Standard Costing and

Variance Analysis
• This requires a responsibility accounting system
to be established.
– so that deviations from budget for various items of
expense can be attributed to the person in charge.
• Standard costing is a control system
– that enables deviations from budget to be analysed in
detail
– to allow costs to be controlled effectively.
• The objective of standard costing is to ensure that
the activities of an organisation adhere to plan.
Standard costing and budgets
Standards
•Very detailed and specific -
relates to products and
units
•Builds up
•Specific cost at planned
level of performance
•Can be built into day to
day accounting
Budgets
•Broad based and
comprehensive
•Relates to departments
•Builds down from
objectives
•General direction
•Not related to costing
system
 About standard costs
• What is a standard cost
– A standard cost is a predetermined cost
that should be incurred under defined
operating conditions
• Where is it best used
– Standard costing is best suited to
organisations whose activities consist of
repetitive and/or common operations
 How the system works
• Standards costs are established prior to
operations
• Actual costs are traced to cost centres
• Standard and actual costs are compared and
variances calculated
– (a variance must be stated in terms of is effect on
profit….adverse or favourable)
• Variances are investigated
• Corrective action is taken
• Standards may be adjusted
Establishment of Standards
• A standard is a detailed piece of information and
should be constructed carefully
• A material standard
– material specification - design/quality
– material usage
– material mixes/alternatives/losses
– prices/discounts
• a labour standard
– grades of labour
– division of labour between grades
– labour hours
– efficiency of labour/idle time
– wage rates
 Detailed analysis
Total Cost Variance

Materials Labour Overhead

Variance Variance Variance

Rate Efficiency
Variable Fixed
Variance Variance
Overheads Overheads
Expenditure Efficiency
Variance Variance

Price Usage Expenditure Volume

Variance Variance Variance Variance
 Types of standards
• Basic standards
– A standard left unchanged over a long period.
– A base is set and trends can be observed.
– Standards are not current targets.
• Ideal standards
– Standards of performance under perfect conditions.
– Goals to be aimed for.
– Can be demotivating
• Current standards
– Difficult but attainable
– Helps in motivating
Purposes and Advantages of
Standard Costing
• To assist with budget setting
• To evaluate managerial performance
• To control activities
• To simplify tracing costs for inventory valuation
• To provide a target for motivation
• To assist management by exception - management
only focuses energy on areas requiring attention
• To encourage cost reduction - setting standards
leads to appraisal of practices
• To assist setting of selling prices
• To encourage an atmosphere of cost consciousness.
Example - materials and labour variances
• The standard cost of an article is £
• materials 22 kg at £1 per kg 22
• labour12 hours at £3 per hour 36
• 58
• the actual results in a month
• materials 99000 kg costing £100400
• labour 63000 hours costing £158300
• £258700
• 4800 units were made
 The total cost variance
• 4800 units should have cost
• 4800 * £58 = £278400
• The actual cost was £258700
• A favourable variance of £19700
• Note
– SC = Actual units * standard cost per unit
– AC = Total actual cost incurred
 Analysis of the total cost variance
• Materials
– 4800 units should have cost 4800 * £22 = .
£105600
– the actual cost was £100400
– favourable variance £5200
• Labour
– 4800 units should have cost 4800 * £36 = .
£172800
– the actual cost was £158300
– favourable variance £14500
• Total £19700
Further analysis – materials 1
• Most variances can be split into a price and a
quantity element
• Material price variance
– std price/kg £1
– act price/kg £100400/99000
• as this price difference relates to 1kg, it must be
multiplied by the actual kg used to give the effect
on profit
• (SP - AP) AQ
– (£1 - £100400/99000) 99000
– Or (£1 * 99000 - £100400)
– = £1400 A
 Further analysis – materials 2
• Material Quantity Variance – usually
called the Usage Variance
– Calculate the material that should have
been used 4800 * 22 kg = 105600 kg
– Compare with the amount used = 99000kg
– Evaluate this difference at the standard
price (£1)
• (SQ – AQ) SP
– (105600 – 99000) £1 = £6600 favourable
 Further analysis – labour 1
• This follows a similar pattern to the material
variances
• Price variance (called rate variance)
– std price/hr £3
– act price/hr £158300/63000
• as this price difference relates to 1hour, it must
be multiplied by the actual hours used to give
the effect on profit
• (SP - AP) AQ
– (£3 - £158300/63000) 63000
– Or (£3 * 63000 - £158300)
– = £30700 F
 Further analysis – labour 2
• The quantity variance is called the efficiency
variance
• std quantity 4800 * 12 hrs 57600hrs
• act quantity 63000 hrs
• This time difference must be multiplied by the
standard price to give the effect on profit
• (SQ - AQ) SP
• [(4800 * 12) - 63000]£3
• = £172800 - £189000
• = £16200 A