Chapter – 10, 11

Standard Costing and operating performance measures

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Standard cost:
An estimated or predetermined cost of performing
an operation or producing a product or service, under
normal conditions.
Standard costs are used as target costs (or basis for comparison
with the  actual costs), and are developed from historical
data analysis and as well as from time and motion studies.
Purpose and advantages of standard costs:
Following are the main purposes of standard costs:
(i). Establishing Budget.
(ii).Controlling costs & measuring efficiency.
(iii).Promoting possible costs reductions.
(iv).Forming the basis for fixation of sales prices.
(v). Standard costs are a key element in a management by
exception approach (i. e. focus on important issues only).
Executives involved in Setting standard components
Accountants, engineers, personnel administrators, and production
managers make combined efforts to set standards based on experience ,
qualifications, and expectations.

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Setting a chart for Standard manufacturing cost
per unit of out put:
,
It is prepared practically as follows:
1. Direct materials standard:
Standard price, Standard quantity consumption per unit
2. Direct labor standards:
Standard labor rate per direct labor hour, Standard direct labor
hours required per unit
3. Factory overhead standard:
Total estimated hours (normal hours) per year, Estimated total
variable factory overhead costs per year, Total estimated fixed
factory overhead costs per year, Standard Variable (Applied)
factory overhead rate, Standard fixed (Applied) factory
overhead rate, Standard hours required per unit,
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Now standard cost of direct materials, direct
labor and factory overhead of actual production
can be computed by multiplying the above
respective standard by actual production for the
period.
 If some difference arises between total actual costs
incurred and total standard costs allowed under the
respective head, then these differences are called
variances in standard costing (favorable or
unfavorable) and that will further be analyzed to
determine the actual causes of variances.
Now we discuss the all variances calculation for each
above (1, 2, and 3) and its impact on company’s profit
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(1).Direct materials cost variance.
If actual material cost incurred is more or less than
the standard material cost allowed against the
actual production, then this variance arises.
It can be analyzed by the following:
Direct material cost variance may be analyzed by
two variance methods.
(i). Direct materials price variance

(ii). Direct materials quantity (or usage)

variance.
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(i). Direct materials price variance
If the manufacturer actually purchases direct
materials at a higher Price than the standard
direct materials price for the materials actually to
be used in manufacturing, then the company will
have an unfavorable direct material price
variance. Similarly vice versa of above statement
will have a favorable variance.
It checks the performance of purchasing
department and measures the effect of price
increase or decrease from standard price on the
company’s profit. It is calculated by two ways:
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If materials price variance is calculated at the time of purchase: Then its is
called:
“Direct material purchase price variance”
 

Formula:
[Actual price –standard price]X Actual quantity purchased =
± Rs xx
  Or,

If materials price variance is calculated at the time of used:

Then its is called:
  “Direct material usage price variance”
Formula:
[Actual price – standard price] X Actual quantity used =
±Rs xx
Note: If actual price is more than the standard price, the above variance will be
unfavorable, else favorable or, if above resultant comes out to be positive; the
variance will be unfavorable, else favorable.
 
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(ii). Direct materials quantity (or usage) variance.
If the manufacturer actually used more direct material in
quantities than the standard quantities allowed for the products
actually manufactured, then the company will have an
unfavorable direct materials usage variance. Similarly vice versa
of above statement will have a favorable variance.
It checks the performance of production department and measures
the effect of quantity consumed more or less on company’s profit.
 Formula:
[Actual quantity used - Standard quantity allowed] X
Standard price = ±Rs xx
Whereas, Standard quantity allowed= Actual production units X
Standard quantity per unit
Note: If actual quantity used is more than the standard quantity
allowed, the above variance will be unfavorable, else favorable or, if
above resultant comes out to be positive; the variance will be
unfavorable, else favorable. 9
(2).Direct labor cost variance.
If actual labor cost incurred is more or less than the
standard labor cost allowed against the actual
production, then this variance arises. It can be
analyzed by the two variance method.
Two variances for direct labor costs are as under:

(i). Direct labor rate variance

(ii). Direct labor efficiency variance.

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(i).Direct labor Rate variance.
If the manufacturer actually paid to direct workers at a higher direct labor
rate per hour than the standard direct labor rate, then the company will
have an unfavorable direct labor rate variance. Similarly vice versa of
above statement will have a favorable variance.
It checks the performance of human resource department and measures
the effect of labor rate increase or decrease on the on company’s profit.
Formula:
[Actual direct labor rate per hour - Standard Direct
labor rate per hour] X Actual Direct labor hours
worked = ±Rs xx
Note: If actual direct labor rate is more than the standard direct labor rate
per hour, the above variance will be unfavorable, else favorable or, if
above resultant comes out to be positive; the variance will be unfavorable,
else favorable.
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(ii).Direct labor Efficiency variance.
If the manufacturer actually spent more direct labor hours on actual production than
the standard direct labor hours allowed for the products actually manufactured, then
the company will have an unfavorable direct labor efficiency variance. Similarly
vice versa of above statement will have a favorable variance.
It checks the performance of production department and measures the effect of labor
hours consumed more or less on company’s profit.
Formula:
[Actual Direct labor hours worked - Standard Direct labor hours allowed]
X Standard labor rate per hour = ±Rs xx

Whereas, Standard direct labor hours allowed= Actual production X Standard labor
hours per unit

Note: If actual direct labor hours worked is more than the standard labor hours
allowed on actual production, the above variance will be unfavorable, else favorable
or, if above resultant comes out to be positive; the variance will be unfavorable, else
favorable.
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3. Factory overhead cost
variance.
Factory cost variance occurs, if actual factory overhead incurred
is more or less than the factory overhead charged /applied to
the WIP/Production/Jobs during the year or period.
If actual factory overhead incurred during the year/period is less
than the applied factory overhead, then the variance will be
favorable, else unfavorable.
 
The above variance may be analyzed by two methods:
 
1. Variable factory (manufacturing) overhead Variances.
2. Fixed factory (manufacturing) overhead Variances.
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1. Variable factory (manufacturing) overhead
Variances.
It is further analyzed by two methods. These two
variances for variable factory variance are as
under:
(i). variable factory overhead rate variance

(ii). variable factory overhead efficiency

variance.
 

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(i). variable factory overhead rate variance
Formula:
[Actual variable factory overhead rate per hour –
Predetermined/ Standard variable factory
overhead rate per hour] X Actual labor hours
worked = ±Rs xx
Note: If actual variable factory overhead rate is more
than the standard variable factory overhead rate, the
above variance will be unfavorable, else favorable or, if
above resultant comes out to be positive; the variance
will be unfavorable, else favorable.

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(ii). variable factory overhead efficiency variance.
Formula:
[Actual hours worked - Standard hours allowed] X
Predetermined/ Standard variable factory
overhead rate per hour = ±Rs xx
Note: If actual hours worked are more than the
standard hours allowed on actual production,
the above variance will be unfavorable, else
favorable or, if above resultant comes out to be
positive; the variance will be unfavorable, else
favorable.

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2. Fixed factory (manufacturing) overhead
Variances.
It is further analyzed by two methods. These two
variances for fixed factory variance are as under:
(i). Fixed factory overhead spending (Budget)
variance

(ii). Fixed factory overhead production volume

variance.

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(i). Fixed factory over head Budget variance
The budget variance is simply the difference between
the actual fixed factory overhead and the budgeted
fixed factory overhead for the period.
Formula:
Actual fixed factory overhead - Budgeted fixed factory
overhead = ±Rs xx
 
Note: If actual fixed factory overhead is more than the
Budgeted fixed factory overhead, the above variance will
be unfavorable, else favorable or, if above resultant
comes out to be positive; the variance will be
unfavorable, else favorable.
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(ii). Fixed overhead production Volume variance.
Formula:
[Denominator (i.e. Normal capacity)hours – Standard
hours allowed on actual production] X Fixed
predetermined Standard factory overhead rate = ±Rs xx
Where as, denominator (i.e. Normal capacity) hours are
capacity level that used in the determination of applied
factory overhead rate.
Note: If denominator hours are more than the standard
hours allowed on actual production, the above variance
will be unfavorable, else favorable or, if above resultant
comes out to be positive; the variance will be
unfavorable, else favorable.
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 Summary of all variances
1. Direct material Price variance
2. Direct material Quantity variance
3. Direct labor rate variance
4. Direct labor efficiency variance
5. variable factory overhead rate variance
6. variable factory overhead efficiency variance
7. Budget variance
8. Volume variance
Note: Sum of all must be equal to:
[Total actual cost of actual production – Total
standard cost of actual production] 20
………. The end ………. 21