Management Control System

Standard Cost & Variance Analysis

Kapil Agarwal

Management Control
Control is the process of ensuring that action conform to plans To ensure operations are in conformity there are two ways

Standard Cost Variance Analysis

Standard
It is an approach to implement and achieve the goals of the firm Standards can be set only for repetitive tasks

Standard Vs Budget
Budget Standard

Budget relates to entire activity It relates holistically

Prepared by management, consultants & finance people Used for planning and coordination

Standard applies to every task It relates to same information on per unit basis By cost accountants

Used as a control device

Standard Costing

Types of costing

Actual Cost

Historical cost Predetermined cost

Standard Cost

Standard Cost

Scientifically pre-determined cost of manufacturing

Either per unit or for certain nos of units

Calculated for a certain period in immediate future

Under current operating conditions

Advantage of Standard Costing

Easy

identification of inefficient operations Measuring performance Controlling and reducing cost Maintaining Inventory level

Levels of Standard Cost

Ideal

max. efficiency under favourable conditions Normal/ Attainable realistic, motivational Expected

Ideal Standard Costs

Ideal cost refers to estimates of costs under perfect conditions There would be no waste, scrap, idle items, no machine breakdown etc

Normal Standard Costs

Assume normal conditions of operation Standard cost means Normal Standard Cost during the discussion

Establishing Cost Standards

Ways of establishing cost standards

Engineering estimates Observed behavior Predicted behavior Desired behavior

Components of Standard Cost

Direct Material Cost Direct Labour Cost Overheads

Variance Analysis
Difference between actual and standard Actual Cost > Std Cost ---- unfavorable AC < SC--- favorable, sign of efficiency Unfavorable variance suggests a condition that may require correction Favorable variance suggest an opportunity that management can exploit

Variance Analysis: Benefits

Benefits Forms basis of cost control Quantify corrective action Pinpoint responsibilities of managers Brings in Management Control

Classification of Variance

Controllable It arises when responsibility for the variance can be attributed to any individual/process Material wastage, labour hour wastage Suggest management to take corrective action Uncontrollable It arises when responsibility for the variance cannot be attributed to any individual/process Price variation in material/ labor, breakdown

Types of Variance

Price variance Cost Variance Quantity/Volume variance Efficiency variance quantity produced in available working hours Capacity variance Calendar variance working days available in month Idle time variance hours lost due to breakdowns

Types of Variance

Sales variance Operating profit due to sales volume Sales quantity is analyzed Operating margins are assumed same Operating profit due to selling price Operating margins are calculated Territory mix variance Different proportion of product mix

Cost Variance
Cost Variance

Material

Labor

Overhead

Material Variance-- MCV

Material cost variance is difference of std cost of material and actual cost incurred It has two components

Material price variance

MPV = (SP AP) X AQ

Material quantity variance

Material Price Variance-- MPV

Factors responsible for MPV

Inflation Change in tax structure, excise Rise in fuel prices leading to rise in freight Material hoarding Cash crunch, unable to avail cash discounts Change in technology, resulting in change in raw material specification Failure to purchase even lot size (30T, 10T)

Material Quantity Variance-- MUV

Factors responsible for MUV (Mat. Usage Variance)

Careless handling of material, process Improper machine adjustment Use of sub standard material Change in design Material theft, pilferage, wastage Defective tools, old technology Substituting one raw material for another, even though total input quantity of all materials does not exceed standard proportion amount

Material Mix Sub variance

Labour Variance

Labor Cost Variance is difference of std labor cost and actual labor cost Labor Rate Variance (LRV)

Also called as Wage Rate Variance Difference between actual wage rate and Std wage rate and actual labor hours worked

LRV = (SR AR) * AH* AO

Should be determined separately for skilled, semi skilled and unskilled laborers

Labour Rate Variance

Factors responsible for LRV

Changes in basic wage structure or piece work rate Employing a worker mix (Skilled workers for semi skilled jobs) Fulfilling urgent orders Seasonal demands During recession Casual and temporary workers proportion to employee strength

Labour Efficiency Variance

It is a function of hours workers should have consumed in actual production, actual hours worked and standard wage rate Reasons of LEV

Working conditions Ergonomic Study Machines, equipments, tools in proper condition Sub standard raw material Organizational efficiency Supervision Training to workers Labour turnover, Gang composition (labour mix)

Labour Efficiency Variance

LEV is further divided into Idle time variance machined breakdown, raw material unavailability, power failure Labour mix variance Labour yield variance

Overhead Variance
OV is difference between actual overhead cost incurred and std overhead cost Types

Variable overhead variance Fixed overhead variance

Calendar Variance
Actual no of working days is different from standard no of working days [No of Std working days(SD) no of actual working days (AD)] * std fixed overheads per day [SD- AD] * SFOD

Capacity Variance
Budgeted hours per day * actual days worked and actual hours worked [ Budgeted hours on basis of actual days worked Actual hours worked] * SOFR per hour SOFR std fixed overhead rate per hour

Thank You