STANDARD COSTING AND VARIANCE ANALYSIS

Standard: It is a predetermined measurable quantity set in defined conditions.

Standard Cost
The standard cost is a predetermined cost which determines in advance what each
product or service should cost under given circumstances.

Definition
• According to the chartered Institute of Management Accountants (C.I.M.A) London,
“Standard cost is the predetermined cost based on technical estimates for
materials, labour and overhead for a selected period of time for a prescribed set of
working conditions.”
• Backer and Jacobsen, “Standard cost is the amount the firm thinks a product or the
operation of a process for a period of time should cost, based upon certain
assumed conditions of efficiency, economic conditions and other factors.”

Standard Costing

Standard costing is a perfect system of controlling the costs and Measuring efficiency and
its development. It is a technique of cost reduction and cost control. It helps to provide
valuable guidance in several management functions such as formulating policies,
determining price level, etc. The essence of standard costing is to set objectives and
targets to achieve them, to compare the actual costs with these targets. Standard Costing
is used to ascertain the standard cost under each element of cost, i.e., materials, labours,
overhead. It can eliminate all kinds of waste. Through the application of this costing it can
be ascertained whether or not the activities of production are going on according as the
pre‐determined plan.

Advantages of Standard Costing

1. Proper Planning: It helps to apply the principle of “Management by exception”. That
is, the management need not worry over those activities which proceed in tandem
plans. It is only on the issues of exceptions that they have to concentrate.
2. Efficient Cost Control: Standard Costing is a tool for the management to gain
reduction in the cost and control over it. Under this technique, differences are
analysed and responsibilities are determined.
3. Motivational Factor: Labour efficiency is promoted and they are destined to be cost
conscious. Standards provide incentives and motivation to work with greater effort.
This increases efficiency and productivity.
4. Comparison of Forecasting and Outcome: A target of efficiency is set for the
employees and the cost consciousness is stimulated. Since the process of standard
 costing allow an appraisal to be made of personnel, machines and method of
working, current inefficiencies come to the notice and get eliminated.
5. 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.
6. Economical System: Standard costing system is economical system from the
viewpoint that it does not require detailed records. It also des not require a big staff.
It results in the reduction in paper work in accounting and needs very few records.
Thus, there is saving of time as well as money.
7. Helpful in Budgeting: Budgets are prepared on the basis of standard costing.
Standards which are set up in respect of materials, labour and overheads, are
helpful in preparing various budgets. For example, flexible budget, sales budget, etc.
8. Helps Formulate Policies: This technique is a valuable aid to the management in
determining prices and formulating production policies. Standard costing equips
cost estimates while planning the production of new products.
9. Helps Distinguish Activities: Standard costing helps in distinguishing between
skilled and unskilled activities. So the skilled worker only gives pays attention to
improving the activities of the unskilled workers.
10. Eliminates Wastage: Through fixing standard, certain waste such as material
wastage, idle time, lost machine hours, etc. are reduced.

Limitations of Standard Costing

1. Standard costing cannot be used in those concerns where non‐standard products
are produced. If the production is undertaken according to the customer’s
specifications then each job will involve different amount of expenditures. Under
such circumstances it is not possible to set up standards for every job. Standard
costing can be used only in those concerns where standardised products are
manufactured.
2. The process of setting up standards is a difficult task as it requires technical skill.
The time and motion study is required to be undertaken for this purpose. These
studies require a lot of time and money.
3. There are no inset circumstances to be considered for fixing standards. The
conditions under which standards are fixed do not remain static. With the change in
circumstances the standards are also to be revised. The revision of standard is a
costly process. In case the standards are not revised the same become
impracticable.
4. This system is expensive and small concerns may not afford to bear the cost. For
small concerns the utility from this system may be less than the cost involved in it.
 5. The fixing of responsibility is not an easy task. The variances are to be classified into
controllable and uncontrollable variances. The responsibility can be fixed only for
controllable variances. The determination of controllable and uncontrollable
variances will be a problem. The variances may be controllable at one point of time
and may become uncontrollable at another time. The problem is faced whenever a
responsibility is to be fixed.
6. The industries liable for frequent technological changes will not be suitable for
standard costing system. The change in production process will require a revision of
standard. A frequent revision of standard will be costly. So this system will not be
useful for industries where methods and techniques of production are fast
changing.

Fixation of Standard Costs

It typically involves the following steps:

1. Analysis of historical data: This involves analysing the company's historical cost
data to identify trends, patterns, and fluctuations in costs. This data provides the
basis for setting the standard costs for materials, labour, and overheads.
2. Benchmarking: Companies may also use industry benchmarks and best practices
to establish standard costs. Benchmarking involves comparing the company's cost
performance with that of its peers and competitors to identify areas for
improvement and set realistic targets.
3. Input from various departments: The fixation of standard costs often involves
input from various departments within the organization, including production,
purchasing, and finance. This input ensures that all relevant factors and
considerations are taken into account when setting standard costs.
4. Management approval: Once the standard costs have been established, they
typically require approval from senior management or the relevant decision‐makers
within the organization. This ensures that the standard costs are aligned with the
company's strategic goals and objectives.
5. Revision and updates: Standard costs are not fixed indefinitely and may require
periodic revision and updates to reflect changes in market conditions, technology,
and other relevant factors. This ensures that the standard costs remain relevant and
realistic over time.

Overall, the fixation of standard costs is a critical component of standard costing and plays
a key role in cost management, budgeting, and performance evaluation within an
organization.
Variances and Variance Analysis.

Variances represent deviations of actual performance from standard performance. There

can be cost variances, profit variances and sales Value variances. Variances can be
favourable or unfavourable depending upon their impact on the profits of the organisation.

Variance analysis is an exercise involving efforts to classify Variances according to causes

for highlighting the situation demanding managerial attention.

Classification of Variances

• Direct Material Variances

• Direct Labour Variances
• Overhead Cost Variances
• Sales or Profit Variances

1. Direct Material Variances

Direct material variances are also known as material cost variances. The material cost
variance is the difference between the standard cost of materials that should have been
incurred for manufacturing the actual output and the cost of materials that has been
actually incurred.

Material Cost Variance comprises of :

a) Material Price Variance, and

b) Material Usage Variance
i) Material Mix Variance
ii) Material Yield Variance
1. Material Cost Variance = Material Price Variance + Material Usage Variance
2. Material Usage Variance = Material Mix Variance + Material Yield Variance
 3. Material Cost Variance = Material Price Variance+(Material Mix Variance Material
Yield Variance )

Materials Cost Variance

Material cost variance is the difference between standard materials cost and actual
materials cost. Material cost variance arises due to change in price of materials and
variations in use of quantity of materials.

Materials Cost Variance = Standard Material Cost – Actual Material Cost

Standard Material Cost = Standard Price per unit x Standard quantity of materials

Actual Material Cost = Actual price per unit × Actual quantity of materials

• If the standard cost is more than the actual cost, the variance will be favourable,
and on the other hand, if the actual cost is more than the standard cost, the
variance will be unfavourable or adverse.

Materials Price Variance

Materials price variance is that part of material cost variance which is due to the standard
price specified and actual price paid. Material price variances may arise due to the
following reasons:
• Changes in basic prices of materials.
• Failure to purchase the quantities anticipated at the time when standards were set.
• Failure to secure discount on purchases.
• Failure to make bulk purchases and incurring more on freight, etc.
• Failure to purchase materials at proper time.
• Not taking cash discount when setting standards.

Materials Price Variance = Actual Quantity (Standard Price‐Actual Price)

• In this case actual quantity of material used is taken. If the answer is in plus,
variance will be Favourable and it will be unfavourable if the result is in negative

Material Usage Variance

Material usage (or quantity) variance is which arises due to the difference that part of
material cost in standard quantity specified and actual quantity of materials used. This
variance may arise due to the following reasons:
• Negligence in use of materials.
• More wastage of materials by untrained workers or defective methods of
production.
 • Loss due to pilferage.
• Use of material mix other than the standard mix.
• More or less yield from materials than the standard set.
• Defective production necessitating the use of additional materials

Materials Usage Variance = Standard Price (Standard Quantity – Actual Quantity)

• If the answer is in plus the variance will be Favourable and if the answer is negative
the variance will be unfavourable.

Material Mix Variance

Materials mix variance is that part of material variance which arises due to changes in
standard and actual composition of mix. It results from a variation in the materials mix
used in production. If material mix used in production is of a higher price and larger in
quantity than the standard mix, cost of actual material mix will be more.

The variance is calculated under two situations:

a) When actual weight of mix is equal to standard weight of mix.

b) When actual weight of mix is different from the standard mix.

a) When Actual weight and Standard Weight of mix are equal

Material mix variance = Standard cost of standard mix – Standard cost of actual mix
Or (Standard Price x Standard Quantity) – (Standard Price × Actual Quantity)
Or Standard unit cost (Standard Quantity – Actual Quantity)

• In case standard quantity is revised due to shortage of one material

Standard unit cost (Revised Standard Quantity – Actual Quantity).

b) When actual weight of mix is different from the standard mix.

Materials Yield Variance.

This is the sub‐variance of material usage variance. Materials yield variance is defined as
“that portion of the direct materials usage variance which is due to the standard yield
specified and the actual yield obtained”. This sub‐variance is very important for processing
industries in which final product of one process becomes the raw material of another
process. This sub‐variance may arise due to low quality of materials, defective methods of
production, carelessness in handling materials, etc.

Material Yield Variance =Standard Rate (Actual Yield ‐ Standard Yield)

There may be a situation where standard mix may be different from the actual mix. In this
case the standard is revised in relation to actual mix and the question is solved with the
revised standard and not with the original standard.

• When actual yield is more than the standard yield , the variance will be Favourable
and vice versa.

2. Direct Labour Variance

Labour Cost Variance

Labour cost variance is the difference between the standard direct wages specified for the
activity and the actual wages paid. Labour cost variance is the function of Labour rate of
pay and total labour efficiency or labour time variance. It arises due to a change in either
wage rate or in time or both.

Labour Cost Variance = Standard Labour Cost for Actual Output‐Actual Labour Cost
= (Standard Time for Actual Output x Standard Wage Rate)‐(Actual Time x Actual Wage Rate
Labour Rate of Pay or Wage Rate Variance

It is that part of labour cost variance which arises due to a change in specified wage rate.
Labour rate variance arises due to the following reasons:

1) Change in basic wage rate or piece‐work rate.

2) Employing persons of different grades then specified.
3) Payment of more overtime than fixed earlier.
4) New Workers being paid different rates than the standard rates.
5) Different rates being paid to workers employed for seasonal work or excessive work
load.

Labour rate of pay variance = Actual Time (stands rate – Actual rate)

• Variance Favourable: If actual rate is less than the standard rate

• Unfavourable: Actual rate is more than standard rate

Total Labour Efficiency or Labour Time Variance

It is that part of labour cost variance which arises due to the difference between standard
labour hours specified and the actual labour hours paid for including idle time. This
variance helps in controlling efficiency of workers.
The reasons for this variance are:
• Lack of proper supervision
• Defective machinery and equipment.
• Insufficient training and incorrect instructions.
• Increase in labour turnover
• Bad Working Conditions.
• Discontentment among workers due to unsatisfactory personnel relations.
• Use of non‐standard material requiring more time to complete work.
 Total Labour Efficiency Variance = Standard Wage Rate (Standard Time For Actual
Output‐Actual Time Paid)

• If actual time taken for doing a work is more than the specified standard time, the
variance will be unfavourable. On the other hand, if actual time taken for a job is less
than the standard time, the variance will be favourable.

Net Labour Efficiency Variance

This variance is that part of total labour efficiency variance which is causal due to the
difference between the standard labour hours specified and the act labour hours worked
excluding abnormal idle time.

(Net) Labour Efficiency Variance = Standard Rate (Standard Time for Actual Output‐Actual
Time Worked)
= Standard Rate[(standard time)‐(Actual Time paid – Idle Time)]

Idle Time Variance

This variance is a sub‐variance of labour efficiency variance. It is the standard cost of

actual time paid to workers for which they have not worked due to abnormal reasons.

The Reasons for idle time may be power failure, defect in machinery, non‐supply of
materials, etc.

Idle Time Variance = Idle Hours X Standard Rate

Labour Mix or Gang Composition Variance

This variances arises due to change in the actual gang composition than the standard gang
composition. The change in labour composition may be caused by the shortage of one
grade of labour necessitating the employment of another grade of labour.
It may be calculated in two ways:
a. When Standard Labour Mix is equal to Actual Labour Mix
b. When Standard Labour Mix is different from Actual Labour Mix

a. When Standard and Actual times of the labour mix are same

Labour mix variance = Standard cost of standard labour mix – Standard cost of actual
labour mix
• Revised
Labour mix variance = standard cost of revised Standard Labour mix – Standard cost of
Actual labour mix
 b. When Standard and actual time of labour mix are different

Labour Yield or Sub-Efficiency Variance

The labour yield variance or the labour sub‐ efficiency variance arises due to the standard
output specified and the actual output obtained.

Labour Yield/Sub‐efficiency Variance = Standard Labour Cost per unit of output (Actual
Yield‐Standard Yield for Actual Time)

3. Overhead Variances

Overhead is the aggregate of indirect material cost, indirect wages (indirect labour cost)
and indirect expenses. Overhead rates are predetermined in terms of either labour hours
(per hour) or production units (per unit of output). The actual labour hours or actual units
produced are multiplied by the standard overhead rate to determine the standard overhead
cost that ought to have been incurred. Standard overhead cost so calculated is then
compared with actual overhead cost to find out the variance .

Overhead cost variance can be defined as the difference between the standard cost of
overhead allowed for actual output (in terms of production units or labour hours) and the
actual overhead cost incurred.

Overhead Cost Variance = Actual Output x Standard Overhead Rate per unit ‐ Actual
Overhead Cost

OR , = Standard Hours for Actual output x Standard Overhead Rate per hour – Actual
Overhead Cost
Variable Overhead Variance

Variable overheads vary directly with the volume of output and hence, the standard
variable overhead rate remains uniform. Therefore, computation of variable overhead
variance, also known as variable overhead cost variance parallels the material and labour
cost variances.

Thus, variable overhead cost variance (VOCV) is the difference between the standard
variable overhead cost for actual output and the actual variable overhead cost.

VOCV = (Actual Output x Standard Variable Overhead Rate per unit) – Actual Variable
Overheads

Or, = (Standard Hours for Actual Output x Standard Variable Overhead Rate per hour) –
Actual Variable Overhead

Variable overhead cost variance can be further classified into:

i. Variable Overhead Expenditure or Spending Variance,
ii. Variable Overhead Efficiency Variance.

Variable Overhead Expenditure or Spending Variance.

This is the difference between the standard variable overheads for the actual hours and the
actual variable overheads incurred
Variable Overhead Efficiency Variance

It represents the difference between the Standard hours allowed for actual production and
the actual hours taken multiplied with the Standard Variable Overhead rate.

Variable Overhead Efficiency variance = Standard Variable Overhead Rate (standard hours
for Actual Output) – Actual Hours.

Fixed Overhead Variance

This variance is calculated as:

Actual Output x Standard Fixed Overheads Rate – Actual Fixed Overheads

The standard fixed overhead rate is calculated by dividing budgeted fixed overheads by
standard output specified.

Fixed overheads variance may be divided into

1. Expenditure Variance
2. Volume variance.

1. Expenditure Variance

It is that part of fixed overhead variance which is due to the difference between budgeted
expenditure and actual expenditure.

Overhead Expenditure Variance = Budgeted Fixed Overheads – Actual Fixed Overheads

2. Volume Variance.

This variance shows a variation in overhead recovery due to budgeted production being
more or less than the actual production. When actual production is more than the
standard production, it will show an over‐recovery of fixed overheads and the variance will
be favourable. On the other hand, if actual production is less than the standard production
it will show an under recovery and the variance will be unfavourable.

Volume variance may arise due to change in capacity, variation in efficiency or change in
budgeted and actual number of working days.

Volume Variance = Actual Output × Standard Rate – Budgeted Fixed Overheads

Volume Variance is sub divided into:

1) Capacity Variance

It is that part of volume variance which arises due to over‐utilisation or under‐utilisation of

plant and equipment. The working in the factory is more or less than the standard capacity.
This variance arises due to idle time caused by strikes, power failure, non‐supply of
materials, break down of machinery, absenteeism etc.

Capacity Variance = Standard Rate (Revised Budgeted Units‐ Budgeted Units)

OR

=Standard Rate (Revised Budgeted Hrs‐ Budgeted Hrs).

2) Calendar Variance

This variance arises due to the difference between actual number of days and the
budgeted days. It may arise due to more public holidays announced than anticipated or
working for more days because of change in holidays schedule, etc. If actual working days
are more than budgeted.

The variance will be favourable and it will be unfavourable if actual working days are less
than the budgeted number of days.

3) Efficiency Variance

This is that portion of the volume variance which arises due to increased or reduced output
because of more or less efficiency than expected. It signifies deviation of standard quantity
from the actual quantity produced. This variance is related to the efficiency variance of
labour.

Efficiency Variance = Standard Rate ( Actual Quantity – Standard Quantity)

OR

= Standard Rate per hour ( Standard Hours Produced – Actual Hours )