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Chapter 9
Standard costing and variance
analysis
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Contents
1. Standard costing and standard costs

2. Cost variances

3. Sales variances and operating statements

4. Interpreting variances and deriving actual data from variance detail

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1. Standard costing and standard costs

Standard costing
• A pre-determination of what a product is expected to cost under specific
working conditions.
• Standard costing is a control technique that reports variances by
comparing actual loss to pre-set standards so facilitating management
by exception (CIMA definition).
• Standard costing involves:
- The establishment of predetermined estimates of the costs of
products or services.
- The collection of actual costs.
- The comparison of the actual costs with the predetermined
estimates.
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Standard cost?
• A standard cost per unit is the expected, or normal, cost per unit, based on
expectations (standards) for:
- the usage of resources; and
- the price per unit of resource.
• The standard cost is set out on a standard cost card
STANDARD COST CARD
Product: the X, No 12345
Unit of Price per unit
resource of resource

$ $
Material 6 kgs 5 30
Labour 2.5 hours 8 20
Variable production overhead 2.5 hours 2 5
Standard variable production cost 55
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Standard costing and management by exception

• practice of concentrating on activities that

Management by require attention and ignoring those which
exception appear to be conforming to expectations.

• are average expected unit costs. Actual results

Standard costs will vary to some extent above or below the
average

• can be viewed as benchmarks for comparison

purposes, variances should be reported and
Standard costs investigated if there is difference between actual
and standard.
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The advantages of standard costing

• Aid to more accurate budgeting.
• A yardstick against which actual costs can be measured.
• Determining the most appropriate materials and methods which may lead to
economies.
• A target of efficiency is set for employees to reach and cost consciousness is
stimulated.
• Variances can be calculated which enable the principle of 'management by
exception' to be operated.
• Standard costs simplify the process of bookkeeping in cost accounting
• Standard times simplify the process of production scheduling.
• Incentive individuals to achieve targets for themselves at work.
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Difficulties in applying standard costing in service environments

Problems:
• It can be difficult to establish a measurable cost unit for some service
• In some service organizations every cost unit will be different
(heterogeneous).
• The human influence is so great => can be difficult to predict and
control the quality of the output and the resources used in its production.
Solution:
• Establish a measurable cost unit
• Attempt to reduce the heterogeneity of services
• Reduce the element of human influence
 2. Cost variances
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What is a variance?

• A variance is the difference between planned, budgeted, or standard cost and

the actual cost incurred. The same comparison can be made for revenues.
(CIMA definition)
• Variance analysis is evaluation of performance by means of variances, whose
timely reporting should maximise the opportunity for managerial action
• Variance analysis is the process by which total difference between standard and
actual result is analysed
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Variances

Variances can be divided into three main groups:

• Variable cost variances:
• Material variances
• Labour variances
• Variable production overhead variances
• Fixed production overhead variances
• Sales variances
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Variances

DIFFERENCES
Actual = Expected
results VARIANCES results

Actual results are better than expected

results => Can be FAVOURABLE
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Variances

DIFFERENCES
Actual = Expected
results VARIANCES results

Actual results are better than expected

results => Can be ADVERSE
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Material variances
Material total variance: 'Measures the difference between the standard material
cost of the output produced and the actual material cost incurred' (CIMA).
Material cost variance

Cost Price Usage

(SQ x SP) - (AQ xAP) AQ (SP-AP) SP x (SQ-AQ)

SQ - Standard quantity AQ - Actual quantity

SP - Standard price AP - Actual price
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Material variances
Example - Material variances

Product X has a standard material cost as follows:

10 kilograms of material Y at £10 per kilogram = £100 per unit of X. During period 4,
1,000 units of X were manufactured, using 11,700 kilograms of material y which cost
£98,631.

Requirement: Calculate the following variance

(a) Material total variance

(b) Material price variance

(c) Material usage variance

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Material variances

Material variances formula:

• Material price variance = (Standard price per unit materials - Actual price per unit
of materials) x Actual quantity of materials
= (SP-AP) x AQ
• Material usage variance = (Standard quantity of materials for actual output - Actual
quantity used) x Standard price per unit of material
= (SQ – AQ) x SP
• Total material cost variance = Material price variance + Material usage variance
= (SP X SQ) - (AP X AQ)
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Material variances

Materials variances and opening and closing inventory

• If closing inventory are valued at standard cost, price variance is
calculated on materials purchases in the period
• If closing inventory are valued at actual cost, price: variance is
calculated on materials used in the period
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Material variances

When to calculate the material price variance:

• If variance are extracted at the time of purchase, they will brought to

the attention of manager earlier then they are extracted as materials is
used.

• Since variances are extracted at the time of purchase, all inventories

will be valued at standard price
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Labour variances
Labour total variance: Measures the difference between the standard labour cost
of the output produced and the actual labour cost incurred.
Labour total variance
Labour rate variance Labour efficiency variance
• Did labour cost more or less per hour • Did production take more or less hours
than expected? than expected?

Actual hours x Actual rate (AH x AR) Rate variance

Actual hours x Standard rate (AH x SR)
Calculation

Actual hours x Standard rate (AH x SR)

Efficiency variance
Standard hours x Standard rate (SH x SR)
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Labour variances
Example - Labour variances

The standard labour rate cost of product X is as follows:

2 hours of grade Z labour at £10 per hour = £20 per unit of product X.
During the period 4, 1,000 units of product X were made, and the labour cost
of grade Z labour was £17,825 for 2,300 hours of works.

Requirement: Calculate the following variance

(a) Labour total variance
(b) Labour rate variance
(c) Labour efficiency variance
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Labour variances

Labour variances formula

• Labour rate variance = (Standard rate of pay per hour – Actual rate of pay per
hour) x Actual labour hours

= (SR - AR) x AH

• Labour efficiency variance = (Standard labours hours for actual output – Actual

labour hours) x Standard rate of pay per hour

= (SH - AH) x SR
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Variable production overhead variances

Variable production overhead total variance

Variable production overhead Variable production overhead

expenditure variance efficiency variance
• Did the variable overhead cost more • Did production take more or less
or less per hours than expected? labour than hour expected?
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Variable production overhead variances

Calculation

Actual hours worked x actual rate (AH x AR)

Expenditure variance
Actual hours worked x Standard rate (AH x SR)

Actual hours worked x Standard rate (AH x SR)

Efficiency variance
Standard hours worked x Standard rate (AH x SR)
(for actual production)
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Variable production overhead variances

Example – VOH variances
The variable overhead cost of product X is as follow:
2 hours at £1.5 = £3 per unit
During the period, 400 units of product X were made. The labour force worked
760 hours. The variable overhead cost was £1,672.
Calculate the following variance
(a) Variable overhead total variance
(b) Variable overhead expenditure variance
(c) Variable overhead efficiency variance
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Variable production overhead variances

Variable overhead variances formulae
Variable overhead expenditure variance
= (Standard variable overhead rate per hour – Actual variable
overhead rate per hour) x Actual hours
= (SR – AR) x AH
Variable overhead efficiency variance
= (Standard hours for actual output – Actual hours) x Standard
variable overhead rate per hour
= (SH – AH) x SR
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3. Sales variances and operating statements

Total sales variance

Sales price variance Sales volume variance

• Did each unit sell for more or less • Did the organization sell more or
than the budgeted selling price? less units than was budgeted?

Actual quantity sold x Actual price (AQ x AP)

Price variance
Actual quantity sold x Standard price (AQ x SP)
Calculation
Actual quantity sold x Standard margin (AQ x SM)
Volume variance
Budget quantity x Standard margin (BQ x SM)
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Sales variances and operating statements

Example - Sales variances

A company budgets to sell 8,000 units of product J for £12 per unit.

The standard variable cost per unit is £7. Actual sales were 7,700 units, at a
price of £12.50 per unit

Requirement: Calculate the following variance

(a) Sale price variance

(b) Sale volume variance

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Sales variances and operating statements

Sales variance formula:

• Sale price variances = (Actual selling price per unit - Standard selling price
per unit) x Actual sales quantity
= (AP - SP) X AQ

• Sale volume variance = (Actual sales quantity – Budgeted sales quantity) x

Standard contribution per unit
= (AQ – BQ) x SC
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Operating statements

• Operating statement is a regular report for management which

compares actual costs and revenue with budgeted figures and shows
variances.

• Most common format is one which reconciles budgeted profit to actual

profit.
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$
Budgeted contribution 928,000
Sales volume variance 17,320 (A)
Sales price variance 11,830 (F)
Actual sales less standard variable cost of sales 922,510
Variable cost variances F A
$ $
Material price 7,210
Material usage 6,190
Labour rate 5,340
Labour efficiency 4,140
Variable overhead expenditure 4,920
Variable overhead efficiency 2,870
Total variable cost variances 12,040 18,540 6,500 (A)
Actual contribution 916,010
Budgeted fixed overhead 400,470
Fixed overhead expenditure variance 15,010 (A)
Actual fixed overhead 415,480
Actual profits 500,530
 4. Interpreting variances and deriving actual 30

data from variance detail

Reasons for variances - Material
Variance Favorable Adverse
Material • Unforeseen discount received • Price increase
price • More care taken in purchasing • Careless purchasing
• Material standard price set too high • Material standard price set too low
Material • Material used of higher quality than • Defective material
usage standard • Excessive waste
• More efficient use of made of • Theft
material • Stricter quality control
• Errors in allocating material to jobs • Errors in allocating material to
 4. Interpreting variances and deriving actual data
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from variance detail

Reasons for variances - Labour

Variance Favorable Adverse

Labour • Use of apprentices or other • Wage rate increase
rate workers at a rate of pay lower • Use of higher grade labour
than standard
Labour • Output produced more quickly • Lost time in excess of standard
efficiency than expected allowed
• Errors in allocating time to jobs • Output lower than standard set
• Error in allocating time to jobs
4. Interpreting variances and deriving actual data 32

from variance detail

Reasons for variances - Overhead

Variance Favourable Adverse

Variable overhead Change in types of overhead Change in types of overhead or their
expenditure or their cost cost.
Variable overhead As for labour efficiency (if As for labour efficiency (if based on
efficiency based on labour hours) labour hours)
Fixed overhead Fixed overheads include a wide range of different items of
expenditure expense. Any of these might be higher or lower than budgeted.
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4. Interpreting variances and deriving actual data from
variance detail
Reasons for variances - Sale
Variance Favorable Adverse
Sales price • Supply shortages meant customers • Supply surplus meant customers
prepared to pay higher prices wished to pay lower price
• Quantity discount given to • Quantity discount given to
customers were lower than expected customers were higher than
• Original standard selling price set expected
too low • Original standard selling price set
too high
Sales volume • Efficient sales force • Demotivated sales force
• Successful advertising campaign • Competitor increased advertising
• Potential market was larger than effort
expected • Original budgeted sales were too
• Original budgeted sales were very optimistic
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Inter-relationships between variances

Variances may affect each other
Material price and usage

Cheaper material Lower quality

Adverse usage variance

Favorable price
variance Adverse labour efficiency variance

Adverse variable overhead efficiency

variance
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Inter-relationships between variances

Variances may affect each other
Labour rate and efficiency

Higher rate paid Adverse rate variance

Experience & skill

Favorable efficiency variance
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Inter-relationships between variances

• Variances may affect each other
Cost and sales variances

Fav. Cost variances Lower quality

Fall in demand Adverse sales volume variances

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Inter-relationships between variances

Variances may affect each other

Sales price and demand/sale volume

Increase in price Favorable price variance

Fall in demand Adverse sales volume variance

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Deriving actual data from standard cost details and variances

Worked example: Deriving actual data
The standard marginal cost card for the TR, one of the products made by P Co, is as follows
£
Material 16 kgs x £6 per kg 96
Labour 6 hours x £12 per hour 72
168

P Co reported the following variances in control period 13 in relation to the TR.

Material price: £18,840 favourable
Material usage: £480 adverse
Labour rate: £10,598 adverse
Labour efficiency: £8,478 favourable
Actual wages cost £171,320. P Co paid £5.50 for each kg of material. There were no
opening or closing inventories of the material.
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Worked example: Deriving actual data

Requirements

Calculate the following.

(a) Actual output
(b) Actual hours worked
(c) Average actual wage rate per hour
(d) Actual number of kilograms purchased and used