STANDARD COSTING

DEFINITION

 According to Chartered Institute of Management

Accountants (CIMA), London, ‘Standard cost is the
predetermined cost based on technical estimates for
materials, labour and overhead for a selected period of time
for a prescribed set of working conditions’

 The words standard means ‘a norm’ or a criterion.

Standard cost is thus criterion cost which may be used as
yardstick to measure the efficiency with which actual cost
has been incurred.
 STEPS INVOLVED IN STANDARD
COSTING

Standard costing system involves the following steps:

1. The setting of standard costs for different elements of cost, i.e.,

material, labour and overheads.

2. Ascertaining actual costs.

3. Comparing standard with actual costs to determine the

differences between the two, known as ‘variances’.

4. Analysing variances for ascertaining reasons thereof.

5. Reporting of these variances and analysis thereof to management

for appropriate action, where necessary
 ADVANTAGES OF STANDARD COSTING

1. Effective cost control- Control is exercised by

comparing actual performance with standards
and taking action on the basis of variances so
revealed.
2. Helps in planning -establishing standards is
a very useful exercise in business planning
which instills in management or habit of
thinking in advance.
3. Provides incentives-standards provide
incentives and motivation to work with greater
effort. Schemes may be formulated to reward
those who achieve or surpass the standard. This
increases efficiency and productivity.
4. Fixing prices and formulating policies- Standard
costs are a valuable at to management and data mining
prices and formulating production policies for example
prices may be fixed by adding a standard margin of
profit to standard cost. Similarly standard costing
furnishes cost estimates while planning production of
new products.
5. Facilitates delegation of authority-In order that
responsibility for or standard performance may be
identified directly with the person's concern and
organization chart is prepared it shows delegated
authority and establishes responsibility of each
executive.
 LIMITATIONS OF STANDARD COSTING
1. The system may not be appropriate to the business.
2. The staff may not be capable of operating the system.
3. A business may not be able to keep standards up-to-date.
In other words a business may not revise standards to
keep pace with frequent changes in manufacturing
conditions. Firms may avoid revising standards as it is a
costly affair.
4. Inaccurate and unreliable standards caused misleading
results and thus may not enjoy the confidence of the users
of the system.
5. Operations of the standard costing system is a costly affair
and small firms cannot afford it.
6. Standard costing is expensive and unsuitable in job order
industries which are manufacturing non standardized
products.
 VARIANCE ANALYSIS

• Cost Variance: Cost variance is the difference between a

standard cost and the comparable actual cost incurred
during a period.

• According to CIMA, London, ‘variance analysis is the

process of computing the amount of variance and isolating
the causes of variance between actual and standard’.

• An important aspect of variance analysis is the need to

separate controllable from uncontrollable variances.
 VARIANCE ANALYSIS
 Where the actual cost is less than standard cost, it is known as
favourable or credit variance.
 On the other hand, where the actual cost is more than standard
cost, the difference is referred to as unfavourable, adverse or
debit variance.
 In simple words, any variance that has a favourable effect on
profit is favourable variance and any variance which has an
adverse or unfavourable effect on profit is unfavourable
variance.
 Favourable variances will be designated by (F) and Adverse by
(A).
 CONTROLLABLE AND
UNCONTROLLABLE VARIANCES
• If a variance can be regarded as the responsibility of a
particular person, with the result that his degree of efficiency
can be reflected in its size, then it is said to be a controllable
variance.
• For example, excess usage of material is usually the
responsibility of the foreman concerned. However, if the
excessive usage is due to material being defective, the
responsibility may rest with the Inspection Department for
non-detection of the defects
• If a variance arises due to certain factors beyond the control
of management, it is known as uncontrollable variance.
• For example, change in the market prices of materials,
general increase in the labour rates, increase in the rates of
power or insurance premium, etc., are not within the control
of the management of the company. Responsibility for
uncontrollable variances cannot be assigned to any person or
department.
 VARIANCE FOR EACH ELEMENT OF COST
Material Variance
 This is the difference between the standard cost of
direct materials specified for the output achieved and
the actual cost of direct material used.
 Material Cost Variance= Material Price Variance
+Material Usage Variance
 Material Price Variance This is ‘that portion of the
material cost variance which is due to the difference between
the standard price specified and the actual price paid
 Reasons for Material Price Variance: This variance
usually arises due to the following reasons:
1. Change in the market prices of materials
2. Failure to purchase the specified quality, thereby resulting
in a different price being paid
3. Change in the quantity of materials, thereby leading to
lower/higher quantity discount
4. Not availing cash discounts, when standards set took into
account such discounts.
5. Inefficient purchasing
6. Change in the delivery costs
7. Rush purchases
8. Purchase of a substitute material on account of non-
availability of the material specified
 Material Usage (or Quantity) Variance This is ‘that portion
of the material cost variance which is due to the difference
between the standard quantity specified and the actual quantity
used.
 Reasons for Material Usage Variance: The material usage
variance may be caused by some or all of the following reasons:
1. Use of defective or sub-standard materials
2. Carelessness in the use of materials
3. Pilferage
4. Poor workmanship
5. Defect in plant and machinery
6. Change in the design or specification of the product
7. Change in the quality of materials
8. Use of substitute materials
9. Use of non-standard material mixture
10. Yield from materials in excess of or less than standard yield
Material Usage Variance
A= {[(80/100)*102] -70}*2= 23.3(F)
B={[(40/100)*102]- 50}*5 =46(A)
Total= 22.8
 LABOUR VARIANCES
▪ The analysis and computation of labour variances is
quite similar to material variances.
▪ Labour Cost Variance This is the difference between
the standard direct labour cost specified for the activity
achieved and the actual direct labour cost incurred.
 Classification of Labour Cost Variance
Labour cost variance is further divided into rate variance and
efficiency variance.
1. Labour Rate Variance: This is that portion of the labour
cost variance which is due to the difference between the
standard rate of labour specified and the actual rate paid.
Reasons for labour rate variance: Usual reasons are:
1. Change in the basic wage rates
2. Use of a different method of wage payment –shifting from
hourly rate to piece rate system.
3. Employing workers of grades different from the standard
grades specified -For example, employing senior workers with
higher pay than budgeted entry-level workers will increase
labor costs.
4. Unscheduled overtime
5. New workers not being paid at full rates
Labour Efficiency (or Time) Variance: This is that
portion of the labour cost variance which is due to the
difference between labour hours specified for actual output
and the actual labour hours expended.
Reasons for labour efficiency variance: This variance is
usually caused by one or more of the following reasons:
1. Poor working conditions, e.g., inadequate lighting and
ventilation, excessive heating, etc.
2. Defective tools and plant and machinery
3. Inefficient workers
4. Incompetent supervision
5. Use of defective or non-standard materials
6. Time wasted by factors, like waiting for materials, tools
or machine breakdown
7. Insufficient training of workers
3.20 (Labour Variances) A group of 10 skilled and 20
unskilled workers expected to produce 400Kg of
chemical in an 8 hour day. The standard rate was
fixed at ₹ 25 and ₹ 15 respectively.

Actually a group of 15 skilled and 10 unskilled

workers were deployed and paid for 8 hour day at
hourly wage rate of ₹ 22 and ₹18 respectively. Only
300 KG of chemical was produced.

Calculate Labour Variances.

The work is actually completed in 32 weeks. Calculate all Labour
variances.