ASSIGNMENT NO.

MBACC 51044 Management Accounting

A pplication of standard costing
G.M. Mudith sujeewa,
Submitted To: Sir
University
of kelaniya

Submitted By:
FGS/MBus/2015/05
C.W.K.kuruppu
Arachchi

Abstract:

July 17, 2015

Standard

costs are aid in the

STANDARD COSTING AND VARIANCE ANALYSIS

INTRODUCTION
DEFINITON

03
04

HOW TO CREATE STANDARD COST

VARIANCE ANALYSIS

07

VARIANCE CALCULATION
CAUSES OF VARIANCE

05

08
12

INVESTINGATING VARIANCE

14

PLANNING AND OPERATION VARIANCE

ADAVANTAGE & DISADVANTAGE

16

20

Introduction to Standard Costing

A standard cost is planned or forecast unit cost for a product or service, which is assumed
to hold good given expected efficiency and cost levels within an organization. It
represents a target cost and is useful for planning, controlling and motivating within an
organization.

Variance analysis is a budgetary control process, which compares standard or budgeted

costs and revenues with the actual results of an organization, in order to obtain
information regarding any exceptions from budget, this information is also used to
improve performance through control action e.g. correction problems.
Standard costing can be used for

Budget preparation e.g. planning

Control through exception reporting e.g. performance measurement
Stock valuation
Cost bookkeeping
Motivating staff

Under a standard costing system an organization can value stock at standard cost,
incorporating this within the ledger or cost accounts of the organization, the budget or
forecasts being a memorandum kept outside the ledger accounts.
Types of Standard
Ideal Standard e.g. attained under the most favorable conditions with no allowance for
any waste, scrap, idle time or downtime.
Attainable or Expected Standard e.g. what should be achieved with a reasonable level
of effort given current efficiency and cost levels.
Loose Standard e.g. loosely set and easy to achieve.
Basic Standard e.g. first standard ever used by the organization and used as a basis or
yardstick for comparing current standards or monitoring trends over time.
Historical Standards e.g. standards used historically in previous accounting periods.

Standard Costing
Costing is the identification of the value of resources used for specified goods or services.
One purpose of costing is to determine what resources were required to provide the goods
or services. A second purpose is to provide a guide to resource usage through the use of
budgets that clearly identify managers' responsibility. It is the second purpose that is
considered in the following discussion.
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Methods of Costing Identified Budgets

Budget figures may be based on actual, budgeted, or standard costs. These categories are
not mutually exclusive. For example, while a standard cost is a budgeted cost, a budgeted
cost is not always a standard cost. An actual cost may or may not be the budgeted cost.
Allowed for forth coming activity. To establish budgeted costs, actual costs of the
previous year, information from supervisors about where resources might be more
efficiently used, and subjective judgments about the need to conserve resources are often
considered. Standard costs are objectively determined costs that reflect Budgets based on
actual costs reflect expenditures anticipated for the level of resource use. Budgeted costs
are generally described as the best estimate about what should be the effective and
efficient use of resources.
Standard Costs
Standard costs are costs established through identifying an objective relationship between
specified inputs and expected outputs.

How to Create a Standard Cost

Standard Material Price

Standard Material Usage

Supplier quotations and estimates

Previous Invoices/trends
Internet/websites of suppliers
Discounts for bulk purchases
Price Seasonality
Cost to Manufacture internally
Differences between the quality of
different material
Time/motion studies
Quality of material e.g. natural wastage

Specification of standard product

manufactured
Operational wastage expected
Market rate for grade/type of labor
Internal rates form HR department
Bonus schemes/piece work rates in
current use

Standard Labor Rate

Standard Labor Efficiency

Standard Overhead Rate

Idle time expected during operations

Time/motion studies
Skill/expertise of staff
Learning curve
Motivation of Staff
Remuneration system in place
Overhead absorption rates obtained by
dividing forecast overhead with an
expected level of activity
Review overhead
Understand
fixed
and
variable
relationship with output, labor hours,
machine hours or % of cost

Methods For Planning And Control

A fixed budget is a budget prepared on the basis of an single estimated production and
sales volume. It does not mean it is never revised or charged, just Fixed at a certain level
of output sold and produced. This tends to be a form of budgeting for a service
organization where a high proportion of total cost if fixed, and therefore does not vary
significantly, with the volume or activity of the service performed. Such a form of
budgeting would be little use for control purposes, when comparing to actual results, if
significant variable cost exists. A fixed budget provides detail of costs, revenues or
resource requirements for a single level of activity.
Flexible budgets are prepared for many different sales and production quantities and can
be used to plan more effectively for an organization e.g. useful at the planning stage for
what it? analysis. Flexible budgeting recognizes different cost behavior patterns, that
may rise or fall with the volume of production or sales and is a better system for control
purposes. A flexible budgeting system based upon its budget set at the beginning of the
period can be flexed to correspond to the actual activity volume of results for a prepared.
When a budget is flexed it would give an appropriate level of revenue and costs as a
yardstick to compare like for like to actual results, at the same activity level, meaningful
variances can then be reported to the managers responsible for control purposes.
Flexible Budgeting
1. Useful at the planning stage (what if analysis)
2. Can be Flexed retrospectively and compared to actual results for control purposes

Variance analysis
By comparing a flexed budget, which has been prepared using standard cost information
to actual results, total variances can be calculated. These reconcilable differences between
the two statements can then be sub-dividend further, calculated, interpreted and used to
correct problems within the organization to stay on target through control action by
management or employees.
Variances Can Occur For The Following Reasons
Inaccurate data when creating standards, producing the budget or compiling actual
results
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 A standard used which is either not realistic or perhaps out of date,

Efficiency of how operations were undertaken by management or employees during the
period of assessment
Random or chance
Budgetary planning involves the production of budgets or forecasts using realistic
standards for cost and efficiency levels. Budgetary Control identifies areas of
responsibility for management and is the process of regularly comparing actual results
against budget or standards. Because the original budget would have forecast a different
number of units produced or sold, when compared to actual units produced or sold, a
Flexed budget would be prepared in order to compare costs and revenues on a like with
like basis.

Variance calculation
Cost Variances

Material Variances:
1. Material Cost Variance

Standard Cost - Actual Cost

2. Material Price Variance

=
=

Standard Cost of Actual Qty. - Actual Cost

Actual Qty. (Standard Price - Actual Price)

3. Material Usage
Variance

4. Material Mix Variance

Standard Cost - Standard Cost of Actual Qty.

Standard Price (Standard Qty. - Actual Qty.)

Actual Qty. (Std. Price of Std. Mix - Std. Price

of Actual Mix
(Actual Qty. x Std. Price of Std. Mix) - Standard Cost of
Actual Qty.

5. Material Sub-Usage Variance = Std. Price of Std. Mix (Total Std. Qty. - Total
Actual Qty.)
=
Standard Cost - (Actual Qty. x Std. Price of
Std. Mix)

6. Material Yield Variance

(When there is Std. Loss or

I/P : O/P ratio differs)

Std. Price of Yield (Actual Yield - Standard

Yield)
i.e. Std. Cost per unit of O/P

Standard Cost - (Std. Price of Yield x

Standard Yield)
7. Standard Price of Standard Mix =

Total Std. Cost/ Total Std. Qty.

=
Std. Cost of Actual Qty. / Total
8. Standard Price of Actual Mix Actual Qty.

Labour Variances:
1. Labour Cost Variance

Standard Cost - Actual Cost

2. Labour Rate Variance

=
=

Standard Cost of Actual Time - Actual Cost

Actual Hrs. (Standard Rate - Actual Rate)

=
=

Standard Cost - Standard Cost of Actual Time

Standard Rate (Standard Hrs. - Actual Hrs.)

3. Labour Efficiency
Variance

4. Labour Gang Variance

=
=

5. Labour Sub-Efficiency
Variance

=
=

Actual Hrs. (Std. Rate of Std. Gang - Std. Rate of

Actual Gang)
(Actual Hrs. x Std. Rate of Std. Gang) - Standard Cost of
Actual Time

Std. Rate of Std. Gang (Total Std. Hrs. - Total

Actual Hrs.)
Standard Cost - (Actual Hrs. x Std. Rate of Std.
Gang)

6. Idle Time Variance

=
=

Std. Rate x Idle Time

Standard Rate (Actual Hrs. Worked - Actual Hrs.
Paid)

7. Standard Rate of Standard

=
Total Std. Cost/ Total Std. Gang Hrs.
Gang
8. Standard Rate of Actual Gang =
Std. Cost of Actual Hrs. / Total Actual Gang
Hrs.

Variable Overhead
Variances:
1. Variable Overhead Variance =
Standard Variable Overheads - Actual
Variable O/hs
2. Variable Overhead Budget/ Expenditure Variance
=
Budgeted Variable Overheads - Actual Variable O/hs for actual hrs.

Actual Hrs. (Std. Rate - Actual Rate)

3. Variable Overhead Efficiency Variance

=
Std. Variable O/h Rate Std. Hrs. for Actual - Actual
Output

Hrs.

= Budgeted Variable O/hs - Budgeted O/hs

for for Budgeted Hrs. Actual Hrs.

Fixed Overhead Variances:

1. Total Fixed Overhead Variance
Overheads

Fixed Overheads Absorbed - Actual Fixed

2. Fixed Overhead Expenditure Variance =

Overheads

Budgeted Overheads - Actual

3. Fixed Overhead Volume Variance

Actual Hrs. - Budgeted)
Rate/ Hr./unit worked
Hrs.

Std. Fixed O/h

(units)

Absorption

(units)

Fixed O/hs Absorbed - Budgeted Fixed O/hs

4. Capacity Variance
=
Std. Fixed O/h
Budgeted Hrs.
Rate/ Hr. Capacity
Capacity

Absorption Actual

Hrs. -

5. Efficiency Variance

Std. Absorption Rate (Std. Hrs. Required - Actual Hrs.)

6. Calander Variance
Budgeted Hrs.)

Std. Absorption Rate (Budgeted Hrs. in Actual Period

Sales Variances

Sales Price Salesolume

V
Variance

Sales Mix

Variance

Sales Margin

Variance

Sales Margin

Sales Margin

Price Variance Volume Variance

Sales Margin

Sales Margin
Quantity Variance

Mix Variance

1. Sales Price Variance =

Actual Sales - Standard Sales (for Actual Qty.)
=
Actual Qty. (Actual Price - Budgeted Price)
2. Sales Volume Variance
=
Standard Sales - Budgeted Sales
=
Budgeted Price (Actual Qty. - Budgeted Qty.)
3. Total Sales Variance =

Actual Sales - Budgeted Sales

4. Sales Margin Variance

Actual Margin - Budgeted Margin

5. Sales Margin Price Variance

=
Margin)
Per Unit

Actual Qty. (Actual Margin - Budgeted

6. Sales Margin Volume Variance

Budgeted Units)
(Profit) Per Unit

Budgeted Margin (Actual Units -

Per Unit

7. Sales Margin Quantity Variance =

Budgeted Margin (Total Actual - Total
Budgeted)
per unit of Qty. Qty.

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Budgeted Mix
8. Sales Margin Mix Variance = Total Actual Qty. Budgeted Margin - Budgeted
Margin
Sold per unit of per unit of
Actual Mix Budgeted Mix

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Causes of variances
Material price variance

Different sources of supply

Unexpected general price increase
Alteration in quantity discounts
Alternation in exchange rates (imported
goods)

Substitution of a different grade of

material
Standard set at mid-year price so one
would expect a favourable price
variance for part of the year and an
adverse variance for the first of the year.
Material Usage Variance

Higher/lower incidence of scrap

Alternation to product design
Substitution of a different grade of
material

Wages Rate Variance

Unexpected national wage award

Overtime/bonus payments different
from plan
Substitution of a different grade of labor

Labor Efficiency Variance

Improvement in methods or working

conditions
Variations in unavoidable idle time
Introduction of incentive scheme
Substitution of a different grade of

Possible causes of the individual variances are:

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labor
Variable Overhead Variance

Unexpected price changes for overhead

items
Labor efficiency variances (see above)

Fixed Overhead Expenditure Variance

Changes in prices relating to fixed

overhead items e.g. rent increase
Seasonal effects e.g. heat/light in
winter. (This arises where the annual
budget is divided into four equal
quarters of thirteen equal fourweekly
periods without allowances for
seasonal factors. Over a whole year
the seasonal effects would cancel
out.)

Fixed Overhead Volume

Change in production volume due to

change in demand or alternatives to
stockholding policy
Changes in productivity of labor or
machinery

Operating Profit Variance Due To

Selling Prices
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Production lost through strikes etc.

Unplanned price increase
Unplanned price reduction e.g. to try
and attract additional business.

Investigating Variances
Statistical Methods For Interpretation
Variances can be expressed relatively rather than absolutely, the variance is normally
expressed as a percentage against the standard cost.
These percentages could be plotted on a graph from one period to the next, which would
provide managers with the following advantages.
Graphical presentation or percentages analyses over time allows easier interpretation
and clearer understanding by managers
Presenting variances over time allows trends to be identified easier
By working out percentages expressed against standard, it removes changes in
monetary size of the variance caused by changing activity levels, improving trend
analysis
Example of a variance chart

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Factors To Consider Before Investigation

1.
2.
3.
4.
5.
6.
7.
8.

The size of it (materiality)

The general trend of it e.g. use of control charts for this
The type of standard that was used
Interdependence with other variances
The likelihood of identifying the cause of it
The likelihood that if a cause is found then it is controllable
The cost and benefits of correcting the cause
The cost of the investigation

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Planning and operational variances

Planning variances are caused by the budget or standard at the planning stage being wrong.
The budget and standard used would therefore need revising if your operational variances are to
be more realistic.
Operational variances are your normal variance calculations as learned earlier within this
chapter, that is assuming all planning errors within the budget have been adjusted for or
removed and your standard used is realistic.

Process of calculating planning variances

1. Calculate the planning variance and adjust the original budget within the operating statement
for this, before any operational variances are calculated
2. Adjust the standard cost used in the budget from ex ante to ex post (revised) standard
3. Now that the original budget and standard cost has been adjusted, the operational variance
that would be effected by the adjustment, will give a more realistic standard.

The effects is to sub-divide a variance into 2 parts

1. The planning variance which is beyond the control of staff e.g. planning errors
2. The operational variances which may be within the control of staff
This allows better management information for control purposes
Planning and operational variances are not alternatives to the conventional approach; they just
produce a more detailed analysis. Further analysis of variances into groups e.g. planning which
are to do with poor planning or inadequate standards used compared with actual true favourable
or adverse operational variances, allow managers to be appraised truly on deviations they can
control not those variances which are beyond their control.

Advantages of planning variances

Highlight between variances which are controllable and uncontrollable

Help motivate managers and staff
Help use more realistic standards
Give a fairer reflection of operational variances

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However critism includes still the question of determining a realistic standard in the first place
and putting too much emphasis on bad planning rather than bad management and the analysis
can be more time consuming and costly than the conventional approach.

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Advantages / Benefits of Standard Costing System:

Standard costing System has the following main advantages or benefits:
1. 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.
2. 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.
3. 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.
4. 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.
Disadvantages / Problems / Limitations of Standard Costing System:
The use of standard costs can present a number of potential problems or
disadvantages. Most of these problems result from improper use of standard costs
and the management by exception principle or from using standard costs in
situations in which they are not appropriate.
1. 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. Timely, frequent
reports that are approximately correct are better than infrequent reports that are very
precise but out of date by the time they are released. Some companies are now
reporting variances and other key operating data daily or even more frequently.
2. 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

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are favorable. For example, workers may put on a crash effort to increase output at
the end of the month to avoid an unfavorable labor efficiency variance. In the rush
to produce output quality may suffer.
3. 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; rather, it is determined by the processing speed of machines.
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.
4. 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.
5. 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.
6. 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.
In sum, managers should exercise considerable care in their use of a standard cost system.
It is particularly important that managers go out of their way to focus on the positive,
rather than just on the negative, and to be aware of possible unintended consequences.
Nevertheless standard costs are still found in the vast majority of manufacturing
companies and in many service companies, although their use is changing. For evaluating
performance, standard cost variances may be supplanted in the future by a particularly
interesting development known as the balanced scorecard.

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