This may be the cause
of a favourable variance in the wage rate. The workers used might also have been given a strict
amount of time to work with so that less hours will be paid for by the production manager. Also,
efficiencies in production processes, such as inventory management efficient machine usage,
can lead to reduced labor costs. (Perera, 2011). The favourable wage rate variance of £44,000
can be explained by such other factors as reduction in employee benefits, lower than expected
inflation and automation (Khan & Jain, 2016)

Although there was a positive variance with the wage rate, the labour efficiency variance of
£52,000 is discouraging. Labour efficiency variance is caused by higher than budgeted labour
hours. The production manager of Juniper Ltd may have used inefficient workers. The workers
may not have adequate skills. Also, as previously suggested, the number of workers may not be
enough to carry out work efficiently. Other factors that cause the adverse variance in labour
efficiency are lack of proper tools to work, poor working conditions, absenteeism and high
labour turnover (Edwards & Bell, 2007).

Generally, if the cost standards used for budgeting and performance evaluation are inaccurate
or outdated, it can lead to variances in material price, material usage, wage rate, and labor
efficiency. (Khan & Jain 2016).

Material price variance, material usage variance, wage rate variance, and labor efficiency
variance are important cost accounting KPIs that can be caused by a variety of internal and
external factors. By identifying and addressing the root causes of these variances, organizations
can improve their cost management and performance.

For variance to serve as a control measure, the management of Jumiper Ltd must investigate
the causes of every cost variance that arises from comparison of standard and actual
performance. A compromise may, however, need to be reached because too much time spent
on analysing variances may lead to inefficiency.
REFERENCES

Charles Horngren, 1978, Accounting for management control: An in introduction. Prentice Hall
Chartered Institute of Management Accountants, 2005, CIMA Official Terminology, Harrison
Library Main Collection
Edwards J & Bell S, 2007, Standard costing and variance analysis, The Handbook of
Management Accounting Research pp. 259-281
Institute of Chartered Accountants of Nigeria (ICAN), 2006, Management accounting, Study
Pack for Professional Examination II, VI Publishing Limited.
Khan M & Jain P, 2016, Variance Analysis- A Key tool for Cost Control, International Journal of
Research in Commerce, Economics and Management, Vol. 6(6), pp 1-6
Mula Khan, Muhammad Rizwan, Fahad Islam, Zain Aabdeen, 2016, The Extent of Application of
Standard Costing: A Comparison of Chinese and Pakistani Manufacturing Firms,
International Journal of Economics and Business Administration, vol. 2(1), pp. 1-6
Neely, R. J. (1995). The use of standard costing and variance analysis in small businesses,
Journal of Small Business Management, Vol. 33(1), pp 42-53
Perera, D. D. D. R. (2011). Standard costing and variance analysis in a lean manufacturing
environment, Journal of Manufacturing Technology Management, Vol 22(6), pp 817-829
Stephanie Edwards-Nutton, 2008, Standard Costing and Variance Analysis,