Setting Standards The setting of standards and the establishment of a standard cost system allow

managers to follow the management by exception principle. which specifies that the manager will
maximize his or her efficiency by . concentrating on those operational factors which are deviations from
the plan. Manatiement by excepti<;>n is especially effective in the area of c::ost control. Events. rather
than time, are the factors that determine when standards should be revised. These events may be
classified as internal or external. Internal events such as technological advances. design, revisions,
method changes, labor rate adjustments, and changes in physical facilities are to some degree
controllable by management. In contrast, external events. suGh as price changes (including the impc:=ict
of inflation), market trends, and specific customer requirements. Accumulation of Actual Cost When a
company uses a standard cost accounting system. it does not mean there is no need for actual costs.
Ac;tual costs shquld likewise be recorded and accumulated. They should be made available for
comparison with standard costs to determine any deviations. Therefore, a standard cost system should
be used in conjunction with the other systems of cost accumulation methods like job order and process
costing systems. Variance Analysis The difference between standard cost and actual cost is called
variance. The expression of this relationship is seen in the following simple formula: Actual Cost =
Standard Cost + Variance By rearranging the terms in the formula. we can determine the variance if we
know the standard cost and actual costs: Variance = Adual Cost - Standard Cost The word "variance"
literally means difference. Variance can b~ computed for all three cost elements of producHon -
materials, labor and overhead. Variance can either be plus or minus, depending on whether the actual
cost is greater or lesser than standard. Since, standard cost is a measurement of what a particular cost
should ought to be. any deviation from it can be interpreted as either good or bad - favorable or
unfavorable to the attainment of company's profit goal. Actually, variances are analyzed to know two
things: l. The difference between the actual and standard cost, and 2. The reasons for such difference.
However. we should not be contended to know the amount of variance. But. ·it is more important to
know the reasons for such variance, since this will be the management concern as a basis for making
economic decisions. Determination of standard cost is based on physical standards - they are of two
types, basic and current. A basic standard is a yardstick against which both expected and actual
performances are compared. It is similar to an index number against which all subsequent results are
measured. The cu"ent standards are of three types: l. The theoretical standard is a standard set for an
ideal or maximum level of operation and · efficiency. Such standard constitute goals to be aimed for
rather than performance that can be currently .achieved. 2. The expeded adual standard is a standard
set for a normal level of operation and efficiency. It is reasonably closed estimate of actual results. 3.
The normal standard is a standard set for normal level of operation and efficiency. instead to represent
challenging yet attainable results. Determining Standard Cost Variances For each item of direct material,
for each labor operations, and for departmentalized factory overhead actual costs are measured against
standard costs, resulting in differences. The differences are analyzed and identified as specific types of
standard cost variances.-If the actual cost exceeds the standard cost, the variance is referred to as
"unfavorable" because the excess has an 1Jnfavorabl~ ' effect on income. Conversely, if the standard
cost exceeds the actual cost, the variance referred to as "favorable" because - they have a favorable
effect on income. ·