Module 4:

Standard Costing and Variance Analysis

Standard & Standard Cost:

The word standard means 'a norm' or a criterion. Standard cost is thus a criterion cost which may be
used as a yardstick to measure the efficiency with which actual cost has been incurred. In other words,
standard costs are predetermined costs or target costs that should be incurred under efficient operating
conditions.

According to Chartered Institute of Management Accountants (CIMA), 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'.

In the words of Brown and Howard, 'the standard cost is a predetermined cost which determines
what each product or service should cost under given circumstances'. Thus standard costs are planned
costs that should be attained under a given set of operating conditions.

Standard cost is a planned cost for a unit of product or service rendered.

The term 'standard', has been called by different names in accounting, e.g., 'a norm', 'a model or example
or comparison', 'a measure of comparison', 'a criterion of excellence', 'a yardstick', 'a benchmark', 'an
index of waste or potential saving', 'a sea level from which to measure cost altitudes', 'a gauge.'

A standard may be a norm or a measure of comparison in terms of specific items such as pounds or
kilograms of materials, labour hours required, hours of plant capacity used. The main object of standard
cost is to look forward and assess what the cost 'should be' as distinct from what the cost has been in the
past.

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Standard Costing:
Standard costing is a technique whereby standard costs are computed and subsequently compared
with the actual costs to find out the differences between the two. These differences (known as
variances) are then analysed to know the causes thereof so as to provide a basis of control.

The CIMA, London has defined standard costing as 'the preparation of standard costs and applying
them to measure the variations from actual costs and analysing the courses of variations with a
view to maintain maximum efficiency in production.'

Brown and Howard have defined it, 'as a technique of cost accounting which compares the standard cost
of each product or service with the actual costs, to determine the efficiency of the operations so that any
remedial action may be taken immediately.'

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Advantages of Standard Costing:

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Disadvantages of Standard Costing:

Variance Analysis
Variance is the difference between a budgeted, planned, or standard cost and the actual amount
incurred/sold.

Variance

Cost Variance Sales Variance Profit Variance

Material Overhead
Labour Cost
Cost Cost
Variance
Variance Variance

Cost variance is the difference between a standard cost and the comparable actual cost incurred during
a period.

Variance Analysis:
Variance analysis is the process of analysing variances by sub-dividing the total variance in such a way
that management can assign responsibility for any off standard performance.

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According to CIMA, London, ‘variance analysis is the process of computing the amount of variance and
isolating the causes of variance between actual and standard’.

A detailed analysis of controllable variances will help the management to identify the persons
responsible for its occurrence so that corrective action can be taken.

Types of Variances:
1. Favourable and Unfavourable Variances:
Where the actual cost is less than standard cost, it is known as favourable or credit variance. On the
other hand, where the actual cost is more than standard cost, the difference is referred to as unfavourable,
adverse or debit variance. Favourable variances are designated by (F) and Adverse by (A).

2. Controllable and Uncontrollable Variances:

If a variance can be regarded as the responsibility of a particular person, with the result that his degree
of efficiency can be reflected in its size, then it is said to be a controllable variance. For example, excess
usage of material is usually the responsibility of the foreman concerned. The variance which can be
controlled by taking necessary actions is called Controllable Variance.

If a variance arises due to certain factors beyond the control of management, it is known as
uncontrollable variance. For example, change in the market prices of materials, general increase in the
labour rates, increase in the rates of power or insurance premium, etc., are not within the control of the
management of the company.

3. Methods Variance:
While setting standards, specific methods of production are kept in view. If, for some reason or the
other, a different method of production is adopted, it will give rise to a different amount of cost, thereby
resulting in a variance. Such a variance is known as methods variance.

4. Revision Variance:
Revision variance is the difference between the standard cost originally set and the revised standard
cost.

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 MATERIAL COST VARIANCE

Material Cost Variance

Material Price Variance Material Quantity/Usage

(MPV) Variance (MQV/MUV)

Material Mix Variance Material Yield Variance

(MMV) (MYV)

1. Material Cost Variance (MCV):

Material cost variance is the difference between the standard cost of direct materials specified for the
output achieved and the actual cost of direct materials used. It is calculated as follows:

MCV = Standard Material Cost for actual Output – Actual Material Cost

AO
MCV = ( × SQ × SP) – (AQ × AP)
SO

MCV = (SQ × SP) – (AQ × AP)

Where, AO = Actual Output

SO = Standard Output
SQ = Standard Quantity
SP = Standard Price
AQ = Actual Quantity
AP = Actual Price

2. Material Price Variance (MPV):

That portion of the material cost variance which is due to the difference between the standard price
specified and the actual price paid, is called Material Price Variance. It is calculated by the following
formula:

MPV = AQ (SP – AP)

Thus, this is the difference between standard price and actual price multiplied by actual quantity.

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3. Material Usage (or Quantity) Variance:
This is 'that portion of the material cost variance which is due to the difference between the quantity
specified and the actual quantity used'.

AO
MQV = SP [( × SQ) – AQ]
SO
MQV = SP (SQ – AQ)

4. Material Mix Variance (MMV):

The material mix variance is defined as that portion of the material usage variance which is due to the
difference between standard and actual composition of materials. It may arise in industries like
chemicals, rubber, etc., where a number of raw materials are mixed to produce a final product. It arises
only where more than one type of material is used for producing the finished product.

MMV = (Revised Standard Quantity – Actual Quantity) × Standard Price

MMV = (RSQ – AQ) × SP

5. Material Sub-usage (or Material Revised Usage) Variance:

This is a sub-variance of the material usage variance and represents that portion of the material usage
variance which is attributed to reasons other than those which give rise to material mix variance. Thus,
the algebraic sum of this revised usage variance and material mix variance is equal to material usage
variance.

MRUV = (SQ – RSQ) × SP

6. Material Yield Variance (MYV):

This is also a sub-variance of material usage variance. It arises in process industries, like chemicals,
where loss of materials in production is inevitable. While setting standards, the normal or standard loss
is taken into account. But actual loss may differ from normal or standard loss. This results in actual yield
or output being different from standard yield.

MYV = (Actual Yield – Standard Yield) × Standard Output Price

MYV = (AY – SY) × SOP
Standard output price (SOP) is the standard material cost per unit of output.

Verification:
(i) MCV = MPV + MQV
(ii) MQV = MMV + MYV

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 LABOUR COST VARIANCES

Labour Cost Variance

Labour Rate of Pay Variance Labour Usage/Efficiency

(LRPV) Variance (LUV/LEV)

Labour Idle Time Labour Mix Labour Yield Variance

Variance (LITV) Variance (LMV) (LYV)

1. Labour Cost Variance (LCV):

AO
LCV = ( × ST × SR) – (AT × AR) If SO is not given, AO can be multiplied)
SO

Where, ST = Standard Time

SR = Standard Rate (Standard Hour)
AT = Actual Time
AR = Actual Rate (Actual Hour)

2. Labour Rate of Pay Variance (LRPV):

This is that portion of the labour cost variance which is due to the difference between the standard rate
of labour specified and the actual rate paid. Thus, this is the difference between standard and actual rates
of wages, multiplied by actual hours.
LRPV = AT (SR – AR)

3. Labour Efficiency Variance (LEV):

This is that portion of the labour cost variance which is due to the difference between labour hours
specified for actual output and the actual labour hours expended. Thus, this variance is the difference
between standard and actual time valued at standard rate.

LEV = SR (ST for AO – AT)

AO
LEV = SR [( SO × ST) – AT]

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4. Labour Idle Time Variance (LITV):
This variance represents that portion of the labour efficiency variance which is due to abnormal idle
time, such as time lost due to machine break-down, power failure, strike, etc.

LITV = Abnormal Idle Time × Standard Rate = IT × SR

Note: LITV is always adverse.

5. Labour Mix Variance (LMV):

It is also known as Gang Composition Variance. This variance is similar to material mix variance. It
arises only when more than one grade of workers is employed and the composition of actual grade of
workers differs from those specified.

LMV = (Revised Standard Time – Actual Time) × Standard Rate

LMV = (RST – AT) × SR

6. Labour Yield Variance (LYV):

This is quite similar to Material Yield Variance. This variance reveals the effect on labour cost of actual
output or yield being more or than the standard yield.

LYV = (Actual Yield – Standard Yield for Actual Input) × Standard Labour Cost per Unit of Output

𝐴𝑇−𝐼𝑇
LYV = SR per Unit × [AY - ( SY)]
𝑆𝑇

Verification:
(i) LITV + LMV + LYV = LEV
(ii) LEV + LRPV = LCV

Sales Variance
The sales variances affect the budgeted profit due to changes in Sales Revenue i.e., changes caused by
either a change in selling prices or sales quantities. A sales value variance reveals the difference between
actual sales and budgeted sales. This variance may arise due to change in sales price, sales volume or
sales mix.

Sales variances may be classified as follows:

a) Sales Value Variance
b) Sales Price Variance
c) Sales Volume Variance
d) Sales Mix Variance.

Sales Value Variance:

A Sales Value Variance is the difference between budgeted sales and actual sales. It is calculated as:

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Sales Value Variance = Actual Value of Sales – Budgeted Value of Sales

If actual sales are more than the budgeted sales, the variance will be favourable and on the other hand,
the variance will be unfavourable if actual sales are less than the budgeted sales.

Sales Price Variance:

A sales price variance is that portion of sales value variance which arises due to the difference between
the standard price specified and the actual price charged. It is calculated as:

Sales Price Variance = Actual Quantity (Actual Price – Standard Price)

Sales Volume Variance:

It is that part of sales value variance which is due to the difference between actual quantity of sales and
budgeted quantity of sales. It is calculated as:

Sales Volume Variance = Standard Price (Actual Quantity of Sales – Standard Quantity of Sales).

Sales Mix Variance:

It is a sub-variance of sales volume variance. The proportion in which different quantities were budgeted
may be different from the proportion of actual quantities sold. It is the difference of standard value of
revised mix and standard value of actual mix.

Note: Solve problems from book relating to Material, Labour and Sales variances.

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