Learning Objectives

 Standard Cost
 Need for Standards
 Purpose of Standard Costing
 Difference between Standard Cost and Budget
Cost
 Advantage of Standard Costs
 Setting up of Standard Cost
 Ideal Versus Attainable Standards
 Standard Cost Per Unit
 Variances from Standards
 Sources of Variance
 Analyzing the variance
 Variance Relationship
 Approach To Variance Analysis
 Reporting Variance
 Example
 Definition of Standard Costing
• STANDARD COSTING may be defined as “a
technique of cost accounting which compares
the “standard cost” of each product or service
with the actual cost, to determine the efficiency
of the operation, so that any remedial action
may be taken immediately”.
• The “standard cost” is a predetermined cost
which determines what each product or service
should cost under given circumstances.
 Standard Costs
1. Standard Cost refers to expected costs under
anticipated conditions.
2. Standard cost systems allow for comparison of
standard versus actual costs.
3. Differences are referred to as standard cost
variances.
4. Variances should be investigated if significant.
 The Need for Standards
 Standards
• Are common in business
• Are often imposed by government agencies (and
called regulations)
 Standard costs
• Are predetermined unit costs
• Used as measures of performance
 Purposes of standard costing

1. To assist in setting budgets and evaluating managerial performance.

2. Act as a control device by highlighting those activities that do not
conform to plan, and thus alerting decision-makers to those
situations that may be out of control and in need of corrective action.
3. To provide a prediction of future costs that can be used for decision-
making purposes.
4. To simplify the task of tracing costs to products for inventory
valuation purposes.
5. To provide a challenging target that individuals are motivated to
achieve.
Distinguishing Between Standards and
Budgets

 Standards and budgets are both

• Pre-determined costs
• Part of management planning and control

 A standard is a unit amount whereas a

budget is a total amount
• Standard costs may be incorporated into a cost accounting
system
Advantages of Standard Costs
 Setting Standard Costs
• Setting standard costs
a. Requires input from all persons who have responsibility
for costs and quantities
b. Standards costs need to be current and should be under
continuous review
• Standard costs are set in a variety of ways:
a. Specified by formulas or recipes.
b. Developed from price lists provided by suppliers.
c. Developed from analyses of past data.
 Ideal Versus Attainable Standards

Two schools of thought:

1. Ideal standards (perfection standards):
developed under the assumption that no
obstacles to the production process will be
encountered.
2. Attainable Standards: developed under the
assumption that there will be occasional
problems in the production process.
 Standard Cost Per Unit

 Standard cost per unit

• Sum of the standard costs for direct materials,
direct labor, and manufacturing overhead
• Is determined for each product and often
recorded on a standard cost card which provides
the basis for determining variances from
standards

labour Manufacturing
materials Overheads
 Variances from Standards
 Variances from standards
• Differences between total actual costs and total
standard costs
• Unfavorable variances occur when too much is paid
for materials and labor or when there are
inefficiencies in using materials and labor
• Favorable variances occur when there are efficiencies
in incurring costs and in using materials and labor
– A variance is not favorable if quality control standards are
sacrificed
 Sources of Variance
• Inefficient Operations
• Inaccurate Standards
• Incorrect actual costs (mistakes in bookkeeping)
• Implementation Breakdown (something went
structurally wrong in production)
• Variances normally happen
 Analyzing variances
 Variances must be analyzed to determine their
significance
• First, determine the cost elements that comprise the
variance
• For each manufacturing cost element, a total Rs.
variance is computed.
• This variance is analyzed into a price variance and a
quantity variance
Variance Relationships
 Variance Analysis for a variable costing system
Profit variance

Selling and distribution Total production Total sales

cost variances cost variance margin variance

Sales margin Sales margin

price variance volume variance

Total direct Total direct wages Total variable Fixed overhead

materials variance variance overheads expenditure
variance variance

Materials Materials Wage Labour

price usage rate efficiency Variable Variable
expenditure efficiency
variance variance variance variance
variance variance
A General Approach To Variance Analysis

1. Direct Material:
– Materials Price Variance
– Materials Quantity Variance.
2. Direct Labor:
– Labor rate (price)
– Labor efficiency (quantity) variance.
3. Overhead:
– Overhead volume variance
– controllable overhead variance.
 Material Variances
1. Differences between standard and actual
material costs:
a. Material price variance.
b. Material quantity variance.
 Material Price Variance
1. Material price variance:(AP – SP) x AQp
 (AP) = actual price per unit of material.
 (SP) = standard price per unit of direct material.
 (AQp) = actual quantity of material purchased.
Actual price > standard price: unfavorable.
Actual price < standard price: favorable.
 Material Quantity Variance

1. Material quantity variance: (AQu – SQ)SP

 (AQu) = actual quantity of material used.
 (SQ) = standard quantity of material allowed.
 (SP) = standard price of material.

Actual quantity > standard quantity: unfavorable.

Actual quantity < standard quantity: favorable.
 Direct Labor Variances
1. Differences between standard and actual
direct labor costs:
a. Labor rate (price) variance.
b. Labor efficiency (quantity) variance.
 Labor Rate Variance

1. Labor rate (price) variance: (AR – SR)AH

 (AR) = actual wage rate (price).
 (SR) = standard wage rate (price).
 (AH) = actual number(quantity) labor hours.

Actual rate > standard rate: unfavorable.

Actual rate < standard rate: favorable.
 Labor Efficiency Variance

1. Labor efficiency (quantity) variance:

(AH – SH)SR
 (AH) = actual number of hours worked.
 (SH) = standard number of hours worked.
 (SR) = standard labor wage rate.

Actual hours > standard hours: unfavorable.

Actual hours < standard hours: favorable.
 Overhead Variances

1. Differences between overhead applied to

inventory at actual overhead costs:
a. Controllable overhead variance.
b. Overhead volume variance.
 Controllable Overhead Variance
1. Actual overhead (Rs.) - flexible budget level of
overhead (Rs.) for actual volume of production.
2. It is referred as controllable because managers are
expected to control costs.
3. Actual > budget: unfavorable.
4. Actual < budget, then the variance is favorable.
 Overhead Volume Variance
1. Overhead volume variance:
Flexible budget level of overhead for actual level of
production - overhead applied to production using
standard overhead rate.
2. The Overhead Volume Variance indicates whether
fixed costs were efficiently used during the period.
3. This variance is solely the result of a different number
of units being produced than planned in the static
budget.
4. Usefulness is limited.
Example: Aspire Ice Cream
 Material Variances

1. Material price variance:(AP – SP) x AQp :

($2.72 - $2.50) x 810,000 = $178,200
unfavorable.
2. Material quantity variance: (AQu – SQ)SP:
(809,000 – 800,000) x $2.50 = $22,500
unfavorable.
 Labor Variances

1. Labor rate (price) variance: (AR – SR)AH:

($12.10 - $12.00) x 130,000 = $13,000
unfavorable.
2. Labor efficiency (quantity) variance:
(AH – SH)SR: (130,000 – 125,000) x $12 =
$60,000 unfavorable.
 Overhead Variances

1. Controllable overhead variance: Actual

overhead ($$) - flexible budget level of
overhead ($$) for actual volume of
production: $680,000 - $700,000 = $20,000
unfavorable.
2. Overhead volume variance: flexible budget
level of overhead for actual level of
production - overhead applied to production
using standard overhead rate: $700,000 -
$750,000 = $50,000 favorable.
 Reporting Variances

 Reporting variances
• All variances should be reported to appropriate levels of
management as soon as possible so that corrective
action can be taken
• The form, content, and frequency of variance reports
vary considerably among companies
• Variance reports facilitate the principle of “management
by exception”
• In using variance reports, top management normally
looks for significant variances