Chapter 8: Standard Costing and Variance Analysis
Standard costing establishes predetermined costs for products and services, then compares them with actual costs to identify variances. This powerful control tool helps management focus on exceptions — areas where performance deviates significantly from plan. This chapter covers setting standards, calculating material, labor, and overhead variances, and interpreting results.
8.1 Standard Costing System
Standard Cost: A predetermined estimate of what a product should cost under normal, efficient operating conditions. It serves as a benchmark against which actual costs are measured.
Types of Standards
| Type | Description | Achievability | Use |
|---|---|---|---|
| Ideal | Perfect conditions, no waste, no idle time | Almost impossible | Theoretical benchmark |
| Attainable (Currently) | Challenging but achievable with efficient effort | Achievable with effort | Most commonly used for budgets |
| Basic | Set once and not changed for long periods | N/A (historical reference) | Trend analysis over time |
| Normal | Average conditions expected over a business cycle | Average performance | Long-term planning |
8.2 Material Variances
| Variance | Formula | Measures |
|---|---|---|
| Material Cost Variance (MCV) | (SQ×SP) - (AQ×AP) | Total material cost difference |
| Material Price Variance (MPV) | AQ × (SP - AP) | Difference due to price paid |
| Material Usage Variance (MUV) | SP × (SQ - AQ) | Difference due to quantity used |
Where: SQ = Standard Quantity for actual output, SP = Standard Price, AQ = Actual Quantity, AP = Actual Price
MCV = MPV + MUV
Worked Example: Material Variances
Standard: 5 kg per unit @ NPR 20/kg = NPR 100/unit
Actual: Produced 200 units. Used 1,100 kg @ NPR 22/kg
SQ = 200 × 5 = 1,000 kg
MCV = (1,000×20) - (1,100×22) = 20,000 - 24,200 = NPR 4,200 (U)
MPV = 1,100 × (20-22) = 1,100 × (-2) = NPR 2,200 (U)
MUV = 20 × (1,000-1,100) = 20 × (-100) = NPR 2,000 (U)
Check: 2,200 + 2,000 = 4,200 ✓
8.3 Labor Variances
| Variance | Formula | Measures |
|---|---|---|
| Labor Cost Variance (LCV) | (SH×SR) - (AH×AR) | Total labor cost difference |
| Labor Rate Variance (LRV) | AH × (SR - AR) | Difference due to wage rate |
| Labor Efficiency Variance (LEV) | SR × (SH - AH) | Difference due to time taken |
Where: SH = Standard Hours for actual output, SR = Standard Rate, AH = Actual Hours, AR = Actual Rate
Worked Example: Labor Variances
Standard: 3 hours per unit @ NPR 150/hour = NPR 450/unit
Actual: Produced 200 units. Worked 650 hours @ NPR 160/hour
SH = 200 × 3 = 600 hours
LCV = (600×150) - (650×160) = 90,000 - 1,04,000 = NPR 14,000 (U)
LRV = 650 × (150-160) = 650 × (-10) = NPR 6,500 (U)
LEV = 150 × (600-650) = 150 × (-50) = NPR 7,500 (U)
Check: 6,500 + 7,500 = 14,000 ✓
8.4 Overhead Variances
| Variance | Formula |
|---|---|
| Variable OH Expenditure | AH × (Standard variable OH rate - Actual variable OH rate) |
| Variable OH Efficiency | Standard variable OH rate × (SH - AH) |
| Fixed OH Budget/Expenditure | Budgeted Fixed OH - Actual Fixed OH |
| Fixed OH Volume | Standard Fixed OH rate × (Actual output - Budgeted output) |
8.5 Variance Interpretation
| Variance | Favorable (F) Means | Unfavorable (U) Means | Possible Causes |
|---|---|---|---|
| Material Price | Paid less than standard | Paid more than standard | Market price change, bulk discount, different supplier, quality difference |
| Material Usage | Used less material | Used more material | Waste, theft, inferior material, efficient/inefficient workers |
| Labor Rate | Paid lower rate | Paid higher rate | Overtime, higher grade workers, wage increase |
| Labor Efficiency | Worked fewer hours | Worked more hours | Skill level, machine breakdown, poor material quality |
8.6 Comprehensive Variance Analysis — Complete Example
Standard Cost Card per Unit of Product X:
| Element | Standard Qty/Hrs | Standard Rate | Standard Cost |
|---|---|---|---|
| Material A | 5 kg | NPR 40/kg | NPR 200 |
| Material B | 2 kg | NPR 60/kg | NPR 120 |
| Direct Labor | 3 hours | NPR 150/hr | NPR 450 |
| Variable OH | 3 hours | NPR 50/hr | NPR 150 |
| Fixed OH | 3 hours | NPR 100/hr | NPR 300 |
| Total Standard Cost | NPR 1,220 |
Budget: 1,000 units. Budgeted Fixed OH = 1,000 × 300 = NPR 3,00,000
Actual Results for 900 units produced:
| Element | Actual Qty/Hrs | Actual Rate | Actual Cost |
|---|---|---|---|
| Material A | 4,800 kg | NPR 42/kg | NPR 2,01,600 |
| Material B | 1,700 kg | NPR 58/kg | NPR 98,600 |
| Direct Labor | 2,850 hours | NPR 155/hr | NPR 4,41,750 |
| Variable OH | NPR 1,48,200 | ||
| Fixed OH | NPR 3,10,000 |
MATERIAL A VARIANCES:
SQ = 900 × 5 = 4,500 kg | AQ = 4,800 kg | SP = 40 | AP = 42
MCV = (4,500×40) - (4,800×42) = 1,80,000 - 2,01,600 = NPR 21,600 (U)
MPV = 4,800 × (40-42) = 4,800 × (-2) = NPR 9,600 (U)
MUV = 40 × (4,500-4,800) = 40 × (-300) = NPR 12,000 (U)
Check: 9,600 + 12,000 = 21,600 ✓
MATERIAL B VARIANCES:
SQ = 900 × 2 = 1,800 kg | AQ = 1,700 kg | SP = 60 | AP = 58
MCV = (1,800×60) - (1,700×58) = 1,08,000 - 98,600 = NPR 9,400 (F)
MPV = 1,700 × (60-58) = 1,700 × 2 = NPR 3,400 (F)
MUV = 60 × (1,800-1,700) = 60 × 100 = NPR 6,000 (F)
Check: 3,400 + 6,000 = 9,400 ✓
LABOR VARIANCES:
SH = 900 × 3 = 2,700 hrs | AH = 2,850 hrs | SR = 150 | AR = 155
LCV = (2,700×150) - (2,850×155) = 4,05,000 - 4,41,750 = NPR 36,750 (U)
LRV = 2,850 × (150-155) = 2,850 × (-5) = NPR 14,250 (U)
LEV = 150 × (2,700-2,850) = 150 × (-150) = NPR 22,500 (U)
Check: 14,250 + 22,500 = 36,750 ✓
VARIABLE OVERHEAD VARIANCES:
Standard VOH rate = NPR 50/hr
VOH Expenditure = AH × SR(VOH) - Actual VOH = 2,850×50 - 1,48,200 = 1,42,500 - 1,48,200 = NPR 5,700 (U)
VOH Efficiency = SR(VOH) × (SH-AH) = 50 × (2,700-2,850) = NPR 7,500 (U)
FIXED OVERHEAD VARIANCES:
FOH Budget Variance = Budgeted FOH - Actual FOH = 3,00,000 - 3,10,000 = NPR 10,000 (U)
FOH Volume Variance = SR(FOH) × (Actual output - Budgeted output) = 300 × (900-1,000) = NPR 30,000 (U)
Total FOH Variance = 10,000 + 30,000 = NPR 40,000 (U)
Variance Summary Report
| Variance | Amount (NPR) | F/U | Action Required |
|---|---|---|---|
| Material A Price | 9,600 | U | Investigate supplier price increase; seek alternatives |
| Material A Usage | 12,000 | U | Check for waste, theft, quality issues in material |
| Material B Price | 3,400 | F | Negotiate similar terms for future; check quality |
| Material B Usage | 6,000 | F | Commend production team; maintain efficiency |
| Labor Rate | 14,250 | U | Investigate: overtime? higher-grade workers used? |
| Labor Efficiency | 22,500 | U | Training needed? Machine issues? Poor material quality? |
| Variable OH Expenditure | 5,700 | U | Review overhead spending categories |
| Variable OH Efficiency | 7,500 | U | Linked to labor efficiency — same root cause |
| Fixed OH Budget | 10,000 | U | Unplanned fixed cost increases |
| Fixed OH Volume | 30,000 | U | Under-production (900 vs 1,000 planned) |
| TOTAL | 1,02,150 | U | Actual cost exceeded standard by NPR 1,02,150 |
8.7 Interrelationship Between Variances
Variances don't occur in isolation — they are often interconnected:
| If This Happens... | It May Cause... | Explanation |
|---|---|---|
| Cheaper material purchased (F price variance) | More waste (U usage variance) | Lower quality material leads to more defects and waste |
| Higher-skilled workers used (U rate variance) | Faster production (F efficiency variance) | Experienced workers complete work faster but cost more per hour |
| Poor quality material (U usage variance) | Slower labor (U efficiency variance) | Workers spend extra time dealing with defective materials |
| Machine breakdown (U efficiency) | Overtime needed (U rate variance) | Lost time compensated by overtime at premium rates |
Management Lesson: Don't evaluate variances in isolation. A purchasing manager who buys cheap material (favorable price variance) may cause unfavorable usage and labor efficiency variances that exceed the price savings. Total cost impact must be assessed.
Practice Questions
Short Answer:
1. What is standard costing? What are the types of standards?
2. List and define the material cost variances.
3. What is the difference between labor rate and labor efficiency variance?
4. What are the possible causes of unfavorable material usage variance?
5. Explain favorable and unfavorable variances.
Long Answer:
6. Standard: Material 4 kg @ NPR 25/kg, Labor 2 hrs @ NPR 200/hr. Actual for 500 units: Material 2,200 kg @ NPR 27, Labor 1,050 hrs @ NPR 190. Calculate all material and labor variances. (15 marks)
7. Explain the standard costing system. What are the advantages and limitations of standard costing for a Nepali manufacturing company? (15 marks)
8. A company's standard cost card shows: Material 3 kg @ NPR 50, Labor 4 hrs @ NPR 100. Production: 1,000 units. Actual: Material 3,200 kg @ NPR 48, Labor 4,100 hrs @ NPR 105. Calculate all variances and interpret each. (15 marks)
9. Discuss the interrelationship between material price and usage variances. Can a favorable price variance cause an unfavorable usage variance? (15 marks)
10. Explain overhead variances (variable and fixed) with a comprehensive numerical example. (15 marks)
Exam Tips: ✓ Variance calculations are ALWAYS asked — practice extensively ✓ Always verify: Cost Variance = Price Variance + Quantity Variance ✓ Label all variances as (F) or (U) ✓ Show standard quantity for ACTUAL output (not budgeted output) ✓ Discuss possible causes alongside calculations for full marks