STANDARD COSTING

&VARIANCE ANALYSIS

MR B D FUSIRE
LEARNING OBJECTIVES

You should be able to:

1. Explain how a standard costing system operates
2. Explain how standard costs are set
3. Calculate and identify causes for variances
4. Explain how the control process uses standard costs and variances
5. Explain and calculate mix, yield variances, planning and operating variances
DEFINATIONS

STANDARD COSTING
• Is the preparation and use of standard costs, their comparison with actual costs, and the analysis of variance to
their causes and points of incidence.
STANDARD COST
• Is a predetermined cost which is calculated from management's standards of efficient operation and the relevant
necessary expenditure. It may be used as a basis for price fixing, inventory valuation and cost control through
variance analysis.
STANDARD PRICE
• is the expected price for selling the standard product or service. When there is a standard sales price and a standard
cost per unit, there is also a standard profit per unit (absorption costing) or standard contribution per unit (marginal
costing).
DEFINATIONS

VARIANCE
• Is the difference between a planned, budgeted or standard cost and the
actual cost incurred
VARIANCE ANALYSIS
• Is the process of computing the amount of, and isolating the cause of
variances between actual costs and standard costs. Variance analysis
involves two phases i.e. computing of individual variances and
determination of the cause(s) of each variance.
OPERATION OF A STANDARD COSTING SYSTEM

OVERVIEW OF THE SYSTEM

1. Standards are set for common or repetitive tasks/process

2. Variances are calculated and traced to responsibility centres
3. The information is used for control purposes to improve performance
ESTABLISHING COSTS STANDARDS

• There are basically two approaches to establish standard costs which are:

I. Past historical records (widely used)

• If historical records are used to set standards, there is a danger that past
inefficiencies will affect the standards. The standards are set based on average
past performance for the same or similar operations.
• The disadvantage of this method is that, unlike the engineering method, it does
not focus attention on finding the best combination of resources, production
methods and product quality.
II. 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
TYPES OF STANDARDS

1. ATTAINABLE STANDARDS
• Defined as standards which should normally equal expectations under ‘normally efficient operating conditions’.
They may represent quite stiff targets to reach, but they are not beyond possibility.
• Currently attainable standards are the most frequently used because they give a fair base for comparisons, they set
a standard which ought to be achieved and they give staff a sense of achievement when the attainable target is
reached
2. BASIC STANDARDS
• These are long-term standards which remain unchanged over a period of years, they show trends over time.
• They give a base line against which to make long-term comparisons. They have the disadvantage of becoming
increasingly unrealistic as circumstances change.
TYPES OF STANDARDS

CURRENT STADARDS
• These are based on current working conditions, they are useful when current conditions are abnormal and any
other standard would provide meaningless information.
• The disadvantage is that they do not attempt to improve upon current conditions
IDEAL STANDARDS
• is one which applies in dream conditions where nothing ever goes wrong. It represents the cost to be incurred
under the most efficient operating conditions.
• It is an almost unattainable target towards which an organisation may constantly aim, but it may also cause a
lowering of morale in the organisation if staff can never reach the target
USES OF STANDARD COSTING

1. Provide a prediction of future costs that can be used for planning.

2. Provide a challenging target that individuals are motivated to achieve.
3. Assist in setting budgets, evaluating performance and setting selling
prices.
4. Act as a control device by highlighting activities that do not conform
to plan.
5. Simplify the task of tracing costs to products for inventory valuation.
6. Promote greater economy by making employees more costs conscious
VARIANCE ANALYSIS

COST VARIANCES

SALES VARIANCES
MATERIAL VARIANCES

MATERIAL COST VARIANCE/ TOTAL MATERIAL VARIANCE

• It is the difference between the actual cost of direct materials used and standard cost of direct materials specified
for the output achieved.
• This variance results from differences between quantities consumed and quantities of materials allowed for
production and from difference between prices paid and prices predetermined.
MCV=(AQ x AP)-(SQ x SP) OR MCV= MUV+MPV
MCV= Material Cost Variance AQ= Actual Quantity
AP= Actual Price
SQ= Standard Quantity SP= Standard Price
MUV= Material Usage Variance
MPV= Material Price Variance
MATERIAL VARIANCES

MATERIAL USAGE/ QUANTITY

• This results when actual quantities of raw materials used in production differ from standard quantities that should
have been used to produce the output achieved. It is that portion of the direct material cost variance which is due
to the difference between the actual quantity used and standard quantity specified.
MUV= (AQ-SQ)x SP
MUV= Material Usage Variance
AQ= Actual Quantity
SQ= Standard Quantity SP= Standard Price
MATERIAL VARIANCES

CAUSES OF MUV
1. Poor materials handling
2. Inferior workmanship by machine operator
3. Faulty equipment
4. Cheaper, defective raw material causing excessive scrap.
5. Inferior quantity control inspection
6. Pilferage
7. Wastage due to inefficient production method.
MATERIAL VARIANCES

MATERIAL PRICE
• This occurs when raw materials are purchased at a price different from standard price. It is that portion of the
direct materials which is due to the difference between actual price paid and standard price specified and cost
variance multiplied by the actual quantity.
MPV=(AP-SP)x AQ
MPV= Material Price Variance
AP= Actual Price
SP= Standard Price
AQ= Actual Quantity.
MATERIAL VARIANCES

CAUSES OF MPV
1. Recent changes in purchase price of materials.
2. Failure to purchase anticipated quantities when standard were
established
3. Not taking cash discounts anticipated at the time of setting standard,
resulting in higher prices
4. Substituting raw material differing from original materials
specifications
5. Freight cost changes & changes in purchasing & storekeeping
costs.
LABOUR COST VARIANCE

• It denotes the difference between the actual direct wages paid and the
standard direct wages specified for the output achieved.
•LCV=(AH x AR- SH x SR) OR LCV= LEV + LRV
•LCV= Labour Cost Variance
•AH= Actual Hours
•AR= Actual Rate
•SH= Standard Hours
•SR= Standard Rate
•LEV= Labour Efficiency Variance
•LRV= Labour Rate Variance
LABOUR EFFICIENCY VARIANCE

• If actual direct labour hours required to complete a job differ from the
number of standard hours specified, a labour efficiency variance
results.
• LEV= (AH-SH for the actual output) x SR
• LEV= Labour Efficiency Variance
• AH= Actual Hours
• SH= Standard Hours for the actual output
• SR= Standard Rate per hour
LABOUR EFFICIENCY VARIANCE

CAUSES OF LEV
1. Inferior raw material
2. Poor supervision
3. Poor employee performance
4. Lack of timely material handling
5. Inefficient production scheduling
6. Inferior engineering specifications
7. New inexperienced employees
8. Inefficient training to workers
9. Poor working conditions
10. Machine Breakdown
LABOUR RATE VARIANCE

• When actual direct labour hour rates differ from standard rates, the result is a labour rate variance.
• Favourable rate variance arise whenever actual rates are less than standard rates; unfavourable variances occur
when actual rates exceed standard rates.
•LRV= (AR-SR) x AH
•LRV= Labour Rate Variance
•AR= Actual Rate
•SR= Standard Rate
•AH= Actual Hours
LABOUR RATE VARIANCE

1. Employing different from the standard

2. Labour strike
3. Labour layoff
4. Employee sickness
5. Recent labour rate changes in the industry
OVERHEADS VARIANCES

• Overall overhead variance is the difference between the actual overhead cost incurred and the standard cost of
overhead for the output achieved.

• Total Overhead Cost Variance = (Actual overhead incurred-Standard hours for the actual
output x standard overhead rate per Hr)
OR
• Total Overhead Cost Variance = Actual overhead incurred - (Actual output x standard overhead rate
per unit)
VARIABLE OVERHEADS VARIANCE

• It is the difference between actual variable overhead cost and standard variable overhead allowed for the actual
output achieved.
• Variable Overhead Variance = Actual overhead cost - (Actual output x variable overhead rate per
unit)
OR
• Variable Overhead Variance = Actual overhead cost - (Standard hours for actual output x standard
variable overhead rate per hour)
• They are classified as variable overhead expenditure variance and efficiency variance
VARIABLE OVERHEADS VARIANCE
VARIABLE OVERHEADS EXPENDITURE VARIANCE
• Is the difference between the amount of variable production overhead that should have been incurred in the actual
hours actively worked, and the actual amount of variable production overhead incurred.
• It indicates the difference between actual overhead and budgeted variable overhead based on actual hours work
• Variable Overhead Expenditure Variance = (Actual variable overhead - budgeted variable overhead)
VARIABLE OVERHEADS EFFICIENCY VARIANCE
• Same formula with LEV but rate is VOR
• Variable Overhead Efficiency Variance = (Actual hours - standard hours for actual output) x Standard variable
overhead rate per hour.
FIXED OVERHEADS VARIANCE (TOTAL)

• It indicates the difference between the actual fixed overhead cost and the standard fixed overhead cost allowed
for the actual output, it is the under- or over-absorbed fixed overheads

• Fixed overhead variance = Actual overhead cost - fixed overhead absorbed

OR
• Fixed overhead variance = Actual overhead cost - (Standard hours for actual output x standard
fixed overhead rate per hour)
• This can be classified into fixed expenditure and volume variances as explained in next slides
FIXED OVERHEADS EXPENDITURE VARIANCE

• It represents the difference between the fixed overheads as per budget and the actual fixed overheads incurred.
• is the difference between the budgeted fixed overhead expenditure and actual fixed overhead expenditure
• If actual fixed overhead costs are greater than budgeted fixed costs, an unfavourable variance results because
actual costs exceeds the budget.

• Fixed overhead expenditure variance = (actual fixed overhead-budgeted fixed overhead)

FIXED OVERHEADS VOLUME VARIANCE

• This arises because the activity level actually attained frequently does not coincide with the activity level used as a
basis for estimating a pre-determined product costing rate for fixed overhead.
• Thus, this fixed overhead variance arises mainly because of the use of a pre-determined OAR based on a normal
volume of activity and of the activity being less or more than the normal volume so selected.
• Fixed Overhead Volume variance = (actual production- budgeted production) x standard fixed
overhead rate per unit
OR
• Fixed Overhead Volume variance = (budgeted overhead applied to actual output-budgeted fixed overhead
based on standard hour allowed for actual output)
FIXED OVERHEADS VOLUME VARIANCE

• Volume variance can be further analysed into capacity variance and efficiency variance
• All these show reasons of actual volume of production being different from the budgeted or estimated volume of
production.
• E.g. capacity variance refers to that part of volume variance that arises if the actual capacity utilised is lower or
higher than the capacity budgeted. Thus capacity variance may arise due to many reasons including breakdown in
machinery, working two shifts instead of one, as estimated earlier and delay in availability of raw materials, etc.
• Efficiency variance, on the other hand, may arise due to the fact that the number of units produced per hour of
work are higher or lower than what is considered as standard
FIXED OVERHEADS VOLUME VARIANCE

FIXED OVERHEADS EFFICIENCY VARIANCE

• It is that portion of volume variance which arises when actual hours of production used for actual
output differ from standard hours specified for that output.

• Fixed Overhead Efficiency Variance = (Actual hours - Standard hours for actual production) x Standard
Fixed Overhead rate per hour
OR
•Fixed Overhead Efficiency Variance = (Actual production - Standard production as per actual time
available) x Standard Fixed overhead rate per unit
FIXED OVERHEADS VOLUME VARIANCE

FIXED OVERHEADS CAPACITY VARIANCE

• It is that part of fixed overhead volume variance which is due to difference between the actual capacity (in
hours) worked during the given period and the budgeted capacity (in hours)

•Fixed overhead capacity variance = (Actual capacity hours - Budgeted capacity hours) x Standard Fixed
overhead rate per hour
SALES VARIANCES

• The sales price variance asks the question: What is the effect of the change in selling price on the profit margin for
the actual sales, assuming that all costs remain at standard costs ?
• The sales margin volume variance asks the question: How does the change in sales volume affect the standard
profit expected ?
RECONCILING BUDGETED AND ACTUAL PROFIT

• It is useful to summarise variances in a statement comparing the budgeted profit of the period with the actual profit
of the period.
• In some cases the usage variance will be sub-divided into mix and yield variances
MIX AND YIELD VARIANCES

MATERIALS MIX AND YIELD VARIANCE

• Material usage variance can be divided into material mix and yield variances where the standard unit consist of
more than one type of material.
• The material mix variance arises when the mix of materials used differs from the predetermined mix included in
the calculation of the standard cost of an operation.
• If the mixture is varied so that a larger than expected proportion of a more expensive material is used there will be
an adverse variance. When a larger than expected proportion of a cheaper material is included in the mix, then a
favourable variance occurs
• The material yield variance arises when there is a difference between the standard output for a given level of input
and the actual output attained
MIX AND YIELD VARIANCES

• Easy steps to calculate the material mix variance are as follows:

1. Write down the actual input. (This is the ACTUAL MIX.)
2. Take the actual input in total and push it down one line and then work it back in the standard proportions. (This
is the STANDARD MIX.)
3. Calculate the difference between the standard mix and the actual mix. This is the mix variance in terms of
physical quantities and must add up to zero in total. (If you use a higher than expected proportion of one
material, you must use a lower than expected proportion of something else!)
4. Multiply by the standard price per kg if its individual units method (or by the difference between weighted
average price and material price i.e. weighted average std price -individual material std price
5. This gives the mix variance in financial terms
MIX AND YIELD VARIANCES

• The yield variance is calculated in total.

• Easy steps to calculate the material mix variance are as follows:
1. Calculate the STANDARD YIELD. This is the expected output from the actual input
2. Compare this to ACTUAL YIELD. The difference is the yield variance in physical terms.
3. To express the variance in financial terms we multiply by the standard cost. One thing to be careful of however
is that the yield variance considers outputs and so the standard cost is the standard cost per kg OF OUTPUT.
4. This gives the yield variance in financial terms.
MIX AND YIELD VARIANCES

LABOUR MIX AND YIELD VARIANCE

• The labour efficiency variance can be divided into yield and mix variance as under the materials
• The labour mix variance arises when the mix of labour used differs from the predetermined mix included in the
calculation of the standard cost of an operation.
• If the mixture is varied so that a larger than expected proportion of a higher grade of labour is used there will be an
adverse variance. When a larger than expected proportion of a lower grade of labour is included in the mix, then a
favourable variance occurs.
• The labour yield variance arises when there is a difference between the standard output for a given level of input
(measured in terms of hours) and the actual output attained
*For calculations follow same steps as under materials mix and yield
PLANNING AND OPERATIONAL VARIANCES

PLANNING PRICE VARIANCE

• Is a classification of variances caused by ex-ante budget allowances being changed to an ex-post basis, they are
sometimes called revision standards
• The planning price variance shows the effect of revising the standard cost by comparing the standard cost of actual
materials under the old and new standard cost:

• This is adverse if the revised standard price is higher than the original standard price.
PLANNING AND OPERATIONAL VARIANCES

OPERATIONAL PRICE VARIANCES

• Is a classification of variances in which non-standard performance is defined as that which differs from an ex-post
standard
• The calculation of the operational price variance is very similar to the calculation of the traditional price variance.
The only difference is that the actual price is compared with the revised standard instead of the original standard:

• This is favourable if the actual cost is less than the revised standard cost.
PLANNING AND OPERATIONAL VARIANCES

PLANNING USAGE/ EFFIENCY VARIANCE

• This is calculated as follows:

• This is adverse if the revised standard quantity exceeds the original standard quantity
PLANNING AND OPERATIONAL VARIANCES

OPERATIONAL USAGE/ EFFIENCY VARIANCE

• This is calculated as follows:
MARKET VOLUME AND MARKET SHARE VARIANCES

• Traditional sales volume variance may result from the market size variance where the size of the market was
different from expected due to a change in the external environment (e.g. economic growth) or market share
variance where the share of that market was different from budget (e.g. due to effective advertising).
• The sales volume variance can therefore be split into sales volume planning variance and sales volume operational
variances
• The management can control market share variance but can not control the sales volume variance i.e. any
remuneration linked to performance should be linked to operational variance.
MARKET VOLUME AND MARKET SHARE VARIANCES

MARKET VOLUME VARIANCE

• This is calculated as follows:
MARKET VOLUME AND MARKET SHARE VARIANCES

MARKET SHARE VARIANCES

• This is calculated as follows:
PLANNING AND OPERATIONAL VARIANCES

BENEFITS
1. In volatile and changing environments, standard costing and variance analysis are more useful using this
approach.
2. Operational variances provide up to date information about current levels of efficiency.
3. Operational variances are likely to make the standard costing system more acceptable and to have a positive
effect on motivation.
4. It emphasises the importance of the planning function in the preparation of standards and helps to identify
planning deficiencies.
PLANNING AND OPERATIONAL VARIANCES

PROBLEMS
1. There is a large amount of labour time involved in continually establishing up to date standards and calculating
additional variances.
2. There is a great temptation to put as much as possible of the total variances down to outside, uncontrollable
factors, i.e. planning variances.
3. There can then be a conflict between operating and planning staff. Each laying the blame at each other's door
4. Extra data requirements (e.g. market volume)
5. More time consuming
ADDITIONAL READING

1. Behavioural aspects of standard costing

2. Standard costing the rapidly changing environment
3. Standard costing vs Morden manufacturing and business environment
QUESTIONS AND CONTRUBUTIONS

THANK YOU

ASANTE

SANA