Standard cost: Standard costs are predetermined costs or target costs that should be incurred

under efficient operating conditions.

According to 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.
According to Brown and Howard, the standard cost is a predetermined cost which determines
what each product or service should cost under a given circumstances.

Standard costing is a technique whereby standard costs are computed and subsequently
compared with the actual costs to find out the differences between the two. These differences are
then analyzed to know the causes thereof so as to provide a basis of control.
According to CIMA, London, the preparation of standard costs and applying them to measure the
variations with a view to maintain maximum efficiency in production.
Features:
1. Standard cost is a pre-determined cost
2. Following processes are included in standard costing
3. Standard costing technique is an effective technique of cost control.
4. Prime object is to guide and advise the management for maintaining maximum level of
efficiency in production.
5. It applied in such industry where a standard product is produced again and again such as
engineering industry.
Steps: standard costing system involves the following steps
1. The setting of standard costs for different elements of costs i,e material, labour and
overheads.
2. Ascertaining actual costs.
3. Comparing standard with actual costs to determine the differences b/w the two, known as
variances.
4. Analyzing variance for ascertaining reasons thereof.
5. Reporting of these variances and analysis thereof to management for appropriate action,
where necessary.
Advantages:
 Measurement of efficiency of different operations of production is possible
under system as standard costs are compared with actual costs.
 Reasons for variation in standard costs and actual costs can be ascertained by
this technique. This facilitates the management in removing in efficiency.
 Management by exception is possible on those operations only where variances
are greater.
 Right and responsibilities of persons are properly and exactly fixed.
 This system helps the management in decision making and in preparation of
future plans.
 It helps in establishing an effective budgetary control.
 Standard provide incentives and motivation to work
 It is helpful in cost audit because if satisfactory reasons variations are disclosed.
 Study of variance helps the management in reducing cost.
Limitations:
 This system cannot be applied under instable market conditions and there is no
control of fluctuations of prices.
 It cannot be applied without the application of budgetary control.
 It cannot be applied effectively in industries which produce non standardized
products.
 This system is not suitable for small concerns.
 This system cannot be applied industries where quality of materials changes
frequently.
 Inaccurate and unreliable standards cause misleading results.
  A business may not be able to keep standards up-to-date.

Similarity b/w standard costing and budgetary control: There are certain basic principles which
are common to both standard costing/ budgetary control
1. The establishment of predetermined targets of performance.
2. The measurement of actual performance.
3. The comparison of actual performance with the predetermined targets.
4. The analysis of various b/w the actual and standard performance.
5. To take corrective measures, where necessary.
Standard costing v/s budgetary control:
The systems are in controlling costs, increasing efficiency, production targets are pre-determined,
they are compared with the actual results, variances are ascertained and remedial steps are taken.
Both systems are applied simultaneously and complementary to each other but there are some
dissimilarity also:

Basis Standard costing Budgetary control

Scope Developed mainly for the Budgets are complied for different
manufacturing function and functions of business – sales , cash etc
sometimes also for marketing and
administration functions.
Intensity Intensive in application as it calls forExtensive in nature and intensity of
detailed analysis of variances. analysis tends to be much less than in
standard costing
Relation Variances are usually revealed Control is exercised by statistically putting
to through accounts. budgets and actual side by side.
accounts
Usefulness It represent realistic yardsticks and It represent an upper limit on spending
more useful for controlling and without consider the effectiveness of exp
reducing costs. in terms of output.
Basis It established after considering Budget may be based on previous year
production capacity, methods and costs without any attention being to
other factors which require attention efficiency
when determining an acceptable level
of efficiency.
Projection It is a projection of cost accounts. It is a projection of financial accounts.

Preliminaries in establishing a system of standard costing:

1. Establishment of cost centres
2. Classification of accounts
3. Types of standards
 Basic standards
 Currents standards (Ideal standards, Expected standards, normal standards)
4. Setting standard costs
 Setting standards for direct materials
a) Material price standard
b) Material usage standard
 Setting standards for direct labour
a) Labour rate standard
b) Labour time/efficiency standard
 Setting standards for direct expenses

Applicability of standard costing:

The applicability of standard costing requires certain conditions to be fulfilled.
 1. A sufficient volume of standard products or components should be produced.
2. Methods, operations and processes should be capable of being standardized.
3. A sufficient number of costs should be capable of being controlled.
4. Industries producing standardized products which are repetitive in nature, i.e industries
using process costing method, fulfil all above conditions and thus the system can be used
to the best advantage in such industries eg fertilizers, cement, steel, sugar etc.
5. In jobbing industries, it is not worthwhile to develop and employ a full system of
standard costing. This is because in such industries each job undertaken may be different
from another and setting standards for each job may prove difficult and expensive. In
such industries, a partial system may be adopted in appropriate circumstances.

Variance analysis: Difference b/w standard and actual is known as variance. Cost variance is the
“difference b/w a standard cost and the comparable actual cost incurred during a period”. CIMA,
London.
Variance analysis is the process of analysis variances by sub-dividing the total variance in such a
way that management can assign responsibility for any off standard performance. An important
aspect of variance analysis is the need to separate controllable from uncontrollable variance. A
detailed analysis of controllable variance will help the management to identify the persons
responsible for its occurrence so that corrective action can be taken.
 When the actual cost is less than standard cost or actual result is better than standard set,
it is known as favourable variance.
 On the other hand, when actual cost exceeds standards cost or actual result is not up to
standard, it is known as unfavourable or adverse variance.
 If variance arises due to certain factors beyond the control of management, it is known as
uncontrollable variance.
 It can be regarded as the responsibility of a particular person, with the result that his
degree of efficiency can be reflected in its size, known as controllable variance

Total cost variance:

1) Material Cost variances (MCV)
2) Labour cost variances (LCV)
3) Overhead cost variance (OCV)

Material cost variances: MCV is the difference b/w standard cost of direct materials specified for
the output and actual cost of direct material used.

MCV= Standard cost –Actual Cost OR,

MCV= (SQ*SP) – (AQ*AP)

Material price variance= MPV= (SP-AP) –AQ. It is arises due to difference b/w standard price
and actual price of direct materials.
Reasons for material price variance:
 Change in the market prices of materials.
 Failure to purchase the specified quality.
 Change in the quantity of material purchased/ efficient purchasing
 Not availing cash discounts
 Change in the delivery costs
 Rush purchases / purchase of a substitute material due to non-availability
 Change in the rates of excise duty and tax
 Off-season purchasing for certain seasonal products.

Material Qty variance :( MQV) = (SQ-AQ) SP. It is arises due to the difference b/w standard
quantity
Reasons for material price variance:
 Use of defective or sub standard materials / Use of substitute material
 Carelessness in the use of materials
 Poor workmanship
 Defect in plant and machinery
 Change in the design or specification of the product
 Change in the quality of materials
 Use of substitute material.

Material mix variance: if the product require two or more types of material, then its production
two or more material are physically mixed in certain ratio. This certain ratio is called mix.
 When total actual mix is equal to total standard mix
MMV= (SQ-AQ) SP
 When total actual mix is unequal to total standard mix
MMV= (RSQ-AQ) SP
MSUV= (SQ-RSQ) SP,
RSQ= Std mix of one material/Total std mix*Total actual mix

Material yield variances: Sometimes actual production is less than the standard production. It
may be due to abnormal loss or spoilage during production operations. The difference b/w actual
performance and standard production is called yield variance.
 When total actual mix is equal to total standard mix
MYV= (AY-SY) SC per unit
 When total actual mix is unequal to total standard mix
MYV= (AY-RY) SC per unit
SC per unit= Total standard cost/standard output
Under this MCV= (AY*SC)-AC

Verification, MCV=MPV+MMV+MYV

Labour cost variances: LCV is the difference b/w standard cost of direct labour specified for the
output and actual cost of direct labour used.
LCV= SLC-ALC OR (ST*SR)-(AT*AR)
Labour time/efficiency variance: LEV is the difference b/w the standard wages of standard time
and the standard wages of actual time. If idle time is given then, (AT= AT-Idle time )
LEV= (ST-AT) SR
Labour rate variance (LRV): The difference b/w the standard wages and actual wages of actual
time is called Labour rate variance
LRV=(SR-AR)AT
Idle time variance (ITV): sometimes workers have to set idle due to strike, lock outs or power
failures etc. this wastage of production time and affect the total labour cost.
ITV= Idle time * standard time (always unfavorable)

Verification, LCV=LRV+LEV+ITV

Overheads variance= Variable overheads variance + fixed overheads variance

Variable overheads variance: The difference b/w the standard variable overheads and actual
variable overheads for actual production is the overheads variance.
(SRU-ARU)AU or (std overhead –Actual overheads),
SRU= Std rate of overhead per unit
ARU= Actual rate of overhead per unit
There are two parts of variable overheads variance:
 Expenditure or budget variance= (NU*SRU)-(AU*ARU)
 Efficiency variance= (AU-NU)SRU
 Normal unit (NU) = Std unit/Normal hrs* Actual hours
Verification, VOV= Expenditure variance + Efficiency variance

Fixed overheads variance= (SRU-ARU) AU

There are two parts of fixed overheads variance:
1. Budget or expenditure variance
2. Volume variance
 Efficiency variance= (AU-NU)SRU
 Calendar variance= (PU-SU)SRU
 Capacity variance
a) When there is calendar variance (NU-SU) SRU
b) When there is no calendar variance (NU-PU) SRU
Possible unit (PU)= Std units/std hours*possible hours