1. Cost accounting
Session 7

2. Learning objectives Define standard costing and standard cost
Determine standard costs for materials, labour and overhead
Calculate basic Material, Labour and Overhead variances
Know what is meant by Variance Analysis and its purpose
Determine causes of Variances

3. Define standard costing and standard cost
Learning objective 1
Define standard costing and standard cost

4. Standard Costing is a technique which
establishes predetermined estimates of the costs of products and services (standard cost)
And compares the standard cost with actual cost as they are incurred.
The difference between standard cost and actual cost is a variance.

5. Standard Cost
Is the planned unit cost of the products, components or services in a period.
A standard cost is not an average of previous costs.

6. Uses of standard costs Performance measurement Control Stock valuation
Determine selling prices
Setting budgets
Provide a challenging target
Decision making (predict future costs)

7. Bases for setting standards
On an ex ante estimate of expected performance
On an ex post estimate of attainable performance
On a prior period level of performance by the same organisation
On the level of performance achieved by comparable organisations
On the level of performance required to meet organisational objectives

8. Types of Standards Basic standard
a standard established for use over a long period from which a current standard can be developed
Ideal standard
based on the best possible operating conditions.
unattainable in practice, hence rarely used.
Attainable standard
based on efficient level of operating conditions.
includes allowances for normal material losses, idle time, machine breakdown, etc.
standards are difficult, but achievable; hence frequently used.

9. Standards and Budgets Standards are a unit concept
apply to particular products, individual operations or processes or services.
Budgets are concerned with totals
lay down cost limits for functions and departments and for the firm as a whole.

10. Motivation and standards
Standards are expected to motivate people to achieve the targets set by the standards.
Three factors affect motivation
- participation
- attainment level
- feedback
Note: there are behavioural aspect to standards.
To some extent, there is subjectivity in setting standards.

11. Advantages of Standard Costing
Variances directs management’s attention to items not going according to plan.
The process of setting, revising and monitoring standards encourages reappraisal of systems, hence leading to cost reduction.
Standard costs represent what parts and products should cost; hence provide better guide to pricing than historical costs.
Provide a simpler basis of inventory valuation
A properly developed standard costing system with everyone’s participation creates a positive, cost effective attitude in the whole organisation.

12. Disadvantages of Standard Costing
May be expensive and time consuming to install and to keep up to date.
Where methods, rates and prices change rapidly, standards become out of date.
Elaborate variances may not be understood by managers and hence become ineffective for control purposes.
Concentrates only on narrow range of financial factors; however, there are other factors affecting performance.
May be less useful in JIT manufacturing; latter assumes continuous improvement.

13. Determine standard costs for materials, labour and overhead
Learning objective 2
Determine standard costs for materials, labour and overhead

14. Setting Standards
A standard cost implies that a target or standard exists for every single element that contributes to the product.
There are two approaches to set standard costs.
past historical records can be used to estimate labour and material usage.
Problem: may include past inefficiencies.
Engineering studies: a detailed study is undertaken of each operation based on careful specification of materials, labour and equipment.
Line managers and top management have ultimate responsibility for setting the standards.

15. Standard costs for Materials
A material cost standard is based on:
Estimates of the quantity of materials required for a unit of product and
Unit standard cost to purchase the materials used.
Management will consult:
engineering department for materials specification (design, types, usage, normal loss/wastage) and
purchasing department regarding suppliers’ prices.

16. Standard costs for Labour
The agreed methods of manufacture are the basis of setting the standard labour times.
The techniques of work measurement are involved, often combined with work study projections.
The labour standards must specify the exact grades of labour and times involved.
Labour time is expressed in standard hours (or minutes).
i.e. the amount of work achievable at standard efficiency levels, in an hour or minute.

17. Standard costs for Overheads
Predetermined overhead absorption rates become the standards for overheads for each cost centre using the standard labour hours as the activity base ( or other such as units, weight, etc).
Standard Variable OAR
= Budgeted variable overheads for cost centre
Budgeted standard labour hours for cost centre
Standard Fixed OAR
= Budgeted fixed overheads for cost centre

18. Standard sales price and margin
Standard selling price
Top management decision, based on number of factors like
Anticipated market demand
Competing products
Manufacturing costs
Inflation estimates, etc.
Standard sales margin
= standard selling price – standard cost

19. Standard Cost Card
Once standards are set, the standard cost of a product is found.
The make-up of the standard cost is recorded on a standard cost card.
The standard cost details can also be held on
Various cards and on a summary card.
Computer file.
Note that standards are rarely changed, but can be adjusted periodically to reflect up-to-date targets.

20. Learning objective 3
Calculate basic Material, Labour and Overhead variances plus Sales variances

21. Materials Variances DM Total Variance =
(standard material cost of output produced –
actual cost of material purchased)
Where the quantities of materials purchased and used are different,
Total variance = Price variance + Usage Variance

22. Materials Variances
DM Price Variance = ((actual quantity of material purchased x standard price) – actual cost of material purchased)
DM Usage Variance
Measures efficiency in usage of materials
= (actual production x standard material per unit – actual material usage) x standard cost per kg, ltr, etc.

23. Labour variances DL Total Variance =
((standard hours produced x standard direct labour rate per hour) – (actual hours paid x actual direct labour rate per hour))

24. Labour variances DL Rate Variance
= ((actual hours paid x standard DL rate/hr) –
(actual hours paid x actual DL rate/hour))
DL Efficiency Variance
= (actual production in standard hours – actual hours worked) x standard direct labour rate per hour

25. Overhead Variances Total overhead absorbed = OAR x SHP,
where SHP is the no. of Standard Hours of Production and OAR is overhead absorption rate.
Fixed overheads absorbed = FOAR x SHP
Variable overheads absorbed = VOAR x SHP
Total overheads absorbed = (FOAR + VOAR) x SHP.

26. Variable Overhead Variances
Variable overhead total variance
= actual variable overheads incurred – variable overheads absorbed.
Variable overhead expenditure variance
= actual variable overheads incurred – allowed variable overheads based on the actual hours worked.
Variable overhead efficiency variance
= allowed variable overheads – absorbed variable overhead

27. Fixed Overhead Variances
Fixed overhead total variance
= fixed overhead attributed & charged to period –
standard cost of fixed overhead absorbed in the production achieved, whether completed or not.
Fixed overhead expenditure variance
= actual fixed expenditure attributed & charged to period – budget cost allowance for production for a specified control period
Fixed overhead volume variance
= budget cost allowance for a specified control period – standard cost absorbed in the production achieved

28. Sales Variances Total sales margin variance
Actual sales margin – budgeted sales margin,
where COS is valued at standard cost of production
Sales margin price variance
(Actual margin/unit – standard margin/unit) x units sold
Sales margin quantity variance
(actual units sold – budgeted no. of units) x standard margin per unit

29. Know what is meant by Variance Analysis and its purpose
Learning objective 4
Know what is meant by Variance Analysis and its purpose

30. Variance Analysis
The evaluation of performance by means of variances, whose timely reporting should maximise the opportunity for managerial action.
Variances arise from differences between
Standard and actual quantities, and/or
Standard and actual prices.
Variances maybe
Adverse, or
Favourable.

31. Purpose of Variance Analysis
Points to off-standard performance so management can
Improve operations
Increase efficiency
Utilise resources more effectively, and
Reduce costs.
*The types of variances which are identified must be those which fulfil the needs of the organisation.
i.e. a variance should only be calculated if it is useful.

32. Determine causes of Variances
Learning objective 5
Determine causes of Variances

33. Causes of Variances Material Variances Price Variances
paying higher or lower prices than planned.
losing or gaining quantity discounts
buying lower or higher quality than planned
buying substitute material
Usage Variances
Greater or lower yield from material than planned
Gains or losses due to substitute or higher/lower quality than planned
Greater or lower rate of scrap than anticipated

34. Causes of Variances Labour Variances Rate Variances
Higher rates being paid than planned due to wage award.
Higher or lower grade of worker being used than planned.
Payment of unplanned overtime or bonus.
Efficiency Variances
Use of incorrect grade of labour.
Poor workshop organisation or supervision.
Incorrect materials and/or machine conditions.
Unexpectedly favourable conditions.

35. Standard Costing and Variance Analysis
End of session 7