Management control and
reporting
[Link] KUMAR
MANAGEMENT AND OPERATIONAL CONTROL
STANDARD COSTING
Standard cost is the amount the firm thinks a product or the operations of a
process for a period of time should cost, based upon certain assumed conditions
of efficiency, economic conditions and other factors.
The techniques of using standard costs for the purpose of cost control is known
as standard costing.
In other words, It is a technique of cost accounting which compares the standard
cost of each product or services with the actual cost to determine the efficiency
of the operation so that any remedial action may be taken immediately.
STANDARD COSTING
Standard cost is divided into: standards for material, labour and overheads.
The actual costs are recorded when they are incurred.
The standard cost is compared to actual cost, and the difference between the
two is known as Variance.
PURPOSE OF STANDARD COSTING
Cost control: sets a benchmark for material, labor, and overhead costs to identify overspending and implement
corrective actions, promoting financial discipline and cost efficiency.
Performance measurement: By comparing actual costs to standard costs, management can evaluate the
efficiency of different departments, processes, or products.
Budgeting and planning: Provides a foundation for creating accurate budgets and financial forecasts, which is
crucial for strategic decision-making and overall financial planning.
Variance analysis: Highlights the differences between expected and actual costs, providing insights into cost
drivers and pinpointing areas needing improvement.
Pricing decision: Helps in accurately setting prices for products by providing a clear estimate of production costs,
allowing for profitable pricing without overpricing.
PURPOSE OF STANDARD COSTING
Motivating employees: Establishes clear production and expense targets, serving as a
motivator for employees to achieve these predetermined standards.
Inventory valuation: Facilitates the valuation of inventory, including work-in-progress and
finished goods, by recording them at their standard per-unit costs .
Facilitating corrective actions: The analysis of variances allows management to understand the
causes of deviations from the plan and take appropriate corrective actions to maintain efficiency.
STEPS INVOLVED IN STANDARD COSTING
The determination of standard cost
The recording of actual cost
The comparison between standard cost and actual cost
The finding out of variance
Thereporting of variance so as to find out inefficiency and necessary corrective
measures.
ANALYSIS OF VARIANCES
The deviations between standard costs, profits or sales and actual costs, profits
or sales respectively is known as variances.
The variances may be favorable or unfavorable.
Unfavorable Favorable
Actual cost > standard cost Actual cost < standard cost
Actual profit < standard profit Actual profit > standard profit
Actual sales < standard sales Actual sales > standard sales
CLASSIFICATIONS OF VARIANCES
Direct material variances
Direct labour variances
Overheads cost variances
Sales/ profit variances
DIRECT MATERIAL VARIANCES
It is also know as material cost variances.
Itis the difference between the standard cost of material that should have been
incurred for manufacturing the actual output and the cost of materials that has
been actually incurred.
DIRECT MATERIAL VARIANCES
Material cost variance
Material price variance Material usage variance
Material mix variance Material yield variance
DIRECT MATERIAL VARIANCE
Material cost variance = Material price variance + Material usage variance
Material usage variance = Material mix variance + Material yield variance
Material cost variance = Material price variance + Material mix variance +
Material yield variance
MATERIAL COST VARIANCES
It is the difference between standard material cost and actual material cost.
It arises due to change in prices of material and variations in use of quantity of
material.
MATERIAL COST VARIANCES
Material cost variance = Standard material cost – Actual material cost
Standard material cost = Standard price per unit * Standard quantity
of materials
Actual material cost = Actual price per unit * Actual quantity of
material
Decision rule: Standard cost > Actual cost (Favorable variance)
Actual cost > Standard cost (Unfavorable variance)
MATERIAL PRICE VARIANCE
Part of material cost variance which is due to standard price specified and actual
price paid.
It arises due to following reasons:
• Change 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 freights.
• Failure to purchase materials at proper time
• Not taking cash discount when setting standards
MATERIAL PRICE VARIANCES
Material price variance = Actual quantity (standard price – actual price)
MATERIAL USAGE VARIANCE
It arises due to difference in standard quantity specified and actual quantity of
material used.
It arises due to 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
MATERIAL PRICE VARIANCES
Material usage variance = Standard price (standard quantity – actual
quantity)
PROBLEM
Following the data of a manufacturing concern. From the figures given
below, calculate:
I. Material cost variance
II. Material price variance
III. Material usage variance
The standard quantity of materials required for producing one ton of
output is 40 units. The standard price per unit of material is $3. During a
particular period 90 tons of output was undertaken. The materials
required for actual production were 4000 units. An amount of $14000
was spent on purchasing the materials.
PROBLEM
Following the data of a manufacturing concern. From the figures given
below, calculate:
I. Material cost variance
II. Material price variance
III. Material usage variance
Products Standard Standard price Actual quantity Actual price
quantity (Units) (Units)
A 1050 2.00 1100 2.25
B 1500 3.25 1400 3.50
C 2100 3.50 2000 3.75
MATERIAL MIX VARIANCE
It arises due to variations in materials mix used in production.
Ifthe material mix used in production is of higher price and larger in quantity
than the standard mix, cost of actual material mix will be more
On the other hand, the use of cheaper materials in larger proportions will mean
lower material cost than the standard.
MATERIAL MIX VARIANCES
Material mix variance = Standard cost of material mix – Standard cost
of actual mix
Material mix variance = (Standard price * Standard quantity) –
(Standard price * Actual quantity)
Material mix variance = Standard unit cost (Standard quantity – Actual
quantity)
In case standard quantity is revised due to shortage of material:
Material mix variance = Standard unit cost (revised standard quantity
– actual quantity)
PROBLEM
From the following information, calculate material mix variance:
Products Standard Standard price Actual quantity Actual price
quantity (Units) (Units)
A 40 10 50 12
B 60 5 50 8
MATERIAL YIELD VARIANCE
Sub-variance of material usage variance.
It results from difference between actual yield and standard yield.
Itis that portion of direct material variance which is due to the standard yield
specified and the actual yield obtained.
MATERIAL YIELD VARIANCES
Standard rate (actual yield – standard yield)
*Standard rate= standard cost of standard mix/ net standard output
* Net standard output = Gross output – standard loss
* Standard rate= standard cost of revised standard mix/ net standard
output
PROBLEM
From the following information, calculate material yield variance:
Products Standard Standard price Actual quantity Actual price
quantity (Units) (Units)
A 80 5 60 4.50
B 70 9 90 8
There is a standard loss of 10%
Actual yield is 125 units
DIRECT LABOUR VARIANCES
Amount paid to employees for their labour is called labour cost.
Labour cost variance is difference between the actual labour cost and standard
cost.
Labour cost variance = standard labour cost for actual output – actual labour
cost
= (standard time for actual output * standard wage rate) – (actual time *
actual wage rate)
DIRECT LABOUR VARIANCES
Labour cost variance
Labour efficiency Labour idle time
Labour rate variance
variance variance
Labour yield
Labour mix variance
variance
LABOUR COST VARIANCES
Labour cost variance is the difference between the standard direct
wages specified for the activity and the actual wages paid.
It arises due to a change in either wage rate or time or both.
LABOUR COST VARIANCES
Labour cost variance = standard cost – Actual cost
OR
(Standard hour * Standard rate)–(Actual hour * Actual rate)
LABOUR RATE VARIANCES
Labour rate variance arises due to change in specified wage rate.
It arises due to following reasons:
Change in basic wage rate
Employing persons of different grades then specified
Payment of more overtime than fixed earlier
New workers being paid different rates than the standard rates
Different rate being paid to workers employed for seasonal work
LABOUR RATE VARIANCES
Labour rate variance = actual time (standard time – actual rate)
Actual rate < standard rate (favorable)
Actual rate > standard rate (unfavorable)
LABOUR EFFICIENCY VARIANCES
It arises due to deviation in the working hours from the standard working
hours.
The reason for such variances are:
Lack of proper supervision
Defective machinery and equipment
Insufficient training and incorrect instructions
Increase in labour turnover
Bad working conditions
Use of non-standard material requiring more time to complete work
LABOUR EFFICIENCY VARIANCES
Labour efficiency variance = Standard wage rate (standard time for actual
output – actual time paid)
Actual time < standard time (favorable)
Actual time > standard time (unfavorable)
LABOUR MIX VARIANCES
It is a measure used to analyze the cost impact caused by changes in the
composition or mix of labor employed compared to the standard labor
mix expected.
It reflects whether the actual labor mix was more or less costly than the
standard mix.
LABOUR MIX VARIANCES
Labour mix variance = Standard Cost of Standard Mix−Standard Cost of Actual
Mix
OR
Labour Mix Variance=(Revised Standard Hours (RSH)−Actual Hours Worked
(AHW))×Standard Rate
Where,
RSH =
AHW= actual hour worked by various labor grades
LABOUR YIELD VARIANCES
It measures the difference in cost due to the variation between the
actual output (yield) and the standard output expected from a given
amount of labor input.
It reflects how efficiently labor inputs have been converted into actual
output compared to the standard.
LABOUR YIELD VARIANCES
Labour yield variance = (actual yield – standard yield)* standard labour cost
Actual yield >standard yield (favorable)
Actual yield < standard yield (unfavorable)
LABOUR IDLE TIME VARIANCES
It measures the cost impact of labor hours that were paid for but not
actually used for productive work due to reasons such as machine
breakdowns, power failures, or other interruptions.
The variance isolates this cost to show how much money was lost due to
idle time compared to the standard expectation.
LABOUR IDLE VARIANCES
Labour idle variance = idle hour * standard labour rate
PROBLEM
The standard and actual figures of a firm are as under:
Standard time for the job 1,000 hours
Standard rate per hour Rs 50
Actual time taken 900 hours
Actual wages paid Rs 36,000
CALCULATE the variances (Labor rate variance, efficiency variance, labor cost
variance)
OVERHEAD VARIANCES
Variable overheads consist of expenses other than direct material and direct
labour which vary with the level of production.
Ifvariable overhead consist of indirect materials, then in this case it varies with
the direct material used. On the other hand, if variable overhead is depending on
number of hours worked then in this case it will vary with labour hour or
machine hours.
If nothing is mentioned specifically, then take labour hour as basis.
OVERHEAD VARIANCES
Overheads cost variance
Variable overhead Fixed overhead
variance variance
Expenditure Efficiency Expenditure Volume
variance variance variance variance
OVERHEAD COST VARIANCES
Variable overhead cost variance calculation is similar to labour cost
variance.
Variable overhead cost variance is divided into two parts
(i) Variable Overhead Expenditure Variance and
(ii) Variable Overhead Efficiency Variance.
VARIABLE OVERHEAD VARIANCES
Variable overhead variance is the difference between what a company
actually spends on variable overheads and what it expected or budgeted
to spend based on production levels.
Variable overheads include costs like utilities and indirect materials that
change with production activity.
EXPENDITURE VARIANCES
Variable overhead expenditure/spending variance measures the
difference between the actual cost per unit of variable overhead and the
standard (budgeted) cost per unit based on the actual hours worked.
Variable Overhead Spending Variance=(Actual Rate−Standard
Rate)×Actual Hours Worked
EFFICIENCY VARIANCES
Variable overhead efficiency variance measures how efficiently
resources (like labor hours) are used compared to the expected standard
hours, multiplying this difference by the standard rate.
Variable Overhead Efficiency Variance=(Actual Hours Worked−Standard
Hours Allowed)×Standard Rate
PROBLEM
Calculate variable overhead variances from the following data:
Budgeted production for Jan, 2024 3000 units
Budgeted variable overhead ₹ 15000
Standard time for one unit 2 hours
Actual production for Jan, 2024 2,500 units
Actual hours worked 4500 hours
Actual variable overhead ₹ 13,500
FIXED OVERHEAD VARIANCES
Fixed overhead variance measures the difference between the budgeted
(or standard) fixed overhead costs and the actual fixed overhead costs
incurred by a company.
Fixed overhead costs are those expenses that do not change with the
level of production, such as factory rent, salaried staff wages, insurance,
and depreciation.
FIXED EXPENDITURE VARIANCES
This is the difference between the actual fixed overhead costs incurred
and the budgeted fixed overhead costs.
If actual costs are higher than budgeted, the variance is unfavorable; if
lower, it is favorable. This variance reflects how well costs are controlled.
Fixed expenditure Variance=Actual Fixed Overhead−Budgeted Fixed
Overhead
FIXED OVERHEAD VOLUME VARIANCES
This reflects the difference between the budgeted fixed overhead
absorbed based on expected production and the fixed overhead
absorbed based on actual production volume.
It shows whether overheads were over-absorbed or under-absorbed due
to actual production being higher or lower than budgeted.
Volume Variance=Budgeted Fixed Overhead−Applied Fixed Overhead
(based on actual production)
PROBLEM
From the following information compute:
i) Fixed overhead variance
ii) Expenditure variance
iii) Volume variance
Budget Actual
Fixed overheads for November ₹ 20,000 20,400
Units of production in November 10000 10,400
Standard time for 1 unit 2 hours
Actual hours worked 20,100 hours
SALES VARIANCES
Sales variance measures the difference between actual sales and
budgeted (expected) sales, helping organizations analyze sales
performance and understand the reasons behind deviations from
targets.
The variance may arise due to change in sales price, sales volume or
sales mix.
SALES VARIANCES
Sales variance may be classified as follows:
I. Sales value variance
II. Sales price variance
III. Sales volume variance
IV. Sales mix variance
SALES VARIANCES
Sales Price Variance: The difference caused by selling at a price higher or lower
than the budgeted price.
Sales Price Variance=(Actual Price−Budgeted Price)×Actual Units Sold
Sales Volume Variance: The difference caused by selling more or fewer units than
planned, calculated at the budgeted price. or fewer units than planned,
calculated at the budgeted price.
Sales Volume Variance=(Actual Units Sold−Budgeted Units Sold)×Budgeted Price
SALES VARIANCES
Sales value Variance: It is the difference between the actual sales revenue and
the budgeted (standard) sales revenue for a period.
Sales Value Variance=Actual Sales Value−Budgeted Sales Value
Sales mix Variance: Sales mix variance shows the effect on profit of selling a
different combination of products than was planned or budgeted. It isolates the
impact caused by changes in the proportion of different products sold, assuming
the total number of units sold remains the same.
Sales Mix Variance=(Actual Mix Quantity−Budgeted Mix Quantity)×Standard Profit
or Contribution per Unit
PROBLEM
The budget and actual sales for a period in respect of two products are as
follows:
Product Quantity Budgeted Value ₹ Quantity Actual price Value ₹
(units) price ₹ (units) ₹
X 600 3 1,800 800 4 3,200
y 800 4 3,200 600 3 1,800
Calculate sales variance.
THANK YOU!