By: Sourabh Aggarwal Hanish Kumar Arjun Nanda

To establish control To set standards for various elements of cost To fix responsibility

Definition: Standard costing is the process of creating and using estimated costs for production activities, usually under the assumption of normal operating conditions. Since standard costs do not necessarily match actual costs incurred, the cost accountant must calculate variances between actual and standard costs, and charge the variances to the cost of good sold.

 The word standard means a benchmark or yardstick. Standard cost is the amount the firm thinks a product or the operation of the process for a period of time should cost, based upon certain assumed conditions of efficiency, economic conditions and other factors.

Standard costing involves: The setting of standards Ascertaining actual results Comparing standards and actual costs to determine the variances Investigating the variances and causes for the same Taking appropriate action where necessary

 The establishment of cost centers with clearly defined areas of responsibility. The type of standard to be operated. The setting of standard costs for each element of cost. Establishment of cost centers: A cost center is a department or part of a department or an item of equipment or machinery or a person or a group of persons in respect of which costs are accumulated, and one where control can be exercised.

 Current Standards: A current standard is a standard which is established for use over a short period of time and is related to current condition. The period for current standard is normally one year. Ideal Standards: This is the standard which represents a high level of efficiency. Ideal standard is fixed on the assumption that favorable conditions will prevail and management will be at its best. Basic Standards: A basic standard may be defined as a standard which is established for use for an indefinite period which may a long period. These standards are revised only on the changes in specification of material and technology productions Normal Standards: As per terminology, normal standard has been defined as a standard which, it is anticipated, can be attained over a future period of time.

Normally, setting up standards is based on the past experience and standard committee which includes general manager, purchase officer, production engg., production manager, sales manager, cost accountants etc. There are three main parts of Standard costing:

a) Direct Material(Quality of material, Price of the material, Cost of materials, Ordering cost, Carrying cost)
b) Direct Labour(Standard labor time for producing, Labor rate per hour, Skilled labor, Semi-skilled labor, Unskilled labor) c)Overhead Expenses(Determination of overheads, Determination of labor hours or units manufactured)

Variance is the difference between a budgeted or standard amount and the actual amount during a given period Unfavorable Variance The variance is said to be either negative () or Adverse (A) or Unfavorable (Unf) if it indicates a loss. Favorable Variance The variance is said to be either Positive (+/Pos) or Favorable (F) if it indicates a gain position or beneficial position in relation to costs/hr.

Direct Material Variances Quantit Material y/ price usage varianc varianc e e Mix Varianc e Yield Varianc e

Standard Costing and Variance Analysis Direct Labor Variances Labor Labor efficienc price y varianc variance e Mix Varianc e Yield Varianc e

Overhead Variances Variable Overhea d

Fixed Overhead
Expenditu re Variance Volume Varianc e
Efficiency Variance Capacity Variance Calendar Variance

Expenditu re Variance Efficienc y Variance

Total material variance is divided into 2 categories

1) Material price variance.

Direct materials price variance is the difference between the actual purchase price and standard purchase price of materials. Formula Materials purchase price variance = (Actual quantity purchased Actual price) (Actual quantity purchased Standard price)
2) Material usage variance.

Direct materials quantity variance or Direct materials usage variance measures the difference between the quantity of materials used in production and the quantity that should have been used according to the standard that has been set. Formula Materials price usage variance = (Actual quantity used Standard price) (Standard quantity allowed Standard price)

 The Schlosser Lawn Furniture Company uses 12 meters of aluminum pipe at $0.80 per meter as standard for the production of its Type A lawn chair. During one month's operations, 100,000 meters of the pipe were purchased at $0.78 a meter, and 7,200 chairs were produced using 87,300 meters of pipe. The materials price variance is recognized when materials are purchased. Required: Materials price and quantity variances.

Meters of pipe Actual purchased actual purchased ----------Materials price variance ======= Actual quantity used Standard 87,300 purchase 100,000 quantity 100,000 quantity 100,000

Unit Cost $0.78 actual

Amount $78,000

$0.80 standard

$80,000

----------$(0.02)

----------$(2,000) fav.

======= 0.80 standard 0.80 standard

======= $69,840 $69120

quantity 86,400

allowed
------------Materials variance ======= ======= ======= quantity 900 ------------0.80 ------------$720 Unfav

Direct material usage variance is further divided into two categories. 1) Mix variance: It is that portion of material usage variance which due to the difference between standard and actual composition of a mixture. Formula: (Standard costing of standard mix) x {actual mix/ standard mix} - standard cost of actual cost 1) Yield variance: It is that portion of material usage variance which due to the difference between standard yield specified and actual yield obtained.

Inefficient buying or failure to make timely purchases Increase in market price Emergency purchases Bulk purchases Change in transport cost Non-availability of standard quality Loss of cash discount Change in the method of material collection

 From the data given below, calculate mix and yield variance:
Raw material
A B

Standard
40 units @ rs. 50 per unit 60 units @ rs. 40 per unit

Actual
50 units @ rs. 50 per unit 60 units @ rs. 45 per unit

Standard yield = 90% of the input Actual yield = 92% of the input

 Material mix variance: =(40*50+60*40)*100/110 (50*50+40*60) = rs 60 (unf.)

Material yield variance: = (4400)/90 * (92-90) =97.77

Poor quality of material Carelessness in the use of material Inefficient production method Defective machinery Unskilled employees Wrong specification Change in mix Experimental production Pilferage

Total labour variance is divided into 2 categories 1)Price variance This variance measures any deviation from standard in the average hourly rate paid to direct labor workers Formula Direct Labor Rate/Price Variance=(Actual hours worked Actual rate) (Actual hours worked Standard rate) 2)Efficiency variance The quantity variance for direct labor is generally called direct labor efficiency variance or direct labor usage variance. Formula Direct Labor Efficiency / Usage / Quantity Variance= (Actual hours worked Standard rate) (Standard hours allowed Standard rate)

Labor Variance Analysis: The processing of a product requires a standard of 0.8 direct labor hours per unit for Operation 4-802 at a standard wage rate of $6.75 per hour. The 2,000 units actually required 1,580 direct labor hours at a cost of $6.90 per hour. Required: labor rate variance or Labor price variance. Labor efficiency or usage or quantity variance.

Time Actual hours worked Actual hours worked 1,580 1.580 -------Labor rate variance 1,580 ===== Actual hours worked Standard hours allowed 1,580 1,600 ---------Labor variance ====== efficiency (20)

Rate $6.90 actual $6.75 standard -------$0.15 ===== $6.75 standard $6.75 standard -----------6.75 standard

Amount $10,902 10,665 -------$237 unfav. ===== $10,665 $10,800 ----------$(135) fav.

======

======

Direct labour usage variance is further divided into two categories. 1) Mix variance. Formula: (Standard costing of standard mix x actual mix)/standard mix - Standard cost of actual mix 2) yield variance Formula: Standard rate ( actual yield - standard yield) Standard rate = standard cost of standard mix Standard yield

 From the data given below, calculate mix and yield variance:
Raw material
A B

Standard

Actual

40 hr @ rs. 50 per 50 hr @ rs. 50 per hr hr 60 hr @ rs. 40 per 60 hr @ rs. 45 per hr hr

Standard yield = 90% of the input Actual yield = 92% of the input

 Material mix variance: =(40*50+60*40)*100/110 (50*50+40*60) = rs 60 (unf.)

Material yield variance: = (4400)/90 * (92-90) =97.77

Revision in wages Overtime for urgent completion of job Change in gang composition or wrong grade of labour Executive overtime, special increment/high labour awards Special rates for experimental production

Inefficient/Untrained workers Machinery breakdown Poor quality of material Inefficient supervision Hours lost in waiting, delay in routing material, tools, instructions and improper production scheduling Poor working conditions Change in design, quality standard of product

 Overhead cost variance can be defined as the difference between the standard cost of overhead allowed for actual output achieved and actual overhead cost incurred. In other words, overhead cost variance is under or over absorption of overheads.

Overhead cost variance can be classified as: 1) Variable overhead variance 2) Fixed overhead variance

 It is the difference between the standard variable overhead cost allowed for actual output achieved and actual variable overhead cost. Variable overhead variance is divided into two parts: 1) Variable overhead expenditure variance Variable overhead expenditure variance= (Actual hours worked x Standard variable overhead rate per hour) (Actual variable overhead) 2) Variable overhead efficiency variance Variable overhead efficiency variance= Standard variable overhead rate per hour(standard hours for actual production actual hours)

 It is that portion of total overhead cost variance which is due to the difference between the standard cost of fixed overhead allowed for actual output achieved and the actual fixed overhead cost incurred. Formula: Fixed Overhead Variance = (Actual output x Standard fixed overhead rate per unit) (Actual fixed overheads) This variance is analyzed as under: 1) Budget or expenditure variance It is that portion of fixed overhead variance which is due to difference between budgeted fixed overheads and the actual fixed overheads incurred. Formula: Budget or expenditure variance = budgeted fixed overheads - actual fixed overheads incurred

It is that portion of fixed overhead variance which is due to difference between the standard cost of fixed overhead allowed for actual output and budgeted fixed overheads for the period during which the actual output has been achieved. Formula: Volume Variance = standard rate (actual output budgeted output) Volume variance is divided into three variances: 1) Capacity variance It is that portion which is due to working at higher or lower capacity than budgeted capacity. It is related to under and over utilization of plant and equipment. Formula Capacity variance = standard rate (revised budgeted units

Possible causes for capacity variance Slackening of sales, lack of orders Lock out/strikes Power failure Seasonal cuts in production Machine breakdowns.
2) Calendar variance It is that portion which is due to the difference between the number of working days in the budget period and the number of actual working days in the period to which the budget is applicable. Formula Calendar variance = inc/dec in production due to more or less working days at the rate of budgeted capacity x standard rate per unit

 Possible causes for calendar variance Difference between the budgeted and actual days 3) Efficiency variance It is that portion which is due to the difference between the budgeted efficiency and actual efficiency achieved. This is related to efficiency of workers in plant. Formula: Efficiency variance = standard rate per hour (standard hours produced actual hours)

1) Two variance The analysis of overhead variances by expenditure and volume is called two variance analysis. 2) Three variance Change in output occurs due to Change in capacity i.e., capacity variance Change in number of working days giving rise to calendar variance Change in level of efficiency resulting into efficiency variance

3) Four variance analysis includes: Expenditure variance Variable overhead efficiency variance Fixed overhead capacity variance Fixed overhead efficiency variance

Budgeted Output No. of working days Fixed Overheads Variable overheads 15,000 units 25 Rs. 30,000 Rs. 45,000

Actual 16,000 units 27 Rs. 30,500 Rs. 47,000

i) Total Overhead Cost Variance: Standard rate = standard overheads / standard output : Fixed: Rs.30, 000/ 15,000 = Rs. 2 : Variable: Rs.45, 000/ 15,000 = Rs. 3 TOCV = Actual units x standard rate Actual overheads cost = 16, 000(2+3)-(30, 500+47, 000) = 2, 500(fav.) ii) Variable Overhead Expenditure Variance: VOEV = Actual units x standard rate Actual variable overheads cost = 16, 000 x 3 47, 000 = 1, 000 (fav.)

iii) Fixed Overhead Variance: FOV = Actual units x standard rate Actual fixed overheads = 16, 000 x 2 30, 500 = 1, 500 (fav.) iv) Volume Variance: VV = Actual units x standard rate budgeted fixed overheads = 16, 000 x 2 30, 000 = 2, 000 (fav.)

v) Expenditure variance: EV = budgeted fixed overheads - Actual fixed overheads = 30, 000 30, 500 = 500 (unfav.)

vi) Capacity variance: CV = standard rate (revised budgeted units budgeted units) Budgeted units for 25 days = 15, 000 units Budgeted units for 27 days = 16, 200 units Revised budgeted units after 5% increase in capacity = 105*16200/100 = 17, 010 CV = 2(17010 16200) =1620 (fav.) vii) Calendar variance: CV = = inc/dec in production due to more or less working days at the rate of budgeted capacity x standard rate per unit Within 25 days, standard production = 15, 000 units Within 2 days(27-25), production will be increase by = 1,200 units CV = 1200 x 2 = 2,400(fav.)

viii) Efficiency variance: EV= standard rate per hour (standard hours produced actual hours) Standard production

Budgeted production

15, 000 units

Production

increased

due

to 810 units

increase in capacity Production increased due to 2 more 1, 200 units working days

EV = 2 (16, 000 17, 010) =2,020 (unfav.)

The analysis of variances will be completed only when the actual profit and standard profit is fully analyzed. Sales variance is of two types: 1) Sales margin variance method Total sales variance = (budgeted quantity x standard margin)- (actual quantity x actual margin) It is of two types Sales margin price variance= (SM AM) AQ Sales margin volume variance= (BQ-AQ) SM SMVV is divided to mix and quantity variance SMMV = Standard margin on revised budgeted sales mix- standard margin on actual sales mix SMQV = Standard margin on revised budgeted sales mix- standard margin on budgeted sales mix

2) Sales value variance = actual value of sales- budgeted value of sales Problem: From the following particulars calculate profit sales variance and sales value variance.
Product Units X Y 3000 2000 Standard Cost per unit 10 15 Actual Price per Units Cost unit per unit 12 18 3200 1600 10.5 14 Price per unit 13 17

 Total sales margin variance= actual profit budgeted profit =12800 12000 = 800 (F) Sales margin variance due to selling price = actual qty. of sales (actual sale price per unit budgeted sales price per cent) X = 3200 (13 - 12) = 3200 (F) Y = 1600 (17 - 18) = 1600 (A) therefore, 1600 (F) Sales margin variance due to volume = standard profit per unit ( actual quantity of sales budgeted quantity of sales) X = 2 (3200 3000) = 400 (F) Y = 3 (1600 - 2000) = 1200 (A) therefore, 800 (A)

 Sales margin variance due to sales mix = standard profit per unit (actual qty. of sales standard promotion for actual sales) X = 2 (3200 2880) = 640 (F) Y = 3 (1600 - 1920) = 960 (A) therefore, 320 (A) Sales margin variance due to sales quantity = standard profit per unit (standard proportion for actual sales budgeted quantity of sales) X = 2 (2880 - 3000) = 240 (A) Y = 3 (1920 - 2000) = 240 (A) therefore, 480 (A) Sales value variance = actual value of sales budgeted value of sales = 68800 72000 = 3200 (A)

 The use of standard costs is a key element in a management by exception approach. If costs remain within the standards, Managers can focus on other issues. When costs fall significantly outside the standards, managers are alerted that there may be problems requiring attention. This approach helps managers focus on important issues. Standards that are viewed as reasonable by employees can promote economy and efficiency. They provide benchmarks that individuals can use to judge their own performance. Standard costs can greatly simplify bookkeeping. Instead of recording actual costs for each job, the standard costs for materials, labor, and overhead can be charged to jobs. Standard costs fit naturally in an integrated system of responsibility accounting. The standards establish what costs should be, who should be responsible for them, and what actual costs are under control.

 Standard cost variance reports are usually prepared on a monthly basis and often are released days or even weeks after the end of the month. As a consequence, the information in the reports may be so stale that it is almost useless. If managers are insensitive and use variance reports as a club, morale may suffer. Employees should receive positive reinforcement for work well done. Management by exception, by its nature, tends to focus on the negative. If variances are used as a club, subordinates may be tempted to cover up unfavorable variances or take actions that are not in the best interest of the company to make sure the variances are favorable. Labor quantity standards and efficiency variances make two important assumptions. First, they assume that the production process is labor-paced; if labor works faster, output will go up. However, output in many companies is no longer determined by how fast labor works. Second, the computations assume that labor is a variable cost. However, direct labor may be essentially fixed, then an undue emphasis on labor efficiency variances creates pressure to build excess work in process and finished goods inventories.

 In some cases, a "favorable" variance can be as bad or worse than an "unfavorable" variance. For example, McDonald's has a standard for the amount of hamburger meat that should be in a Big Mac. A "favorable" variance would mean that less meat was used than standard specifies. The result is a substandard Big Mac and possibly a dissatisfied customer.

There may be a tendency with standard cost reporting systems to emphasize meeting the standards to the exclusion of other important objectives such as maintaining and improving quality, on-time delivery, and customer satisfaction. This tendency can be reduced by using supplemental performance measures that focus on these other objectives.
Just meeting standards may not be sufficient; continual improvement may be necessary to survive in the current competitive environment. For this reason, some companies focus on the trends in the standard cost variances aiming for continual improvement rather than just meeting the standards. In other companies, engineered standards are being replaced either by a rolling average of actual costs, which is expected to decline, or by very challenging target costs

Budgetary Control

Standard Costing

Budgetary control is concerned with the Standard costing is related with the control of operation of business as a Whole. cost mainly. Hence, budgetary control is broader than standard costing. Budgets are prepared based on past actual data Standard costs are fixed based on technical adjusted to future trends. assessment.

Budgets set up maximum limits of expenses, Standards are minimum targets which are to be which the actual expenditure should not attained by actual performance at specific normally exceed. Budget is a projection of financial accounts. efficiency level. Standard cost is the projection of cost accounts. costing cannot exist without

Budgets can be adopted without standard Standard costing. budgeting.

Standard costing It is predetermined cost. It is an ideal cost. It is a future cost; it is used for cost control.

Historical costing It is recorded after production. It is an actual or incurred cost. It is related to past, cannot be used for cost control.

It is used for the measurement of operational It is used to ascertain the profit or loss incurred efficiency of the enterprises. during a particular period.

Standard cost

Estimated cost

It is scientifically used & it is a regular system It is used as statistical data and based on lot of

based upon estimation or survey.

be?

guess work.

Its object is to ascertain, what the cost should Its object is to ascertain, what the cost will be?

It is used for effective cost control & proper Its purpose is planning & ascertainment of cost

action to maximize.

for fixing sale price.

It is continuous process of costing & takes into It is used for specific use i.e. fixing sale price. account all the manufacturing process. It is used where standard costing is in operation. It is used where standard costing is not in

operation.
It is more accurate than estimated cost. It is not as accurate as it is based on past experience.

 Measurement errors Outdated standards Out of control operations 1) Measurement Errors The recorded amount for actual cost or actual uses may differ from actual incurred amount. For e.g. Labour hours for a particular operations may be incorrectly added up or indirect labour cost may be incorrectly classified as direct labour cost. 2) Outdated standards Standards become outdated because of change in production conditions like where frequently changes in prices of input occurred, there is danger that standard price may be outdated. Standards can also become outdated where operations are subject to frequent technological changes. 3) Out of control operations Variances may result from inefficient operation due to a failure to follow prescribed procedure, faulty machinery or faulty human force.