STANDARD COSTING
&
VARIANCE ANALYSIS
LEARNING OBJECTIVES
▪Explain the theory and practice of standard
costing.
▪Determine the standards.
▪Prepare basic variance analysis.
BASIC
VARIANCE ANALYSIS
INTRODUCTION
▪ Standard costing is an important control technique (how effective
and efficient the business is being operated)
▪ It is best suited to repetitive manufacturing process
▪ It establishes as predetermined estimates of the cost of products
or services, collects actual costs and compares the actual result
with the predetermined estimates
▪ The predetermined costs are known as standard costs and the
difference between standard and actual is known as variance
▪ The process by which the total variance is subdivided is known as
variance analysis
4
DEFINITION OF STANDARD COSTING
▪ A predetermined calculation of how much costs should be under
specified working conditions
▪A planned cost for a unit of production prepared in advance
▪It is an estimate of the cost required to make a unit of product during
a predetermined future.
▪It is also a target cost which should be achieved under efficient
conditions.
▪Standard cost provides a yardstick against which actual performance
can be measured
5
Differences between Standards and Budget
▪ Standard is a unit concept. It is more detailed and applied to a
particular product, to individual operations or process
▪ Budgets are concerned with totals. Laid down cost limits for
functions, departments and organization as a whole
6
OBJECTIVES OF STANDARD COSTING
Facilitate budget setting & appraisal of managerial
performance
As a control device by directing action according to the plan
Provide future cost projections that can be used for decision
making
Simplify the task of tracing the cost for inventory valuation
As a challenging target for managers to strive for it
7
PURPOSES OF STANDARD COSTING
1. To provide a prediction of
future costs that can be used
for decision-making.
2. To provide a challenging
target that individuals are
motivated to achieve.
3. To assist in setting budgets
and evaluating performance.
4. To act as a control device by
highlighting those activities
that do not conform to plan.
5. To simplify the task of tracing
costs to products for Figure 1: Standard costs for inventory valuation and
inventory valuation. profit measurement
8
ADVANTAGES OF STANDARD COSTING
Facilitate comparisons of actual performance with standards.
The variance can be analyzed to enable management to know
the cause so that corrective action can be done
Reveal inefficiencies-adverse situation
Develop cost consciousness
Reveal effect of price fluctuations on costs
Helps manager to focus on important issues
Provide the measure of the performance of an individual
manager
9
DISADVANTAGES OF STANDARD COSTING
Company may tend to retain a particular standard longer than it
should be without modifying it
Standard is set based on judgments and subject to errors
Employee may forgo the quality of product to reduce cost
Material prices are difficult to set because of external influences
Setting labour efficiency standard often give rise to disagreement
Deciding on quality of material used is difficult because the quality
will have a bearing on material wastage
10
TYPE OF STANDARDS
▪ Four different types of standards to consider:
▪ Ideal or Perfection Standard
▪ Practical or Attainable Standard
▪ Normal Standard
▪ Basic Standard
TYPE OF STANDARD COST
▪ Ideal Standard
▪ Based on perfect operation condition, no
breakdowns, no defects, no accidents, no wastage
and no error.
▪ The difference between actual and standard may be
significant
▪ It may have an adverse effect on employee’s morale
so it could de-motivate employees
▪ Unrealistic and unattainable
12
TYPE OF STANDARD COST
▪ Attainable/Expected Standard
▪ Based on normal operation condition-still efficient but not
perfect operating condition
▪ Useful psychological incentive, realistic and challenging
target of efficiency
▪ Allowance are made for normal material losses, fatigue and
machine breakdown
▪ It could motivate staff to achieve
▪ It can be used for product costing, cost control, stock
valuation, etc
13
TYPE OF STANDARD COST
▪ Current Standard
▪ Based on current working condition
▪ Standard that is set for use over a short period (usually
one year) to reflect current conditions
▪ When condition is stable, current standard will be the
same as attainable standard
▪ When there is unexpected price increase, current
standard should be set to cover a few months so as to
deal with the temporary changes
14
TYPE OF STANDARD COST
▪ Basic Standard
▪ Kept unaltered over a long period of time, may be
outdated.
▪ Advantages – able to show the trend analysis for items
such as material prices, labor rates and efficiency
▪ Disadvantages – standards meaningless when changes
occur
▪ It is also used as a basis for setting current standards
▪ Cannot be used to highlight current efficiency or
inefficiency
15
VARIANCE ANALYSIS
• Indication of how far the organization adheres to its plans.
• Investigation should be undertaken so that necessary
corrective action can be implemented.
• Traditional Variance Analysis:
1. Material Cost variance
2. Labour cost variance
3. Variable Production overheads
4. Fixed Production overheads
5. Sales variance
16
DIRECT MATERIAL VARIANCES
1. Material price variances [MPV] 2. Material usage variance [MUV]
▪ The measure of the effect ▪ A measure of the effect on cost of using a
on cost of purchasing at a different quantity of material in production
compared with the standard quantity that
price that is different from should have been used for the actual
standard production output
= (AP – SP) AQ = (AQ – SQ fap) SP
Where Where
AQ = actual quantity purchased SP = standard price
AP = actual price AQ = actual material quantity used
SP = standard price SQfap = standard quantity of
actual production
SP = standard price
17
Direct labour variances
3. Labour rate variance 4. Labour efficiency variance
▪ A measure of the effect on cost of ▪ A measure of the effect on cost of
paying a different labour rate, using a different number of direct
compared with standard labour hours, compared with the
= (AR – SR) AH standard hours that should have been
used for the actual production output
Where AH = actual hours worked
= (AH – SH fap) SR
AR = actual rate per hour
Where AH = actual hours worked
SR = standard rate per hour
SH = standard hours for
actual production
SR = standard rate per hour
5. Labour idle time variance
= Idle hours x SR
18
Variable Overhead Variance
Variable Overhead
Cost Variance
Variable Overhead Variable Overhead
Spending Efficiency
Variance Variance
19
Variable Overhead variances
5. Variable overhead expenditure 6. Variable overhead efficiency variance
variance A measure of the difference between the
actual activity and the standard activity
A measure of the difference between the allowed, given the actual output multiplied by
actual variable overhead and the standard the standard variable overhead rate
variable overhead rate multiplied by
actual activity = (AH – SH fap) VOAR
= Actual variable overhead – (AH × VOAR) Where SH = standard direct labour hours
Where AH = actual direct labour hours
VOAR = standard variable allowed for actual production
overhead absorption rate AH = actual direct labour hours
VOAR =variable overhead absorption rate
20
Interpreting variable overhead variances
• Expenditure variance
• Actual cost of variable overhead is greater/less than
expected, after adjusting for the actual quantity of cost
driver that is used- Used to control variable overhead cost
• The expenditure variance is the real control variance for
variable overhead
• Efficiency variance
• The cost effects of excessive or minimal use of the
particular activity (cost driver)
21
Fixed Overhead Variance
Fixed Overhead
Cost Variance
Fixed Overhead Fixed Overhead
expenditure Volume
Variance Variance
Fixed Overhead Fixed Overhead
Capacity Efficiency
Variance Variance
22
Fixed overhead variances
1. FOHD Expenditure Variance: 3. FOHD Volume capacity variance:
= (Actual hours – Budgeted
= Actual fixed overhead cost-
Budgeted fixed overhead cost hours)Fixed overhead absorption rate
= (AH- BH) FOAR
=AFOHD ~ Budgeted FOHD
4. FOHD Volume efficiency variance:
2. FOHD Volume Variance: = (Actual Hours ~ Standard hours of
actual production) Fixed overhead
= (Actual volume – budgeted
volume) Fixed overhead absorption rate
absorption rate = (AH – SH fap)FOAR
= (AV-BV)FOAR
23
Interpreting fixed overhead variances
▪ Fixed overhead spending variance
▪ Used for control
▪ Assumes fixed overhead will not change as activity
varies
▪ Fixed overhead volume variance
▪ Standard cost driver allowed for actual output is
more/less than the planned level of production
24
Sales Variance
Sales price variance:
= (Actual Sales Price ~Standard sales price) Actual volume
Sales volume variance:
= (Actual Volume ~ Budgeted Volume) Standard Sales Price
Sales margin price variance:
= (Actual profit per unit* ~ Std Profit per unit) Actual Sales Volume
*Act. Profit/ unit = Actual Sales Price – Std cost per unit
Sales margin volume variance:
= (Actual Volume ~ Budgeted Volume) Std margin per unit
25
Interrelationship of variances
• Sales price variance and volume variance is
interdependent.
• Changes in selling price are likely to affect sales
volume.
• Consequently, a favorable price variance will tend
to be associated with an adverse volume variance
and vice versa.
26
EXAMPLE Q
Calculate the following variances for
Purity Sdn Bhd:
▪ Direct material price
▪ Direct material usage
▪ Direct labour rate
▪ Variable production overhead
expenditure
▪ Fixed production overhead volume
▪ Fixed production overheads expenditure
▪ Sales price
▪ Sales volume
Variance Answer
1. Direct material price 3. Direct labour rate
= (Actual Price – std Price) Actual qty purchased = (Actual Rate - std Rate) Actual Hours paid
= (RM7.20 – RM7 ) X 16,000 kg = (RM10 ~ RM11 ) 27,700 hrs
= RM3,200 A = RM27,700 F
2. Direct material usage 4. Direct labour efficiency
= (Actual Qty-SQ of actual production)Std Price = (Actual Hrs -Std Hrs of actual
= [16,000kg- (1.6kg X 9,800 )]RM7 production)Std Rate
= RM2,240 A = [27,700 hrs- (3hrs x 9800units)] RM11
=18,700 F
Variance Answer
4. Variable production overhead expenditure
= Actual VOH- (Std VOAR X Actual hours)
= (RM63,710 – (RM2 X 27,700 hours )
= RM8,310 A
5. Fixed production overhead volume
= (Actual volume ~ Budgeted volume)FOAR/unit
= (9,800 -10,000 ) RM7
= RM1,400 F
6. Fixed production overhead expenditure
= Actual FOH - Budgeted FOH
= RM62,500 - RM70,000
= RM7,500 F
Variance Answer
Sales price variance:
= (Actual SP - Std SP) Actual volume
= (RM120 – RM110 ) X 9,800 units
= RM98,000 F
Sales volume variance:
= (Actual Volume ~ Budgeted Volume) Standard Sales Price
= (9,800- 10,000) RM 110
= RM 22,000 A
Cause of variances
Material Labour
▪ Price – losing or gaining quantity disc. ▪ Rate – higher rates being paid than
By buying in smaller or larger quantities planned due to wage award.
than planned.
▪ Idle time – Actual hours paid is more
▪ Usage – used more or less quantity of than actual hours worked due to
materials from standard set. machine break down, strike, lay-offs,
etc.
▪ Mix – changes in the actual quantity and
mixture of materials ▪ Efficiency – use of incorrect grade of
labour.
▪ Yield – storage losses, handling losses,
spoilage, scrap.
Cause of variances
Overheads Sales
▪ Expenditure – actual overheads spent is ▪ Price – customer demands a lower
more or less than budgeted depending on selling price.
the utilisation of production hours.
▪ Quantity – quantities not saleable
▪ Efficiency – hours spent do not confirm when the actual sales take place.
with hours budgeted due to labour
inefficiency. ▪ Mix – combination of quantities of the
mixture of products is different from
▪ Volume – capacity not utilised according plan.
to standard due to machine breakdown,
time lost through lack of mat, tools or
instructions, efficiency of workers, use of
higher/lower grade of workers, lack of
orders for products.
