Standard costs and Variance analysis Unit 10 University of Sunderland Dr Vidya Kumar 1

Standard A standard is an approved or acceptable level of performance Standards are not universal they depend upon individuals setting the standard. University of Sunderland Dr Vidya Kumar 2

Standard Costing - Definition The preparation of standard costs of products and services." a standard is calculated for each operation that makes up the manufacture of each individual product a standard cost is set this becomes a benchmark against which the actual cost are compared this process is called as Standard Costing University of Sunderland Dr Vidya Kumar 3

Purpose of Standard Costing To provide information regarding deviation from the plan To indicate what is attainable by efficient working To highlight those areas where attainable efficiency is not achieved To compare the product cost to what it ought to cost To highlight significant adverse variances To report in detail any deviation from the standard. To facilitate speedy corrective action when adverse variances are detected University of Sunderland Dr Vidya Kumar 4

Advantages of Standard Costing is usually less expensive than a normal product costing system standard costs provide a basis for cost comparison variances help in performance evaluation since standards are set well in advance it motivates the employees help managers to follow 'Management by Exception’ University of Sunderland Dr Vidya Kumar 5

Other uses for standard costing measuring operational efficiency product sourcing decisions determining the cost of inventories and work in progress for income measurement purposes determining the cost of items for use in pricing decisions University of Sunderland Dr Vidya Kumar 6

Limitations of standard costing Standards can quickly become out of date Factors may affect a variance for which a particular manager is accountable but over which the manager has no control. creating clear lines of demarcation between the areas of responsibility of various managers may be difficult may create incentives for managers and employees to act in undesirable ways. University of Sunderland Dr Vidya Kumar 7

Standard Costing and Cost Control 1. a predetermined standard cost is set. 2. measuring the actual cost involved 3. the actual cost is compared with the budgeted or standard cost. Any difference between the 2 is called a deviation. University of Sunderland Dr Vidya Kumar 8

Management by Exception managers do not have the time to look into the cause of every standard cost variance. they look into only the significant variances this is known as management by exception. Significant cost variances may be investigated to determine their cause and corrective action can be taken when needed University of Sunderland Dr Vidya Kumar 9

Cost Variance Any difference between the budgeted cost and actual cost is called a cost variance. Cost variances are used in controlling costs. University of Sunderland Dr Vidya Kumar 10

Variance Analysis analysis of variances between planned and actual performance. the purpose of such an analysis is to bring to the attention of the management the reasons why actual operating profit and budgeted operating profit are not the same variances can be favourable (F) or unfavourable (U). University of Sunderland Dr Vidya Kumar 11

Summary of Variance Formulae Material Variances Material Price variance = (sp - ap) x aq Material usage variance = (sq - aq) x sp University of Sunderland Dr Vidya Kumar 12

Summary of Variance Formulae Labour Variances Labour Rate variance = (sr - ar) x ah Labour Efficiency variance = (sh - ah) x sr University of Sunderland Dr Vidya Kumar 13

Summary of Variance Formulae Overhead Variances - Variable Variable Overhead Expenditure variance = Actual variable overhead - (Actual hours x variable overhead rate) Variable Overhead Efficiency variance = (Actual hours - Standard hours) x variable overhead rate University of Sunderland Dr Vidya Kumar 14

Summary of Variance Formulae Fixed overhead capacity variance = Budgeted fixed overhead -( Actual hours x F.O.A.R.) Fixed overhead efficiency variance = (Actual hours - Standard hours) x F.O.A.R. University of Sunderland Dr Vidya Kumar 15

Q & A University of Sunderland Dr Vidya Kumar 16