Accounting For Managerial

Decisions
Unit 3
Standard Costing
Standard Costing
• Standard costing is a method of cost and management accounting which starts with
setting of standards and ends with reporting of variances to management for
taking corrective actions
• Standard Cost: A predetermined norm applied as a scale of reference for assessing
actual cost, whether these are more or less.
• The standard cost serves as a basis of cost control and as a measure of productive efficiency
when ultimately posed with an actual cost.
• It provides management with a medium by which the effectiveness of current results is
measured and responsibility for deviation is placed.
• Standard costs are used to compare the actual costs with the standard cost with a view to
determine the variances, if any, and analyze the causes of variances and take proper
measure to control them.
• CIMA defines “Control technique that reports variances by comparing actual costs
to pre-set standards so facilitating action through management by exception”
• Main use of standard costing is in,
• Performance measurement
• Control
• Stock valuation and
• In the establishment of selling price
Standard Costs

Based on carefully
predetermined amounts.

Standard Used for planning labor, material

Costs are and overhead requirements.

The expected level

of performance.

Benchmarks for
measuring performance.
Standards vs. Budgets

A standard is the expected

cost for one unit.
Are standards the same as A budget is the expected cost
budgets? for all units.
Types of Standards
• Ideal Standards
• These standards are the standards when the maximum efficiency is
achieved in utilization of resources resulting in maximum output at
minimum cost.
• The level of performance achieved when material prices and labour cost
is most favourable
• When the output is at its peak
• With the best equipment and layout
• Normal Standards
• These standards are achieved under normal operating conditions
• Normal activity is the number of standard hours, which will produce at
normal efficiency, which is sufficiently good to meet the average sales
demand over a term of years.
Types of Standards
• Basic Standard
• It is a standard established for use over a long period from which a current
standard can be developed.
• They are used only when they are likely to remain unaltered or constant
over a long period of time.
• Current Standard
• It is a standard established for use over a short period of time, related to
current conditions.
• These are the cost which the business will incur if the anticipated prices
are paid for the goods and services and the usage corresponds to that
believed to be necessary to produce the planned output.
Process of Standard Cost
Setting Standard Costs
Accountants, engineers, personnel administrators, and
production managers combine efforts to set standards
based on experience and expectations.
 Steps in Standard Costing

• Set the standard cost

✓ A standard quantity is predetermined and
standard price per unit is estimated.

✓ Budgeted cost is calculated by using

standard cost.
 Steps in Standard Costing

•Record the actual cost

✓ Calculate actual quantity and cost incurred
giving full details.
 Steps in Standard Costing

• Variance Analysis
✓ Comparison of the actual cost with the
budgeted cost.

✓ The cost variance is used in controlling cost.

 Steps in Standard Costing

• Variance Analysis
✓ Take suitable corrective action.

✓ Fix responsibilities to ensure compliance

Dr. Varadraj Bapat 13

 Steps in Standard Costing

• Variance Analysis
✓ Create effective control system.

✓ Resetting the budget, if required.

What all could be
the reasons for
the actual
manufacturing
cost or the
sales/profit to
vary from their
standard costs
and price/profit?
Variance

• The difference between standard cost and

actual cost of the actual output is defined
as Variance. A variance may be favourable
or unfavourable.
Variance

• If the actual cost is less than the standard

cost, the variance is favourable and if the
actual cost is more than the standard cost,
the variance will be unfavourable.
Variance - Types

The purpose of standard costing reports is

to investigate the reasons for significant
variances so as to identify the problems
and take corrective action. Variances are
broadly of two types, namely, controllable
and uncontrollable.
Controllable Variance

Controllable variances are those which

can be controlled by the departmental
heads whereas uncontrollable variances
are those which are beyond their control.
If uncontrollable variances are of
significant nature and are persistent, the
standards may need revision.
Variance Analysis

Variance analysis is the dividing

of the cost variance into its
components to know their
causes, so that one can approach
for corrective measures.
Variance Analysis

Variances of Efficiency:
Variance arising due to the
effectiveness in use of material
quantities, labour hours. Here
actual quantities are compared
with predetermined standards.
Variances of Price Rates:
Variances arising due to change
in unit material prices, standard
labour hour rates and standard
allowances for indirect costs.
Here actual prices are compared
with predetermined ones.
Variances of Due to Volume:
Variance due to effect of difference
between actual activity and the level
of activity estimated when the
standard was set.
Variance Analysis
• Cost Variance: is the difference between the
standard cost and the actual costs.
• Variance Analysis: is the resolution into constituent
parts and the explanation of the variances.
❖ Favorable & Unfavorable Variances.
❖Controllable & Uncontrollable Variances
 How will the material price
variance and material usage be
computed if the quantity
purchased is different from the
quantity used?

The price variance is computed

on the entire quantity
purchased.
The quantity variance is
computed only on the quantity
used.
 1. Material 2. Labour 3. Overhead 4. Other
Variance Variance Variance Variances

Material Cost Labour Cost Overhead Cost Calendar

variance Variance Variance Variance

Types of
Variances Material Price Labour Rate Variable Sales Value
Variance Variance overheads Var. variance

Labour
Material Usage Variable o/h Sales price
Efficiency
Variance efficiency var. variance
Variance

Labour Mix
Material Mix Variance Variable o/h Sales volume
Variance expenditure var. variance
Idle Time
Variance
Material Yield Fixed overhead
Profit Variance
Variance variance
Material Cost Variance
Material Cost
Variance

Material Price Material Usage

Variance Variance

Material Mix
Variance

Material Yield
Variance
Reasons of Material Variance

• Change in Basic price

• Fail to purchase anticipated standard quantities
at appropriate price
• Use of sub-standard material
• Ineffective use of materials
• Pilferage
 Material Cost Variance

• Material cost variance arises due to variance in the price of material or its
usage.

• This can be calculated by using the following formula,

• Material Cost Variance = (SQ x SP) – (AQ x AP) ,

Where
SQ = Standard quantity for the actual output
SP = Standard price per unit of material
AQ = Actual quantity
AP = Actual price per unit of material

• A positive result implies favorable variance, and a negative result implies

unfavorable variance (adverse variance).
 Material Price Variance
• Material price variance may arise due to number of reasons like fluctuations in
market prices, error in buying due to wrong purchasing policy etc,

• This can be calculated by using the following formula,

• Material Price Variance = (SP – AP) x AQ

• Where,
SP = Standard price per unit of material
AQ = Actual quantity
AP = Actual price per unit of material

• A positive result implies favorable variance and a negative result implies

unfavorable variance (adverse variance).
 Material usage Variance

• Material Usage variance is the difference between the actual quantities of raw
materials used in production and the standard quantities that should have been
used to produce the product,

• MUV may arise due to number of reasons like Pilferage of materials , Wastage ,
Sub-standard or defective materials etc,

• This can be calculated by using the following formula,

• Material Usage Variance = (SQ – AQ) x SP
Material Variance

• Material Cost Variance= (Standard Quantity X

Standard Price) –(Actual Qty X Act Price)
• Material Price Variance= Actual Quantity (Standard
Price - Actual Price)
• Material Usage Variance=Standard Price (Standard
Quantity - Actual Quantity)
 Material Mix Variance
• MMV is calculated when a product uses mixture of different raw
materials,

• MMV is that portion of the materials quantity variance, which is due to

the difference between the standard and actual composition of a
mixture.

• It can be represented by the following formula:

Material mix variance =
(Standard cost of actual quantity of the standard mixture – Standard
cost of actual quantity of the actual mixture) or (Revised SQ – AQ) x SP
 Practical Problems

1. A furniture company uses sunmica tops for tables. It provides

the following data:
St. Quantity for sunmica per table 4 sq. ft
St. price per sq. ft of sunmica Rs. 5
Actual prod. Of tables 1000
Sunmica actually used 4,300 sq.ft
Actual purchase price per sq. ft Rs. 5.50.
Calculate Material variances.
2. From the following information calculate (i) material cost
variance (ii) material price variance (iii) Material Usage variance
Standard output 100 units
Standard Material per unit 3 Ibs
Standard price per Ib. Rs. 2
Actual output 80 units
Actual price Rs. 5.50
Actual materials used 250 Ibs
3. From the following information calculate (i) material
cost variance (ii) material price variance (iii) Material
Usage variance
Quantity of material purchased 3000 units
Value of material purchased Rs. 9000
St. quantity of raw material req. p.u. 25 units
Standard rate of material per unit Rs. 2 per
Opening stock of material Nil
Closing stock of material 500 units
Finished production during the period 80 units
4. The standard output of the production house has been
set at 1000 pieces per month. However actually 1020
pieces were produced. Following is the data for actual
and standard production.
Standard Actual Results
Usage 1.5 sq. ft per pad 1.3 sq. ft per pad
Price Rs. 0.15 per sq. ft Rs. 0.18 per sq. ft
Calculate all material variances.
5. A mfg. concern, which has adopted standard costing, furnishes the
following information:
Standard:
Material for 70 kg. Of finished products 100 kgs.
Price of materials Rs. 1 per kg.
Actual:
Output 210,000 kgs
Material used 280,000 kgs.
Cost of materials Rs. 2,52,000
Calculate all material variances.
Practice
1. The standard and actual figures of product z are
Standard Actual
50 Units 45 units Material Quantity
₹1.00 ₹0.80 Material Price per unit

Calculate Material Cost Variance

2. NXE Manufacturing Concern furnishes the following information:
Standard: Material for 70kg finished products 100kg
Price of material per kg Rs. 1
Actual: Output 2,10,000 kg
Material used 2,80,000 kg
Cost of materials ₹2,52,000
Calculate (i) Material usage variance (ii) Material price variance (iii) Material cost variance
Material Mix Variance

• Material Mix Variance

= [Revised St. Qty – Actual Qty] x St. Price
Rev. St. Qty = St. Qty of 1 Mat. x Actual Total
Standard Total

• Material Yield Variance

= (Std Input Qty- Actual Input Qty)*Std Price of Std Input
Practice

• The standard quantity and standard price of raw material required for one unit of product
A are given as follows
Quantity (kg.) S.P. (₹)
Material X 2 3
Material Y 4 2

The actual production and relevant data are as follows:

Material X 1,100 kgs. @ ₹ 3,410
Material Y 1,800 kgs. @ ₹ 3,960
Calculate Variances. Actual production was 500 units.
1. From the data given below, calculate the Material Price Variance, Material Usage Variance
and Material Mix Variance:
Raw Material Standard Actual
X 40 units @ Rs. 50 p.u. 50 units @ Rs. 50 p.u.
Y 60 units @ Rs. 40 p.u. 60 units @ Rs. 45 p.u.
Total 100 units 110 units

2. From the following information regarding a standard product, compute 1. Mix 2. Price 3.
Usage Variance:

Standard Actual
Unit
Material Qty. Rs. p.u. Total Qty Price Total
A 4 1.00 4.00 2 3.50 7.00
B 2 2.00 4.00 1 2.00 2.00
C 2 4.00 8.00 3 3.00 9.00
Total 8 7.00 16.00 6.00 8.50 18.00
Practice
• Standard cost of a chemical mixture is as follows:
40% material A at Rs. 20 per Kg
60% material B at Rs. 30 per Kg
Standard output is 180 kgs of the product.
A standard loss of 10% of input is expected in production. The cost
records for a period showed the following usage
90kg material A at a cost of Rs. 18 per kg
110kg material B at a cost of Rs. 34 per kg
The quantity produced was 182 kg of good product.
Labour Variance - Reasons
• Time Related Issues • Rate Related Issues
• Change in design and quality • Increments / high labour wages
standard
• Overtime
• Low Motivation
• Labour shortage leading to
• Poor working conditions higher rates
• Improper
scheduling/placement of • Union agreement
labour
• Inadequate Training

Dr. Varadraj Bapat 46

 Material variances
Labour Variances

• Labour Cost Variance SH*SR – AH*AR

• Labour Usage/Efficie. Var (SH-AHactual)*SR
• Labour Rate Variance (SR-AR)* AH
• Idle time Variance SR*Idle time

• SH – Standard Hour
• SR – Standard Rate
• AH – Actual Hour
• AR – Actual Rate
Practice Problem
A firm gives you the following data:
Standard time per unit 2.5 hours
Actual hours worked 2,000 hours
Standard rate of pay Rs. 2 per hour
25 % of the actual hours has been lost as idle time.
Actual output 1,000 units
Actual wages Rs. 4,500
Calculate all labour variances.
Practice Problems
Compute the Labour variances from the information
given below:
Standard time 3 hours per unit
Standard rate of wages Rs. 6 per hour
Actual production 700 units
Actual time taken 2000 hours
Actual Wages Rs. 14000
Idle time 50 hours
Labor Efficiency Variance- Causes
Poorly Poor
trained quality
workers materials

Unfavorable
Efficiency
Variance
Poor Poorly
supervision maintained
of workers equipment
Responsibility for Labor Variances

You used too much

time because of poorly
trained workers and I am not responsible for
poor supervision. the unfavorable labor
efficiency variance!
You purchased cheap
material, so it took more
time to process it.
Overhead Variances
• Overhead variances arise due to the difference between
actual overheads and absorbed overheads. The estimate
of budget of the overheads is to be divided into fixed and
variable elements. i.e.
1. Variable overhead variances.
• Variable overhead budget or expenditure variance, and
• Variable overhead efficiency variance.
2. Fixed overhead variances.
Formulas
1. Variable overhead variances.
(Standard variable o/h for actual prodn. – Actual variable o/h)
2. Variable overhead budget or expenditure variance,
(Budgeted variable overhead for actual hours –
Actual variable overhead) i.e. AH*BR – Actual Cost
3. Variable overhead efficiency variance.
Standard variable overhead rate per hour [Std. hours
for actual output – Actual hours] i.e. (SH-AH) *SR
4. Fixed Overhead Variance
Budgeted FO- AFO
Sales Variances

• Sales Margin Price Margin = (AP-BP)*AQ

• Sales Margin Volume variance = (AQ-BQ)*BC
• Total Sales Margin variance = AQ*AC – BQ*BC
Reasons of Labour Variance

• Time Related Issues

• Change in design and quality standard
• Low Motivation
• Poor working conditions
• Improper scheduling/placement of labour
• Inadequate Training