STANDARD
COSTING AND
VARIANCE
ANALYSIS
Standard costing is a method of cost and
management accounting which starts with
setting of standards to reporting of variances to
management for taking corrective actions.
Uses of standard costing
1. Cost control and reduction
2. Budgeting and forecasting
3. Variance analysis and corrective actions
4. Cost tracking and and management
5. Pricing strategies and decisions
6. Improving resource utilization
7. Reducing waste and inefficiencies
8. Performance evaluation
THE PROCESS OF STANDARD
COSTING
Setting of Standards
Ascertainment of actual costs
Comparison of actual cost with standard cost
Investigate the reasons for variances
Disposition of variances
Importance of Standard Costing:
Standard costing plays a vital role in minimizing
costs and maximizing profits by:
Cost Minimization:
1. Identifying cost inefficiencies
2. Setting realistic targets
3. Encouraging cost reduction initiatives
4. Monitoring and controlling expenses
5. Optimizing resource utilization
Profit Maximization:
6. Accurate pricing strategies
2. Efficient production planning
3. Reduced waste and scrap
4. Improved quality control
5. Enhanced decision-making
Procedures for Setting Standards:
Step 1: Data Collection
Step 2: Material Standards
Step 3: Labor Standards
Step 4: Overhead Standards
Step 5: Standard Cost Calculation
Step 6: Review and Revision
TYPES OF VARIANCES
Controllable and un-controllable variances: For
effective cost control it is necessary to investigate into the
reasons for cost variances and to take corrective actions.
For this purpose variances are classified as controllable and
uncontrollable variances. Controllable variances are
those which can be controlled under the normal
operating conditions if a responsibility centre takes
preventive measures and acts prudently. Uncontrollable variances
are those which occurs due to conditions which are beyond
the control of a responsibility centre and cannot be controlled even
though all preventive measures are in place. Responsibility centres are
answerable for all adverse variances which could have been
controlled. Controllability is a subjective matter and varies from
situation to situation. If the uncontrollable variances are of significant
nature and are persistent, the standard may need revision.
Favourable and Adverse variance: Favourable variances
are those which are profitable for the company and
adverse variances are those which causes loss to the
company. While computing cost variances favourable variance
means actual cost is less than standard cost. On the other hand,
adverse variance means actual cost is exceeding standard cost.
The situation will be reversed for sales variance. Favourable
variances mean actual is more than budgeted and adverse when
actual is less than budgeted. Favourable variance in short
denoted by capital ‘F’ and adverse variances by capital ‘A’.
CLASSIFICATION OF VARIANCES
Total Cost
Variance
Material Cost Labour Cost Overhead Cost
Variance Variance Variance
Labour Labour
Material Material
Rate Efficiency
Price Usage
Varianc Varianc Variance Varianc
e e e
Material Material Labour Idle Labour
Mix Yield Mix Time Yield
Varianc Varianc Varianc Variance Varianc
e e e e
Fixed Overhead
Variable Overhead Cost
Variance
Expenditure or Efficiency Variance Expenditure or Volume
Budget Variance Budget Variance Variance
Efficiency Capacity Calendar
Variance Variance Variance
COMPUTATION OF VARIANCES
SQ*SP – AQ*AP
(SP– AP) × (SQ – AQ) ×
AQ SP
(RSQ – AQ) × SP (SQ – RSQ) × SP
RSQ = [TAQ / TSQ]× SQ
Material Cost Variance
Material cost variance is the difference between standard cost of
materials usedand the actual cost of materials. Mathematically it is
written as.
[Standard Cost – Actual Cost]
Or
SQ*SP – AQ*AP
Reasons for variance Material cost variance arises mainly
because of either difference in material price from the standard price or
difference in material
Material Price Variance
It measures variance arises in the material cost due to difference in actual
material purchase price from standard material price.
Actual Quantity (AQ) × {Std. Price (SP) – Actual Price(A)}
(SP -AP)× AQ
Responsibility for Material Price Variance: Generally, purchase
department purchases materials from the market. Purchase department is
expected to perform its function very prudently so that company never
suffers loss due to its inefficiency. Purchase department is held responsible
for adverse price variance arises due to the factors controllable by the
Material Usage Variance
It measures variance in material cost due to usage/
consumption of materials. It is computed as below:
[Std. Price (SP)× { Std. Quantity (SQ) - Actual Quantity
(AQ) }
(SQ – AQ) × SP
Reasons for variance: Actual material consumption may differ
from the standard quantity either due to difference in proportion
used from standard proportion or due to difference in actual yield
Material Mix Variance
Variance in material consumption may arise due to difference
in proportion actually used from the standard mix/
proportion. It only arises when two or more inputs are used to
produce a product.
Std. Price (SP) × {Revised Std. Quantity (RSQ) – Actual
Quantity (AQ)}
(RSQ – AQ) × SP
Variance in material consumption which arises due to
yield or productivity of the inputs. It may arise due to use of
sub- standard quality of materials, inefficiency of workers or due
Material Yield Variance
Variance in material consumption which arises due
to yield or productivity of the inputs. It may arise due to
use of sub- standard quality of materials, inefficiency of workers
or due to wrong processing.
Std. Price (SP) × {Std. Quantity (SQ) – Revised Standard
Quantity (RSQ)}
(SQ – RSQ) × SP
RSQ= Total Actual Quantity / Total Standard Quantity × Standard Quantity of
each material
Revised Standard Mix:
A revised standard mix refers to the updated mixture of inputs (materials, labor, and overhead)
used to produce a product or provide a service, reflecting changes in production processes,
technology, or market conditions.
Necessity:
Revising the standard mix is necessary due to:
1. Changes in material availability or quality
2. Technological advancements or process improvements
3. Shifts in market demand or customer preferences
4. Fluctuations in labor costs or productivity
5. Obsolescence of existing standards
6. Need for cost reduction or efficiency gains
7. Regulatory or compliance requirements
Benefits:
Revising the standard mix enables:
3. Accurate cost estimation and budgeting
2. Improved production planning and control
3. Enhanced product quality and consistency
4. Increased efficiency and productivity
5. Better decision-making and pricing strategies
6. Reduced waste and minimized errors
7. Alignment with changing business environments
Verification of the formulae: [Reconciliation]
Material Cost Variance = Material Usage Variance +
Material
Price Variance
Or,
Material Cost Variance = (Material Mix Variance +
Material
Yield Variance) + Material price variance
Material usage variance= Material Mix
variance+
Material yield variance
Term Meaning
Standard Quantity of inputs to be used to
Quantity (SQ) produce actual output.
Actual Quantity Quantity of inputs actually used to
(AQ) produce actual output.
Revised If Actual total quantity of inputs
Standard were used in standard proportion.
Quantity (RSQ)
The standard and actual figures of product ‘Z’ are as under:
Standard
Actual
Material quantity 50 units 45
units Material price per unit ` 1.00 ` 0.80
CALCULATE material variances.
The variances may be calculated as under:
(a)Standard cost = Std. Qty × Std. price = 50 units × ` 1.00
= `50
(b)Actual cost = Actual qty. × Actual price = 45 units × `
0.80 = ` 36
Price variance = Actual qty (Std. price – Actual price)
45 units (` 1.00 – ` 0.80) = ` 9 (F)
Usage variance = Std. price (Std. qty – Actual qty.)
` 1 (50 units – 45 units) = ` 5 (F)
Material cost variance = Standard cost – Actual cost (Total
variance) = ` 50 – ` 36 = ` 14 (F)
Reconciliation
Material Price variance + Material Usage variance= Material
cost variane
Solution:
Material Mix Variance = (Revised Standard Quantity – Actual Quantity) × Standard Price
here, Revised Standard Quantity =
Total Actual Quantity / Total Standard Quantity × Standard Quantity of each material
Material A = 12 /10 × 2 = 2.4 kg
Material B = 12/10 × 8 = 9.6 kg
Computation of Material Mix Variance
A: (Revised Standard Mix – Actual Mix) × Standard Price of A =
(2.4 kg. – 8 kg.) × Rs. 2 = 5.6 kg. × Rs.2 = Rs.11.2 (A)
B: (Revised Standard Mix—Actual Mix) × Standard Price of B =
(9.60 kg. – 4 kg.) × Rs. 1.00 = 5.60 kg. × Rs. 1.00 =
Rs. 5.60 (F)
Total Material Mix Variance = Rs. 11.2 (A) + Rs. 5.60 (F) = Rs. 5.60
2 time same question
5.B. solution
RSQ= Total Actual Quantity / Total Standard
Quantity × Standard Quantity of each material
Total actual quantity=
Actual quantity A = 3000/1000= 3
Actual quantity B = 2000/1000= 2
Actual quantity C = 6000/1000= 6
Total = 3+2+6 = 11
Total standard quantity = 2+3+5 = 10
Apply the above equation to find revised std
quantity (RSQ]
A = 11/10* 2= 2.2
B = 11/10* 3= 3.3
C = 11/10* 5= 5.5
Material Cost Variance = Material Usage Variance + Material Price
Variance
Material Usage variance = material mix variance + Material yield
variance
Material variance = Material price variance + material usage
variance
10000.[A]= 16000 [f] – MUV
MUV = -10000-16000 = 26000 [A]
MUV = Material yield variance + material mix
26000 [A] = MYV + 6000 [F]
MYV = -26000-6000= 32000 [A]
Labor cost variance = labor time + labor rate variance
16000 [F] = 12000[A] + labor rate variance
Labor rate variance = 16000+12000 = 28000 [F]
Labour rate variance = labour efficiency + labor mix variance
28000 [F] = 10000 [F] + labor mix variance
Labor mix = 28000-10000 = 18000 [F]
Variance Analysis Report
Material Variances
1. Material Variance: $16,000 (Favorable) - Indicates overall material costs were lower than expected.
2. Material Price Variance: Not explicitly calculated, but included in Material Variance.
3. Material Usage Variance (MUV): $26,000 (Adverse) - Suggests actual material usage exceeded standard
quantities.
4. Material Yield Variance (MYV): $32,000 (Adverse) - Implies actual material yield was lower than expected,
leading to increased waste or inefficiency.
5. Material Mix Variance: $6,000 (Favorable) - Indicates a favorable mix of materials, potentially reducing costs.
Labor Variances
2. Labor Cost Variance: $16,000 (Favorable) - Reveals overall labor costs were lower than expected.
2. Labor Time Variance: $12,000 (Adverse) - Suggests actual labor hours exceeded standard hours.
3. Labor Rate Variance: $28,000 (Favorable) - Implies actual labor rates were lower than expected.
4. Labor Efficiency Variance: $10,000 (Favorable) - Indicates improved labor efficiency, reducing labor hours.
5. Labor Mix Variance: $18,000 (Favorable) - Suggests a favorable mix of labor skills or grades, potentially
reducing costs.
Interpretation-
Material usage and yield variances indicate potential inefficiencies in production processes.-
Labor variances suggest effective cost management, with favorable rate and efficiency variances offsetting adverse
time variance.- Overall, material and labor variances contribute to a favorable total variance.
Recommendations
1. Investigate and address material usage and yield inefficiencies.2. Monitor labor efficiency and maintain favorable
labor mix.3. Consider revising standard material quantities and labor hours.4. Analyze material price variance to
identify opportunities for cost savings.5. Continuously review and adjust processes to sustain favorable variances.
1.Labour Cost Variance
Amount paid to employees for their labour is generally known as
employee or labour cost. In this chapter labour cost is used to denote
employees cost. Labour (employee) cost variance is the difference between
actual labour cost and standard cost. Mathematically it can be written as:
Labour Cost Variance = [Standard Cost – Actual Cost]
Or
[(SH × SR) – (AH* × AR)]
* Actual hours paid.
Reasons for variance: Difference in labour cost arises either due to
difference in the actual labour rate from the standard rate or difference in
numbers of hours worked from standard hours. Labour cost variance can be
divided into three parts namely (i) Labour Rate Variance (ii) Labour Efficiency
Variance and (iii) Labour Idle time Variance
(A)Labour Rate Variance:
Labour rate variance arises due to difference in actual rate paid from
standard rate. It is very similar to material price variance. It is calculated as
below
Labour Rate Variance = [Standard Cost of
Actual Time – Actual Cost]
Or
Actual Hours (AH*) × {Std. Rate (SR) – Actual
Rate (AR)}
Or
(SR – AR) × AH
Responsibility for labour rate variance: Generally labour rates are influenced
by the external factors which are beyond the control of the organisation.
However personnel manager is responsible for labour rate negotiation
(A)Labour Efficiency Variance:
Labour efficiency variance arises due to deviation in the working
hours from the standard working hours.
[Standard Cost of Standard Time for Actual Production – Standard Cost of Actual
Time]
Or
Std. Rate (SR) × {Std. Hours (SH) – Actual Hours (AH*)}
Or
(SH –AH# ) × SR
# Actual Hours worked
Responsibility for labour efficiency variance: Efficiency variance may arise due
to ability of the workers, inappropriate team of workers, inefficiency of production
manager or foreman etc. However, production manager or foreman can be held
responsible for the adverse variance which otherwise can be controlled.
Labour efficiency variance is further divided into the following variances:
(a)Labour Mix Variance or Gang variance
(b)Labour Yield Variance (or Labour Revised-efficiency Variance)
(a)Labour Mix Variance:
Labour efficiency variance which arises due to change in the mix or
combination of different skill set i.e. number of skilled workers, semi-skilled
workers and un-skilled workers. Mathematically,
Labour Mix Variance Or Gang Variance =
[Standard Cost of Actual Time Worked in Standard Proportion – Standard Cost of
Actual Time Worked]
Or
Std. Rate (SR) × {Revised Std. Hours (RSH) – Actual HoursWorked(AH)}
Or
[(RSH – AH# ) × SR)
# Actual Hours worked
(a)Labour Yield Variance:
Labour efficiency variance which arises due to productivity
of workers.
Labour Yield Variance Or Sub-Efficiency Variance =
[Standard Cost of Standard Time for Actual Production –
Standard Cost of Actual Time Worked in Standard Proportion]
Or
Std. Rate (SR) × {Std. Hours (SH) – Revised Std. Hours (RSH)}
Or
(SH – RSH ) × SR
(A)Idle Time Variance:
It is calculated for the idle hours. It is difference between
paid and worked hours. It is calculated as below:
Labour Idle Time Variance = [Standard Rate per Hour × Actual Idle
Hours]
Or
Std. Rate (SR) {Actual HoursPaid – Actual HoursWorked}
Or
[(AH* × SR) – (AH# × SR)]
* Actual hours paid; # Actual Hours worked
Verification of formulae:
Labour Cost Variance = Labour Rate Variance + Labour Efficiency Variance
(if hours
paid and hours worked is same)
OR
Labour Cost Variance = Labour Rate Variance + Idle Time Variance +
Labour
Efficiency Variance
OR
Labour Efficiency Variance = Labour Mix Variance + Labour Yield Variance
Variable Overheads Cost
Variance
Variable overheads consist of expenses other than direct material and direct labour which vary
th the level of production. If variable overhead consist of indirect materials, then in this case it varies
th the direct material used. On the other hand, if variable overhead is depending on number of hours
orked then in this case it will vary with labour hour or machine hours. If nothing is mentioned
ecifically then we take labour hour as basis. Variable overhead cost variance calculation is similar to
bour cost variance. Variable overhead cost variance is divided into two parts (i) Variable Overhead
penditure Variance and (ii) Variable Overhead Efficiency Variance.
(a)Fixed overhead Efficiency variance: this is the difference between
overhead absorbed and standard fixed overhead.
(b)Fixed Overhead Capacity Variance: This is the difference between
standard fixed overhead and budgeted overhead.
(c)Fixed Overhead Calendar Variance: This variance arises due to difference
in number of actual working days and the standard working days.
Note: When calendar variance is computed, there will be a modification in the
capacity variance. In that case revised capacity variance will be calculated and the
formula is:
Revised Capacity Variance = (Actual hours – Revised budgeted hours) × Std. fixed
rate per hour
Verification of formulae:
F.O. Cost Variance = F.O. Expenditure Variance + F.O. Volume Variance
F.O. Volume Variance = Efficiency Variance + Capacity Variance + Calendar
Variance
Basic terms used in the computation of overhead variance
Standard overhead rate (per hour) = Budgeted Overhead
Budgeted hours
Or
Standard overhead rate (per unit) = Budgeted Overhead
Budgeted output in units
Note: Separate overhead rates will be computed for fixed and variable
overheads.
Basic calculations before the computation of overhead variances:
The following basic calculation should be made before computing variances.
(i) When overhead rate per hour is used:
(a)Standard hours for actual output (SHAO)
SHAO = Budgeted Hours ×Actual Output Budgeted Output
(b)Absorbed (or Recovered) overhead = Std. hours for actual output × Std.overhead rate per hour
(c)Standard overhead = Actual hours × Std. overhead rate per hour
(d)Budgeted overhead = Budgeted hours × Std. overhead rate per hour
(e)Actual overhead = Actual hours × Actual overhead rate per hour
(ii) When overhead rate per unit is used
(a)Standard output for actual hours (SOAH)
SOAH = Budgeted Output×Actual Hours Budgeted Hours
(b)Absorbed overhead = Actual output × Std. overhead rate per unit
(c)Standard overhead = Std. output for actual time × Std. overhead rate
per unit
Budgeted overhead = Budgeted output × Std. overhead rate per unit
Actual overhead = Actual output × Actual overhead rate per unit
Overhead cost variance = Absorbed overhead – Actual overhead
OCV= (Std. hours for actual output × Std. overhead rate) – Actual overhead
Responsibility Accounting
Responsibility Accounting- Concept
• It is used to measure performance of divisions of an organisation rather than organisation
as a whole.
• Responsibility Accounting is a system of control where responsibility is assigned for the
control of costs. The persons are made responsible for the control of costs.
• Proper authority is given to the persons so that they are able to keep up their
performance. In case the performance is not according to the predetermined standards then
the persons who are assigned this duty will be personally responsible for it. In responsibility
accounting the emphasis is on men rather than on systems.
• Responsibility Accounting collects and reports planned and actual accounting information
about the inputs and outputs of responsibility centres”
• Responsibility Accounting must be designed to suit the existing structure of the
organization.
• Responsibility should be coupled with authority. An organization structure with clear
assignment of authorities and responsibilities should exist for the successful functioning of
the responsibility accounting system. The performance of each manager is evaluated in
terms of such factors.
Responsibility Accounting- Meaning & Definition
• Responsibility accounting is a system of management accounting under which
accountability is established according to the responsibility delegated to various levels
of management and a management information and reporting system instituted to
give adequate feedback in terms of the delegated responsibility.
• Under this system, divisions or units of an organisation under a specific authority in
a person are developed as responsibility centres & evaluated individually for their
performance.
• Horngreen: defines “Responsibility accounting is a system of accounting that
recognizes various responsibility centres throughout the organisation and reflects the
plans and actions of each of these centres by assigning particular revenues and costs
to the one having the pertinent responsibility. It is also called profitability accounting
and activity accounting”. According to this definition, the organisation is divided into
various responsibility centres and each centre is responsible for its costs. The
performance of each responsibility centre is regularly measured.
• Institute of Cost and Works Accountants of India defines Responsibility accounting as
“a system of management accounting under which accountability is established
according to the responsibility delegated to various levels of management and a
management information and reporting system instituted to give adequate feedback
in terms of the delegated responsibility. Under this system divisions or units of an
organisation under a specified authority in a person are developed as responsibility
centres and evaluated individually for their performance.”
