Standard Costing, Variance Analysis and Management Cycle
Apply dollar, time, and quantity standards to work.
(C) Ghanendra Fago (M. Phil, MBA)
Use standard costs to report on operations and managers’
performance.
Calculate variances between standard and actual costs,
determine their causes, identify inefficient operations, and
take corrective action. Use variances to evaluate managers’
performance.
Use standard costs to prepare budgets and establish goals for product costing.
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Standard Costs
1.
2.
Standard costs are predetermined costs
that are developed from analyses of both:
1.
a. Past operating costs, quantities, and times
2.
b. Future costs and operating conditions.
In a standard costing system, standard
costs for direct materials, direct labor, and
manufacturing overhead flow through the
inventory accounts and eventually into the
Cost of Goods Sold account.
(C) Ghanendra Fago (M. Phil, MBA)
2
The Management Cycle
Managers use standard
management cycle:
costs
throughout
the
• In the planning stage of the management cycle,
standard costs aid in the development of budgets.
• During the executing stage, standard costs,
quantities, and time are applied to work performed.
• During the reviewing stage, actual costs are
compared with standard costs to compute variances,
and managers analyze the causes of those variances
to improve operations.
• During the reporting stage, a variance report
provides information on operations and managerial
performance
(C) Ghanendra Fago (M. Phil, MBA)
3
The Management Cycle
In today’s globally competitive environment,
new standards or measurements are
necessary to help managers:
–
–
–
–
Reduce processing time.
Improve quality.
Improve customer satisfaction.
Improve on-time deliveries
(C) Ghanendra Fago (M. Phil, MBA)
4
Standard Costs
• Standard costs are used with existing job
order or process costing systems.
• Standard costs are usually expressed as the
cost per unit of a finished product or process.
– Standard costs are based on:
– Engineering estimates.
– Forecasted demand.
– Worker input.
– Time and motion studies.
– Type and quality of direct materials
(C) Ghanendra Fago (M. Phil, MBA)
5
Standard Costing
• The technique for application of standard cost is known
as Standard Costing. It is the preparation of standard cost
and applying them to measure the variation between
standard cost and actual cost.
• The preparation of standard costs of products and service
and a technique whereby the planned activities of an
undertaking are expressed in budgets, standard costs,
standard selling price and standard profit margins, and
the differences between these and the comparable actual
results are accounted for.’
• Standard costing is expensive to use because the
management accounting system must keep separate
records of actual costs to compare with what should have
been spent.
(C) Ghanendra Fago (M. Phil, MBA)
6
Standard costing may be summarized as
• To fix the standard cost for material, labour
and overhead.
• To find out the actual cost
• To compare the actual cost with standard cost
• To analyse the variance between standard
cost and actual cost
(C) Ghanendra Fago (M. Phil, MBA)
7
Use of Standard Costs
 Preparing operating budgets.
 Identifying production costs and processes that
must be managed to reduce waste and
inefficiency.
 Evaluating the performance of managers and
workers.
 Setting prices.
 Simplifying inventory and product costing
procedures
(C) Ghanendra Fago (M. Phil, MBA)
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Standard Cost per Unit
There are six standards used to determine the
standard cost per unit:
1. Direct materials price standard
2. Direct materials quantity standard
3. Direct labor time standard
4. Direct labor rate standard
5. Standard variable manufacturing overhead rate
6. Standard fixed manufacturing overhead rate
(C) Ghanendra Fago (M. Phil, MBA)
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Direct Materials Price Standard
The direct materials price standard is found by
carefully considering:
– Expected price increases
– Changes in available quantities.
– Possible new sources of supply.
Direct Materials Quantity Standard
The direct materials quantity standard is
affected by:
– Product engineering specifications.
– Quality of direct materials.
– Age and productivity of machines.
– Quality and experience of the work force.
(C) Ghanendra Fago (M. Phil, MBA)
10
Direct Labor Time Standard
The direct labor time standard is based on current
time and motion studies of workers and machines
and past performance.
Direct Labor Rate Standard
The direct labor rate standards are affected by
labor union contracts and company personnel
policies.
(C) Ghanendra Fago (M. Phil, MBA)
11
Standard Direct Materials, Standard Direct
Labor Costs Manufacturing Overhead Costs
Standard Direct Materials Cost
= Direct Materials Price Standard X Direct
Materials Quantity Standard
Standard Direct Labor Cost
= Direct Labor Time Standard X Direct
Labor Rate Standard
Standard Manufacturing Overhead Cost
= (Standard Variable Overhead Rate
+Standard Fixed Overhead Rate) X
Application Basis
(C) Ghanendra Fago (M. Phil, MBA)
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Standard Rates
Standard Variable Manufacturing Overhead Rate
= Total budgeted variable manufacturing
overhead costs ÷ Expected number of
standard machine hours
Standard Fixed Manufacturing Overhead Rate
= Total budgeted fixed manufacturing overhead
costs ÷Normal capacity in terms of standard
machine hours
(C) Ghanendra Fago (M. Phil, MBA)
13
Standard Unit Cost
• A product’s standard unit cost is determined by
adding standard direct materials cost, standard
direct labor cost and standard manufacturing
overhead rate.
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14
Four Step Approach of Variance Analysis
1. Compute the variance. If the variance is
insignificant, actual operating results are close
to or equal to anticipated operation conditions,
no corrective action is needed.
2. Determine the cause of any significant variance.
3. Identify the performance measures that track
those activities.
4. Take action to correct the problem or continue to
improve operations.
(C) Ghanendra Fago (M. Phil, MBA)
15
Using Variance Analysis to Control Costs
Compute Variance
Is the Variance
Material Significant?
Yes
Determine Cause(s)
of Variance
No
No Corrective
Action Needed
Identify and Analyze
Performance Measures
to Determine
Corrective Action
Take Corrective Action
(C) Ghanendra Fago (M. Phil, MBA)
16
Material Variance Analysis
 The term variance refers to the deviation of the actual
cost from the standard cost due to the various
causes.
 Variances will occur if in any given production period
the actual costs vary from the standard costs.
 "Cost variance is the difference between the standard
cost and the comparable actual cost incurred during
a given period“ : ICMA
 For example, if the price paid for material bought
during a given production period, differed from the
standard (expected) price for that material, a material
price variance will arise.
 Similarly if the amount of material actually used
exceeded the standard (expected) usage a material
usage variance will arise.
(C) Ghanendra Fago (M. Phil, MBA)
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Material Cost Variance
The difference between material at the standard
material price and actual material price is known
as material usage variance. The variance can be
favorable or unfavorable .If the actual cost is
lower than the standard cost, it is considered as a
favorable variance and if the actual cost exceeds
the standard cost the difference is deemed to be
unfavorable.
• Material Cost Variance (MCV):
•
= SQSP–AQAP
= (SQ*SP)-(AQ*AP)
= ((SQ/SO*AO)*SP)-(AQ*AP)
(C) Ghanendra Fago (M. Phil, MBA)
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Material Price Variance (MPV)
• Material price variance is the deviation of the
actual price paid from the standard price
specified.
Formula:
• Material Price Variance (MPV)= AQ (SP–AP)
(C) Ghanendra Fago (M. Phil, MBA)
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Possible Causes of Direct Materials
Price Variance
• Changes in vendor prices, inaccurate or
outdated direct materials price standards, and
differences between the quality of direct
materials purchased and the quality desired.
• Differences between quantity
received and those anticipated.
discounts
• The purchase of substitute direct materials
that differ from product specifications.
(C) Ghanendra Fago (M. Phil, MBA)
20
Material Usage Variance (MUV)
• It indicates the difference between the standard
quantities of the material specified from the
actual quantity of output and actual quantities of
material used .The material usage variance can
be calculated by multiplying the difference
between the actual quantity and standard
quantity by standard price.
Formula:
• Material Usage Variance (MUV) = SP*(SQ-AQ)
(C) Ghanendra Fago (M. Phil, MBA)
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Material Mix Variance (MMV)
The material mix variance is the result of the
deviation of the actual composition of a mixture
of the material from the standard one. Normally, a
material mix variance arises where there is the
change in the composition of the material mixture
Formula:
Material Mix Variance (MMV) = (Total Weight of
AM/Total weight of SM)(SC of SM)–SC of AM
(C) Ghanendra Fago (M. Phil, MBA)
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Possible causes of a direct materials quantity
variance
•
Inaccurate or outdated direct materials
quantity standards
•
Poor workmanship or excellent
workmanship
•
Faulty equipment
•
Inferior or superior quality of direct
materials
•
Poor materials handling
(C) Ghanendra Fago (M. Phil, MBA)
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Material Yield Variance (MYV)
• The difference between the standard yield output)
specified and actual yield (output) obtained
• This variance is based on the output of the product
• The standard loss during its processing is expected to
be 15%.
Formula:
Material yield variance (MYV): (Actual yield or outputStandard yield or output for actual input)*Standard cost
per unit = SC/SO (Actual Yield –standard Yield)
(C) Ghanendra Fago (M. Phil, MBA)
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VERIFICATION
Material Cost Variance
(MCV)
Material Price Variance
(MPV)
Material Usage Variance
(MUV)
Material Mix Variance
(MMV)
Material Yield Variance
(MYV)
(C) Ghanendra Fago (M. Phil, MBA)
25
Direct Cost Variance (LCV)
 Is the difference between the standard direct labor
cost for the actual output and the actual labor cost
paid.
 The deviation of the actual direct wages paid from
the direct wages specified for the standard output.
Formula:
 Labour Cost Variance (LCV)
= ST SR – AT  A
= ((ST/SO AO)*SR) -(AT AR)
(C) Ghanendra Fago (M. Phil, MBA)
26
Labor Rate (wage) Variance
 Difference between standard wage rate per
hour/day/week/month/fixed and actual wage rate paid.
 It is usually caused due to increases in wage rate
because of negotiation with the union or other
causes.
 Labour Rate Variance = AT (SR – AR)
Causes of Direct Labor Rate Variance
• A worker is hired at a pay rate that is higher or lower
than expected.
• An employee performed the duties of a higher- or
lower-paid position.
(C) Ghanendra Fago (M. Phil, MBA)
27
Labor Efficiency Variance (LEV)
•
“Have the workers performed as efficiently as they were
expected to perform”?
•
It compares the quantity of work achieved in the time
paid for, with the production that should have been
achieved in that time if the labor force had worked
according to standard timings.
Labour Efficiency Variance (LEV) = SR (ST – AT)
Causes of Direct Labor Efficiency Variance
•
Overall wage rates changed due to New labor
agreements, labor strikes that cause the temporary
hiring of unskilled help, large layouts that result in
unusual usage of remaining workers etc.
(C) Ghanendra Fago (M. Phil, MBA)
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Favorable Direct Labor Efficiency
Variance
A favorable direct labor efficiency variance can be caused by
improved training of employees, new machinery and higher
quality of materials.
Unfavorable Direct Labor Efficiency
Variance
An unfavorable direct labor efficiency variance can be caused
by machine breakdowns, inferior direct materials, poor
supervision, slow materials handling, and poor employee
performance
(C) Ghanendra Fago (M. Phil, MBA)
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Labor Mix Variance (MMV)

It is possible when more than one type of labor
is used for the job.

It represents the variance due to the change in
standard and actual labor force composition.
Labour Mix Variance (LMV) = (Total AT Mix/Total
ST Mix)– SC of AM
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Labor Yield Variance (LYV)

It represents that portion of labor efficiency
variance which is due to difference between the
standard output and the actual output.

If the actual labor output is higher as compare to
the relative standard, then variance would be
favorable and vice versa
Labour Yield Variance (LYV)= SR (Actual Yield or
Output – Standard Yield for Actual Input i.e.
Time)
(C) Ghanendra Fago (M. Phil, MBA)
31
Labor Idle Time Variance (LITV)

Sub efficiency variance.

Indicates the standard cost of the actual hours
for which the employees may remain idle due to
abnormal circumstances like strikes, lockouts,
power failure, breakdown of machinery,
unavailability or raw materials etc.

Always unfavorable.

For the accurate of the labor efficiency variance
labor, idle time should be adjusted.

Labour Idle Time Variance = Idle Time  SR (U)
(C) Ghanendra Fago (M. Phil, MBA)
32
VERIFICATION
Labour Cost Variance (LCV)
Labour Rate Variance
(LRV)
Labour Efficiency
Variance (LEV)
Labour Mix Variance
(LMV)
Labour Idle Time
Variance (LITV)
Labour Yield Variance
(LYV)
(C) Ghanendra Fago (M. Phil, MBA)
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