Standard costing and Variance
Meaning of Standard Costing
It is a method of costing by
which standard costs are employed. According to ICMA, London, Standard Costing
is “the preparation and use of standard costs, their comparison with actual
cost and the analysis of variances to their causes and points of incidence”.
According to Wheldon, it is a
method of ascertaining the costs whereby statistics are prepared to show:
(i) The standard cost;
(ii) The actual cost;
(iii) The difference between
these costs which is termed the variance.
But W. Bigg expresses:
“Standard Costing discloses the
cost of deviations from standards and clarifies these as to their causes, so
that management is immediately informed of the sphere of operations in which
remedial action is necessary.”
Thus, from the above, it
becomes clear that Standard Costing involves:
(i) Ascertainment and use of
Standard Costs;
(ii) Recording the actual
costs;
(iii) Comparison of actual
costs with standard costs in order to find out the variance;
(iv) Analysis of variance; and
(v) After analysing the
variance, appropriate action may be taken where necessary.
Objectives of Standard Costing:
The objectives of Standard
Costing for which it is implemented are:
(a) It helps to implement
budgetary control system in operation;
(B) IT HELPS TO ASCERTAIN
PERFORMANCE EVALUATION.
(c) It supplies the ways to
utilise properly material, labour and also overhead which will be economic in
character.
(d) It also helps to motivate
the employees of a firm to improve their performance by setting up a ‘standard’.
(e) It also helps the
management to supply necessary data relating to cost element to submit
quotations or to fix up the selling price of a firm.
(f) It also helps the
management to make proper valuations of inventory (viz., Work-in- progress, and
finished products).
(g) It acts as a control device
to the management.
(h) It also helps the
management to take various corrective decisions viz., fixation of price,
make-or-buy decisions etc. which will be more beneficial to the firm.
Development of Standard Costing:
Importance of Standard Costing
cannot be ignored for the following and that is why the same is well-developed
in the present-day world:
(i) Compilation of Historical
Cost is very expensive and difficult:
A manufacturing firm making
large number of parts requires too much clerical work which is required in
order to compile the materials, labour and overhead charges to each and every
cost of parts produced for ascertaining the average cost of the product.
(ii) Historical Costs are
inadequate:
In order to measure the
manufacturing efficiency, historical costs are not practically adequate. It
fails to explain the reasons of increased cost or any change in cost structure.
(iii) Historical Costs are too
old:
In many firms, costs are
determined and selling prices are ascertained even before the production
starts—which is not desirable.
(iv) Historical Costs are not
typical:
This is due to the wide
fluctuation in market for which there is no relation between the selling price
per unit and cost price per unit.
Advantages of Standard Costing:
The following advantages may be
derived from Standard Costing:
(i) Standard Costing serves as
a guide to the management in several management functions while formulating
prices and production policies etc.
(ii) More effective cost
control is possible under standard costing if the same is reviewed and analysed
at regular intervals for improvements and immediate action can be taken if
deviations from standards are found out which, ultimately, leads to cost
reduction.
(iii) Analysis of variance and
its measurement helps to detect inefficiencies and mistakes which enable the
management to investigate the reasons.
(iv) Since standard costs are
predetermined costs they are very useful for planning and budgeting. It also
helps to estimate the effect of changes in Cost-Price-Volume relationship which
also helps the management for decision-making in future.
(v) As standard is fixed for
each product, its components, materials, process operation etc. it improves the
overall production efficiency which also ultimately reduces cost and thereby
increases profit.
(vi) Once the Standard Costing
System is implemented it will lead to saving cost since most of the costing
work can be eliminated.
(vii) Delegation of authority
and responsibility becomes effective by setting up standards for each cost
centre as the supervisors or executives of each cost centre will know the
standard which they have to maintain.
(viii) This system also helps
to prepare Profit and Loss Account promptly for short period in order to know
the trend of the business which helps the management to take decisions
promptly.
(ix) Standard costing also is
used for inventory valuation purposes. Stock can be valued at standard cost
which can reduce the fluctuation of profit for different methods of valuation
for the same.
(x) Efficiency of labour is
promoted.
(xi) This system creates
cost-consciousness among all employees, executives and top management which
increase efficiency and productivity as well.
Disadvantages of Standard Costing:
The alleged disadvantages of
Standard Costing are:
(i) Since Standard Costing
involves high degree of technical skill, it is, therefore, costly. As such,
small organisations cannot, introduce the system due to their limited financial
resources. But, once introduced, the benefits achieved will be far in excess to
its initial high costs.
(ii) The executives are liable
for those variances that are found from actions which are actually controllable
by them. Thus, in order to fix up the responsibilities, it becomes necessary to
segregate variances into non-controllable and controllable portions although
that is not an easy task.
(iii) Standards are always
changing since conditions of the business are equally changing. So, standards
are to be revised in order to make them comparable with actual results. But
revision of standards creates many problems, particularly in inventory
adjustment.
(iv) Standards are either too liberal or rigid since the same are
based on average past results, attainable good performance or theoretical
maximum efficiency. So, if the standards are very high, it will adversely
affect the morale and motivation of the employees.
Variance Analysis: Material
& Labour Variances!
The function of standards in cost accounting
is to reveal variances between standard costs which are allowed and actual
costs which have been recorded. The Chartered Institute of Management
Accountants defines variances as the difference between a standard cost
and the comparable actual cost incurred during a period. Variance analysis can
be defined as the process of computing the amount of, and isolating the cause
of variances between actual costs and standard costs. Standard costs
provide information that is useful in performance evaluation. Standard costs
are compared to actual costs, and mathematical deviations between the two are
termed variances. Favorable variances result when actual costs are less than
standard costs, and vice versa. The following illustration is intended to
demonstrate the very basic relationship between actual cost and standard cost.
AQ means the “actual quantity” of input used to produce the output. AP means
the “actual price” of the input used to produce the output. SQ and SP refer to
the “standard” quantity and price that was anticipated. Variance analysis can
be conducted for material, labor, and overhead.
Variance analysis, also
described as analysis of variance or ANOVA, involves assessing the difference
between two figures. It is a tool applied to financial and operational data
that aims to identify and determine the cause of the variance. In applied
statistics, there are different forms of variance analysis. In project management,
variance analysis helps maintain control over a project's expenses by
monitoring planned versus actual costs. Effective variance analysis can help a
company spot trends, issues, opportunities and threats to short-term or
long-term success.
Budget vs. Actual Costs
Variance analysis is
important to assist with managing budgets by controlling budgeted versus actual
costs. In program and project management, for example, financial data are
generally assessed at key intervals or milestones. For instance, a monthly
closing report might provide quantitative data about expenses, revenue and
remaining inventory levels. Variances between planned and actual costs might
lead to adjusting business goals, objectives or strategies.
Materiality
A materiality threshold
is the level of statistical variance deemed meaningful, or worth noting. This
will vary from company to company. For example, a sales target variance of
$100,000 will be more material to a small business retailer than to a national
retailer accustomed to generating billions in annual revenues. Conversely, a 2
percent cost overrun might be immaterial for a small business but translate
into millions of dollars for a large company.
Relationships
Relationships between
pairs of variables might also be identified when performing variance analysis.
Positive and negative correlations are important in business planning. As an
example, variance analysis might reveal that when sales for widget A rise there
is a correlated rise in the sales for widget B. Improved safety features for
one product might result in sales increases. This information might be used to
transfer this success to other similar products.
Forecasting
An important type of
prediction is business forecasting. It uses patterns of past business data to
construct a theory about future performance. Variance data are placed into
context that allows an analyst to identify factors such as holidays or seasonal
changes as the root cause of positive or negative variances. For example, the
monthly pattern of sales of television sets over five years might identify a
positive sales trend leading up to the beginning of the school year. As a
result, forecasts for television sales over the next 12 months might include
increasing inventory by a certain percentage — based on historical sales
patterns — in the weeks before the start of local universities' fall term.
Variance analysis involves two phases:
(1) Computation of individual variances, and
(2) Determination of Cause (s) of each
variance.
I.
Material Variance:
The following variances constitute materials variances:
Material Cost Variance:
Material cost variance is the difference
between the actual cost of direct material used and standard cost of direct
materials specified for the output achieved. This variance results from
differences between quantities consumed and quantities of materials allowed for
production and from differences between prices paid and prices predetermined.
This can be computed by using the following formula:
Material cost variance = (AQ X AP) – (SQ X
SP)
Where AQ = Actual quantity
AP = Actual price
SQ = Standard quantity for the actual
output
SP = Standard price
The material quantity or usage variance
results when actual quantities of raw materials used in production differ from
standard quantities that should have been used to produce the output achieved.
It is that portion of the direct materials cost variance which is due to the
difference between the actual quantity used and standard quantity specified.
As a formula, this variance is shown as:
Materials quantity variance = (Actual
Quantity – Standard Quantity) x Standard Price
A material usage variance is favourable when the
total actual quantity of direct materials used is less than the total standard
quantity allowed for the actual output.
Compute the materials usage variance from the following
information:
Standard material cost per
unit Materials issued
Material A — 2 pieces @ Rs. 10=20 (Material A
2,050 pieces)
Material B — 3 pieces @ Rs. 20 =60 (Material
B 2,980 pieces)
Total =
80
Units completed 1,000
Material usage variance = (Actual Quantity –
Standard Quantity) x Standard Price
Material A = (2,050 – 2,000) x Rs. 10 = Rs.
500 (unfavourable)
Material B = (2980 – 3000) x Rs. 20 = Rs. 400
(favourable)
Total = Rs. 100 (unfavourable)
It should be noted that the standard rather
than the actual price is used in computing the usage variance. Use of an actual
price would have introduced a price factor into a quantity variance. Because
different departments are responsible, these two factors must be kept separate.
(a) Material Mix Variance:
The materials usage or quantity variance can
be separated into mix variance and yield variance.
For certain products and processing
operations, material mix is an important operating variable, specific grades of
materials and quantity are determined before production begins. A mix variance
will result when materials are not actually placed into production in the same
ratio as the standard formula. For instance, if a product is produced by adding
100 kg of raw material A and 200 kg of raw material B, the standard material
mix ratio is 1: 2.
Actual raw materials used must be in this 1:
2 ratio, otherwise a materials mix variance will be found. Material mix
variance is usually found in industries, such as textiles, rubber and
chemicals, etc. A mix variance may arise because of attempts to achieve cost
savings, effective resources utilisation and when the needed raw materials
quantities may not be available at the required time.
Materials mix variance is that portion of the
materials quantity variance which is due to the difference between the actual
composition of a mixture and the standard mixture.
It can be computed by using the following
formula:
Material mix variance = (Standard cost of
actual quantity of the actual mixture – Standard cost of actual quantity of the
standard mixture)
Or
Materials mix variance = (Actual mix –
Revised standard mix of actual input) x Standard price
Revised standard mix or proportion is
calculated as follows:
Standard mix of a particular material/Total
standard quantity x Actual input
Example:
A product is made from two raw materials,
material A and material B. One unit of finished product requires 10 kg of
material.
The following is standard mix:
During a period one unit of product was produced
at the following costs:
Compute the materials mix variance.
Solution:
Material mix variance = (Actual proportion –
Revised standard proportion of actual input) x Standard price.
(b) Materials Yield Variance:
Materials yield variance explains the
remaining portion of the total materials quantity variance. It is that portion
of materials usage variance which is due to the difference between the actual
yield obtained and standard yield specified (in terms of actual inputs). In
other words, yield variance occurs when the output of the final product does
not correspond with the output that could have been obtained by using the
actual inputs. In some industries like sugar, chemicals, steel, etc. actual
yield may differ from expected yield based on actual input resulting into yield
variance.
The total of materials mix variance and
materials yield variance equals materials quantity or usage variance. When
there is no materials mix variance, the materials yield variance equals the
total materials quantity variance. Accordingly, mix and yield variances explain
distinct parts of the total materials usage variance and are additive.
The formula for computing yield variance is as
follows:
Yield Variance = (Actual yield – Standard
Yield specified) x Standard cost per unit
Example:
Standard input = 100 kg, standard yield = 90
kg, standard cost per kg of output = Rs 200
Actual input 200 kg, actual yield 182 kg.
Compute the yield variance.
In this example, there is no mix variance and
therefore, the materials usage variance will be equal to the materials yield
variance.
The above formula uses output or loss as the
basis of computing the yield variance. Yield variance can also be computed on
the basis of input factors only. The fact is that loss in inputs equals loss in
output. A lower yield simply means that a higher quantity of inputs have been
used and the anticipated or standard output (based on actual inputs) has not
been achieved.
Yield, in such a case, is known as sub-usage
variance (or revised usage variance) which can be computed by using the
following formula:
Sub-usage or revised usage variance =
(Revised Standard Proportion of Actual Input – Standard quantity) x Standard
Cost per unit of input
Example:
Standard material and standard price for
manufacturing one unit of a product is given below:
Materials yield variance always equal
sub-usage variance. The difference lies only in terms of calculation. The
former considers the output or loss in output and the latter considers standard
inputs and actual input used for the actual output. Mix and yield variance both
provide useful information for production control, performance evaluation and
review of operating efficiency.
Materials Price Variance:
A materials price variance occurs when raw
materials are purchased at a price different from standard price. It is that
portion of the direct materials which is due to the difference between actual
price paid and standard price specified and cost variance multiplied by the
actual quantity. Expressed as a formula,
Materials price variance = (Actual price –
Standard price) x Actual quantity
Materials price variance is un-favourable
when the actual price paid exceeds the predetermined standard price. It is
advisable that materials price variance should be calculated for materials
purchased rather than materials used. Purchase of materials is an earlier event
than the use of materials.
Therefore, a variance based on quantity
purchased is basically an earlier report than a variance based on quantity
actually used. This is quite beneficial from the viewpoint of performance
measurement and corrective action. An early report will help the management in
measuring the performance so that poor performance can be corrected or good
performance can be expanded at an early date.
Recognizing material price variances at the
time of purchase lets the firm carry all units of the same materials at one price—the
standard cost of the material, even if the firm did not purchase all units of
the materials at the same price. Using one price for the same materials
facilities management control and simplifies accounting work.
If a direct materials price variance is not
recorded until the materials are issued to production, the direct materials are
carried on the books at their actual purchase prices. Deviations of actual
purchase prices from the standard price may not be known until the direct
materials are issued to production.
Example:
Assuming in Example 1 that material A was
purchased at the rate of Rs 10 and material B was purchased at the rate of Rs
21, the material price variance will be as follows:
Materials price variance = (Actual Price –
Standard Price) x Actual Quantity
Material A = (10 – 10) x 2,050 = Zero
Material B = (21 – 20) x 2,980 = 2980
(un-favourable)
Total material price variance = Rs 2980
(un-favourable)
The total of materials usage variance and
price variance is equal to materials cost variance.
|
Causes of material variances
|
||
|
Variance
|
Favourable
|
Adverse
|
|
Material Price
|
|
|
|
Material Usage
|
|
|
Note: The
material price variance and the material usage variance may be linked. For
example, the purchase of poorer quality materials may result in a favourable
price variance but an adverse usage variance.
Materials variances
Calculation
|
Causes of material variances
|
||
|
Variance
|
Favourable
|
Adverse
|
|
Material Price
|
|
|
|
Material Usage
|
|
|
Note: The
material price variance and the material usage variance may be linked. For
example, the purchase of poorer quality materials may result in a favourable
price variance but an adverse usage variance.
Material waste
Material waste may be a normal part of a process and
could be caused by:
- evaporation
- scrapping
- testing
Waste would affect the material usage variance. Expected
waste can be built into the standards used, so only excessive
("abnormal") waste would contribute towards the usage variance.
II.
Labour Variances:
Direct labour variances arise when actual
labour costs are different from standard labour costs. In analysis of labour
costs, the emphasis is on labour rates and labour hours.
Labour variances constitute the following:
Labour Cost
Variance:
Labour cost variance denotes the difference
between the actual direct wages paid and the standard direct wages specified
for the output achieved.
This variance is calculated by using the
following formula:
Labour cost variance = (AH x AR) – (SH x SR)
Where:
AH = Actual hours
AR = Actual rate
SH = Standard hours
SR = Standard rate
1. Labour Efficiency Variance:
The calculation of labour efficiency or usage
variance follows the same pattern as the computation of materials usage
variance. Labour efficiency variance occurs when labour operations are more
efficient or less efficient than standard performance. If actual direct labour
hours required to complete a job differ from the number of standard hours
specified, a labour efficiency variance results; it is the difference between
actual hours expended and standard labour hours specified multiplied by the
standard labour rate per hour.
Labour efficiency variance is computed by
applying the following formula:
Labour efficiency variance = (Actual hours –
Standard hours for the actual output) x Std. rate per hour.
Assume the following data:
Standard labour hour per unit = 5 hr
Standard labour rate per hour = Rs 30
Units completed = 1,000
Labour cost recorded = 5,050 hrs @ Rs 35
Labour efficiency variance = (5,050-5,000) x
Rs 30 = Rs 1,500 (unfavourable) It may be noted that the standard labour hour
rate and not the actual rate is used in computing labour efficiency variance.
If quantity variances are calculated, changes in prices/rates are excluded, and
when price variances are calculated, standard quantities are ignored.
(i) Labour Mix Variance:
Labour mix variance is computed in the same
manner as materials mix variance. Manufacturing or completing a job requires
different types or grades of workers and production will be complete if labour
is mixed according to standard proportion. Standard labour mix may not be adhered
to under some circumstances and substitution will have to be made. There may be
changes in the wage rates of some workers; there may be a need to use more
skilled or expensive types of labour, e.g., employment of men instead of
women; sometimes workers and operators may be absent.
These lead to the emergence of a labour mix
variance which is calculated by using the following formula:
Labour mix variance = (Actual labour mix –
Revised standard labour mix in terms of actual total hours) x Standard rate per
hour
To take an example, suppose the following were
the standard labour cost data per unit in a factory:
In a period, many class B workers were absent
and it was necessary to substitute class B workers. Since the class A workers
were less experienced with the job, more labour hours were used.
The recorded costs of a unit were:
Labour mix variance will be calculated as
follows:
Labour mix variance = (Actual proportion –
Revised standard proportion of actual total hours) x standard rate per hour
Revised standard proportion:
(ii) Labour Yield Variance:
The final product cost contains not only
material cost but also labour cost. Therefore, gain or loss (higher or lower
output than the standard output) should take into account labour yield variance
also. A lower output simply means that final output does not correspond with
the production units that should have been produced from the hours expended on
the inputs.
It can be computed by applying the following
formula:
Labour yield variance = (Actual output –
Standard output based on actual hours) x Av. Std. Labour Rate per unit of
output.
Or
Labour yield variance = (Actual loss –
Standard loss on actual hours) x Average standard labour rate per unit of
output
Labour yield variance is also known as labour
efficiency sub-variance which is computed in terms of inputs, i.e., standard
labour hours and revised labour hours mix (in terms of actual hours).
Labour efficiency sub-variance is computed by
using the following formula:
Labour efficiency sub-variance = (Revised
standard mix – standard mix) x Standard rate
2. Labour Rate Variance:
Labour rate variance is computed in the same
manner as materials price variance. When actual direct labour hour rates differ
from standard rates, the result is a labour rate variance. It is that portion
of the direct wages variance which is due to the difference between actual rate
paid and standard rate of pay specified.
The formula for its calculation is:
Labour rate variance = (Actual rate –
Standard rate) x Actual hours
Using data from the example given above, the
labour rate variance is Rs 25,250, i.e.,
Labour rate variance = (35 – 30) x 5050 hours
= 5 x 5050 = Rs 25,250 (unfavourable)
The number of actual hours worked is used in
place of the number of the standard hours specified because the objective is
to know the cost difference due to change in labour hour rates, and not hours
worked. Favourable rate variances arise whenever actual rates are less than
standard rates; unfavourable variances occur when actual rates exceed standard
rates.
3. Idle Time Variance:
Idle time variance occurs when workers are
not able to do the work due to some reason during the hours for which they are
paid. Idle time can be divided according to causes responsible for creating
idle time, e.g., idle time due to breakdown, lack of materials or power
failures. Idle time variance will be equivalent to the standard labour cost of
the hours during which no work has been done but for which workers have been
paid for unproductive time.
Suppose, in a factory 2,000 workers were idle
because of a power failure. As a result of this, a loss of production of 4,000
units of product A and 8,000 units of product B occurred. Each employee was
paid his normal wage (a rate of? 20 per hour). A single standard hour is needed
to manufacture four units of product A and eight units of product B.
Idle time variance will be computed in the
following manner:
Standard hours lost:
Product A = 4, 000/ 4 = 1,000 hr.
Product B = 8, 000 / 8 = 1,000 hr.
Total hours lost = 2,000 hr.
Idle time variance (power failure)
2,000 hours @ Rs 20 per hour = Rs 40,000
(Adverse)
Labour variances
Calculation
|
Causes of labour variances
|
||
|
Variance
|
Favourable
|
Adverse
|
|
Labour rate
|
|
|
|
Labour efficiency
|
|
|
Note: The
labour rate variance and the labour efficiency variance may be linked. For
example, employing more highly skilled labour may result in an adverse rate
variance but a favourable efficiency variance.
Idle time
Idle time occurs when employees are paid for time when
they are not working e.g. due to machine breakdown, low demand or
stockouts.
If idle time exists an idle time labour variance should
be calculated.
Controlling Idle time
Idle time can be prevented or reduced considerably by :
1. Proper maintenance of tools & machinery
2. Advanced production planning
3. Timely procurement of stores
4. Assurance of supply of power
5. Advance planning for machine utilisation
A consideration of labour variances can be extended
to incorporate labour ratios as well
Comments
Post a Comment