Management
Accounting
Module - I
Standard Costing
Historical Costing
• In the initial stages of development of cost accounting, historical
costing was the only system available for ascertaining costs.
• In historical costing only actual costs are ascertained. Historical
costs are the actual costs which have been incurred in the past.
Such cost are ascertained only after these have been incurred.
Limitations of Historical Costing
• No basis of cost control
• No yardstick for measuring efficiency.
• Delay in availability of information.
• Expensive system.
STANDARD COSTING
• Standard costing is a cost accounting technique which compares
the results of actual production with the basic standard, as
anticipated, in terms of costs so as to determine the reasons for
discrepancies between the anticipated and actual costs.
ACCORDING TO W W BIGG
• “Standard costing discloses the cost deviations from standard
and classifies these as to their causes, so the managements are
immediately informed of the spheres of operations in which
remedial action is necessary.
ACCORDING TO ICMA, LONDON
“The preparation and use of standard costs, their comparison with
actual costs and the analysis of variances to their causes and
points of incidence.”
ACCORDING TO WHELDON
“A method of ascertaining the cost whereby statistics are
prepared to show
• standard cost,
• the actual cost and
• the difference between these costs which is termed the
variance.”
TYPES OF STANDARDS
• The following are the various standards used in
standard costing:
Current Standard
Current standard is a standard established for use over a short period of time, related to current
conditions. The problem with this type of standard is that it does not try to improve on current levels of
efficiency.
Basic Standard
Basic standard is standard established for use over a long period from which a current standard can be
developed. The main disadvantage of this type of standard is that, it has remained unaltered over a long
period of time, it may be out of date. The main advantage is in showing the changes in trend of price and
efficiency from year to year.
Ideal Standard
Ideal standard is a standard which can be attained under the most favourable conditions. No provision is
made, e.g., for shrinkage, spoilage or machine breakdowns. Users believe that the resulting
unfavourable variances will remind management of the need for improvement in all phases of
operations. Ideal standards are not widely used in practice because they may influence employee
motivation adversely.
Attainable Standard
Attainable standard is a standard which can be attained if a standard unit of work is carried out
efficiently, on a machine properly utilized or material properly used. Allowances are made for normal
shrinkage, waste and machine breakdowns. The standard represents future performance and objectives
which are reasonably attainable.
NEED FOR STANDARD COSTING
Importance of Standard Costing cannot be ignored for the following and that is why the same
is well-developed in the present-day world:
(i) Compilation of Historical Cost is very expensive and difficult:
A manufacturing firm making large number of parts requires too much clerical work which is
required in order to compile the materials, labour and overhead charges to each and every
cost of parts produced for ascertaining the average cost of the product.
(ii) Historical Costs are inadequate:
In order to measure the manufacturing efficiency, historical costs are not practically
adequate. It fails to explain the reasons of increased cost or any change in cost structure.
(iii) Historical Costs are too old:
In many firms, costs are determined and selling prices are ascertained even before the
production starts—which is not desirable.
(iv) Historical Costs are not typical:
This is due to the wide fluctuation in market for which there is no relation between the
selling price per unit and cost price per unit.
OBJECTIVES OF STANDARD COSTING
1. Cost Control:
The most important objective of standard cost is to help the management in cost control. It can be used as a yardstick
against which actual costs can be compared to measure efficiency. The management can make comparison of actual costs
with the standard costs at periodic intervals and take corrective action to maintain control over costs.
2. Management by Exception:
The second objective of standard cost is to help the management in exercising control over the costs through the principle
of exception. Standard cost helps to prescribe standards and the attention of the management is drawn only when the actual
performance is deviated from the prescribed standards. It concentrates its attention on variations only.
3. Develops Cost Conscious Attitude:
Another objective of standard cost is to make the entire organisation cost conscious. It makes the employees to recognise
the importance of efficient operations so that costs can be reduced by joint efforts.
4. Fixation of Prices:
To help the management in formulating production policy and helps in fixing the price quotations as well as in submitting
tenders of various products. This can be done with accuracy with standard cost than the actual costs. It also helps in
formulating production policies. Standard costs removes the reflection of abnormal price fluctuations in production
planning.
5. Management Planning:
Budget planning is undertaken by the management at different levels at periodic intervals to maximize the profit through
different product mixes. For this purpose it is more convenient using standard costing than actual costs because it is done
on scientific and rational manner by taking into account all technical aspects.
PROCESS OF STANDARD COSTING
The steps involved in standard costing are as follows:
[Link] Standards:
First and foremost, the standards are to be set on the basis of management’s estimation, wherein the
production engineer anticipates the cost. In general, while fixing the standard cost, more weight is given to
the past data, the current plan of production and future trends. Further, the standard is fixed in both quantity
and costs.
2. Determination of Actual Cost:
After standards are set, the actual cost for each element, i.e. material, labour and overheads is determined,
from invoices, wage sheets, account books and so forth.
3. Comparison of Actual Costs and Standard Cost:
Next step to the process, is to compare the standard cost with the actual figures, so as to ascertain the
variance.
4. Determination of Causes:
Once the comparison is done, the next step is to find out the reason for the variances, to take corrective
actions and also to evaluate the overall performance.
5. Disposition of Variances:
The last step to this process, is the disposition of variances by transferring it to the costing profit and loss
account.
Standard costing can be helpful in ascertaining the profitability of the business at any level of
production. Further, it is also useful in practical management functions, i.e. planning and
controlling.
ADVANTAGES
• Measuring efficiency: Standard costing provides yardsticks against which actual
costs are compared to ascertain efficiency of actual performance. Thus, standard
costing helps in exercising cost control and provides information, which is helpful
in cost reduction.
• Determination of variance: By comparing actual cost with standard costs
variances are determined. Analysis of variance will assist to single out inefficiency
and locate person who are possible to take corrective measures at the earliest.
• Facilitates cost control: Every costing system aims to cost control and cost
reduction. Standard costing helps in exercising cost control and provide
information, which is helpful in cost reduction.
• Eliminating inefficiency: Standard costing will make possible to eliminate
inefficiency at different steps of activities relating to materials, labor and
overheads. Because setting standard require detailed study of various operations
so that they may be made efficiency.
• Fixing Responsibility: Variance analysis can determine the persons responsible
for each variance. Shifting or evading responsibility is not easy under this system.
• Helpful in taking important decisions: Standard costs being predetermined
costs and useful in planning and budgeting, it provides a valuable guidance to
the management in taking important decision. The problem created by
inflection, rising prices can be effectively taken with help of standard costing.
• Management by Exception: The principle of ‘management by exception can be
easily followed because problem areas are highlighted by negative variances.
• Improvement in Methods and Operations: Standards are set on the basis of
systematic study of the methods and operations. As a consequence, cost
reduction is possible through improved methods and operations.
• Guidance for Production and Pricing Policies: Standards are valuable
guides to the management in the formulation of pricing policies and production
decisions.
LIMITATIONS/DISADVANTAGES
• Difficulty in establishing standards: It is very difficult to establish standard
costs of materials, labor and overheads. So, sometimes in accurate and out of date
standards are set which do more harmful than any benefit as they provides wrong
yardsticks.
• Expensive: This system is expensive so small concerns may not afford to bear the
costs. Establishment of standard costing requires high degree of technical skill.
• Ignorance to qualitative aspects: Standard costing system controls the
operating part of an organization only as it ignores the other aspects like quality,
lead time, service, customer’s scarification and so on.
• Assumption of constant condition: Conditions of the business are changing.
Hence, standard must be revised form time but it us very difficultly bringing
changes in standard and is also expensive. Non-flexible standard loose their
importance.
• Variation in Price: One of the chief problems faced in the operation of the
standard costing system is the precise estimation of likely prices or rate to be paid.
• Varying Levels of Output: If the standard level of output set for pre-
determination of standard costs is not achieved, the standard costs are said
to be not realized.
• Changing Standard of Technology: In case of industries that have
frequent technological changes affecting the conditions of production,
standard costing may not be suitable.
• Problem in fixing Responsibility: The fixing of responsibility is not an easy
task. The variances are to be classified into controllable and uncontrollable
variances. Standard costing is applicable only for controllable variances.
PRE-REQUISUITES FOR STANDARD COSTING
Installation of standard costing system for accomplishing the desired objectives require
existence of certain pre-requisites. These prerequisites can be put as follows:
Acceptance of the System
The standard costing system can have the desired effects only when the system is
acceptable both to the management as well as to the workers. The management should
take sufficient interest in the system to make it effective. Similarly the workers should also
believe that in the long run, the system would be beneficial to all of them. This is possible
by fixing the standards in a way that they are capable of being achieved by an average
worker.
Judicious Setting of Standards
The standards should be fixed after a careful study of all technical processes and
operations of the business. They should be fixed judiciously and should not be ideal but
capable of being achieved. Setting of standards at too high a level will create resentment
among the workers and depress their performance while setting of standards at too low a
level will have adverse effects on personal initiative and costs. It will be appropriate to fix
the responsibility of setting standards on a committee consisting of important persons such
as Production Controller, Purchase Manager, Personnel Manager, Cost Accountant etc.
Reasonable Size
The system of standard costing can be introduced with advantage in concerns which are
of a reasonable size. The system may not be suitable for small concerns since in their
case careful scheduling of production may not be possible. For example, in a small
concern a worker may be handling different machines and at times he may be called to
handle different jobs and therefore, it may not be possible to correctly fix the standard
time for different jobs or different operations handled by him. Moreover, the system of
standard costing requires specialization of jobs and processes which may not be
possible in a small concern.
Competent Staff
The successful operation of standard costing system requires existence of well qualified
and trained staff for fixing the standards, measuring performance and reporting
variances to different levels of management. The reports submitted help the
management in applying the principle of “management by exception” which means that
the management pays attention only to those cases where performance is below or
above the standard.
Existence of Budgetary Control System
Existence of budgetary control system is a pre-requisite for the standard costing system.
Budgets fix the targets which the executives have to achieve. They create a sense of
discipline, financial or otherwise, among employees at different levels. Budgets are
projections for the future and therefore they are of great use to the effective functioning
of the standard costing system.
Proper Delegation of Authority and Responsibility
Standard costing system requires proper delegation of authority and
responsibility at different levels. This is possible by drawing an organization
chart clearly laying down the authority and responsibility of different
executives in the organization.
Efficient Accounting System
An efficient accounting system is also an essential requisite for successful
operation of the standard costing system. The accounting information supplied
should not only be accurate but also be complete and up to date. The system of
coding may be used for speedy recording and analyzing the accounting
information. Appropriate cost centres should also be set up in the organization
Standard costing
• Here is an example showing how a manufacturing company may calculate its
standard costing:
• Faster Path Production manufactures running shoes. The management conducts
a meeting with team leaders and they plan to manufacture 300 units of shoes in
the coming year. They estimate the costs as follows:
• direct labour: ₹500 per hour
• raw material: ₹1000 per unit
• manufacturing overhead: ₹800 per unit
• time to produce one unit: 5 hours
• fixed overhead: ₹1,00,000
1. Calculate the cost of direct labour, raw materials and
manufacturing overhead
• To calculate standard costs, the first step is to calculate each sub-component in the
formula. In this example, they are as follows:
• Materials cost = ₹1000 (cost per unit) x 300 (total number of units) = ₹3,00,000
• Direct labour = ₹500 (employee hourly rate) x 5 (number of hours to produce one unit) x
300 (total number of units) = ₹7,50,000
• Manufacturing overhead = ₹1,00,000 (fixed overhead) + ₹800 (variable manufacturing
overhead) x 300 (total number of units) = ₹3,40,000
2. Calculate the standard cost
• Once you have calculated the cost of direct labour, materials and overhead, you can add
them together to find the overall standard cost.
Standard cost = ₹3,00,000 (materials cost) + ₹7,50,000 (direct labour) + ₹3,40,000
(manufacturing overhead) = ₹13,90,000.
The company can estimate the cost of manufacturing one unit of running shoes, by
dividing the standard cost by the total number of units, which for this example is ₹4634.
Using the standard costing value, the company can plan the manufacturing budget and
decide the final selling price of the product.
Variance Analysis and Control
Variance Analysis
• Variance Analysis is the process of analyzing variance by sub-dividing the
total variance in such a way that management can assign responsibility for
any off standard performance.
• Variance analysis is the process of computing the amount of variance and
isolating the causes of variance between actual and standard.
• An important aspect of variance analysis is the need to separate controllable
from uncontrollable variance. A detailed analysis of controllable variance will
help the management to identify the persons responsible for its occurrence
so that the corrective action can be taken.
Cost Variance
• Cost Variance is the difference between a Standard
Cost and the comparable Actual Cost incurred during a
period.
Favorable and Unfavorable Variance
• Where Actual Cost< Standard Cost, - Favorable/Credit Variance.
• Where Actual Cost> Standard Cost, - Unfavorable, Adverse or Debit
Variance.
• In simple words, any variance that has a favorable effect on profit is
favorable variance and any variance that has an adverse or unfavorable
effect on profit is unfavorable variance.
• Positive(+) Variance will indicate favorable variance and Negative(-) Variance
will indicate adverse variance. Favorable Variance will b designated by (F)
and Adverse Variance by (A).
Controllable & Non-Controllable Variance
• If a variance arises due to the factors beyond the control of management, it is
known as Uncontrollable Variance.
• For example- Change in market prices of material, general increases in the labor
rates, increase in the rate of power or insurance premium, etc. are not within the
control of the management of the company.
• Responsibility for Uncontrollable Variance cannot be assigned to any person or
department.
• If a Variance can be regarded as the responsibility of a particular person, with the
result that his/her degree of efficiency can be reflected in its size, then it is said to
be Controllable Variance .
• For example- Excess usage of material is usually the responsibility of the foreman
concerned. However, if the excessive usage is due to material being defective, the
responsibility may rest with the Inspection Department for non-detection of the
defect.
Types of Variances
Material Cost Variance
Material Variance
• Material Cost Variance is the difference between the Standard Cost of Direct
Material specified for the output achieved and the Actual Cost of Direct
Material used.
• Material Cost Variance = Standard Cost of Actual Output – Actual Cost
• MCV = (Std. Quantity x Std. Price) ‐ (Actual Quantity x Actual Price)
• (SQ x SP) ‐ (AQ x AP)
Example:
A furniture company uses sunmica tops for tables. It provides the following
data:
• Standard quantity of sunmica per table =4 [Link].,
• Standard price [Link]. of sunmica=₹5,
• Actual production of table=1000 units,
• Sunmica actually used=4300 [Link].,
• Actual purchase price of sunmica [Link].,= ₹5.50.,
• Material Cost Variance will be calculated as under:
MCV = (SQ x SP)- (AQ x AP)
MCV = (1000 x 4 x 5) – (4300 x ₹5.50)
= 20000 – 23650
=3650 (A)
Material Price Variances (MPV):
• It is that portion of the material cost variance which is due to the difference
between the standard price specified and the actual price paid.
• Material Price Variance = (Standard Price – Actual Price) x Actual Quantity
• MPV = Actual Quantity (Std. Price ‐ Actual Price)
• AQ (SP - AP)
• Where, Price = Rate
Example:
A furniture company uses sunmica tops for tables. It provides the
following data:
• Standard quantity of sunmica per table =4 [Link].,
• Standard price [Link]. of sunmica=₹5,
• Actual production of table=1000,
• Sunmica actually used=4300 [Link].,
• Actual purchase price of sunmica [Link].,= ₹5.50.
• Material Price Variance will be calculated as under:
MPV = (SP – AP) x AQ
MPV = (5 – 5.50) x 4300
= ₹ 2150 (A)
Reason for Material Price Variance
• Change in the market price of materials.
• Change in the Quantity of materials, thereby leading to
lower/higher quantity discount.
• Inefficient purchasing.
• Change in the delivery costs.
• Rush/Emergency purchase
Material Usage(or Quantity) Variances (MUV):
• It refers to that portion of the material cost variance which is due to the
difference between the Standard Quantity Specified and the Actual Quantity
Used.
• Material usage variance is a part of Direct Material Cost Variance. MUV is
determined by difference found between the standard quantity and the use of
actual quantity.
• Later, the difference found is multiplied by the standard price.
• Material Usage Variance = (Standard Quantity for actual output – Actual
Quantity) x Standard Price
MUV = Standard Price (Std. Quantity ‐ Actual Quantity)
= SP (SQ ‐ AQ)
Example:
A furniture company uses sunmica tops for tables. It provides the
following data:
• Standard quantity of sunmica per table =4 [Link].,
• Standard price [Link]. of sunmica=₹5,
• Actual production of table=1000,
• Sunmica actually used=4300 [Link].,
• Actual purchase price of sunmica [Link].,= ₹5.50.
• Material Usage Variance will be calculated as under:
MUV = (SQ – AQ) x SP
MPV = (4000 - 4300) x 5
= ₹ 1500 (A)
Check
• The algebraic sum of material price variance and
material usage variance should be equal to material
cost variance. Thus:
MCV = MPV + MUV
3650 (A) = ₹2150 (A) + ₹1500 (A)
Reasons for Materials Usage Variance
• Use of defective or sub-standard material
• Careless in the use of material
• Pilferage
• Poor workmanships
• Defect in Plant & Machinery
• Change in design or specification of the product
• Change in quality of materials
Material Mix Variance (MMV):
• It is that portion of material usage variance which is due to the difference between
standard and actual composition of material.
• It may arise in industries like chemical, rubber etc, where a number of raw material are
mixed to produce a final product
• Change from standard mix may be due to the non-availability of one or more components
of the mix or due to non purchase of material at proper time.
• Increase in the proportion of cheaper material results in favourable mix variance and
vice versa, the use of more expensive materials in larger portion results in advance
variance.
• Material Mix Variance = (Revised Standard Quantity – Actual Quantity) x Standard Price
• MMV = (RSQ – AQ) x SP
• The revised standard quantity is nothing but the standard proportion of total of actual
quantities of all the materials. This is calculated as under:
• RSQ= Standard quantity of one material x Total of Actual Quantities of all materials
Total of standard quantities of all materials
Material Yield Variance (MYV):
• Material Yield Variance is that portion of the Material Usage
Variance which is due to the difference between Standard Yield
Specified and Actual Yield obtained.
• One important feature of yield variance which differentiates it from
other material variance (price, usage & mix variances) is that yield
variance is an Output Variance, while others are Input Variance.
• In other words, yield variance represents a Gain/Loss on output in
terms of finished production, while other variance represent a
Gain/Loss on cost of material input.
• Material Yield Variance = (Actual Yield – Standard Yield) x
Standard Output Price
• MYV = (AY – SY) x SOP
Example: During the month of May, the following data applies:
Raw material Standard Mix Actual Mix
Units kgs. Price Rs. Amount Units kgs. Price Rs. Amount
X 60 25 1500 56 25 1400
Y 40 50 2000 44 50 2200
Total 100 3500 100 3600
Less: Loss 30 26
Yield 70 74
The Standard loss is 30%. Calculate Material Yield Variance.
Labour Variance
• Labor variances occur because of the difference in actual rates and
standard rates of labor and the variation in actual time taken by
labors and the standard time allotted to them for doing a job. These
variances include Labor Cost Variances, Labor Rate Variances, Labor
Time or Efficiency Variances, Labor Idle Time Variances, Labor Mix
Variances.
Labour Variance
Labor cost
variance
Labor
Labor rate
efficiency
variance
variance
Labor yield Idle time Labor mix
variance variance variance
1. Labour Cost Variance (LCV):
• This is the difference between the standard direct labour cost and the actual direct
labour cost incurred for the production achieved.
• LCV = (Std. Time x Std. Rate) ‐ (Actual Time x Actual Rate)
• (ST x SR) ‐ (AT x AR)
2. Labor Rate Variances (LRV):
This is that portion of the labour cost variance which is due to the difference between
the standard rate specified and the actual rate paid.
LRV = Actual Time (Std. Rate ‐ Actual Rate), AT (SR ‐ AR)
Note: Actual Time = Actual Hours, Std. Rate = Std. Wage Rate
Reasons of Labor Rate Variance
• Change in basic wage rate
• Use of a different method of wage payment
• Employing worker of grades different from the
standard grades specified
• Unscheduled overtime
• New workers not being paid at full rates
• Often, Labor Rate Variance will be Uncontrollable
Variance as labour rates are usually determined by
Demand and Supply conditions in the labour market.
(3) Labor Time (Efficiency) Variances (LTV/LEV):
It is defined as the difference between the standard hours (Time) for the actual production
achieved and the hours actually worked, valued at the standard labor rate.
LTV = Standard Rate (Std. Time ‐ Actual Time)
SR (ST ‐ AT)
(4) Idle Time Variance (ITV):
ITV comes up because of idle time of workers on account of abnormal causes. The wages paid
for the time during which the workers remained idle due to causes like strikes, breakdown on
plant, etc. are treated as idle time variances.
ITV = Idle Time x Standard Rate, IT x SR
(5) Labor Mix Variance / Gang Composition Variance (LMV):
It occurs only when more than one grade of workers is employed and the composition of actual
grade of workers differs from those specified.
LMV = (Revised Std. Time ‐ Actual Time) x Standard rate
(RST ‐ AT) x Standard rate
Reason for Labor Efficiency
Variance
• Poor working conditions, Eg., inadequate lighting and
ventilation, excessive heating etc.
• Defective tools and plant and machinery
• Inefficient workers
• Incompetent supervision
• Use of defective or non-standard material
• Time wastage by factor like- waiting for material, tools
or machine breakdown
• Insufficient training of workers
(6). Labor Yield Variance: This is quite similar to Material
Yield Variance. This variance reveals the effect on labor cost of
actual output or yield being more or less than the standard yield.
LYV = (Actual yield – Std. yield from actual input) x Std. labor
cost per unit of output
Example:
Standard output 500 units
Actual output 450 units
Standard time 1000 hrs
Standard rate Rs. 20 per hour
Calculate Labor yield variance.
Overhead Variance
Overhead is the aggregate of indirect materials, indirect labour and
indirect expenses. Analysis of overhead variances is different from that of
direct material and direct labour variances by two reasons.
(1) It is difficult to establish Standard overhead rate for fixed overhead
because changes in the volume of output will affect the standard overhead
rate even if there is no change in the amount of fixed overhead cost.
(2) For computing overhead variances, there are quite a few
terminological options and methods.
The overhead variances include fixed overhead variances and variable
overhead variances. Moreover, further analysis of overhead variances is
also possible according as the available source information. It is
significant to know at the beginning that the overhead variance is not
anything but under or over‐ absorption of the overhead.
Overhead Variance
Overhead
cost
variance
Variable Fixed
Overhead overhead
cost cost
variance variance
Variable Variable
overhead overhead Calendar Capacity Efficiency
expenditure efficiency variance variance variance
variance variance
(a) Variable Overhead Cost Variance (VCOV):
VCOV is the difference between the standard variable overhead cost for production and the actual
variable cost incurred during the period.
VCOV = (Std. hours for actual Output x Std. variable overhead rate) ‐ Actual overhead cost
(1)Variable Overhead Expenditure Variance (VOEV):
VOEV is known as spending variance or 'Budget Variance'. This variance arises due to the
difference between standard variable overhead allowed and actual variable overhead incurred.
VCOV = (Std. Variable Overhead Rate x Actual Hours) ‐ Actual overhead cost
Standard V. O. ‐ Actual V. O.
(2) Variable Overhead Efficiency Variance (VOEV):
VOEV can occur due to the difference between standard hours allowed for actual output and actual
hours.
VOEV = (Std. Variable for actual output ‐ Actual hours) x Std. Variable overhead rate
Check V. O. Expenditure Variance + V. O. Efficiency Variance
(b) Fixed Overhead Cost Variance (VCOV):
FOCV is the difference between standard fixed overhead cost for actual output and
actual fixed overhead.
FOCV = (Std. hours for actual output x Std. F. O. Rate) ‐ Actual F.O.
(1)Fixed Overhead Expenditure Variances (FOEV): This is known as spending variance or
Budget Variance. It arises due to the difference between budgeted fixed overhead and actual
fixed overhead.
FOEV = Budgeted Fixed Overhead ‐ Actual Fixed Overhead
(2) Fixed Overhead Volume Variances (FOVV):
It is known as that portion of overhead variance which arises due to the difference between
standard cost of overhead absorbed by actual production and the standard allowance for that
output.
FOVV = (Std. Time for Actual Output ‐ Budgeted Time) x Std. Rate Absorbed
Overhead ‐ Budgeted Overhead
(i) Efficiency Variances (EV): It classifies that portion of volume variance which reflects the increased
or reduced output arising from efficiency above or below the standard which is expected.
EV = (Std. Time for Actual Output ‐ Actual Time) x Std. Rate
(ii) Capacity Variances (CV): It classifies that portion of the volume variance which is caused by
functioning at higher or lower capacity usage than the standard. It is affected by the factors like strikes,
power failure, over demand etc.
CV = (Actual Time Worked ‐ Budgeted Time) x Std. Rate
Std. Fixed Overhead ‐ Budgeted Overhead
Note: Actual Time = Actual Hours
(iii) Calendar Variances (CV): It classifies that portion of the volume variance which is caused by the
difference between the number of working days in the budget period and the number of actual working
days in the period to which the budget is applied.
This variance arises only in exceptional circumstances because normal holidays are taken into account
while laying down the standard.
CV = Actual No. of Working Days ‐ Std. No. of Working Days) x Std. Rate per Day
(Revised Budgeted Time ‐ Budgeted Time) x Std. Rate per Time
Reporting of Variances:
In order that a standard costing system may be of maximum value to the
management, it is essential that reports exhibiting variances from standards for
each element of cost of each department and operation should be quickly and
efficiently presented to the management. Moreover, it is essential that the
management should act speedily to investigate variances and where possible
make decisions to prevent recurrence of adverse variances.
Essentials of Effective Variance Report:
The following points for effective reporting under standard costing should be
considered:
• The report should be simple, clear and quick. If reports fail to inform the
management in a lucid and unambiguous manner of what has taken place
and what action may be taken, they should not fully serve their purpose.
• The report should present the result of the given period and evaluate the
level of efficiency achieved.
• The report should put forth a comparison of results obtained with those
planned.
• Special care should be taken of significant variances and thereby ensuring
the 'principle of exception' rule.
• Variances reports should profusely make use of the charts and graphs
wherever possible.
Presentation of variance:
The benefits of standard costing will depend how quickly and in what form
the variances are presented to the management. Although no standard firm
can be laid down for all purpose, it is essential that the details of standard
and actual cost figures along with variances are presented to the appropriate
management. Sometimes, a Reconciliation Statement is prepared to show the
standard cost or profit, variances and actual cost or profit.
Control Ratio:
In addition to variances, certain control ratios are commonly used by the management for
the use in controlling operations. These ratios are generally expressed in terms of
percentage. If the ratio is 100% or above, it indicates favorable position and vice versa.
Three important ratios are given below:
(a) Efficiency Ratio: It is defined as the standard hour equivalent to the work produced
expressed as a percentage of actual hours spent in production. Thus this ratio shows
whether actual time taken in production is more or lesser than the time allowed by the
standard. Its formulae is as follows:
Efficiency Ratio = Standard hours for actual output /Actual hours worked x 100
(b) Activity Ratio: It is defined as the standard hour equivalent to the work produced
expressed as a percentage of budgeted standard hours. This ratio shows the extent to
which the production facilities have been utilized as compared with that contemplated in
budgets. Its formula is:
Activity Ratio = Standard hours for actual output /Budgetary hours x 100
(c) Capacity Ratio: It shows the relation, between actual hours worked and the budgeted
hours. Its formula is:
Disposition (Disposal) of Variance
There is differing of opinions among the accountants as regards disposal of
cost variances. Variances are disposed of in accounts by the following methods:
• All types of variances are transferred to costing Profit and Loss Account.
• If inventories are valued at standard cost rather than at actual cost, different
operational statements can be made available at an earlier date.
• The amount of variances is equitably distributed over cost of sales and stock
of finished and semi‐finished goods. By doing so, the cost of sales and stock is
shown as actual cost in the financial statement.
• Each variance is carefully analyzed in accord with to the causes of its
occurrence. The profit or loss caused by the variances as were results of
controllable factors would be transferred to costing Profit & Loss Account.
On the other hand, the variances born of uncontrollable causes should be
given to cost of sales and stock. However, when the variances are prorated or
setup as reserves, they may not draw similar attention of executives.