Standard Costing

Standard Costing & Variance Analysis:
Standard costing is the establishment of cost standards for activities and their periodic analysis to
determine the reasons for any variances. Standard costing is a tool that helps management
account in controlling costs.
Standards are set according to the past performance and making the changes according to the
prevalent conditions but it might happen sometimes that few of the market & organizational
conditions were not predicted and there is difference between the standards and actual.
For example, at the beginning of a year a company estimates that labor costs should be $2 per
unit. Such standards are established either by historical trend analysis of the cost or by an
estimation by any engineer or management scientist. After a period, say one month, the company
compares the actual cost incurred per unit, say $2.05 to the standard cost and determines whether
it has succeeded in controlling cost or not.
Advantages:
1. Cost Consciousness: since standards are set before the operators so they remain
conscious for the cost occurrence.
2. Work motivation: standards are made to achieve, when met provide motivation as
incentives are linked to it.
3. Cost control & cost reduction: comparison of the standards with the actual enables the
management to understand whether the standards are not set as per the prevalent
conditions or there has been some unusual happening in the organization.
It tells the management precisely the point where the problem is existing? and
management can take corrective measures.
4. Standards are useful in preparation of budget also: Budgets and standards are
techniques of planning, so standards are used for the preparation of budgets also.
5. Regular checks: Variance analysis ensures regular checks ae made on the expenditures
incurred. There is a quick localization of deviations from the pre determined standards.
6. Better economy, efficiency & productivity: efficiency & productivity of all the
elements of cost are measured and the resources are optimally utilized.
7. Aids in product pricing: As they form the basis of cost they are helpful in determining
the piece of the product.
8. Helpful in production planning: production policies are made in advance on the basis
of standard cost of production.
9. Basis for job evaluation & wage fixation: standards set will be used for job evaluation,
provision of incentive scheme of payment for employees.
10. Optimal use of resources: Standard costing optimizes the use of plant facilities, current
assets & available funds.
Limitation:
1. Difficulty in fixing standards: It is easier to review the past but it is difficult to foresee
the future, so standards might not be formed with 100% accuracy.
2. Estimation of price difficult: precise estimation of likely price changes of material &
labor rate is very difficult.
3. Apprehension of output change: the value of output may not be same as expected
because of some unforeseen situation like machine failure, power breakdown etc.
4. Outdated standards: Standards are required to be frequently reviewed and changed
which may be missed few times.
5. Costly for Non standard products: as every time a new product is designed, standards
are to be set from scratch.
6. Explanation of variance many not be possible because of random factors.
7. Resistance from within: workers are not much supportive of the analysis as it discloses
their non meeting of standards.
8. Not suitable for smaller concerns: as the smaller concerns do not have a fixed schedule
of activities so standards are not advisable.
9. Lack of management enthusiasm
Variance analysis:
The comparison of actual costs with standard costs is called variance analysis and it is vital for
controlling costs and identifying ways for improving efficiency and profitability. If actual cost
exceeds the standard costs, it is an unfavorable variance. On the other hand, if actual cost is less
than the standard cost, it is a favorable variance.
Variance analysis is usually conducted for
a. Direct material costs (price and quantity variances);

b. Direct labor costs (wage rate and efficiency variances); and
c. Overhead costs.
The Institute of Cost & Management Accountants defines variance as the difference between a
standard cost and the comparable actual cost incurred during a period. Variance Analysis can be
defined as the process of computing the amount of and isolating the cause of variances between
actual costs and standard costs. It involves two phases:
Computation of individual variances
a. Determination of the cause(s) of each variance
b. Comparison
Care to be taken while comparing actual and standard cost3.Conditions might have changed, thus
rendering the standard costs unrealistic – for instance the quality of available materials may be
low.5.Standards fixed upon on too idealistic a basis will remain unattainable.7.The service
rendered by a service departments may not be upto the mark so that, for example time is lost due
to a machine working slow. In certain activities, fixation of standard is either not possible or not
desirable. Goods requiring artistic work of high quality cannot be and should not be subject to
quantitative standards. In certain cases work cannot be properly measured. Standards in these
cases will be useless.
Classification
1. Material Variances
2. Labor Variances
3. Overhead Variances
4. Sales Variances
(For Formula’s: PPT attached)

Standard Costing

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Standard Costing & Variance Analysis:

Variance analysis is usually conducted for

a. Direct material costs (price and quantity variances);

Computation of individual variances

a. Determination of the cause(s) of each variance

(For Formula’s: PPT attached)

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