Standard Costing

• Standard costs are predetermined costs for direct materials, direct

labor, and factory overhead.

• They are established by using information accumulated from past

experience and data secured from research studies.

• It is a financial control system that enables deviations from budget to

be analyzed in detail, thus enabling costs to be controlled more
effectively. This system of control is called standard costing.
Operation of a Standard Costing System
• Standard costing is most suited to an organization whose activities
consist of a series of common or repetitive operations where the input
required to produce each unit of output can be specified.

• It is therefore relevant in manufacturing companies, since the

processes involved are often of a repetitive nature.

• Standard costing procedures can also be applied in service industries

such as units within banks, where output can be measured in terms of
the number of cheques or the number of loan applications processed,
and there are also well-defined input–output relationships
Over View of Standard Costing System
Establishing Cost Standards
• There are two approaches that can be used to set standard costs. First, past
historical records can be used to estimate labour and material usage.
• Second, standards can be set based on engineering studies. This involves a
detailed study of each operation based on careful specifications of
materials, labour and equipment and on controlled observations of
operations.
• If historical records are used to set standards, there is a danger that past
inefficiencies will affect the standards. If historical standards are used,
standards are set based on average past performance for same or similar
operations.
• The disadvantage of this method is that, unlike engineering method, it
does not focus attention on finding the best combination of resources,
production methods and product quality. Nevertheless, standards derived
from average historical usage do appear to be widely used in practice.
 Variances
These measure the budgeted performance against what
actually happened. Variance is difference between the two.

Favourable (positive) variance is better than expected:

costs lower than expected
revenue (sales) higher than expected
Adverse (negative) variance is worse than expected:
costs higher than expected
revenue (sales) lower than expected

You need to use these two terms within the exam.

 Worked January–March 2021
Example Budget Actual Favourable
Variance
(Rs.) (Rs.) or adverse?

Cost of materials 1,000 900 100

Wages/salaries 1,000 1,500 500
Marketing costs 1,000 800 200
Other costs 1,000 1,200 200
Total costs 4,000 4,400 400
Sales income 5,000 4,500 500
Profit 1,000 100 900
 Practice question 1
January February

Budget Actual Variance Budget Actual Variance

Sales income 50,000 60,000 60,000 60,000

Cost of materials 20,000 25,000 20,000 30,000

Wages/salaries 10,000 10,000 10,000 10,000

Overheads 10,000 15,000 10,000 15,000

Total costs 40,000 50,000 40,000 55,000

Profit 10,000 10,000 20,000 5,000

 Practice question 2
March April

Budget Actual Variance Budget Actual Variance

Sales income 30,500 29,700 26,100 28,520

Cost of materials 10,000 11,000 6,000 7,000

Wages/salaries 5,000 5,525 10,000 10,500

Overheads 12,000 11,700 10,000 9,700

Total costs 27,000 28,225 26,000 27,200

Profit 3,500 1,475 100 1,320

 Material Variances
The costs of the materials that are used in a manufactured product are
determined by two basic factors:
the price paid for the materials
the quantity of materials used in production

This gives rise to the possibility that the actual cost will differ from the
standard cost because the actual price paid will be different from the
standard price and/or that the actual quantity of materials used will be
different from the standard quantity
Standard Price – Actual Price
(SP – AP)
 Material Price Variance
The starting point for calculating this variance is simply to compare the standard
price per unit of materials with the actual price per unit

Material Price Variance = (Standard Price – Actual Price) x Quantity Purchased

(SP – AP) x AQ
Material usage variance
The starting point for calculating this quantity variance is simply to
compare the standard quantity that should have been used with the
actual quantity which has been used.

Material Usage Variance =

(Standard Quantity – Actual Quantity)
X
Price?
Causes of Material Usage Variance
• Common causes of material usage variances include the careless
handling of materials by production personnel, the purchase of inferior
quality materials, pilferage, changes in quality control requirements or
changes in methods of production
Example
J&M Ltd makes a single product with the following budgeted material costs per unit:

2 kg of material A at Rs 10/kg
Actual details:
Output 1,000 units
Material purchased and used 2,200 kg
Material cost Rs 20,900
Calculate the total materials variance.
LABOUR VARIANCES
• The cost of labour is determined by:

the price paid for labour

And
the quantity of labour used

Thus a price variance (wage rate variance)

and a quantity variance (labour efficiency variance)
will also arise for labour.
 Wage Rate Variance [Labour Price]
Wage rate variance is equal to the difference between the
standard wage rate per hour (SR)
and
actual wage rate (AR)
multiplied by
actual number of hours worked (AH):
(SR - AR) x AH
Note the similarity between this variance and the material price variance.
Both variances

multiply
the difference between the standard price and the actual price paid for a unit of a resource
by the actual quantity of resources used
 Labour Efficiency Variance
Labour efficiency variance is equal to the difference between:

Standard labour hours for actual production (SH)

And
Actual labour hours worked (AH)
multiplied by
standard wage rate per hour (SR):

(SH - AH) x SR

This variance is similar to the material usage variance. Both variances multiply the
difference between the standard quantity and actual quantity of resources consumed by
the standard price.
 Total Labour Variance

Total labour variance is the difference between

Standard labour cost (SC) for actual production

and
Actual labour cost (AC):
SC - AC
 Example 5
Ivan Korshunov Ltd makes a single product and has the following budgeted / standard information:

• Budgeted production 1,000 units

• Labour hours per unit 3
• Labour rate per hour Rs 8
Actual results:
• Output 1,100 units
• Hours paid for and worked 3,400 hours
• Labour cost Rs 28,300
• Calculate rate and efficiency variances for labour.
 TRUE / FALSE

1. A direct material quantity standard generally includes an allowance for waste.

2. Practical standards allow for normal machine downtime and employee rest periods.

3. Ideal standards can be used in forecasting and planning whereas practical standards cannot be used for such
purposes.

4. Most companies compute the materials price variance when materials are placed into production.

5. A materials price variance is favorable if the actual price exceeds the standard price.

6. An unfavorable materials quantity variance occurs when the actual quantity used in production is less than the
standard quantity allowed for the actual output of the period.

7. An unfavorable labor rate variance can occur if workers with high hourly wage rates are assigned to work on
products whose standards assume workers with low hourly wage rates.
• When computing standard cost variances, the difference between actual and standard price multiplied by
actual quantity yields a(n):
A) combined price and quantity variance.
B) efficiency variance.
C) price variance.
D) quantity variance.
• Which of the following would produce a materials price variance?
A) an excess quantity of materials used.
B) an excess number of direct labor-hours worked in completing a job.
C) shipping materials to the plant by air freight rather than by truck.
D) breakage of materials in production.
• Which of the following would produce a labor rate variance?
A) Poor quality materials causing breakage and work interruptions.
B) Use of persons with high hourly wage rates in tasks that call for low hourly wage rates.
C) Excessive number of hours worked in completing a job.
D) An unfavorable variable overhead spending variance.

• Which of the following statements is a good description of the variances that should be investigated under the
management by exception concept?
A) all variances should be investigated.
B) only unfavorable variances should be investigated.
C) a small random sample of all variances should be investigated.
D) unusually large favorable and unfavorable variances should be investigated.