School of Business

MBA Dual Specialization

2020-2022

MBDS5034 – Management Accounting and

Decision Making

Continuous Assessment Test (CAT-III)

Second Semester 2020-21
Group 17 Batch – 2

‘Standard Costing and Variance Analysis Case Study - 2’

Submitted To: Shilpa Bahl Ma’am

Submitted By:
1. Gauri Singh 20GSOB2010026
2. Meenakshi Singh 20GSOB2010190
3. Shashwat Srivastava 20GSOB2010153
CASE STUDY
A company operates a standard cost system to control the variable works cost of its only
product. The following are the details of actual production, costs and variances for
November, 2015.

Production and cost (actual)

Production 10,000 units
Direct Materials (1,05,000 kg.) ` 5,20,000
Direct Labour (19,500 hrs.) ` 3,08,000
Variable Overheads ` 4,10,000

Cost variances
Direct materials – Price ` 5,000 (F)
Direct materials – Usages ` 25,000 (A)
Direct labour – Rate ` 15,500(A)
Direct labour – Efficiency ` 7,500 (F)
Variable overheads ` 10,000 (A)

The Cost Accountant finds that the original standard cost data for the product is missing from
the cost department files. The variance analysis for December, 2015 is held up for want of
this data. Required:
(i) Calculate- Standard price per kg. of direct material
(ii) Calculate- Standard quantity for each unit of output
(iii) Calculate- Standard rate of direct labour hour
(iv) Calculate- Standard time for actual production
(v) Calculate- Standard variable overhead rate

Solution:
What is Standard Costing?
Standard costing is the establishment of cost standards for activities and their periodic
analysis to determine the reasons for any variances. Standard costing is a tool that helps
management account in controlling costs.
For example, at the beginning of a year a company estimates that labor costs should be $2 per
unit. Such standards are established either by historical trend analysis of the cost or by an
estimation by any engineer or management scientist. After a period, say one month, the
company compares the actual cost incurred per unit, say $2.05 to the standard cost and
determines whether it has succeeded in controlling cost or not.
This comparison of actual costs with standard costs is called variance analysis and it is vital
for controlling costs and identifying ways for improving efficiency and profitability. If actual
cost exceeds the standard costs, it is an unfavourable variance. On the other hand, if actual
cost is less than the standard cost, it is a favourable variance.

Advantages of Standard Costing

Though most companies do not use standard costing in its original application of calculating
the cost of ending inventory, it is still useful for a number of other applications. In most
cases, users are probably not even aware that they are using standard costing, only that they
are using an approximation of actual costs. Here are some potential uses:
 Budgeting. A budget is always composed of standard costs, since it would be
impossible to include in it the exact actual cost of an item on the day the budget is
finalized. Also, since a key application of the budget is to compare it to actual results
in subsequent periods, the standards used within it continue to appear in financial
reports through the budget period.
 Inventory costing. It is extremely easy to print a report showing the period-end
inventory balances (if you are using a perpetual inventory system), multiply it by the
standard cost of each item, and instantly generate an ending inventory valuation. The
result does not exactly match the actual cost of inventory, but it is close. However, it
may be necessary to update standard costs frequently, if actual costs are continually
changing. It is easiest to update costs for the highest-dollar components of inventory
on a frequent basis, and leave lower-value items for occasional cost reviews.
 Overhead Application. If it takes too long to aggregate actual costs into cost pools for
allocation to inventory, then you may use a standard overhead application rate instead,
and adjust this rate every few months to keep it close to actual costs.
 Price formulation. If a company deals with custom products, then it uses standard
costs to compile the projected cost of a customer’s requirements, after which it adds a
margin. This may be quite a complex system, where the sales department uses a
database of component costs that change depending upon the unit quantity that the
customer wants to order. This system may also account for changes in the company’s
production costs at different volume levels, since this may call for the use of longer
production runs that are less expensive.
Nearly all companies have budgets and many use standard cost calculations to derive product
prices, so it is apparent that standard costing will find some uses for the foreseeable future. In
particular, standard costing provides a benchmark against which management can compare
actual performance.

Problems with Standard Costing

Despite the advantages just noted for some applications of standard costing, there are
substantially more situations where it is not a viable costing system. Here are some problem
areas:
 Cost-plus contracts. If you have a contract with a customer under which the customer
pays you for your costs incurred, plus a profit (known as a cost-plus contract), then
you must use actual costs, as per the terms of the contract. Standard costing is not
allowed.
 Drives inappropriate activities. A number of the variances reported under a standard
costing system will drive management to take incorrect actions to create favorable
variances. For example, they may buy raw materials in larger quantities in order to
 improve the purchase price variance, even though this increases the investment in
inventory. Similarly, management may schedule longer production runs in order to
improve the labor efficiency variance, even though it is better to produce in smaller
quantities and accept less labor efficiency in exchange.
 Fast-paced environment. A standard costing system assumes that costs do not change
much in the near term, so that you can rely on standards for a number of months or
even a year, before updating the costs. However, in an environment where product
lives are short or continuous improvement is driving down costs, a standard cost may
become out-of-date within a month or two.
 Slow feedback. A complex system of variance calculations is an integral part of a
standard costing system, which the accounting staff completes at the end of each
reporting period. If the production department is focused on immediate feedback of
problems for instant correction, the reporting of these variances is much too late to be
useful.
 Unit-level information. The variance calculations that typically accompany a standard
costing report are accumulated in aggregate for a company’s entire production
department, and so are unable to provide information about discrepancies at a lower
level, such as the individual work cell, batch, or unit.
The preceding list shows that there are many situations where standard costing is not useful,
and may even result in incorrect management actions. Nonetheless, as long as you are aware
of these issues, it is usually possible to profitably adapt standard costing into some aspects of
a company’s operations.

Standard Cost Variances

A variance is the difference between the actual cost incurred and the standard cost against
which it is measured. A variance can also be used to measure the difference between actual
and expected sales. Thus, variance analysis can be used to review the performance of both
revenue and expenses.
There are two basic types of variances from a standard that can arise, which are the rate
variance and the volume variance.
Variance analysis is usually conducted for
 Direct material costs (price and quantity variances);
 Direct labor costs (wage rate and efficiency variances); and
 Overhead costs.
Analysis of variance in planned and actual sales and sales margin is also vital to ensure
profitability.

Calculation of the Required:

 1. Standard Price per Kg. of Direct Material
Material Price Variance = Standard Cost of Actual Quantity – Actual Cost
5,000 (F) = Standard Cost of Actual Quantity – 5,20,000
Standard Cost of Actual Quantity = 5,20,000 + 5,000 = 5,25,000
Standard Cost of Actual Quantity = Standard Price per Kg. × Actual Quantity
5,25,000 = Standard Price per Kg. × 1,05,000 Kg.
Standard Price per Kg. = Rs. 5,25,000 / 1,05,000 kg
Standard Price per Kg. = 5 (Favorable)

2. Standard Quantity for each unit of output

Material Usage Variance = Standard Cost of Standard Quantity for Actual Output – Standard
Cost of Actual Quantity
25,000 (A) = Standard Cost of Standard Quantity for Actual Output – 5,25,000
Standard Cost of Standard Quantity for Actual Output
= 5,25,000 – 25,000
= 5,00,000
Standard Cost of Standard Quantity for Actual Output = Standard Price per Kg. × Standard
Quantity for Actual Output
5,00,000 = 5 × Standard Quantity for Actual Output
Standard Quantity for Actual Output = Rs. 5, 00, 000 / Rs. 5 = 1, 00, 000 Kg.
Standard Quantity for each unit of output = 1, 00, 000 kg / 10, 000 units = 10Kg.
(Unfavorable)

3. Standard Rate of Direct Labour Hour

Direct Labour Rate Variance = Standard Cost of Actual Time – Actual Cost
15,500 (A) = Standard Cost of Actual Time – 3,08,000
Standard Cost of Actual Time = 3,08,000 – 15,500 = 2,92,500
Standard Cost of Actual Time = Standard Rate per hr. × Actual Hours
2,92,500 = Standard Rate per hr. × 19,500 hrs
Standard Rate per hr. = Rs. 2, 92, 500 / 19, 500 hrs. = 15 (Unfavorable)
 4. Standard Time for Actual Production
Labor Efficiency Variance = Standard Cost of Standard Time for Actual Production –
Standard Cost of Actual Time
7,500 (F) = Standard Cost of Standard Time for Actual Production – 2,92,500
Standard Cost of Standard Time for Actual Production = 2,92,500 + 7,500 = 3,00,000
Standard Cost of Standard Time for Actual Production = Standard Rate per hr. × Standard
Time for Actual Production
3,00,000 = 15 × Standard Time for Actual Production Standard Time for Actual Production
Standard Time for Actual Production Standard Time for Actual Production = Rs. 3, 00,
000 / Rs. 15 = 20, 000 hrs. (Favorable)

5. Standard Variable Overhead Rate

Variable Overhead Variance = Standard Variable Overheads for Production – Actual
Variable
Overheads
10,000 (A) = Standard Variable Overheads for Production – 4,10,000
Standard Variable Overheads for Production = 4,10,000 – 10,000 = 4,00,000
Standard Variable Overheads for Production = Standard Variable Overhead Rate per Unit ×
Actual Production (Units)
4,00,000 = Standard Variable Overhead Rate per Unit × 10,000 units
Standard Variable Overhead Rate per unit = Rs. 4, 00, 000 / 10, 000 units = 40
Or
Standard Variable Overheads for Production = Standard Variable Overhead Rate per Hour ×
Standard Hours for Actual Production
4,00,000 = Standard Variable Overhead Rate per Hour × 20,000 hrs
Standard Variable Overhead Rate per hour = Rs. 4, 00, 000 / 20, 000 hrs. = 20
(Unfavorable)

Conclusion
Thus, variances are based on either change in cost from the expected amount, or changes in
the quantity from the expected amount. The most common variances that a cost accountant
elects to report on are subdivided within the rate and volume variance categories for direct
materials, direct labor, and overhead. It is also possible to report these variances for revenue.
It is not always considered practical or even necessary to calculate and report on variances,
unless the resulting information can be used by management to improve the operations or
lower the costs of a business. When a variance is considered to have a practical application,
the cost accountant should research the reason for the variance in detail and present the
results to the responsible manager, perhaps also with a suggested course of action.