STANDARD COSTING AND BASIC VARIANCES

✓ Standard costing is a control technique which compares standard cost and revenues with actual results
to obtain variances which are used stimulate improved performance.
✓ A standard cost is an estimated unit cost.
✓ Standard costing is principally used to value inventories and cost production and to act as a control
device.
✓ Standards costing involve the establishment of predetermined estimates of the cost of products or services,
the collection of actual cost and the comparison of the actual cost with the predetermined estimates. The
predetermined costs are known as standard cost and the difference between standard and actual cost is
known as a variance.
The process by which the total difference between standard and actual result is analyzed is known as variance
analysis.
The main purpose of standard costing
1. To value inventories and cost production for cost accounting purposes. It is an alternative method of
valuation to methods like FIFO and LIFO.
2. To act as a control device by establishing standards (expected costs) and comparing actual costs with the
expected costs, thus highlighting areas of organization which may be out of control.
3. To enable the principle of management by exception to be practiced (establish average expected unit cost).
4. To provide a prediction of future costs to be used in decision- making situations.
5. To motivate staff and management by the provision of challenging targets.
6. To provide guidance on possible ways of improving efficiency.
Advantages of standard costing systems
1. Carefully planned standards are an aid to more accurate budgeting.
2. Standards costs provide a yardstick against which actual cost can be measured.
3. The setting of standards involves determining the best materials and methods which may lead to
economics.
4. A target of efficiency is set for employees to reach and cost-consciousness is stimulated.
5. Variance can be calculated which enable the principle of management by exception to be operated.
6. Standard costs and variance analysis can provide a way of motivation to managers to achieve better
performance.
However, care must be taken to distinguish between controllable and non-controllable costs in variance reporting.
Preparing standard costs.
A standard cost is based on technical specifications for the materials, labour time and other resources required and
the prices and the rates for the materials and labour.
Example
X Ltd makes two products. Information regarding one of those products is given below:
Budgeted output for the year: 900 units
Standard details for one unit:
Direct materials: 40 square meters at Ksh 5.30 per square meter
Direct wages: Bonding department: 24 hours at Ksh 5.00 per hour
Finishing department 15 hours at Ksh 4.80 per hour
Budgeted costs and hours pa:
Ksh Hours
Variable overhead:
Bonding department 45,000 30,000
Finishing department 25,000 25,000
Fixed overhead apportioned to this product:
Production 36,000
Selling, distribution and administration 27,000
a) Prepare a standard cost card for one unit and enter on the standard cost card the following subtotals:
i. Prime cost
ii. Variable production cost
 iii. Total production cost
iv. Total cost
b) Calculate the selling price per unit allowing for a profit of 25% of the selling price.
Calculate the resulting contribution per unit and the profit per unit before non-production overheads.
Solution Ksh
a) Direct materials (40x Ksh 5.30) 212
Direct labour:
Bonding (24 hours x Ksh 5.00) 120
Finishing (15 hours x Ksh 4.80) 72
Prime cost 404
Variable overhead:
Bonding (24 hours at Ksh 1.50 per hour) 36
Finishing (15 hours at Ksh 1 per hour) 15
Variable production cost 455
Production overhead 40
Total costs 495
Non-production overheads 30
Total cost 525
b) Profit (25/75 x 525) 175
Price
Contribution per unit = Ksh (700- 455) = Ksh 245
Profit per unit before non-production overheads = Ksh (700- 495)
= Ksh 205
Working notes:
45,000/30,000 = Ksh 1.50 25,000/25,000 = Ksh 1.00
36,000/900 = Ksh 40 27,000/900 = Ksh 30

Types of standards
There are four types of standard and they have an impact on employee’s motivation.
1. An ideal standard
Is a standard which can be attained under perfect conditions, no wastage, no inefficiencies, no idle time,
and no breakdowns?
2. An attainable standard
Is a standard which can be attained if production is carried out efficiently, machines are properly
operated/or materials are properly used. Some allowances is made for wastage and inefficiencies.
3. A current standard
Is standard based on current working conditions (current wastage, current inefficiencies)
4. A basic standard.
Is a long-term standard which remains unchanged over the years and is used to show trends?
Idle time and waste
Idle time
A workforce that is expected to work at a particular level of efficiency may not always be able to achieve this.
Idle time may be caused by machine breakdowns or not having enough work to give to employees, perhaps
because of bottlenecks in production or a shortage of orders for customers.
Can be built into an attainable labour hour into labour budget hours.
Wastage
The amount of raw material used to meet the budgeted production level might be less than the amount of raw
material contained in the finished products for a number of reasons:
✓ Evaporation
✓ Spillage
✓ Natural wastage (such as the skin of fruit used to make fruit juice)
 Can built into attainable material standard and adjustment can be made to materials budgets. If the wastage
occurs before production commences, the materials purchases budget must be adjusted. If the wastage
occurs during production, the materials usage budget must be adjusted.

Example
A machine has running cost of Ksh 60 per hour and typically incurs 5% non-productive time. To get 60 minutes
of outputs (a standard hour) would take 60 ÷ (100-5) % = 63.16 minutes. The standard cost of production or cost
of idle time is therefore Ksh 63.16 per hour.
Illustration
A business requires 15,400 units of production in a period and each unit uses 5 kg of raw materials. The
production process has a normal loss of 10% during the production process. What is the total amount of the raw
material required for the period?
Solution Kg
Kg required for production 5 x 15400 77,000
Additional for normal loss 77000 x 10/90 8,556
Required usage 15400 x 5 x 100/90 85,556

Standard costs and the flexing of budget

Standard cost may be used to help prepare budgets. The budgets are based on a given level of output. If actual
output a flexed budget can be prepared this provides a more meaningful estimate of expected costs than the
original fixed budget.
Fixed costs do not change when output level change.
Controllable and non-controllable costs
A cost is controllable if managers is responsible for it being incurred or is able to authorize the expenditure.
Managers may become demotivated if they are made responsible for non-controllable costs
Factors which should be taken into consideration:
1. Over a long enough time span most costs are controllable at some management level.
2. Some costs are unavoidable.
3. Some costs may have joint responsibility.
Basic variance analysis
Materials variances
Standard cost > Actual cost = Positive (+) or Favorable or Credit
Standard cost < Actual cost = Negative (-) or Adverse or Unfavorable or debit
MCV = SC – AC = (SQ x SP) – (AQ x AP)
MCV or MTV = Material Cost Variance or Material Total Variance SQ = Standard Quantity SP = Standard Price
AP = Actual Price
Material Usage Variance (MUV) = SP x SQ – SP x AQ or SP (SQ – AQ)
Material Price Variance (MPV) = AQ (SP –AP) or AQP (SP-AP) AQP = Actual Quantity of Material Purchased.
Material Mix Variance (MMV) = SP (SQ-AQ) or SP (RSQ-AQ) RSQ = Revised Standard Quantity
Material Yield Variance (MYV) = SYR (AY-SY)
MTV = MPV + MUV MUV = MMV + MYV
Possible reasons for price variance
1. Wrong budgeting
2. Higher/lower quantity of material used
3. Careful/careless purchasing
4. Losing/gaining bulk discounts by buying smaller/larger quantities.
5. Change of supplier
Possible reasons for usage variance
1. Wrong budgeting
2. Higher/lower quality of materials used
3. Higher/lower grade of worker
4. Sticker quality control
 5. Theft
6. Change in product specification.
Labour variances
Labour Cost Variance (LCV) = SH x SR – AH x AR or SC –AC where SH = Standard Hour SR = Standard Rate
AR = Actual Rate AH = Actual Hours (including idle time if any)
Labour Rate Variance (LRV) = AH (SR – AR)
Labour Efficiency Variance (LEV) = SR (SH-AH) AH= Actual hours paid less idle hours paid.
Idle Time Variance (ITV) = IH x SR IH =Idle Hours
Labour Mix Variance (LMV) = SR (RSH-AH) AH = Actual Hours after deducting idle time.
Labour Yield Variance (LYV) = SYRL (AY-SY) SYRL = Standard Labour cost per unit of finished goods
Possible reasons for rate variances:
1. Wrong budgeting
2. Higher rate being paid due to wage award
3. Higher/lower grade of worker
4. Payment of unplanned overtime or bonus.
Possible reasons for efficiency variance:
1. Wrong budgeting
2. Higher/lower grade of worker
3. Higher/lower grade material to work with
4. More or less efficiency working through motivation.
Overhead variances
Overhead cost can be classified as:
Variable overhead variance and fixed overhead variance
Total overhead variance = Actual output x St. Rate – Actual overhead cost
Variable overhead variance
Total variable overhead variance = Actual output x St. Rate per unit – Actual overhead
Variable overhead variance = Actual output x St. Variable overhead rate – Actual variable overheads
Or Standard hours for actual output x St. Variable overhead rate per hour – Actual variable overheads
Variable overhead expenditure variance = Actual output x St. Variable overhead rate –Actual overheads
Variable overhead efficiency variance = St. Time for actual production x St. Variable overhead rate per hour –
Actual hours worked x St. Variable overhead rate per hour
Possible reasons for expenditure variance:
1. Wrong budgeting
2. Overheads consist of a number of items, such as: indirect materials, indirect labor, maintenance costs,
power etc.
Possible reasons for efficiency variance
1. Wrong budgeting
2. Higher/lower grade of worker
3. Higher/lower grade of material to work with
More or less efficient working through motivation
Fixed overhead variance
The total fixed production overhead variance may be broken down into two parts:
An expenditure and volume variances, the volume may in turn be split into an efficiency variance, capacity
variance and calendar variance.
Fixed overhead variable = Actual output x St. fixed overhead rate – Actual fixed overheads or Standard hours
produced x St. fixed overhead rate per hour – Actual fixed overheads.
Expenditure or Budget or Spending variance = Budget fixed overhead – Actual fixed overheads
Volume variance = Actual output x St. Rate budgeted fixed overheads or St. Rate (Actual output – Budgeted
output) or St. Rate per hour (standard hours produced – Budgeted hours)
Capacity variance = St. Rate (Revised budgeted units – Budgeted units) or St. rate (Revised budgeted hours –
Budgeted units).
Calendar variance = Increase or decrease in production due to more or less working days at the rate of budgeted
capacity x St. rate per unit.
Efficiency variance = Standard rate (Actual production in units – Standard production in units) or St. Rate hour
(standard hours produced – Actual hours).
Total Overhead Cost Volume = FOV +VOV
Fixed Overhead Variance = Volume Variance + Expenditure Variance
Volume Variance = Capacity Variance + Calendar Variance + Efficiency Variance
Causes of variances:
Fixed overhead expenditure variance:
✓ Changes in price relating to fixed overhead items
✓ Seasonal effect.
Fixed overhead volume variance:
✓ Changes in production volume due to change in demand or alteration to stockholding policy.
✓ Changes in productivity of labour or machinery.
✓ Production lost through strikes, etc
Fixed overhead capacity variance:
✓ Hours worked different from original budget
✓ Changes in production volume
✓ Change in productivity
✓ Strikes overtime.
Fixed overhead efficiency variance:
Same as for labour and/or variable overhead efficiency
Sales variances
The selling price variance is the difference between what revenue should have been for the quantity sold and the
actual revenue.
The sales volume variance is the difference between the actual and budgeted sales volumes, valued at standard
profit or contribution margin per unit.
“Margin” = contribution (marginal costing) or profit (absorption costing) per unit.
Sales variance = (Budgeted sales volume – Actual sales volume) x Contribution margin per unit or standard profit.
Causes of Sales variances
1. Higher or lower discounts than expected offered to customers
2. A greater or lesser proportion of higher priced products sold than expected.
3. More or less price competition from competitors.
Sales volume variance may be caused by:
1. Changes in customer’ buying habits.
2. Successful or unsuccessful marketing campaigns.
3. Higher demand as a result of price cuts or vice versa.

Operating statement under absorption costing

The purpose of calculating variances is to identify the different effects of each item of cost/income on profit
compared to the expected profit. These variances are summarized in a reconciliation statement or operating
statement
An operating statement/ statement of variances is a report, usually to senior management at the end of a control
period, reconciling budgeted profit for the period to actual profits.
Operating statement is a regular report for management of actual costs and revenues, as appropriate. Usually
compares actual with budgeted and shows the variances.
Investigating the cause of a variance
Variances may arise because of:
1. Poor budgeting
2. Poor recording of cost
3. Operational reasons
Factors that need to be considered when investigating variances are:
1. The size of the variance
2. Whether favorable/adverse – firms often treat adverse variance as more important than favorable
3. Correction costs versus benefits
4. Ability to correct
5. Past pattern
6. Budget reliability
7. Reliability of measurement/recording systems.

Example
K Ltd manufactures one product and the entire product is sold as soon as it is produced. There is no opening or
closing inventories and work in progress is negligible. The standard cost card for the product is as follows:
STANDARD COST CARD
Ksh
Direct Materials 0.5 kilos at Ksh 4.00 per kilo 2.00
Direct Wages 2 hours at Ksh 2.00 per hour 4.00
Variable Overhead 2 hours at Ksh 0.30 per hour 0.60
Fixed Overhead 2 hours at Ksh 3.70 per hour 7.40
Standard Cost 14.00
Standard profit 6.00
Standard selling price 20.00
Selling and administration expenses are not included in the standard cost, and are deducted from profit as a period
charge. Budgeted output for the month of June 2017 was 5,100units. Actual results for June year 7 were as
follows:
Production of 4,850 units was sold for Ksh 95,600 materials consumed in production amounted to 2,300 kg at a
total cost of Ksh 9,800. Labour hours paid for amounted to 8,500 hours at a cost of Ksh 16,800.
Actual operating hours amounted to 8,000 hours. Variable overhead amounted to Ksh 2,600. Fixed overhead
amounted to Ksh 42,300. Selling and administration expenses amounted to Ksh 18,000.
Required:
Calculate all variances and prepare an operating statement for the month ended 30th June 2017.
Solution
a) MPV = AQ (SP-AP) = 2,300(4 – 4.260869565) = 600(A) 9800/2300 = 4.260869565
b) MUV = SP (SQ –AQ) = 4(2425- 2300) = 500(F) 4850/0.5 = 2425
c) LRV = AH (SR – AR) = 8,500 (2 – 1.976470588) = 200(F) 16800/8500 = 1.976470588
d) LEV= SR (SH – AH) = 2(9700 – 8000) = 3400(F) 4850 x 2 = 9700 HRS
e) ITV = (SR x IH) = 2 x 500 = 1000(A)
f) Variable overhead expenditure variance = 4850 x 0.536082474 – 2400 = 2600 – 2400 = 200(A) 2600/4850
= 0.536082474 8000 x 0.3 = 2400
g) Variable overhead efficiency variance, the same as labour efficiency variance = SR (SH – AH) = 0.3 (9700
– 8000) = 510(A)
h) Fixed overhead expenditure variance = Budget fixed overhead – Actual fixed overheads
5100 x 2 x 3.70 – 42300 = 4560(A)
i) Fixed overhead volume variance = St. Rate (Actual output – Budgeted output)
= 4850 x (3.70 x 2) – 5100 x 3.70 x 2 = 1850(A)
j) Fixed overhead efficiency variance = Standard rate (Actual production in units – Standard production in
units) = 1700hrs (F) x 3.70 per hour = 6290(F) Or 3.70 (9700 – 8000) = 3.70 x 1700(F) = 6290(F)
k) Capacity variance = St. rate (Revised budgeted units – Budgeted units) = 3.70 (5100 x 2 – 8000) =
8140(A)
l) Revenue from 4850 x 20 = 97000 – sold at 95600 = 1400(A) Selling price variance
m) Budgeted sales volume – Actual sales volume x Contribution or standard profit
= 5100 – 4850 x 6 = 250 x 6 = 1500(A)
Ktd Operating Statement June 2017
Ksh Ksh
Budgeted profit before sales and administration costs 30,600
Sales variances: Price 1,400(A)
Volume 1,500(A) 2,900(A)
Actual sales minus the standard cost of sales 27,700
Cost variances (F) (A)
Material price 600
Material usage 500
Labour Rate 200
Labour efficiency 3400
Labour idle time 1000
Variable overhead expenditure 200
Variable overhead efficiency 510
Fixed overhead expenditure 4560
Fixed overhead efficiency 6290
Fixed overhead capacity - 8140
10900 14500 3600(A)
Actual profit before sales and admin c/f 24100
Sales and administration costs 18000
Actual profit for June 2017 6,100

Check
Ksh Ksh
Sales 95,600
Materials 9,800
Labour 16,800
Variable overhead 2,600
Fixed overhead 42,300
Sales and administration 18,000 89,500
Actual profit 6,100

Example
From the following information of lucky Plc calculate.
Budgeted Actual
Product A Product B Product A Product B
Units 400 800 480 790
Sales price Shs.5 Shs.4 Shs.4.75 Shs.3.9
Cost Shs.4.5 Shs. 3 Shs.4.6 Shs.2.9

a) Sales price variance

b) Sales margin price variance
c) Sales volume variance
d) Total sales value variance
e) Total sales margin variance.
Solution
a) Sales price variance = (Actual selling price per unit – standard selling price per unit) x
actual quantity sold.
Product A = sh. (4.74 – 5) x 480 units = sh. 120(A)
 Product B = sh. (3.9 – 4) x 790 units = sh. 79 (A)

b) Sales margin price variance = (actual contribution margin – standard contribution

margin) × actual sales volume.
Product A = sh. (0.25 – 0.25) × 480 units = sh. 120 (A)
Product B = sh. (0.90 – 1) × 790 units = sh. 79 (A)

Workings
W1 standard contribution margin
A = sh. (5 – 4.50) = sh. 0.50
B = sh. (4 – 3) = sh.1

W2 Actual contribution margin

A = sh. (4.75 – 4.5) = sh. 0.25
B = sh. (3.9 – 3) = sh. 0.90
c) Sales margin volume variance = (Actual quantity – Budgeted
quantity) x standard margin Product A = (480 – 400) units × sh. 0.50
= sh. 40(F)
Product B = (790 – 800) units ×sh.1 = sh. 10(A)

d) Total sales value variance =

Actual sales – budgeted sales
Product A = sh. 2,280 –shs. 2,000 =
sh. 280 (F)
Product B = sh. 3,081 –shs. 3,200 = sh. 119(A)

e) Total sales margin variance = actual margin

– budgeted margin Product A = (480 units ×sh.
0.25) – (400 units × sh. 0.50) = sh. 80 (A)
Product B = (790 units × sh. 0.9) – (800 units
× sh. 1) = sh. 89(A)