STANDARD COSTING
(1) WHAT IS A STANDARD
A standard is a pre-determined measurable quantity that is set in a defined condition
against which actual performance can be measured for an element of work, activity
e.t.c
(2) STANDARD COST
A standard cost is defined by CIMA as “a predetermined cost which is calculated
from the management’s standard of efficient operation and the relevant expenditure”. It can
be said to be a predetermined measurable quantity set in defined conditions, expressed in
money and built up from an assessment of the value of cost elements.
(3) STANDARD HOUR
A standard hour is a measure of production that can be achieved under normal or
standard condition by an average worker.
It can also be defined as an hypothetical hour which represent the amount of work
which should be performed in 1 hr under stated conditions.
(4) STANDARD COSTING
A standard costing system is merely the preparation of standard cost and their use in
planning & controlling purposes. It is a control device, that establish in advance, the expected
cost & revenue of a future production.
(5) STANDARD COST (I.E PRE-DETERMINED COST) AND HISTORICAL
COST COMPARED
STANDARD COST
1) It is a predetermined cost. Thus, it is a cost
that is set before actual production take
place.
2) It is a future cost, which means that, it
would be incurred in future.
HISTORICAL COST
1) It is the recorded cost of an
activity. Thus, is referred to as
the actual cost of an activity.
2) It is a past cost i.e. a cost that
has already been incurred.
3) It may be used for cost control. Thus the
standard cost is compared with actual cost
to make sure that cost conforms to
standard.
4) It is an ideal cost. It may not be attained.
3) It may be used to ascertain
profit or loss for the period.
The revenue is compared with
actual cost (historical cost) to
ascertain profit or loss.
4) It is a cost which has actually
been incurred.
(6) STANDARD & BUDGET COMPARED
 Refer to note given under budget.
(7) APPLICABILITY OF STANDARD COSTING
Standard costing system is mostly used in industries producing standardized products
which are repetitive in nature i.e industries using process costing method.
(8) ADVANTAGES OF STANDARD COSTING
(a) Standard costing is an example of “management by exception” by studying the
variance, management’s attention is directed towards those items which are not
proceeding according to plan. Management is able to delegate cost control through
the standard costing system knowing that variance would be unworkable.
(b) The process of setting, revising and monitoring standards encourages re-appraisal of
methods materials and techniques so leading to cost reductions.
(c) A properly developed standard costing system with full participation and involvement
creates positive, cost effective attitude through all levels of management right down to
operation management.
(d) Standard costing is an economical & simple means of cost accounting. It results in
reduction in paper work and considerable saving in clerical labour.
(e) Establishing standard is a very useful exercise in biz planning which instills in the
management a habit of thinking in advance.
(9) DISADVANTAGES OF STANDARD COSTING
(a) It is expensive and unsuitable in job order industry manufacturing non-standardized
products.
(b) The staff may not be capable of operating the system.
(c) If a standard is too easy to attain or unattainable, it becomes dis-incentive to staff
and they can go at their pace
(d) The setting of standard
and reporting through variance analysis, is now a
complicated, laborious and time wasting
(e) In volatile conditions with rapidly changing, methods, rates and prices, standards
quickly become out of date and thus lose their control and motivational effects. This
can cause resentment and loss of goodwill.
(10)
PURPOSE OF STANDARD COSTING
The following are the major purposes for which a standard costing system can be
used;
(a) To assist in setting budgets and evaluating managerial performance.
(b) To provide a challenging target that individuals are motivated to achieve
(c) To provide a prediction of future costs that can be used for decision-making purposes.
(d) To simplify the task of tracing costs to products for inventory valuation purposes.
(11)
PRELIMINARIES IN ESTABLISHING A SYSTEM OF STANDARD
COSTING
(a) Establishment of standard cost or revenue
(b) Recording of actual cost
(c) Comparison of standard cost with actual cost
(d) Analysis of variance
(e) Investigation of variance in order to inform management to take appropriate action
when necessary.
(12)
TYPES OF STANDARD

Basic

Ideal

Current

Attainable

Basic standard
These are standards which have been established for use over a long period of time.
The advantages of basic standard are

They could be used as a basis for setting current standard.

They could be used to show changes in trend over time.
It’s disadvantages is that basic standard would not form part of the reporting system
as any variance produced will have little or no meaning being an unknown mixture of
controllable and un-controllable factors.
CURRENT STANDARD
These are standards which have been established for use over a short period of time
and it’s purpose is to reflect current condition. In a situation where the condition’ is stable
current standard will be the same as attainable standard.
ATTAINABLE STANDARD
These are standards which have been established for use based on normal, efficient
(but not perfect) operating conditions i.e allowances are made for fatigue, machine
breakdown, strike, some in-efficiency, normal material loss.
IDEAL STANDARD
These are standards which have been established for use based on perfect operating
condition i.e no allowance is made for fatigue, material loss, machine breakdown e.t..c. Ideal
standards are NOT often used in practice because they are perceived by the employees as
being unrealistic & may have an adverse motivational impact on the workforce. The standard
is however useful for highlighting areas where a large cost saving can be realized.
(13) RESPONSIBILITY FOR SETTING STANDARD
The line managers who have to work with and accept the standards must be involved
in establishing the. Engineers, accountants and other specialist provide technical assistance
and information but the line managers must be involved in the critical part of standard
setting.
(14)
TYPICAL STANDARD COST CARD PER SHEET
Standard. D.M cost per unit of output
xx
Standard. D.L cost per unit of output
xx
Variable std. management overhead per unit of output
xx
Fixed standard management o/H per unit of output
xx
ST PRODUCTION COST PER UNIT
Add: Std Admin & selling o/H cost/unit of output
xxx
xx
STD COST OF SALE
xxx
Add: Standard profit ( on % of sale )
xx
xxx
A Standard cost card is a record of the standard material, labour and overhead costs.
Such a card is maintained for each product or service. The card will normally show the
quantity and price of each material item to be consumed, the time and rate of labour required,
the overheads to be absorbed and the total cost.
(15)
SETTING STANDARD COST
When setting cost standards, there are two approaches

To use the prices or rates which are current at the time the standards are set. This has
the advantage that each standard is clearly identifiable with a known fact. On the
other hand, if prices are likely to change, then the standard base on them will have a
limited value for planning purposes.

To use a forecast of average prices or rates over the period for which the standard is to
be used. This can postpone the need for revision but has the disadvantage that the
standard may never correspond with observed fact and that the forecast may be
subject to significant error.
 MATERIAL COST STANDARDS
For material cost, two kinds of standards must be set: (i) materials usage or quantity
standards & (ii) materials price standards. The important prerequisites for developing
materials cost standards are the existence of a sound system of physical control over
materials, a detailed analysis of product and the availability of basic information on operating
conditions and other relevant factors. If a firm does not have an adequate control over its
activities of purchasing, receiving, storing, issuing and handling of materials, it will not be
possible to obtain reliable cost data and other information to establish standards and control
costs.
VARIANCE ANALYSIS
A variance is the difference between standard cost and actual cost. Variance analysis
therefore is the process whereby the difference between standard cost and actual cost is subanalysed into their constituent parts.
An important aspect of variance analysis is the need to separate controllable from
uncontrollable variances. A detailed analysis of controllable variance will help the
management to identify the persons responsible for its occurrences so that corrective action
can be taken.
 FAVOURABLE & UNFAVOURABLE VARIANCES
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” or “debit” variance.
 CONTROLLABLE & 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 defective material, 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 un-controllable variance, for example, change in the market prices of material,
increases in labour rate e.t.c. are not within the control of management. Responsibility for uncontrollable variances cannot be assigned to any person or department the division of
variances into controllable and un-controllable is extremely important. The management
should place more emphasis on controllable variances; the un-controllable variance should be
ignored.
SOURCES OF VARIANCES
There are several reasons why actual performance might differ from standard
performance. Some of the reasons are:
(i)
Out of date standards – where frequent changes in prices of inputs occur, there
is a danger that standard prices may be out of date. Consequently, any
investigation of price variances will indicate a general change in market prices
rather than any inefficiencies or efficiencies in acquiring the resources.
(ii)
Out of control operations – variances may result from inefficient operations due
to a failure to follow prescribed procedures, faulty machinery or human errors.
Investigation of variances in this category should
pinpoint the cause of the
inefficiency and lead to corrective action to eliminate the inefficiency being
repeated.
(iii)
Model Deviation – An in-appropriate model may have been used to prepare the
budget. For instance a linear cost function may have been used to estimate costs
whereas the true relationship may be curvilinear.
(iv)
Implementation Deviations - plans may have been poorly implemented.
(v)
Measurement Deviation – An error may have been made in measuring the actual
costs.
FACTORS TO BE CONSIDERED WHEN INVESTIGATING & INTERPRETING
VARIANCES
(i)
Benefits - The potential benefit that would be derived from taking corrective
measures should outweigh the cost of investigation.
(ii)
Size – The larger the variance, the more likely that investigation would be carried
out because it may satisfy the materiality level specified by management.
(iii)
Cost/Benefit Analysis - The ultimate criterion is the comparison between the
cost of investigation and the financial benefits of an investigation.
(iv)
Controllability – whether the variance related to price or efficiency can be a
factor to be considered. Price variances are un-controllable. Obvious uncontrollable variances would clearly be candidate for not investigating.
(v)
Magnitude of variances - The magnitude of variance is a factor to be considered.
Generally, variance of more than 5% (relative) or N5,000 (absolute) may be
deemed worthy of investigation.
(vi)
Strategic significance – The customer sees the quality of the quality of material,
hence given labour and material variance, it would probably be better to
investigate the material variance in order to maintain the reputation of the product.
(vii)
Cost – variances The cost of investigation should not be too prohibitive or else
investigation would not be carried out.
(viii) Planning & operational variances - control or operational variances may be
investigated on a monthly basis. Planning variances would probably be subjected
to less frequent study e.g. half-yearly or manually or whenever standard costs are
normally revised.
(ix)
Degree of Analysis- variances which apparently or ostensibly are immaterial
could still be investigated if such variances have not been analysed into as much
detail as possible because of the possibility of variances offsetting each other.
PROBLEMS ENCOUNTERED IN THE INTERPRETATION AND INVESTIGATION
OF VARIANCES
(i)
Variance analysis highlights strength and weakness but does not indicate what
action to be taken.
(ii)
Inflation poses a problem
(iii)
Some variances are controllable, hence
action can be taken and the system
brought back on course. Other variances may be uncontrollable resulting in the
revision of budget.
(iv)
Some managers feel that a standard represent an average, therefore variances will
inevitably arise and should NOT be taken seriously.
(v)
Inaccuracies (owing to pressure on a budgetary control system) can arise in the
recording of actual results.
(vi)
There may be interdependence between variances e.g buying a cheaper material
will result in favourable price variance but may adversely affect the material
usage and labour efficiency variance.
(vii)
Who is responsible for a particular variance poses a problem
(viii) Setting tolerance limit for the purpose of investigation (which can be either
subjectively or statistically established) can pose a problem.
The above list of problems regarding the interpretation and investigation of variances
is not exhaustive. Management will have to consider these problems deeply before initiating
control action.
DIRECT MATERIAL COST VARIANCE
D.M COST VARIANCES
Price variance
Usage/Quantity variances
Mix variance
(A) MATERIAL COST VARIANCE
Yield variance
This is the difference between the standard direct material cost of actual production
volume and the actual cost of direct material. It can also be described as the sum of the direct
material price and usage variance.
The purpose of calculating this variance is to identify the extent to which profits will
differ from those expected by reason of the actual price paid for direct materials being
different from the standard price.
SC
_
AC
OR
Standard price at standard quantity for actual production
xx
Less; Actual Quantity at Actual price
(xx)
Total direct material cost variance
xx
(B) DIRECT MATERIAL PRICE VARIANCE
It is the difference between the standard price and the actual purchase price for the
actual of material.
The purpose of calculating this variance is to identify the extent to which profits will
differ from those expected by reason of the actual price paid for direct material being
different from the standard price.
The formula for this variance is
(Standard
Price
−
Quantity
(Actualused
Actual
) Actual
Price
at
Quantity used
Standard
)
Price
Quantity
- (Actualused
at
Actual
Price
Or
Kg (i.e actual quantity of D.M used)
N
Xx kg should have cost
xx
)
but it actually cost
xx
 REASONS FOR MATERIAL PRICE VARIANCE
(i)
Change in the basic prices of materials
(ii)
Change in the quantity of materials, thereby leading to lower/higher quantity
discount.
(iii)
Change in delivery cost
(iv)
Unexpected general price fluctuation.
(v)
Change in price policies
(vi)
In-efficiency in policies
(vii)
Purchase of a substitute material on
(viii)
Off-season purchasing for certain seasonal products like umbrella, natural
fruits during Ramadan fasting.
(ix)
Not availing cash discount, when standard set took into account such discount.
 RESPONSIBILITY FOR MATERIAL PRICE VARIANCE
Normally, the purchase manager is responsible for material price variance. However,
he cannot be held responsible for variance due to change in market prices, because a change
in prices is obviously outside his control. Similarly purchase of smaller quantity may be due
to shortage of finances which is a financial matter and beyond his control.
(C) DIRECT MATERIAL QUANTITY (OR USAGE) VARIANCE
It is the difference between the standard quantity specified for the actual production
and the actual quantity used measured at standard purchase price.
The purpose of this variance is to quantify the effect on profit of using a different
quantity of raw material from the expected for the actual production achieved.
Standard quantity
production
(
Standard quantity
for acutal production
Actual
quantity used
−
(for actual
at
) Standard price
Standard
Actual Quantity
)−(
Price
used
standard
)
Price
at
OR
Units
Kg
xx units should have used but actually used
xx
but it actually used
(xx)
xx @ Sp
 REASONS FOR DIRECT MATERIAL USAGE VARIANCE
(i)
Substitution of a difference grade of material
(ii)
Careless handling of material
(iii)
Inefficient production method
(iv)
Pilferage
(v)
Change in the quality of materials
(D) MATERIAL MIX VARIANCE
It is the difference between the total quantity in standard proportion, priced at the
standard price and the actual quantity of material used prices at the standard price.
It may also be defined as that portion of the material usage variance which is due
Actual quantity in
proportions
−
(standard mix
Actual quantity
in actual mix )
at Standard price
OR
Revised standard
quantity
at
(
(
Standard cost
of revised )
standard mix
Actual
Quantity
Standard cost
of actual
)
mix
-(
) at Standard price
N:B – The revised standard quantity is the revised standard proportion of actual input. This
is calculated as follows
RSM
Standard quantity of any one material
Total of standard quantities of all types of material
x
Total of actual
Quantities of all material
(E) MATERIAL YIELD VARIANCE
It is defined as the difference between the standard yield of the actual material input
and the actual yield, both valued at the standard material cost of the product.
It can also be defined as that portion of the material usage variance which is due to
the difference between standard yield specified and actual yield obtained.
The standard yield is the output expected from the standard input of raw materials. It
should be noted that yield variance as used in standard costing is the same thing as abnormal
loss or abnormal gain in other costing systems.
One important feature of yield variance is that it is an output variance while others
are input variances.
(
𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑦𝑖𝑒𝑙𝑑 𝑜𝑓
𝐴𝑐𝑡𝑢𝑎𝑙 𝑦𝑖𝑒𝑙𝑑 𝑜𝑓
−
) at standard material cost
𝑖𝑛𝑝𝑢𝑡
𝑎𝑐𝑡𝑢𝑎𝑙 𝑖𝑛𝑝𝑢𝑡
DIRECT LABOUR VARIANCE
Wage/Rate
Time /Efficiency
Idle Time
Mix
Revised usage
(A) DIRECT LABOUR COST VARIANCE
It is the difference between the standard direct labour cost and the actual direct labour
cost incurred for the production achieved.
It is the difference between direct labour cost specified for the actual output and the
actual direct labour cost incurred.
Standard cost -
Actual cost
[Standard Hour for actual output at SR] – [Actual Hr @ Actual Rate]
Standard Rate at standard hr (time)for
Actual price at
(
)[
at
Actual hrs (time)
actual produciton actual input
Actual
]
Hrs (time)
(B) Direct labour wage/rate variance
It can also be called “labour rate of pay” variance. It is the difference between the
standard actual direct labour hour rate per at standard material cost hour for the total hours
worked
(Standard Rate – Actual Rate) at Actual Hrs (time).
OR
Hrs
N
xxx Hrs should have cost
Xx
but it actually cost
(xx)
xxx
 REASONS FOR LABOUR RATE VARIANCE
(i)
Substitution of a difference grade of labour
(ii)
Payment of unplanned overtime or bonus
(iii)
Wrong setting of standards
(iv)
Change in the basic wage rate
(C) DIRECT LABOUR EFFICIENCY/TIME VARIANCE
It is the difference between the standard hours for the actual production achieved and
the hours actually worked valued at the standard labour rate.
[
Standard hrs (time)
for actual production
at
Actual
] at standard rate
Hours (time)
OR
Units
Hrs
xxx units should have taken
xxx
but actually took
xxx
xxx
(8) at standard rate (N)
=
N _____
 REASONS FOR LABOUR EFFICIENCY VARIANCE
(i)
In sufficient training of workers
(ii)
Incompetent supervision
(iii)
Inefficient workers
(iv)
Defective tools, plant & machinery
(v)
Substitution of a different grade of labour
(vi)
Use of incorrect grade of labour
(vii)
Setting wrong standard
(viii)
Unexpectedly favourable conditions.
(D) IDLE TIME VARIANCE
This variance represents that portion of the labour efficiency variance which is due to
abnormal idle time, such as time lost due to machine break-down, power failure, strikes e.t.c.
As idle time represents a loss, idle time variance is always unfavourable or adverse.
Hrs
Hrs paid for
xx
Hrs actually worked
(xx)
Idle Hours
Xx
@ SR/hr
=N
====
Idle Hrs at Standard Rate
(E) LABOUR MIX VARIANCE
This variance is similar to material mix variance. It arises only when more than on
grade of workers are employed and the composition of actual grade of workers differs from
those specified.
(
Revised standard
hour
−
Actual
) at standard rate
Hours
OR
Standard cost of
Standard of
(
)- (
)
revised
actual mix
standard mix
VARIABLE OVERHEAD VARIANCES
(N )
Expenditure (budget/
spending
Hrs
Efficiency
Hrs
Volume
INTRODUCTION
Analysis of overhead variance is somewhat different from material
and
labour variance and is considered to be the most difficult part of variance analysis
because
 There are different method of calculating overhead variances
 The establishment of a standard overhead absorption rate is made difficult due to
the FIXED PART of overhead cost.
 When overhead rate is expressed in terms of labour hours
OAR =
Budgeted overhead cost
Budgeted Hours
 When overhead is expressed in terms of unit produced
OAR =
Budgeted overhead cost
Budgeted output (units)
 Where the standard costing system uses total absorption costing principle (i.e
where fixed and variable overhead are absorbed into production cost). The total
overhead absorbed can be sub-divided into
 Fixed overhead absorption rate (FOAR)
 Variable overhead absorption rate (VOAR)
FOAR =
Fixed overhead absorbed
Standard Hours in production
Variable overhead absorbed
VOAR =
Wh
Standard Hours in production
 Where the standard costing system uses marginal costing principle, only variable
overhead will be absorbed into production cost.
OVERHEAD COST VARIANCE
This is the difference between the standard cost of overhead absorbed based on actual
output and the actual overhead cost.
This variance occurred because the actual overhead incurred differs from the standard
overhead absorbed. The difference resulting from this is either the over or under absorbed
overheads.
Standard Hours
( based on actual at
output (boao)
where SOAR =
Standard overhead
absorption
) at Actual overhead cost
rate (SOAR)
Budgeted overhead
Budgeted Hrs or (units)
SH: BOAO =
Budgeted Hours
Budgeted production
x Actual output
OVERHEAD EXPENDITURE (BUDGET) VARIANCE
This variance is also called spending variance. It is the portion of overhead cost
variance which is due to the difference between standard allowance for the output achieved
and the actual expenditure incurred i.e it is the difference between what ought to have been
spent in the light of actual output and what was actually spent.
Budget overhead
Actual overhead
( based on actual ) - (
)
incurred
output
OR
(
Actual variable
Actual labour
)- (
) at VOAR
overhead
hours worked
Hrs (Actual operating D.L hrs worked)
N
xxx Hrs should have cost
xx
but actually cost
xx_
 CAUSES OF OVERHEAD EXPENDITURE VARIANCE
(i)
Changes in the price of indirect materials
(ii)
Changes in the quantity of indirect materials
(iii)
Changes in the grade of materials
(iv)
Changes in the grade of Labour
VARIABLE OVERHEAD EFFICIENCY VARIANCE – (SIMILAR TO D. LABOUR)
EFFICIENCY VARIANCE
This is that portion of the overhead variance which is due to the difference between
budgeted efficiency of production and the actual efficiency attained.
It arises due to the difference between the standard hours required for actual
production and the actual hours worked.
Standard hours based
Actual hours
(
)- (
) at VOAR
on actual output
worked
Units (Actual production/output
Hrs
xxx units should have taken
xxx
xxx but actually took
(xx) Actual D.L Hrs
 CAUSES OF EFFICIENCY VARIANCE
(i)
Poor working condition
(ii)
Defective materials
(iii)
Defective tools
(iv)
Variation in labour performance
(v)
Non-standard grade of labour
OVERHEAD VOLUME VARIANCE (Hrs)
It is that portion of overhead variance which is due to the difference between the
budgeted level of output and the actual level of output attained.
This variance arises when
output (in units or hours) achieved is more or less than what was specified in the budget.
The overhead volume variance represent under or over-absorption of only fixed
overhead during the budget period because variable overhead tend to increase or decrease in
proportion to the volume of output and cause no volume variance.
(Actual Hrs – standard Hrs) SOAR.
FIXED PRODUCTION OVERHEAD COST VARIANCE
Expenditure
(ESA)
Efficiency
ASB
Volume
TOTAL FIXED OVERHEAD COST VARIANCE
Is the difference between the standard cost of fixed overhead absorbed in the
production achieved, whether completed or not, and the fixed overhead attributed and
changed to that period.
Actual fixed overhead
Standard fixed overhead
(
)- (
)
cost for actual
cost for standard hours alllowed
hours worked
FIXED OVERHEAD EXPENDITURE VARIANCE (SPENDING/EXPENSE)
It is the difference between the cost which should have been incurred, assuming the
normal volume and the cost which is actually incurred i.e. this variance is equal to the
difference between budgeted (NOT standard) fixed overheads and actual fixed overheads.
(
Budgeted fixed
Actual Expenditure
)- (
)
on fixedoverheads
overhead cost
It should be realized that most of the time there will not be difference between
budgeted and actual fixed overheads since fixed overhead are managerial commitment and
unlikely to change quickly.
Units
N
xxx units actually cost
xxx
but actually cost
(xx)
xxx
FIXED OVERHEAD EFFICIENCY VARIANCE
It is the difference between actual hours taken to complete a job and standard hours
allowed to that job multiplied by the standard fixed overhead rate.
This variance represent the MISUSED
(or efficiently used)
volume or capacity
Fixed overhead
Fixed overhead
( absorbed at ) - ( absorbed at )
standard hours
actual hours
(SH-AH) SFR
OR
Actual labour
Standard Hours
hours at
produced
(
)-(
)
FOAR
at FOAR
OR
Units
Hrs
xxx units should have taken
xx
but actually took
xx
xxx
at standard Rate/unit
xx = xxx
FIXED OVERHEAD VOLUME VARIANCE
It is the difference between the standard cost absorbed in the production achieved,
whether completed or not and the budget cost allowance for a specified control period.
(
Actual units
Budgeted units
)- (
)
produced
at FOAR
OR
(
Budgeted fixed
Standard fixed
)–(
)
overhead cost
overhead cost
OR
Units
Actual
xx
Budget
xx
xx
at standard Rate/unit
__
FIXED OVERHEAD CAPACITY VARIANCE
Is that portion of the fixed production overhead volume variance which is due to
working at higher or lower capacity than standard. Capacity is usually expressed in terms of
average direct labour hours and the variance is the difference between the budget cost
allowance & the actual D.L hours worked (valued at the standard hourly absorption rate)
(
Budgeted fixed
Actual Labour Hours
)–(
)
At FOAR
overhead