UNIT V

STANDARD COSTING AND VARIANCE ANALYSIS

Standard Costing and Variance Analysis: Meaning of Standard cost and Standard Costing - Steps
involved in Standard Costing - Advantages and Limitations of Standard Costing - Variance
analysis - Material Variances, Labour Variances.

INTRODUCTION
Financial Accounting is only historical costing and is only a post – marten examination of
cost and hence, is not very much useful to management for cost control and cost reduction
purposes. Besides this, historical costing is not useful to managerial decision making and
policy formulating purposes. Hence, to the accounting world, a new concept (or) tool by
name “Standard Costing” appeared as a very big way out.
CONCEPT OF STANDARD COSTING
Normally it is understood as a long step by step process of fixing standards, using
standards, and their comparisons with the actuals, finding out of variances in between
standards and actuals, analysing these variances, finding out of causative factors for these
variances, classifying these causes into controllables and uncontrollables, controlling and
taking remedial actions, revising these standards if necessary etc. Thus, it is a cost
controlling and cost reducing device.
ICMA, London Defines “Standard Costing is the preparation and use of Standard costs,
their comparison with actual costs and analysing of variances to their causes and points of
incidence”.
Controlling Process in standard Costing:
 Formulation of Standard Costs : For all elements of cost viz., Materials,
Labour and Expenses, standard costs are fixed very much scientifically by experts based on
multiple criteria.

 Matching Actuals with Standards : In this step, actual costs are compared with
standard costs for the purposes of verifying whether actual cost is more or less than the
standard costs.
 Variances and Analysis thereof : The difference between actual and the
standard is known as variance and this is further analysed to find out whether variance is
debit variance (or) Credit variance.

 Analysis of causative factors for variances : For all debit (or) unprofitable
variances, causative factors (or) reasons responsible are unearthed and then are classified
into controllable and uncontrollable reasons.

 Corrective Measures : In relation to controllable causes, the people responsible

are held up and are instructed to take necessary remedial measures and see that they do not
repeat in the time to come.

 Reporting to Management : Depending upon the degree of severity of the

variances, information by following the principle of “Management by Exception”, will be
reported to the concerned management level for necessary cost control measures.

 Revising the standards : With regard to uncontrollable variances, an idea of

revising the standards watching the changed scenario, may be though of.

STANDARD COST

The whole of standard costing revolves around standard costs. Hence, we are very much
obliged to explain what is standard cost. It is a predetermined cost computed in advance of
production on the basis of specification of all factors affecting costs.

Blocker and Weltmer defines, Standard cost is a common sense cost reflecting the best
Judgement of management as to what costs ought to be if this plant is operated with the
highest degree of efficiency.
TYPES OF STANDARDS
Importantly, there are : Basic, current, Ideal, Expected and Normal standards.
 Basic standards : It is a standard set for a long term in an unaltered way. It is
suitable mostly to those products whose costs / prices do not change much.
 Current Standard : It is a standard set for a relatively shorter period based on
current market conditions. It claims to be more realistic and most companies use it.
 Ideal Standard : It is self explanatory as this is set based on all idealistic
conditions which are never seen.
 Expected Standard : It is a standard set based on certain conditions which are
expected to be attained. Conditions prevailing in industry and that are likely to hit the
industry in future are all considered while this standard is set. So, it is attainable standard.
 Normal Standard : It is a standard set on the basis of average conditions (or)
normal conditions. Since we do not have any control over future, this normal standard may
not be of much use.
Process in setting Standards:
The function of setting standards for costs (or) revenues is a rational and professional job.
Hence, it is entrusted to a committee called – standards Committee consisting of
Production Manager, purchase manager, personnel Manager, Cost Accountants etc. This
committee sets standards for each and every element of cost viz., Materials, Labour and
expense. Let us see them separately.
Standard for Direct Material Cost: [SMC]
This SMC is a product of standard quantity and standard price. So, it is clear that standard
quantity and standard price are to be determined first and SMC is obtained by multiplying
these two. SMC is briefly called as SC (Standard Cost).
Standard Material Quantity [SMQ]:
SMQ is briefly called – Standard Quantity (SQ). Based on input – output relations, normal
material losses as per are laboratory tests, SQ is determined.
Standard price [SP] :
SP is determined taking multiple criteria into account like : price of material in Stock,
materials already contracted, future price trends, discounts etc. So, SC for material is the
product of SQ and SP. Therefore SC = SQ x SP
Standard for Direct Labour Cost [SLC]
This resembles SMC in that it is a product of standard hours and standard rate.
SLC = SH x SR
In this also, SH and SR are to be found out.

 Standard Hours : With the help of time and motion studies in a laboratory,
work study job analysis, Normal idle time, Therbligs etc. standard time (or) Hours are
fixed.

 Standard Rate : This is 2nd aspect in finding SLC. It is fixed based on the past,
going rates, consultations with Trade union, demand for labour, supply of labour etc.
Thus, the product of SH and SR gives SLC.

 Standard for Expenses : [Overheads] While we fix standards for expenses (or)
overheads (OH) we need to go in three steps.
(1) Determination of total overhead
(2) Determination of production in units
(3) Calculation of standard overhead rate.

Sometime, for the entire overhead, a standard rate can be calculated. On the other hand,
overhead can see split into fixed and variable overheads and separately, standard Overhead
rates can be determined. The following formula can be used to calculate the overhead rate.

This rate can be calculated in hours also.

Total OH
Standard OH. Rate per unit =
Budgeted output
Standard overhead rate per hour = Standard overhead Budgeted
Hours in the period
VARIANCE ANALYSIS

This part is the most integral part of standard costing. The purposes of cost Accounting
can be achieved by costing through variance analysis in standard costing. Variances are to
be calculated for all the elements of cost viz., Materials, Labour and Expenses (or)
overhead (OH). We now examine Material Variance Analysis in the first place. The
following chat will explain it best.

MATERIAL VARIANCE ANALYSIS :

(1) (SQ x SR – AQ x AR)

Material Cost Variance

(2) (SR – AR) AQ (3) (SQ – AQ) SR

Price Quantity
Variance Variance

MMV = (RQ – AQ) SR

MUV = (SQ – RQ) SR (4) MYV = (AY – SY) SC (5)
MYV = (AY – RY) RC
Mix variance Yield
Variance
(1) Material cost variance: This is the difference between standard cost of
standard quantity for Actual output and actual cost of actual Material used for actual output. The
formula for this is :
MCV = SC – AC = SQ x SR – AQ x AR
Where : SC = Standard cost, AC = Actual cost, SQ = SQ for AY, SR = Standard Rate, AQ
= Actual Quantity, AR = Actual Rate.
Importantly, SQ = SQ for AY
Where AY = Actual Yield (or) Actual output.

(2) Material Price Variance: From the above chart, it is understood that 2nd
variance is price variance and this will also lead to MCV. This is a part of the MCV and
arises due to the difference in standard price set and the actual price paid.
The formula is :
MPV = (SR – AR) AQ where SR = Standard Rate, AR = Actual Rate and AQ = Actual
Quantity of material.

(3) Material quantity variance: (MQV) It is also known as usage variance and it is
a part of the MCV as per the above chart. This may arise due to any of the reasons viz.,
workers, quality of Materials, skill and efficiency of workers, changes in product design
etc. Mostly, it arises due to the difference in utilisation of raw materials. Its formula is :
MQV = (SQ – AQ) SR where SQ = SQ for AY, AQ = Actual Quantity, SR = Standard
Rate, AY = Actual Yield.

(4) Material mix variance [MMV]: As per the chart of material variances, MMV is
that portion of MQV due to changes in standard mix of materials and actual mix of the
materials. It may be also due to subsequent shortage of raw materials. In this case,
standard quantities are to be revised as per a formula and with these revised quantities the
MMV is to be calculated. How do we revise the Quantity?
For the sake of convenience, MMV is discussed in a phased manner. Some assumptions
are made here. In the 1st phase, the following are the assumptions.
(1) only mix ratio differs.
(2) Total weights of the mixes are the same
MMV in this case uses the same formula used for MQV.
Therefore, MMV = (SQ – AQ) SR
In the 2nd phase, the assumption are:
(1) Mix compositions differ.
(2) Total weights of the mixes are also different

MMV in this case is calculated with the following formula.

MMV = (RSQ – AQ) SR where:
RSQ = Revised Standard Quantity, AQ = Actual Quantity, SR = Standard Rate.
RSQ = Total weight of Actual Mix x old standard ratio.
Further, it is to be noted that MQV calculated as per the earlier said formula will be
divided into two parts viz., (1) MMV (due to change in mix Ratio) and (2) MUV (due to
efficiency (or) in efficiency in the utilization of materials).
So, MMV = (RSQ – AQ) SR and
MUV = (SQ – RSQ) SR
From the above it is to be noted that MQV must be equal to the total of MMV and MUV.

(5) Material yield variance (MYV) :

In all processing industries, material loss is inevitable. So, while setting standards for
material and output from materials, a provision is made for normal loss while abnormal
loss is not provided for. Though a provision is made for normal loss in the Standard, some
difference is bound to arise between standard output for the actual input and the actual
output. Hence, need for calculation of yield variance arises. Thus, there is difference
between standard yield and actual yield because of efficiency (or) in efficiency of workers,
poor quality of materials, etc. As per the material variances. Chart given above, it is 5th
variance which is a part of the MQV which is due to reasons said above. For the sake of
convenience, it is sought to be handled in two situations. They are:

(1) (a) Mix varies , (b) Weights do not vary.

In the above case, the formula for MYV is MY = (AY – SY) SC, where: AY = Actual
Yield, SY = Standard yield for actual input of material used, SC = Standard cost of unit.

(2) (a) Mix Varies, (b) Weights also vary.

In this case, since there is alround change standards set are to be revised and Revised Mix
is to be calculated and Revised yield also is to be found out. The earlier yield variance
formula is expressed now in Revised Terms. The formula is:
MY = (AY – RY) RC
SC (or) RC calculation:
It is standard cost per unit of finished goods. It is calculated as per the following:
SC (pu) (or) RC = Total Standard cost (OR)
Total input - Normal loss
Normal cost of Normal output
Normal output
Verifications (or) checking:
(1) MCV = MPV + MQV
(2) MQV = Mix + Yield
(3) MQV = Mix + usage
(4) MQV = Mix + usage (or) yield
(5) MUV = MYU

DIRECT LABOUR COST VARIANCES

These variances are about the 2nd element of cost, i.e. Labour. We get reminded of all
material variance formula when we look at Labour variances. There is a lot of similarity.
The first variance is Direct Labour Cost Variance (DLCV). This is difference between
standard cost of labour and actual cost of labour. This is like MCV. Formula is given
below:
DLCV = SC – AC = SH X SR – AH X AR
SC = Standard cost,
AC = Actual Cost,
SH = SH for actual output,
SR= Standard Rate,
AH = Actual Hours,
AR = Actual Rate.
1. Labour Rate Variance [LRV]:
This is just like Material Price Variance. This is part of the DLCV which is due to
difference between standard wage rate and actual wage rate paid. Formula is:
LRV = (SR – AR) AH,
Where: SR = Standard Rate AR = Actual Rate, AH = Actual Hours.
2. Labour Time (or) Total Efficiency Variance : (LTV (or) LEV)
This is again like material quantity variance. This is post of DLCV which is due to difference
in standard Hours for Actual output and Actual Hours. The relevant formula is:
LTV (or) LEV : (SH – AH) SR where:
SH = Standard Hours, AH = Actual Hours, SR = Standard Rate.

3. Labour Efficiency variance : (LEV)

(1) Idle Time Variance : As per the chart of labour variances, it is portion of the
Labour Efficiency (or) Time variance. As there is material loss in the case of materials,
there is problem of idle time is the case of Labour. This idle time is due to abnormal reasons
viz., non – availability of raw materials, of special kind of labour, break down of Plant &
Machinery etc. Formula is:
ITV = Abnormal Idle Hours x SR
Note: This is always adverse variance.

(2) Labour Mix variance : This is similar to material mix variance and all the
formula of material mix variance can be used by using SH in the place of SQ and RSH
(Revised standard hours) in the place of RSQ (or) RQ the relevant formula are :
(a) LMV = (RSH – AH) SR
(b) LUV = (SH – RSH) SR
From the above it can be understood that the total Labour Efficiency (or) Time variance is
a sum of (1) Idle Time variance, (2) Mix variance and (3) usage variance. When LUV is
calculated in Labour time variance, there is no need to specially calculate Labour yield
variance as it is very much equal to LYU.

(3) Labour yield variance : This is very much similar to MYV. The formula are :
(1) LYU = (AY – SY) SC
(2) LYU = (AY – RY) RC
 SC – AC = SH x SR – AH x AR
Direct Labour Cost Variance

(SR – AR) AH (SH – AH) SR

Total Efficiency
Rate Variance
(or) Time
Variance

Idle Hrs x HR [SH – [AH – IT Hrs] SR]

Idle Time Variance Efficiency Variance

4. Labour Efficiency Variance : [LEV]

As per the chart, this is part of Total Efficiency variance. When we seek to calculate the
real efficiency variance, from out of total Hrs. actually worked, Idle Hours lost due to
abnormal condition shall be set aside and with these actual hours, efficiency variance is to
be calculated. The formula is:
LEV = [SH – (AH – Idle Hours)] SR

(SH – AH) SR
When there is mix = =
Total Efficiency
Variance
(AY – SY) SC
(or)
Idle Hrs. x SR (RH – AH) SR (SH – RH) SR (AY – RY) RC

(or)
Idle Time Mix Usage Yield
Variance + Variance + Variance Variance

TLEV = Idle + Mix + Usage (or) Yield

1. Denotes Total Actual Hours worked including idle Time Hours.
Verifications:
(1) LCV = Rate + Total Time (or) Total Efficiency.
(2) Total Efficiency Variance = Idle Time + Efficiency.
(3) Total Efficiency Variance = Idle + Mix + usage (or) Yield
(4) Usage = Yield.

Advantages of Standard Costing:

In the areas of Accounting, Cost Accounting and Management Accounting,
Standard Costing enjoys a significant place in acting as a cost controlling and cost
reducing managerial tool. The utility of standard costing is unlimited. The following are
some important merits.

1. Application of “Management by Exception” principle: here is no need to

waste away the most significant time of Top management with negligible and
inappropriate things in controlling. With the help of variance analysis, attention
of the Management towards exceptional areas of performance may be drawn and
accordingly, they may be contained. Management by Exception principle says
that only exceptional aspect needs to be reported to the most right level of
management.
2. Optimum utilisation of Resources: Because of the cost consciousness
developed in the minds of people in the organisation, people tend to make the
best utilisation of all scarce resources for the maximisation of profits and
minimisation of costs.
3. People are motivated: Since standards are set with the involvement and
participation of lower level people also, they are very much motivated to
accomplish the standards that they also set, along with higher ups in the
organisation.
4. Most Important Managerial Tool of Cost control / Cost Reduction: There
are several tools and techniques to control costs and performance aspects. Among
all these tools, standard costing is a significant tool to control and reduce costs.
5. Weak sports un earthed: The efficient and inefficient areas of working in the
 entire organisation are revealed by the variance analysis. Accordingly, remedial
action can be planned.
6. Valuation of Inventory at Standard Rates: Since stocks can be valued at
standard costs, this will reduce fluctuation of profits due to adoption of different
methods for stock valuation.
Disadvantages of Standard Costing:
 Setting standards itself is the most difficult task.
 Categorising the causes for variances into controllable and un controllable itself
is another difficult barrier.
 Standard costing is not very much suitable to those industries which are exposed
to constant changes in the market.
 Standards set once are never revised as per the changed scenario and hence, they
may prove to be of no use.
 It is a costly and time-consuming tool.
 Employees resist the new life style in the organisation, because of standard costing.
 Not very much suitable to small and medium sized organisations.

In spite these problems (or) criticisms, standard costing has got its own value and
no limitations can stand against the utility of standard costing.