Standard Costs

The estimate of the cost the company expects to incur in the production process. It is
the standard against which to measure the actual performance. Standard Costs are
predetermined costs; they are target costs that should be incurred under efficient
operating system.

A budget relates to an entire activity or operation; a standard presents the same

information on a per unit basis.

A standard therefore provides cost expectations per unit of capacity and a budget
provides the cost expectation for the total activity. A standard costing is most suited
to an organization whose activities consist of a series of common or repetitive
operations where the input required to produce each unit of output can be specified.
 Managing costs
First a predetermined or standard cost is set. A standard cost is the company’s best
estimate average cost to produce a single unit of product or service.

Standard costs are used with a flexible budgeting system. The established standard costs
need to be reviewed periodically to confirm it is still accurate.

It is questionable whether the allocation of actual costs to products serves any useful
purpose. Standard costs represents future target costs, they are preferable to actual past
costs decision-making.

Control over costs is best effected through action at the point where the costs are
incurred. Hence the standard should be set for the quantities of material, labour, and
services to be consumed in performing an operation. Variances from these standards
should be reported to show cause and responsibilities for deviation from standard.
 Setting standards
A standard is a predetermined measure relating to materials, labor, or overheads. It is
a reflection of what is expected, under specific conditions, of plant and personnel. In
setting standards, the key question is to decide on the type of standard to be used in
fixing the cost. The main types of standards are ideal, basic, and currently attainable
standards.
• Ideal standards, also called perfection standards, are established on a maximum
efficiency level with no unplanned work stoppages. They are tight standards
which in practice may never be obtained. They represent the level of attainment
that could be reached if all the conditions were perfect all of the time.

• Basic standards are long-term standards and they remain the same after being
computed for the first time. They are projections that are rarely revised or updated
to reflect changes in products, prices, and methods. Basic standards provide the
basis for comparing actual costs over time with a constant standard. They are used
primarily to measure trends in operating performance.
 Setting standards
• Currently attainable standard is one that represents the best attainable
performance. It can be achieved with reasonable effort. These standards make
proper allowances for normal recurring interferences such as machine breakdown,
delays, rest periods, unavoidable waste, and so on.
Objectives of Using a Stand Costing System
• First, a standard costing system may be used to control costs, which is achieved
mainly by setting standards for each type of cost incurred: material, labor, and
overhead.
• The second objective that a standard costing system may be used to achieve is to
help in setting budgets.
• Third, such a system may be used to provide useful and detailed information for
managerial planning and decision-making.
• Fourthly, a standard costing system may be used to assess the performance and
efficiency of staff and management.
• Finally, standard costing is a control technique that follows the feedback control
cycle.
Therefore, the feedback system may help to eliminate unwanted costs in the future,
leading to a potential reduction in costs.
 Components of Standard Costing
There are three fundamental aspects of a manufacturing system, which comprise the
following:
• Direct Material: It is calculated by multiplying the amount of each material by
the material cost per unit.
• Direct Labour: It is calculated by multiplying the total number of hours worked
by the hourly labour cost.
• Overhead: It contains both variable and fixed overhead costs, which are
determined by multiplying the standard amount by the standard variable overhead
rate.
 Materials Cost = market price per unit x total number of units
 Manufacturing Overhead = Fixed Overhead + (Variable Manufacturing
Overhead × Total Number of Units)
 Direct Labour = employee hourly rate x no. of hours worked x total number of
units
 Direct Material Standards
The standard cost of direct materials is closely related to the quantities and prices of
materials to be used in production. Hence, two related standards are set:

Materials Usage Standard: The object of setting the materials usage standard is to
achieve maximum efficiency in materials usage. The standard quantities of materials
to be used per unit of production can be laid down by one of the following means:
• By reference to the weight of materials in the final production.
• On the basis of past performance with due allowance for change in conditions.
• By means of test runs conducted under different conditions and taking an average
of quantities used.
Due allowance must be made for normal wastage
 Direct Material Standards
• Materials Price Standard: Standards are set for material prices after due
consideration of the efficiency of purchasing and store-keeping functions. The
aim of setting materials price standard is to achieve maximum efficiency in this
function, and thus minimize direct materials costs. The price standard should
provide for discount on purchases, economy of bulk purchasing and anticipated
changes in market price.
 Direct Labour Standards
Direct labour costs depends upon labour time and wage rates and therefore, setting
standard cost for direct labour involves setting two related standard:

Standard Labour Time: This indicates the precise time (hours) that labour of a
particular grade should take to perform a given operation. The main object of setting
standard labour time is to derive maximum efficiency in the use of labour time. The
standard time may be set on the basis of past performance with adjustments for
change of conditions.

Labour Rate Standard: This refers to the wage rates expected to be paid to different
grades of labour employed in the organization. The object is to plan for the actual
wages to be paid. A variety of factors should be considered and allowance made for
them while setting standard wage rates
 Overhead Standards
The principal object of setting standard overhead rates is to minimize the overhead
costs chargeable to production. Following steps are necessary for setting standard
rates:

• The level of activity of production departments and the work to be done by the
service departments should be determined.
• Overheads costs should be classified into fixed, variable and semi-variable
overheads.
• The standard overhead rates for each of the service departments should be
calculated, and applied to the producing departments.
• The standard overhead rates for the producing departments may be determined as
a direct labour hour rate, or a machine hour rate, or as a percentage of direct
wages.
 Variance analysis- Standard Costing
Standard costing variance analysis is a technique businesses use to keep track of their
costs. It involves setting a "standard" cost for each item or activity and comparing
actual costs to these standards, and then monitoring performance against that
benchmark.
Variances
Uncontrollable
Controllable
When variance is due to the factors
Deviation caused by such factors beyond the control of the concerned
which could be influenced by the person or department
executive action E.g. excess usage of
E.g. wage rate increased on account
materials, excess time taken by a
of strike, government restrictions,
worker
change in market price
 Variance analysis- Standard Costing
Standard costing variance analysis is a technique businesses use to keep track of their
costs. It involves setting a "standard" cost for each item or activity and comparing
actual costs to these standards, and then monitoring performance against that
benchmark.
Variances

Unfavourable
Favourable Also known as negative or debit
Also known as positive or credit variance. When the actual cost
variance. When the actual cost incurred is more than the standard
incurred is less than the standard cost
cost
 Manufacturing Variances
Manufacturing input variances:
• Direct Materials
• Direct Labor
• Overhead
 Manufacturing Input Variances
Total input variances are subdivided into
1. A price variance reflecting the difference between actual and budgeted input
prices, and
2. A quantity variance, also called an efficiency variance, reflecting the
difference between actual and budgeted input quantities.
 Total Direct Materials Variance
The total materials variance is the difference between the actual direct material costs
and the expected direct material costs in the flexible budget.

SC- AC
SC- Standard material cost
AC- Actual cost

This difference in material cost maybe partly due to

difference in usage of raw material and partly due to
difference in prices.
 Quantity and Price Variances
The total materials variance may be broken down into two sub variances:
1. The quantity variance, and
2. The price variance.
Direct Materials Variances
Total Material
Variance

Quantity
Price Variance (or Efficiency)
Variance

Mix Yield
Variance Variance
 Quantity Variance
It is that portion of the materials cost variance which is the difference between the
standard quantity specified for the production achieved, whether completed or not,
and the actual quantity used, both valued at standard prices
The reasons for price variance can be inefficiency, lack of skills or training and
faulty workmanship, incorrect processing of materials whereby wastages may occur,
pilferage, use of defective or substandard material, use of substitute material etc.
The quantity variance is also called the efficiency variance, or the usage variance.

(AQ – SQ) × SP

Positive result is unfavorable and negative result is favorable.

 Price Variance
It is that portion of the Materials cost variance which is due to the difference between
the standard price specified and the actual price paid for the direct materials used

The reasons for price variance can be fluctuations in market prices, increase or
decrease in prices on account of agreement between various suppliers or on account of
government interference, buying efficiency or inefficiency, high or low cost of
transportation and carriage of goods etc.
Measures the effect on the total variance caused by the actual price being different
from the expected price.

(AP – SP) × AQ

Positive result is unfavorable and negative result is favorable.

 Material Mix Variance (MMV)
It arises when two or more materials are used in the manufacture of a product

The difference between the standard composition and the actual composition of
material mix is the material mix variance. It represents the variation in cost arising as
a result of change in in the ratio in which the different materials are used compared
to the standard fixed for the purpose.
Standard Price x (Revised Standard Quantity – Actual Quantity)
= SP * (RSQ- AQ)
RSQ = Total weight of actual mix x Standard Quantity
Total weight of standard mix
 Material Yield variance (MYV)
It is that portion of the material usage variance which is due to the difference
between the standard yield specified and the actual yield obtained.
• The variance arises due to abnormal contingencies like spoilage, chemical reaction
etc.

Standard Price x (Revised Standard Quantity – Actual Quantity)

= Standard output price *(Actual Yield-Standard Yield)

 PRACTICE QUESTION
Ardmore Enterprises uses a standard cost system in its small appliance division. The standard cost of
manufacturing one unit of Zeb is as follows:
Direct materials -- 60 pounds at $1.50 per pound $ 90
Direct labor -- 3 hours at $12 per hour 36
Overhead -- 3 hours at $8 per hour 24
Total standard cost per unit $150
The budgeted variable overhead rate is $3 per direct labor hour, and the budgeted fixed overhead is $27,000
per month. During May, Ardmore produced 1,650 units of Zeb compared with a normal capacity of 1,800
units. The actual cost per unit was as follows:
Direct materials (purchased and used) --
58 pounds at $1.65 per pound $ 95.70
Direct labor -- 3.1 hours at $12 per hour 37.20
Overhead -- $39,930 per 1,650 units 24.20
Total actual cost per unit $157.10

Ardmore’s total direct materials quantity variance and price variance for May is
 ANSWER
The direct materials quantity variance equals the difference between the standard
and actual quantities times the standard price. Hence, the favorable direct materials
quantity variance is $4,950 [1,650 units × (60 standard pounds – 58 actual pounds) ×
$1.50 standard].

The direct materials price variance equals the actual quantity used times the
difference between the standard and actual price per unit. Thus, the unfavorable
direct materials price variance is $14,355 [1,650 units × 58 actual pounds × ($1.50
standard price – $1.65 actual price)].
 PRACTICE QUESTION
Jackson Industries employs a standard cost system in which direct materials inventory is carried
at standard cost. Jackson has established the following standards for the prime costs of one unit
of product:
Standard Standard Standard
Quantity Price Cost
Direct materials 5 pounds $ 3.60/pound $18.00
Direct labor 1.25 hours $12.00/hour 15.00
$33.00
During May, Jackson purchased 125,000 pounds of direct materials at a total cost of $475,000.
The total factory wages for May were $364,000, 90% of which were for direct labor. Jackson
manufactured 22,000 units of product during May using 108,000 pounds of direct materials and
28,000 direct labor hours.
• Jackson’s direct materials usage (quantity) variance for May is?
• The purchase price variance for the direct materials acquired by Jackson Industries during
May is?
 ANSWER
This variance equals the standard unit cost times the difference between the actual
quantity used and the standard quantity for good production. Consequently, the
variance is $7,200 favorable {[(5 pounds × 22,000 units) – 108,000 pounds used] ×
$3.60}.

The materials price variance is calculated by multiplying the number of units

purchased, in this case, 125,000, times the difference between the standard price
($3.60) and the actual price paid. The actual price paid for 125,000 units was
$475,000, or $3.80 per unit ($475,000/125,000 units). Subtracting the $3.60
standard price from the $3.80 actual price results in an unfavorable price variance of
$.20 per unit. Multiplying $.20 times the 125,000 units results in a total price
variance of $25,000. Because the actual price was greater than the standard price,
that variance is unfavorable.
 Total Direct Labor Variance
The total labor variance is the difference between the actual labor costs and the
expected labor costs in the flexible budget.
SC- AC

1. Labour Rate Variance:

It is that portion of the labour cost variance which arises due to the difference
between the standard rate specified and the actual rate paid. It is calculated as
follows:
(SR – AR) × AH

Rate Variance = Actual Time Taken (Standard Rate – Actual Rate).

 Total Direct Labor Variance
2. Labour Efficiency Variance: The efficiency variance measures the effect on
the total variance that was caused by the actual quantity used being different
from the expected quantity to be used for the actual level of output that was
produced.

(SH – AH) × SR

Standard Rate (Standard Time – Actual time)

 PRACTICE QUESTION
Water Control Systems manufactures water pumps and uses a standard cost system. The standard
overhead costs per water pump are based on direct labor hours and are as follows:
Variable overhead (4 hours at $8 per hour) $32
Fixed overhead (4 hours at $5* per hour) 20
Total overhead cost per unit $52
* Based on a capacity of 100,000 direct labor hours per month.
The following information is available for the month of November:
22,000 pumps were produced although 25,000 had been scheduled for production.
94,000 direct labor hours were worked at a total cost of $940,000.
The standard direct labor rate is $9 per hour.
The standard direct labor time per unit is four hours.
Variable overhead costs were $740,000.
Fixed overhead costs were $540,000.

Water Control’s direct labor price variance and direct labor efficiency for November was
 ANSWER
The direct labor price variance equals actual labor hours times the difference between
standard and actual labor rates. The actual direct labor cost was $940,000 for 94,000
hours, or $10 per hour. The standard rate was $9 per hour. Thus, the variance is
$94,000 unfavorable [94,000 hours × ($9 – $10)].

The direct labor efficiency variance equals the difference between standard and
actual hours times the standard rate. Hence, the variance is $54,000 unfavorable
{[(22,000 units × 4 standard hours per unit) – 94,000 hours] × $9}. The variance is
unfavorable because the actual hours exceeded the standard hours.
 MULTIPLE TYPE OF DM & DL
Manufacturing processes usually involve several types of direct material. In such
cases, direct material and quantity are computed for each type of material. Then
these variances are added to obtain a total price and quantity variance.

The total price variance of multiple inputs is the sum of the price variances for each
input of the mix. The variance for each input is calculated individually using the
price variance formula.

The total quantity or efficiency variance of multiple inputs is the sum of the quantity
variances for each input of the mix. The variance for each input is calculated
individually using the quantity variance formula
 OVERHEAD VARIANCES
Overhead variances arise when the actual overhead costs incurred differ from the
expected amounts. Each of these variances applies to a different aspect of overhead
expenditures.
Total Overhead Variance = Actual total variable and fixed overhead
incurred
(money actually spent on these items) –
Total variable and fixed overhead
applied to production using
predetermined rates
 Total Variable Overhead Variance
Also called the flexible budget variance.
Equal to the difference between the actual variable overhead incurred and the
standard variable overhead applied, based on the standard usage of the allocation
base.
The total variable overhead variance is calculated as:
Actual total variable overhead incurred (AP x AQ)
− Flexible budget amt of variable OH (SP x SQ)
= Total Variable Overhead Variance
 Variable Overhead Spending Variance
Determines how much of the total variance was caused by the actual variable
overhead rate per unit of the allocation base actually used being different from the
standard overhead application rate per unit of the allocation base actually used.

(AR – SR) × AH
Actual variable overhead incurred (AR x AH)
− Budgeted variable overhead based on inputs
ACTUALLY USED (SR x AH)
= Variable Overhead Spending Variance
 Variable Overhead Efficiency Variance
Determines how much of the total variance was caused by the actual number of the
allocation base (direct labor hours, number of parts…) used being different than the
expected number of the allocation base to be used.

(SH – AH) × SR
The variable overhead efficiency variance is the difference between the actual and
budgeted hours worked, which are then applied to the standard variable overhead
rate per hour
Budgeted variable OH based on inputs actually used (SR x AH)
− Standard variable OH allowed for /
applied to production (SR x SH)
= Variable overhead efficiency variance
 PRACTICE QUESTION
Water Control Systems manufactures water pumps and uses a standard cost system. The standard overhead costs
per water pump are based on direct labor hours and are as follows:
Variable overhead (4 hours at $8 per hour) $32
Fixed overhead (4 hours at $5* per hour) 20
Total overhead cost per unit $52
* Based on a capacity of 100,000 direct labor hours per month.
The following information is available for the month of November:
22,000 pumps were produced although 25,000 had been scheduled for production.
94,000 direct labor hours were worked at a total cost of $940,000.
The standard direct labor rate is $9 per hour.
The standard direct labor time per unit is four hours.
Variable overhead costs were $740,000.
Fixed overhead costs were $540,000.

Water Control’s variable overhead spending variance and variable overhead efficiency variance for November
was
 ANSWER
The variable overhead spending variance is the difference between actual variable
overhead and the variable overhead based on the standard rate and the actual activity
level. Thus, the variable overhead spending variance was $12,000 favorable [(94,000
actual hours × $8 standard rate) – $740,000 actual cost].

The variable overhead efficiency variance equals the standard price ($8 an hour)
times the difference between the actual hours and the standard hours allowed for the
actual output. Thus, the variance is $48,000 unfavorable {[(22,000 units produced ×
4 standard hours per unit) – 94,000 actual hours] × $8}.
 Fixed Overhead Variances
Because of the nature of these expenses, much less control can be maintained or
effected over these costs.

Total Fixed Overhead Variance

Difference between the actual fixed overhead incurred and the amount
that was applied using the standard rate and the standard usage for the
actual level of output.
Actual Fixed Overhead Incurred
− Standard Fixed Overheads Applied
= Total Fixed Overhead Variance
 Fixed Overhead Spending Variance
Difference between the actual fixed overhead costs and the budgeted fixed overhead
amount.
Actual Fixed Overhead Incurred
- Budgeted Fixed Overhead
= Fixed Overhead Budget/Spending Variance
 Fixed Overhead Production-Volume Variance
Difference between the budgeted amount of fixed over-head and the amount of
fixed overhead applied.

Budgeted Fixed OH (Static Budget Amt.)

− Standard Fixed Overheads Applied
= Fixed OH production-volume variance
 PRACTICE QUESTION
Tiny Tykes Corporation had the following activity relating to its fixed and variable overhead for the month of July:
Actual costs
Fixed overhead $120,000
Variable overhead 80,000
Flexible budget
(Standard input allowed for actual
output achieved × budgeted rate)
Variable overhead 90,000
Applied
(Standard input allowed for actual
output achieved × budgeted rate)
Fixed overhead 125,000
Variable overhead spending variance 2,000 F
Production volume variance 5,000 U
Tiny Tykes’ fixed overhead efficiency variance is
 ANSWER
Variable overhead variances can be subdivided into spending and efficiency components. However, fixed overhead
variances do not have an efficiency component because fixed costs, by definition, are not related to changing levels of
output. Fixed overhead variances are typically subdivided into a budget (or fixed overhead spending) variance and a
volume variance.
 PRACTICE QUESTION
Zazoo, Inc. specializes in reviewing and editing technical magazine articles. Zazoo sets the following standards for
evaluating the performance of the professional staff:
Annual budgeted fixed overhead costs for normal capacity level of 10,000 articles reviewed and edited
$600,000
Standard professional hours per 10 articles
200
Flexible budget of standard labor costs to process 10,000 articles
$10,000,000
The following data apply to the 9,500 articles that were actually reviewed and edited during the current year.
Total hours used by professional staff
192,000
Flexible costs
$9,120,000
Total cost
$9,738,000

Zazoo’s fixed overhead spending variance for the year is

 ANSWER
Budgeted fixed overhead costs are $600,000. The actual costs were $618,000 ($9,738,000 total costs – $9,120,000
flexible costs). Because actual costs were $18,000 higher than the budget, the variance is unfavorable.
 Factory Overhead Variances
Total Overhead Variance

Total Variable Overhead

Total Fixed Overhead Variance
Variance

Fixed Fixed
Variable Variable
Overhead Overhead
Overhead Overhead
Spending or Production-
Spending Efficiency
Budget Volume
Variance Variance
Variance Variance
Total OH FLEXIBLE BUDGET Var.
Total Overhead Variance

Total Variable Overhead

Total Fixed Overhead Variance
Variance

Fixed Fixed
Variable Variable
Overhead Overhead
Overhead Overhead
Spending or Production-
Spending Efficiency
Budget Volume
Variance Variance
Variance Variance
 2-way, 3-way and 4-way Analysis
In 4-way variance analysis, each of the four subvariances are looked at and measured
individually.
In 3-way variance analysis, the variable and fixed overhead spending variances are
combined into one spending variance.
In 2-way variance analysis, the spending variance is combined with the variable
overhead efficiency variance in what is called the controllable variance.
 Variable Overhead Variance Fixed Overhead Variance Analysis
Analysis

4-way Efficiency Spending Spending Production-

Variance Variance Variance Volume
Variance
(AQ − SQ) × (AP − SP) × Actual − Budgeted -
SP AQ Budgeted Applied
3-way Efficiency Spending Variance Volume
Variance Variance

2-way Controllable Variance Volume

Also the Total OH Flexible Budget Variance Variance
Investigation of Standard Cost Variances
Standard costing can also be used to investigate dynamic variances, which is done by
looking at the number of inputs used in production and how this has changed over
time. Standard costing can help identify when there has been a change in the number
of inputs used and how this has affected the cost of production.

Favorable cost variances occur when actual costs are lower than expected costs.
Unfavorable cost variances occur when actual costs are higher than expected costs.
Responsibility Accounting and Variances
It is used to measure performance of divisions of an organization rather than organization
as a whole. Under this system, divisions or units of an organization under a specific
authority in a person are developed as responsibility centres & evaluated individually for
their performance.

To be able to exercise this control, the cost and /or budget department must issue
monthly reports that compare the actual results with predetermined amounts or budget
allowances in a view to Variance Analysis for Responsibility Accounting. Many of the
variable expenses are controllable at the departmental level while fixed expenses are not.

Conversely, a department manager may have some control over certain fixed costs —
those that involve a long-term commitment.
These costs should be individually identified as controllable by the manager of the
department.