Business Processes & Accounting Systems · Week 15

Standard Costing & Variance Analysis

Standard cost vs budgeted cost, setting material, labour and overhead standards, the four types of standards, the standard cost card (Rs 134 example), the variance tree with every formula (material, labour, variable and fixed overhead, sales), a full worked variance example, and the advantages and limitations.

ITE36221 video · 28 min📄 Standard costing and variance analysis session 15.pdf📄 Practice – Standard costing & variance.pdf

▶Lecture videos

Click any timestamp — here or inside the notes — to jump the video to that moment. Your position is remembered.

Standard Costing

What standards are and how they're set, the types of standards, the standard cost card, and the advantages and limitations. The variance formulas are in the PDF.

00:02Introduction 01:17Why standard costing: controlling cost (the carpenter's chair, 15,000 vs 18,000)03:08What standard costing is 04:21What a standard cost is 05:31Uses: control, stock valuation, pricing 06:25Standard cost vs budgeted cost 07:51Example: 10,000 units × Rs 3 = Rs 30,000 budget 08:51Setting standards: historical records vs engineering studies 10:48Direct material standards: bill of materials and purchasing 13:37Direct labour standards 14:12Overhead standards: short run vs long run 15:51Four types of performance standards 17:15Ideal standards 18:29Attainable standards 19:15Current standards 19:45Basic standards 20:20Standard cost card 21:01Example: product A = Rs 134 per unit 22:24Advantages of standard costing 25:17Limitations of standard costing

1Standard cost & standard costing

Definitions

Standard cost: a predetermined (planned) estimated unit cost of a product, component or service, used for stock valuation and control 04:21. It's what a unit should cost under efficient operating conditions.
Standard costing: a control technique that compares standard costs and revenues with actual results to obtain variances, which are used to stimulate improved performance 03:08.

The carpenter 02:16

A carpenter targets Rs 15,000 per chair, but the actual cost is Rs 18,000. That's a Rs 3,000 adverse variance. He investigates why and controls that cost next time. This is the core idea of standard costing.

Standard costing involves:

Set standards

Ascertain actual results

Compare → variances

Investigate & take action

Uses of standard costs:

cost control
performance evaluation
stock valuation
setting selling prices 05:31

Standard vs budget

	Standard	Budget
Unit	Per unit of product or activity	Total activity or operation
Example 07:51	Rs 3 per unit	10,000 units × 3 = Rs 30,000

Similarities:

both are forecasts about the future
both are control tools

They're interrelated: budget = standard × budgeted activity.

2Setting standards

Two approaches 08:51:

Historical records: use past experience of materials, labour and overhead per unit. It's simple.
Engineering studies: a technical study of the input–output relationship. It's more complex but more precise.

Component	Quantity standard	Price or rate standard
Direct material	Bill of materials (BOM) per product, allowing for unavoidable waste (avoidable waste is not allowed) 11:44	Purchasing department: contracts, supplier discussions, forecast price movements
Direct labour	Standard hours for an average worker to do the job	Contractual wage rate 13:37
Overheads	Standard hours (absorption base)	Standard overhead absorption rate. Fixed overheads don't vary in the short run, but are absorbed per unit for financial reporting and inventory valuation 14:55

3Types of standards

Type	Based on	Effect
Ideal	Perfect conditions: no waste, spoilage, inefficiency, idle time or breakdowns 17:15	Unattainable, so it demotivates
Attainable	Allows for normal waste and inefficiency; realistic but challenging 18:29	Best for motivation ✓
Current	Current conditions, including current waste and inefficiency 19:15	Doesn't try to improve efficiency
Basic	Old standards, never changed 19:45	Least useful; mainly for showing long-term trends

4Standard cost card

The standard cost card shows the full details of the standard cost of each product, one card per product. It's confidential: for top management decision-making only 20:20.

Product A standard cost card 21:01

Element	Standard quantity	Standard price or rate	Rs per unit
Direct material	2 kg	Rs 10 per kg	20
Direct labour	3 hours	Rs 24 per hour	72
Variable overhead	3 hours	Rs 8 per hour	24
Fixed overhead	3 hours	Rs 6 per hour	18
Standard cost per unit			134

5The variance tree

A = adverse (actual cost > standard, or actual revenue < standard): reduces profit.

F = favourable: increases profit.

6Variance formulas

DIRECT MATERIAL
Price variance = (AQ × AP) − (AQ × SP) = Actual cost − Standard cost of actual quantity
Usage variance = (AQ − SQ) × SP (SQ = standard quantity for the actual output)

DIRECT LABOUR
Rate variance = (AH × AR) − (AH × SR)
Efficiency variance = (AH − SH) × SR (SH = standard hours for actual output)

VARIABLE OVERHEAD
Expenditure variance = Actual VOH − (AH × standard VOH rate)
Efficiency variance = (AH − SH) × standard VOH rate

FIXED OVERHEAD
Total variance = Actual FOH − Absorbed FOH (actual output × FOAR)
Expenditure variance = Actual FOH − Budgeted FOH
Volume variance = Absorbed − Budgeted = (Actual output − Budgeted output) × FOAR per unit

SALES
Selling price variance = (Actual price − Standard price) × Actual units sold
Sales volume variance = (Actual units − Budgeted units) × standard profit per unit (absorption costing) or × standard contribution per unit (marginal costing)

Sign check

For costs, actual > standard is adverse. For revenue and volume, actual > standard is favourable. The two sub-variances always add up to the total.

Worked variance example (built on the product A card)

Data:

Budget: 1,000 units; budgeted fixed overhead Rs 18,000 (FOAR Rs 18 per unit); standard price Rs 180 (standard profit 180 − 134 = Rs 46).
Actual:
produced and sold 1,100 units at Rs 175
materials 2,300 kg costing Rs 24,150
labour 3,200 hours costing Rs 78,400
overheads: VOH Rs 26,000; FOH Rs 19,500

Standards for the actual output:

SQ = 1,100 × 2 = 2,200 kg
SH = 1,100 × 3 = 3,300 hours

Variance	Working	Rs
DM price	24,150 − 2,300 × 10	1,150	A
DM usage	(2,300 − 2,200) × 10	1,000	A
DL rate	78,400 − 3,200 × 24	1,600	A
DL efficiency	(3,200 − 3,300) × 24	2,400	F
VOH expenditure	26,000 − 3,200 × 8	400	A
VOH efficiency	(3,200 − 3,300) × 8	800	F
FOH expenditure	19,500 − 18,000	1,500	A
FOH volume	(1,100 − 1,000) × 18	1,800	F
FOH total (check)	19,500 − 1,100 × 18 = 19,500 − 19,800	300	F ✓
Selling price	(175 − 180) × 1,100	5,500	A
Sales volume	(1,100 − 1,000) × 46	4,600	F

Interpretation:

Workers were efficient: fewer hours than standard.
But they were paid a higher rate, and materials cost more and more were used. Did cheaper, poor-quality material slow anything? Here it didn't, but investigate the interdependence.
Selling more units at a lower price gave a net Rs 900 adverse sales effect.

🧪 Try it — Variance analyser

Standards (from the cost card). Edit any value.

Std kg/unit Std Rs/kg Std hrs/unit Std Rs/hr VOH Rs/hr Budget FOH Budget units Std price

Actuals

Units made and sold Actual price kg used Material cost Hours Labour cost Actual VOH Actual FOH

7Advantages & limitations

Advantages 22:24	Limitations 25:17
Predicts future costs for decision-making	Too much emphasis on direct labour; modern production is capital-intensive
Gives employees a target, which motivates them	Needs repetitive operations and homogeneous output, so it's unsuited to non-standardised or customised production
Evaluates managerial performance	Hard to apply in service organisations
Helps set budgets (standard × activity)	Built for stable environments; standards go out of date as prices change
Acts as a control device: management by exception	Assumes performance to standard is acceptable, which conflicts with continuous improvement
Simplifies costing for profit measurement and inventory valuation	Assigning responsibility for variances is difficult (they're interdependent)
	Reporting delay: variances arrive late
	Behavioural issues: unattainable standards demotivate; blame culture

Exam focus

Expect:

Define standard cost and standard costing.
Standard vs budget.
How standards are set, for material, labour and overhead.
The four types of standards, and why attainable is preferred.
Prepare a standard cost card.
Calculate and interpret variances. Always label A or F, and use SQ and SH for actual output.
Advantages and limitations.

8Practice questions (course paper)

Q1: Material variances (10,000 bags of cement)

Standard quantity: limestone 11 kg × 10,000 = 110 tons; sand 26 kg × 10,000 = 260 tons.

Variance	Limestone	Sand	Total
Price: (SP − AP) × AQ	(70 − 75) × 100 = 500 A	(14 − 10) × 250 = 1,000 F	500 F
Usage: (SQ − AQ) × SP	(110 − 100) × 70 = 700 F	(260 − 250) × 14 = 140 F	840 F
Total: SQ·SP − AQ·AP	7,700 − 7,500 = 200 F	3,640 − 2,500 = 1,140 F	1,340 F

Q2: Labour variances (10,000 denims)

Actual hours: 0.50 × 10,000 = 5,000. Standard hours: 0.55 × 10,000 = 5,500.

Rate: (SR − AR) × AH = (10 − 12) × 5,000 = 10,000 A
Efficiency: (SH − AH) × SR = (5,500 − 5,000) × 10 = 5,000 F
Total: SH × SR − AH × AR = 55,000 − 60,000 = 5,000 A

Q3: Variable overhead variances (Araliya Sports)

Standard hours for actual output:

Plus: 4,500 × 2 = 9,000 direct labour hours @ 10
Gold: 5,200 × 1 = 5,200 machine hours @ 12

Expenditure: (actual hours × standard rate) − actual cost = (10,000 × 10 + 5,000 × 12) − 175,000 = 160,000 − 175,000 = 15,000 A

Efficiency:

Plus: (9,000 − 10,000) × 10 = 10,000 A
Gold: (5,200 − 5,000) × 12 = 2,400 F
Net 7,600 A

Total: standard cost 152,400 − actual 175,000 = 22,600 A (= 15,000 A + 7,600 A ✓)

Q4: Fixed overhead variances (automobiles)

Absorbed: 275,000 × 2,000 = Rs. 550 Mn
Budgeted: 250,000 × 2,000 = Rs. 500 Mn
Actual: Rs. 600 Mn

Variance	Calculation	Result
Total	550 − 600	50 Mn A
Expenditure	500 − 600	100 Mn A
Volume	550 − 500	50 Mn F

Q5: Sales variances (NHK-II fertiliser)

Sales price: (actual price − standard price) × actual quantity = (380 − 400) × 200 = 4,000 A
Sales volume (margin): (actual quantity − budgeted quantity) × standard margin = (200 − 210) × (400 − 250) = 1,500 A

9Quick revision sheet

Concept	Remember it as
Standard cost	Predetermined unit cost under efficient conditions
Standard costing	Compare standard with actual → variances → action
Standard vs budget	Per unit vs total activity (Rs 3 × 10,000 = 30,000)
Setting standards	Historical records · engineering studies; BOM, purchasing, contract wage rate
Types	Ideal (perfect, demotivating) · attainable (best) · current (no improvement) · basic (old)
Cost card example	20 + 72 + 24 + 18 = 134
DM price / usage	AQ(AP − SP) / SP(AQ − SQ)
DL rate / efficiency	AH(AR − SR) / SR(AH − SH)
VOH	Expenditure: actual − AH × rate; efficiency: (AH − SH) × rate
FOH	Expenditure: actual − budget; volume: (actual − budget units) × FOAR
Sales	Price: (AP − SP) × actual units; volume: (actual − budget units) × standard profit or contribution
A vs F	Higher cost or lower revenue = adverse
Limitations	Labour focus · homogeneous output only · services · stable environment · no continuous improvement · responsibility · delay · behaviour

?Self-check quiz

12 questions on this week. Answer them all, then press Check my answers. Your best and latest scores are saved and shown on the subject page.

← PreviousBudgeting — Purposes, Budgetary Control, the Master Budget & Functional Budgets to the Cash Budget