STANDARD COSTING

Introduction
Standard costing technique is a control technique which is used such that a comparison can
be made between a pre-determined cost (standard cost) and the actual cost when this becomes
known. This adopts the concept of budgetary control.

It should be noted that while the terms budgeted cost and standard are often used inter-
changeable, a line of distinction can be drawn thus: Budget is a total concept while standard
is a unit concept, therefore budgeted costs are usually in totals in contrast to standard cost
which reflects unit.

Definition:
A standard cost is a predetermined cost calculated in relation to a prescribed set of working
conditions correlating technical specification and scientific measurement of materials and
labour time with prices and wage rates that are expected to apply in a future period.

Types of Standards:

1. Ideal Standards: These standards consider perfection. They are standards that can
be attained under most favourable condition i.e. no breakdown, no stoppage in
production, no material or inventory-out, no idle time, in short perfect efficiency.

2. Attainable Standards: They are standards, which are set where provisions for
normal loses, and wastages are made. They are based on efficiency (not perfect)
operating conditions. The standard will include allowances for normal material losses,
realistic allowance for fatigue, machine breakdown etc.

3. Loose Standards: These are standards that can be achieved with little or no effort.

4. Current Standards: These are standards established for short term. They are for use
over a short period of time, and they relate to current condition.

5. Basic Standards: These are standard that are established on long term basis. They
are expected to remain unchanged over a long period of time.

Advantages of Standard Costing

1. It facilitates control
2. It enhances cost reduction
3. It facilitates the use of management by exception (MBE). Variance can be calculated
which enable the principles of management by exception to be operated.
4. It facilitates stock valuation
5. It can be used in some cases of price setting

Disadvantages of Standard Costing

1. It may be very expensive to operate
2. Standards quickly get outdated
3. Elaborate variances are imperfectly understood by line managers and thus they are
ineffective for control purposes.
4. Some variance may sound illogical and unreasonable e.g. mix variance where materials
cannot be substituted.
Setting of Standards
Like under Budgetary control, the responsibility for setting standards will be given to a
specific person or to a committee. The committee will usually consist of:
1. The Production Controller: To provide production requirements or specification
2. The Buyer: To give prices and market trends
3. The Personnel Manager: Labour rates and possible changes.
4. Time Study Engineer: Provides standard time for operation in the factory
5. The Cost Accountant: He provides all necessary cost figures such as overhead
recovery rates, and co-ordinates the activities of the committee. In the absence of a
committee, the accountant will most certainly be responsible for setting the standard.

For Material: The responsibility of providing material price is that of buying department.
The price used are not the past cost but the forecast expected cost for the relevant current
period.

The expected cost should take into consideration:

1.Trend of material prices
2. Anticipated changes in purchasing policies
3. Quantity and cash discount
4. carriage
5. Packing charges and other;
6. factors which would influence material cost.

For Labour: The concept of standard hours is important and can be defined as quantity of
work achievable at standard performance expressed in terms of standard unit of work in a
standard period of time. It is the production manager who is for setting this standard. The
factors to be considered are: Skill, availability, etc nature of job etc.

For Overhead: The predetermine OHAR become the standard for O/H for each cost center
using the budgeted standard hour as the activity base.

For Realistic control: O/H must be analysed into fixed and variable component and
separate absorption rate calculated for both fixed and variable OHAR. Thus
Std Var O/H = Budgeted Variable O/H for cost center
Budgeted Std Labour Hour for cost center

For Sales Price and Margin: The setting of the selling price is frequently a top-leveled
decision and is based on a variety of factors including:
i. Anticipated market
ii. Demand
iii. Competing products manufacturing costs, inflation estimates.

Finally, after decision and investigation, a selling price is established at which it is planned
to sell the products during the period, this becomes the standard selling price.
Standard Cost Card
This card shows the specifications, quantity and price for each element of cost per unit of
product. It may also show the selling price and the contribution or profit per unit. It must be
realized that fixed overhead will not be included in the standard cost card for where standard
marginal costing method is being operated. It will however be on the card for standard total
absorption costing.

Standard Costing Vs Budgetary Control

It will be seen that though standard costing and budgetary control are not one and the same
technique, they are similar being both pre-determined and forward-looking planning and
controlling system. Although one can operate without the other for instance it will be easier
to compute budgets for products cost and sales when standard cost has previously been set
and the level of output can therefore be ascertained, it is easier to compute standard cost.

The major difference between the 2 is that while standard costing relates to the cost of unit of
product or service, budgetary control relates to the expenses of a dept or company or a
country.

The other very important similarity between standard costing and budgetary control is the
area of behavioural consideration, participation should be;

TOTAL: letting those concerned have a hand in setting their goals, winning their co-
operation and confidence.

Motivation: Making the budget or standard motivational. Goal congruence:

Harmonization of personal goal with those of top management. Recognition of the difference
between controllable and uncontrollable cost.

Provision of accurate, timely and relevant data or reports for prompt action.

Variance Analysis
Meaning: Variance analysis is concerned with breaking down a variance (deviation) into its
components.

Variance is the result of comparing standards with actual and thus may relate to both cost and
revenue. It should be noted that they are usually expressed in financial terms and defined as
either favourable (F) unfavourable (U), some will say adverse (a) for unfavourable variance.

To enhance our understanding of variance, the following should be followed:

Where standard cost is greater than actual cost, variance is said to be favourable i.e. standard
cost = F

Where standard cost is less than actual cost variance is said to be unfavourable or adverse i.e.
standard cost < actual cost variance = (a) or (U).
Detailed analysis of Production Cost Variances
We shall adopt the descriptive approach to calculation of variances. It simply understands the
definition of the variance that we intend to calculate at any point in time.

a. Direct Material Total Variance: This is the difference between the standard
material costs of the actual production volume and the actual cost of direct
material.
i. Direct Material Cost Variance
Std cost boao – Actual Cost
ii. Direct Material Price Variance
(SP – AP) AQ
iii. Direct Material Usage Variance
(SQ (boao) - AQ) SP

b. Direct Labour Total Variance: This is the difference between the standard
direct labour cost and the actual direct labour cost incurred for the production
achieved.
i. Direct Labour Cost Variance
Std cost boao – Actual Cost
ii. Direct Labour Rate Variance
(SR – AR) AHW
iii. Direct Labour Efficiency Variance
(SH (boao) - AH) SR

c. Variable Overheads Variance: This is the difference between the actual

variable overheads incurred and the variable overheads absorbed.
i. Variable Overhead Cost Variance
Std cost boao – Actual Cost
ii. Variable Overhead Expenditure Variance
(SR - AR) AH
iii. Variable Overhead Efficiency Variance
(SH (boao) - AH) SR

d. Fixed Overhead Cost Variance: This is the difference between the fixed
overhead absorbed by actual productions and the actual fixed overheads for
the period.
i. Fixed Overhead Cost Variance:
(SC boao - AC)
• Fixed Overhead Expenditure Variance:
(SR – AR) AH
• Fixed Overhead Volume Variance:
(SH boao - AH) SR
❖ Fixed Overhead Volume Capacity Variance:
(SH boao – SH bobc) SR
❖ Fixed Overhead Volume Efficiency Variance:
(SH bobc -AH) SR
Possible causes of variances
1. Material price variance
i. Inefficiency on the part of the purchasing department
ii. Purchase of inferior quality material
iii. Losing or gaining quantity discount
iv. Buying substitute material due to unavailability of planned materials
v. Changes in market conditions

2. Material Usage Variance

i. Poor handling of material by production staff
ii. Changes in method of production
iii. The use of inferior quality material
iv. The use of substitute material as a result of in-availability of planned material
v. Greater/lower yield from material than anticipated

3. Labour Rate Variance

i. Higher rate being paid than planned
ii. Higher/lower grade of workers being used than planned
iii. Payment of unplanned overtime or bonus
iv. Learning curve effect
v. Labour efficiency

4. Labour Efficiency Variance

i. Changes in production methods
ii. High labour turnover
iii. Poor motivation
iv. Use of incorrect grade of labour
v. Poor workshop organization or supervision
vi. Incorrect material and or machine problem

5. Overheads Variance
i. Budgeted expenditure not agreeing with actual
ii. Budgeted activity level not agreeing with actual
Practice Questions
Question 1
Design a standard cost card for product G, the only product of Gansh Ltd. product G has the
following cost and selling price characteristics:
Direct Material 4Kg at N3 per Kg
Direct Labour 5hrs at N4 per Kg
Variable Overhead N1 per direct labour hour
Fixed overhead is absorbed into a unit of G at N15
The standard selling price of G is N60 per unit

Question 2
BUDDY Limited manufactures a single product, a laminated kitchen unit, with a standard
cost of #80, made up as follows:
#
Direct Materials (15 sq meters @ #3 per sq meter) 45
Direct Labour (5 hours @ #4 per hour) 20
Variable Overheads (5 hours @ #2 per hour) 10
Fixed Overheads (5 hours @ #1 per hour) 5
80

The standard selling price of the kitchen unit is #100. The monthly Budgeted production and
sales is 1,000 units.

Actual figures for the Month of April 2020 are as follows:

Production of 1,400 units was sold @ #102 each

Direct Materials: 22,000 sq meters @ #4 per square meter
Direct Wages 6,800 hours @ #5 per hour
Variable Overheads #11,000
Fixed Overheads #6,000

You are required to calculate:

a. Total Cost Variance
b. Direct Materials Variance
c. Direct Labour Variance
d. Variable Overheads Variance

Question 3
MAYOR Manufacturing Company has developed the following standards for one of their
products;
STANDARD VARIABLE COST CARD
#
Materials: 15 square feet @ #5 per square foot 75.00
Direct Labour: 8 hours @ #7per hour 56.00
Variable Manufacturing overhead: 8hrs @ #5 per hour 40.00
171.00
The company records materials price variances at the time of purchase. The following
activity occurred during the month of April;

Materials purchased: 40,000 square feet at #5.30 per square foot.

Materials used: 37,000 square feet
Units produced: 2,500 units
Direct Labour: 21,000 hours @ #6.70 per hour
Actual Variable manufacturing overhead: #114,000

You are required to calculate the following:

a. Direct materials price variance
b. Direct materials usage variance
c. Direct labour rate variance
d. Direct labour efficiency variance
e. Variable overhead expenditure variance
f. Variable overhead efficiency variance.