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Standard Costing and Variance Analysis

Standard costing is a tool that sets predetermined costs for producing goods and services. Actual costs are compared to standards to identify variances, which are differences that need investigation. Standards are typically set for materials, labor, and overhead. Management by exception focuses investigation on significant variances to uncover and address recurring problems, rather than routine supervision. Standards should encourage efficient future operations based on past records and combined expertise, not just repeat past inefficiencies. Ideal standards assume perfect conditions while practical standards allow for reasonable wastages during normal production.

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20 views2 pages

Standard Costing and Variance Analysis

Standard costing is a tool that sets predetermined costs for producing goods and services. Actual costs are compared to standards to identify variances, which are differences that need investigation. Standards are typically set for materials, labor, and overhead. Management by exception focuses investigation on significant variances to uncover and address recurring problems, rather than routine supervision. Standards should encourage efficient future operations based on past records and combined expertise, not just repeat past inefficiencies. Ideal standards assume perfect conditions while practical standards allow for reasonable wastages during normal production.

Uploaded by

Jeff Errand
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Standard costing is a tool used in managerial accounting that sets

predetermined standards for the costs of producing goods or services.


Variance analysis then compares actual results against these standards to
identify areas where costs are higher than expected.
Standard cost are pre-determined costs established by management to be used as
a basis for comparison with actual costs. In most cases, standard costs are
computed for manufacturing costs only, namely, materials, labor, and
manufacturing overhead.

Management by exception – is a concept which only those variances that are


material (whether favorable or unfavorable) should be investigated, so that
management ay have more time for more important problems of the business, not
just routine supervision of subordinates. The purpose is to find the problem and
eliminate it so that it does not recur.

In our daily lives, we operate in a management by exception mode most of the


time. Consider what happens when you sit down in the driver’s seat of your car.
You put the key in the ignition, your turn the key, and your car starts. Your
exception (standard) that the car will start is met; you do not have to open the car
hood and check the battery, the connecting cables, the fuel lines, and so on. If you
turn the key and the car does not start, then you have a discrepancy (variance).
Your exceptions are not met, and you need to investigate why. Note that even if
the car is started after a second try, it would be wise to investigate anyway. The
fact that exception was not met should be viewed as an opportunity to uncover the
cause of the problem rather than as simply an annoyance. If the underlying cause
is not discovered and corrected, the problem may recur and become much worse.

PURPOSE OF STANDARD COSTING:


Standard cost systems aid in planning operations and gaining insights into
the probable impact of managerial decisions on cost levels and profits.
Standard costs are used for:
1. Establishing budgets.
2. Controlling costs, directing and motivating employees and measuring
efficiencies.
3. Promoting possible cost reduction.
4. Simplifying costing procedures and expediting cost reports.
5. Assigning costs to materials, work in process, and finished goods
inventories.
6. Forming the basis for establishing bids and contracts and for setting
sales prices
Setting price and quantity standards requires the combined expertise of all
persons who have responsibility over input prices and over effective use of inputs.
In a manufacturing firm, this might include accountants, purchasing managers,
engineers, production supervisors, line mangers, and production workers. Past
records of purchase prices and input usage can help in setting standards. However,
the standards should be designed to encourage efficient future operations, not a
repetition of past inefficient operations.
Ideal standards are the standards which are set by assuming best-case working conditions.
Ideal standards do not consider any wastage that may occur in the production process due to
machinery breakdowns, employee strikes, employee unproductivity, material shortages etc.
When ideal standards are set, it is assumed that all systems work at 100% efficiency i.e.,
machines never malfunction, employees work at highest productivity and
material supply disruptions never take place.
Practical standards are the standards that are set for normal working conditions. They
account for reasonable and unavoidable wastages that are part and parcel of the normal
production process.

Ideal standards Practical standards


“Theoretical standards” or “maximum-efficiency “Currently attainable or normal standards”
standards” or “Perfect standards”
Attainable only under the best circumstances Tight but attainable through highly efficient
(requires perfect performance) operating conditions
No allowance for machine breakdown, work Has allowance for normal machine breakdown &
interruption, wastages, etc. employee rest periods, work interruption, normal
wastages, etc.

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