Standard costing
1
Standard costing system
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2
The management evaluates the performance
of a company by comparing it with some
predetermined measures
Therefore, it can be used as a process of
measuring and correcting actual performance
to ensure that the plans are properly set and
implemented
Procedures of standard costing
system
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3
Set the predetermined standards for sales margin and
production costs
Collect the information about the actual performance
Compare the actual performance with the standards to
arrive at the variance
Analyze the variances and ascertaining the causes of
variance
Take corrective action to avoid adverse variance
Adjust the budget in order to make the standards more
realistic
Functions of standard costing
system

Valuation
–
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Planning
–
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Use the current standards to estimate future sales
volume and future costs
Controlling
–
4
Assigning the standard cost to the actual output
Evaluating performance by determining how
efficiently the current operations are being carried
out

Motivation
–
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5
Notify the staff of the management’s expectations
Setting of selling price
Variance
6
Variance analysis
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7
A variance is the difference between the
standards and the actual performance
When the actual results are better than the
expected results, there will be a favourable
variance (F)
If the actual results are worse than the
expected results, there will be an adverse
variance (A)
Profit variance
Selling and
administrative
Cost variance
Total production
Cost variance
Total sales margin variance
Sales margin
Price variance
Materials
cost
variance
8
Labour
Cost
variance
Variable
Overhead
variance
Sales margin
volume variance
Fixed
Overhead
variance
Materials cost variance
Material Price variance
Material Usage variance
Labour cost variance
Labour rate
variance
9
Labour Efficiency
variance
Variable Overhead variance
VO Expenditure variance
VO Efficiency variance
Fixed Overhead variance
Fixed Expenditure variance
10
Fixed Volume variance
Cost variance
11
Cost variance
•Cost variance = Price variance + Quantity variance
Cost variance is the difference between the standard cost and the
Actual cost
•Price variance = (standard price – actual price)*Actual quantity
A price variance reflects the extent of the profit change
resulting from the change in activity level
12
•Quantity variance = (standard quantity – actual quantity)*
standard cost
A quantity variance reflects the extent of the profit change
resulting from the change in activity level
Three types of cost variance
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13
Material cost variance
Labour cost variance
Variable overheads variance
Material and labour variance
14
Material cost variance

Material price variance
= (standard price – actual price)*actual quantity

Material usage variance
= (Standard quantity – actual quantity)* standard price
= (Standard quantity for actual production – actual
quantity production) * standard price
15
Labour cost variance

Labour rate variance
= (standard price – actual price)*actual quantity

Labour efficiency variance
= (standard quantity – actual quantity)*standard price
= Standard quantity for actual production – actual
quantity used) * standard price
16
Example
17
ABC Ltd. makes and sells a single product. The company uses a
Standard marginal costing system. It plans to produce and sell 1000
units in May 2005. A budget statement is produced as follow:
Budgeted income statement for the month ended 31 May 2005
$
$
Sales ($50*1000)
50000
Less: Variable cost of goods sold
Direct materials ($3*4000)
12000
Direct labour ($5*3000)
15000
Variable overheads ($2*3000)
6000 33000
Budget contribution
17000
Fixed overhead
3000
Budget profit
14000
18
The actual sales and production is 800 units. The actual income
statement is shown as follows:
Income statement for the month ended 31 May 2005
$
Sales ($60*800)
Less: Variable cost of goods sold
Direct materials ($3.2*2400)
Direct labour ($6*3200)
Actual Variable overheads
Contribution
Fixed overhead
Net profit
19
$
48000
12000
15000
5500 32380
15620
2600
13020
Material cost variance
Material price variance
= (standard price – actual price)*actual quantity
= ($3 - $3.2)*2400
= $480 (A)
 Material usage variance
= (Standard quantity – actual quantity)* standard price
= (Standard quantity for actual production – actual
quantity production) * standard price
4000 units
= (4*800 – 2400)*$3
1000 units
= $2400 (F)
20
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Material cost variance
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21
Material price variance
Material usage variance
Total Material cost variance
$480 (A)
$2400 (F)
$1920 (F)
Labour cost variance

Labour rate variance
= (standard price – actual price)*actual quantity
= ($5 - $6)*3200
= $3200 (A)

3000 units
1000 units
22
Labour efficiency variance
= (standard quantity – actual quantity)*standard price
= Standard quantity for actual production – actual
quantity used) * standard price
= (3* 800 – 3200)*$5
= $4000 (A)
Labour cost variance
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23
Labour rate variance
$3200 (A)
Labour efficiency variance $4000 (A)
Total labour cost variance $7200 (A)
Overheads variance
24
Overheads variance
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25
Variable overheads variance
Fixed overheads variance
Variable overheads variance
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26
Variable overheads variance is the difference
between the standard variable overheads
absorbed into the actual output and the actual
overheads incurred
Actual VO
Budgeted VO
(SP * Actual
hours worked
VO expenditure variance/
VO spending variance
VO efficiency variance
Total VO variance
(under-/over- absorbed)
27
Absorbed VO
(SP* standard
hours for actual
output
Calculation on overhead absorbed

Step 1
Budgeted overheads
POAR = Budgeted activity level in standard hours

Step 2
Overhead absorbed = POAR * Standard hours for actual
number of units produced
28
Variable overheads variance

Variable overheads variance
= variable overheads absorbed – actual variable overheads
incurred

Variable overheads expenditure variance
= standard variable overheads for actual hours worked – Actual
variable overheads incurred

29
Variable overheads efficiency variance
= Standard variable overheads for standard hours of output –
Actual variable overhead absorbed
= (standard hours for actual output – Actual hours worked)*
standard price
Example
30
ABC Ltd. makes and sells a single product. The company uses a
Standard marginal costing system. It plans to produce and sell 1000
units in May 2005. A budget statement is produced as follow:
Budgeted income statement for the month ended 31 May 2005
$
$
Sales ($50*1000)
50000
Less: Variable cost of goods sold
Direct materials ($3*4000)
12000
Direct labour ($5*3000)
15000
Variable overheads ($2*3000)
6000 33000
Budget contribution
17000
Fixed overhead
3000
Budget profit
14000
31
The actual sales and production is 800 units. The actual income
statement is shown as follows:
Income statement for the month ended 31 May 2005
$
Sales ($60*800)
Less: Variable cost of goods sold
Direct materials ($3.2*2400)
Direct labour ($6*3200)
Actual Variable overheads
Contribution
Fixed overhead
Net profit
32
$
48000
12000
15000
5500 32380
15620
2600
13020
Budgeted overheads
POAR = Budgeted activity level in standard hours
= $6000
3000
= $2
Overhead absorbed = POAR * Standard hours for actual
number of units produced
= $2 *3 hr per unit * 800 units
Standard hr per unit = 3000 hr /1000 units
33
Variable overheads variance
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34
Variable overheads variance
= variable overheads absorbed – actual variable
overheads incurred
= $4800 - $5500
= $700 (A)
Variable overheads expenditure variance
= standard variable overheads for actual hours
worked – Actual variable overheads incurred
= ($2* 3200 hr) - $5500
= $900 (F)

35
Variable overheads efficiency variance
= Standard variable overheads for standard
hours of output – Actual variable overhead
absorbed
= (standard hours for actual output – Actual
hours worked)* standard price
= (3 hr *800 units – 4 hr *800 units)*$2
= $1600 (A) Actual hour per unit = $3200 hr/800 units
Variable overheads variance
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36
Variable overheads expenditure variance $900 F
Variable overheads efficiency variance
$1600 A
Total Variable overhead variance
$400 A
Sales variance
37
Actual
contribution
Budgeted contribution
(Standard margin * Actual
Volume)
Sales margin price variance
Budgeted
contribution
(Standard margin*
Standard volume)
Sales margin volume variance
Total sales margin variance
38
Sales variance (Marginal costing)

Total sales margin variance
= actual contribution – budgeted contribution
= [(Actual selling price – Standard cost of sales )*Actual sales
volume] – Budgeted contribution

Sales margin price variance
= (Actual contribution per unit – Standard contribution per unit) *
Actual sales volume

39
Sales margin volume variance
= (Actual volume – Budget volume)* Standard
contribution per unit
Sales variance (Absorption costing)

Sales margin price variance
= (Actual profit margin per unit – Standard profit margin
per unit) * Actual sales volume

Sales margin volume variance
= (Actual volume – Budget volume)* Standard profit
margin per unit
40
Example
41
ABC Ltd. makes and sells a single product. The company uses a
Standard marginal costing system. It plans to produce and sell 1000
units in May 2005. A budget statement is produced as follow:
Budgeted income statement for the month ended 31 May 2005
$
$
Sales ($50*1000)
50000
Less: Variable cost of goods sold
Direct materials ($3*4000)
12000
Direct labour ($5*3000)
15000
Variable overheads ($2*3000)
6000 33000
Budget contribution
17000
Fixed overhead
3000
Budget profit
14000
42
The actual sales and production is 800 units. The actual income
statement is shown as follows:
Income statement for the month ended 31 May 2005
$
Sales ($60*800)
Less: Variable cost of goods sold
Direct materials ($3.2*2400)
Direct labour ($6*3200)
Actual Variable overheads
Contribution
Fixed overhead
Net profit
43
$
48000
12000
15000
5500 32380
15620
2600
13020
Sales variance (Marginal costing)

Total sales margin variance
= actual contribution – budgeted contribution
= [(Actual selling price – Standard cost of
sales )*Actual sales volume] – Budgeted
contribution
= [($60 - $33)*800] - $17000
= $21600 - $17000
$33000/1000 units
= $4600 (F)
44
Sales variance

Sales margin price variance
= (Actual contribution per unit – Standard contribution
per unit) * Actual sales volume
= [($60 - $33) – ($50 - $33)]*800
$33000/1000 units
= $8000 F

Sales margin volume variance
= (Actual volume – Budget volume)* Standard
contribution per unit
= (800 -1000)*$17
$17000/1000 units
= $2800 (A)
45
Sales variance (Marginal costing)
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46
Sales margin price variance
Sales margin volume variance
Total sales variance
$8000 F
$3400 A
$4600 F
Sales variance (Absorption costing)

Sales margin price variance
= (Actual profit margin per unit – Standard profit margin per unit) *
Actual sales volume
= [($60-$36) – ($50-$36)]*800
(33000+3000)/1000 units
= $8000 F

Sales margin volume variance
= (Actual volume – Budget volume)* Standard profit margin per
unit
= (800-1000)*$14
= $3400 A
$14000/1000 units
47
Sales variance (Absorption costing)
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48
Sales margin price variance
Sales margin volume variance
Total sales variance
$8000 F
$2800 A
$5200 F
Fixed overhead variance
49
Actual FO
Budgeted FO
FO expenditure variance/
FO spending variance
FO volume variance
Total FO variance
(under-/over- absorbed)
50
Absorbed VO
(SP* standard
hours for actual
output
Fixed overhead variance
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51
Fixed overheads variance
= Fixed overheads absorbed – Actual fixed overheads
incurred
Fixed overheads expenditure variance
Budgeted fixed overheads – Budgeted overheads
absorbed
Fixed overheads volume variance
= Absorbed fixed overheads – Budgeted overheads
absorbed
Example
52
ABC Ltd. makes and sells a single product. The company uses a
Standard marginal costing system. It plans to produce and sell 1000
units in May 2005. A budget statement is produced as follow:
Budgeted income statement for the month ended 31 May 2005
$
$
Sales ($50*1000)
50000
Less: Variable cost of goods sold
Direct materials ($3*4000)
12000
Direct labour ($5*3000)
15000
Variable overheads ($2*3000)
6000 33000
Budget contribution
17000
Fixed overhead
3000
Budget profit
14000
53
The actual sales and production is 800 units. The actual income
statement is shown as follows:
Income statement for the month ended 31 May 2005
$
Sales ($60*800)
Less: Variable cost of goods sold
Direct materials ($3.2*2400)
Direct labour ($6*3200)
Actual Variable overheads
Contribution
Fixed overhead
Net profit
54
$
48000
12000
15000
5500 32380
15620
2600
13020
Fixed overhead variance



55
Fixed overheads variance
= Fixed overheads absorbed – Actual fixed overheads incurred
= ($1*3*800) - $2600
= $200 A
Fixed overheads expenditure variance
= Budgeted fixed overheads – Budgeted overheads absorbed
= $3000 - $2600
= $400 F
Fixed overheads volume variance
= Absorbed fixed overheads – Budgeted overheads absorbed
= ($1*3*800) - $3000
= $600 A
FO Variance in marginal and
absorption costing
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In marginal costing:
–
–
56
Fixed overheads are charged as period costs
instead of charging to product in marginal costing.
It is assumed that the fixed overheads remain
unchanged with the change in the level of activity.
Single fixed overhead expenditure variance will be
used
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In absorption costing
–
–
57
Fixed overheads are charged to the products and
included in the valuation of closing stock.
Total fixed overheads variance is divided into fixed
overheads price variance and fixed overheads
volume variance
Profit reconciliation statement
58
Profit reconciliation statement
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59
Profit reconciliation statement is used to sum
up all variances
It can help the top management to explain the
major reasons for the difference between
budgeted and actual profits
The sales margin variance and fixed
overheads variance are different between
absorption and marginal costing system
Marginal costing
60
61
Profit Reconciliation Statement
$
$
Budgeted profit
Sales variances
Sales margin price
8000 F
Sales margin volume 3400 A
4600 F
Materials cost variance
Materials price
480 A
Material usage
2400 F
1920 F
Labour cost variance
Labour rate
3200 A
Labour efficiency
4000 A
7200 A
Variable overhead variance
VO Expenditure
900 F
VO Efficiency
1600 A
700 A
Fixed overhead expenditure variance
400F
Actual profit
$
14000
980 A
13020
Absorption costing
62
63
Profit Reconciliation Statement
Budgeted profit
Sales variances
Sales margin price
8000 F
Sales margin volume 2800 A
5200 F
Materials cost variance
Materials price
480 A
Material usage
2400 F
1920 F
Labour cost variance
Labour rate
3200 A
Labour efficiency
4000 A
7200 A
Variable overhead variance
VO Expenditure
900 F
VO Efficiency
1600 A
700 A
Fixed overhead variance
FO expenditure
400F
FO Volume
600 A
200 A
Actual profit
14000
980 A
13020
Reasons for variances
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Material price variance
–
–
–
64
Price changes in market conditions
Change in the efficiency of purchasing dept. to
obtain good terms from suppliers
Purchase of different grades or wrong types of
materials
Reasons for variances

Materials usage variance
–
–
–
–
65
More effective use of materials/ wastage arising
from the efficient production process
Purchase of different grade or wrong types of
materials
Wastage by the staff
Change in production methods
Reasons for variances

Labour rate variance
–
–
–
66
Non-controllable market changes in the basic wage
rate
Use of higher/lower grade of workers
Unexpected overtime allowance paid
Reasons for variances

Labour efficiency variance
–
–
–
–
–
–
–
–
–
67
Purchase of different grade or wrong types of materials
Breakdown of machinery
High/low labour turnover
Changes in production method
Introduction of new machinery
Assignment wrong type of worker to work
Adequacy of supervision
Changes in working condition
Change in motivation methods
Reasons for variances

Variable overheads expenditure variance
–
–
68
It may be caused by the non-controllable change in the price
level of indirect wages or utility rates since the predetermined
rate is set
It is meaningless to interpret this kind of variance on its own.
One should look various components of the fixed overheads
Reasons for variances

Variable overheads efficiency variance
–
69
Both the variable overheads and direct labour cost
vary with the direct labour hours worked
Reasons for variances

Fixed overheads expenditure
–
–
70
It is meaningless to interpret this kind of variance on
its own.
It may be caused by the change in the price levels
of rent, rates and other fixed expenses
Reasons for variances

Fixed overhead volume variance
–
71
When the level of activity is higher than the
budgeted level, there is a favourable variance
Reasons for variances

Sales margin price variance
–
–
–
–
72
Change in the pricing strategies of the company
Response to the change of pricing policies of its
competitors
Higher profit margin with growing demand for the
product
Lower profit margin for simulating sales
Reasons for variances

Sales margin volume variance
–
–
73
Change in prices and demand
Change in the market share of its competitiors