Standard Cost & Variance Analysis

Management Control System

Kapil Agarwal

Management Control

Control is the process of ensuring that action conform to plans

To ensure operations are in conformity there are two waysStandard CostVariance Analysis

Standard

It is an approach to implement and achieve the goals of the firm

Standards can be set only for repetitive tasks

Standard Vs Budget

Budget Standard

Budget relates to entire activity

Standard applies to every task

It relates holistically It relates to same information on per unit basis

Prepared by management, consultants & finance people

By cost accountants

Used for planning and coordination

Used as a control device

Standard Costing

Types of costingActual Cost

Historical costStandard Cost

Predetermined cost

Standard Cost

Scientifically pre-determined cost of manufacturing

Either per unit or for certain nos of unitsCalculated for a certain period in immediate

futureUnder current operating conditions

Easy identification of inefficient operations

Measuring performanceControlling and reducing costMaintaining Inventory level

Advantage of Standard Costing

Levels of Standard Cost

Ideal– max. efficiency under favourable conditions

Normal/ Attainable– realistic, motivational

Expected

Ideal Standard Costs

Ideal cost refers to estimates of costs under perfect conditions

There would be no waste, scrap, idle items, no machine breakdown etc

Normal Standard Costs

Assume normal conditions of operationStandard cost means Normal Standard

Cost during the discussion

Establishing Cost Standards

Ways of establishing cost standardsEngineering estimatesObserved behaviorPredicted behaviorDesired behavior

Components of Standard Cost

Direct Material CostDirect Labour CostOverheads

Variance Analysis

Difference between actual and standardActual Cost > Std Cost ---- unfavorableAC < SC--- favorable, sign of efficiency

Unfavorable variance suggests a condition that may require correction

Favorable variance suggest an opportunity that management can exploit

Variance Analysis: Benefits

BenefitsForms basis of cost controlQuantify corrective actionPinpoint responsibilities of managersBrings in Management Control

Classification of Variance

Controllable It arises when responsibility for the variance

can be attributed to any individual/process Material wastage, labour hour wastage Suggest management to take corrective action

Uncontrollable It arises when responsibility for the variance

cannot be attributed to any individual/process Price variation in material/ labor, breakdown

Types of Variance

Price variance Cost Variance Quantity/Volume variance Efficiency variance– quantity produced in

available working hours Capacity variance

Calendar variance– working days available in month

Idle time variance– hours lost due to breakdowns

Types of Variance Sales variance Operating profit due to sales volume

Sales quantity is analyzed Operating margins are assumed same

Operating profit due to selling price Operating margins are calculated

Territory mix variance Different proportion of product mix

Cost Variance

Cost Variance

Material Labor Overhead

Material Variance-- MCV

Material cost variance is difference of std cost of material and actual cost incurred

It has two components Material price variance

MPV = (SP – AP) X AQ Material quantity variance

Material Price Variance-- MPV

Factors responsible for MPV Inflation Change in tax structure, excise Rise in fuel prices leading to rise in freight Material hoarding Cash crunch, unable to avail cash discounts Change in technology, resulting in change in raw material

specification Failure to purchase even lot size (30T, 10T)

Material Quantity Variance-- MUV

Factors responsible for MUV (Mat. Usage Variance) Careless handling of material, process Improper machine adjustment Use of sub standard material Change in design Material theft, pilferage, wastage Defective tools, old technology

Material Mix Sub variance Substituting one raw material for another, even though total

input quantity of all materials does not exceed standard proportion amount

Labour Variance

Labor Cost Variance is difference of std labor cost and actual labor cost

Labor Rate Variance (LRV) Also called as Wage Rate Variance Difference between actual wage rate and Std wage rate

and actual labor hours worked LRV = (SR – AR) * AH* AO

Should be determined separately for skilled, semi skilled and unskilled laborers

Labour Rate Variance

Factors responsible for LRV Changes in basic wage structure or piece work rate Employing a worker mix (Skilled workers for semi skilled

jobs) Fulfilling urgent orders Seasonal demands During recession Casual and temporary workers proportion to employee

strength

Labour Efficiency Variance

It is a function of hours workers should have consumed in actual production, actual hours worked and standard wage rate

Reasons of LEV Working conditions– Ergonomic Study Machines, equipments, tools in proper condition Sub standard raw material Organizational efficiency Supervision Training to workers Labour turnover, Gang composition (labour mix)

Labour Efficiency Variance

LEV is further divided into Idle time variance– machined breakdown, raw

material unavailability, power failure Labour mix variance Labour yield variance

Overhead Variance

OV is difference between actual overhead cost incurred and std overhead cost

TypesVariable overhead varianceFixed overhead variance

Calendar Variance

Actual no of working days is different from standard no of working days

[No of Std working days(SD) – no of actual working days (AD)] * std fixed overheads per day

[SD- AD] * SFOD

Capacity Variance

Budgeted hours per day * actual days worked and actual hours worked

[ Budgeted hours on basis of actual days worked – Actual hours worked] * SOFR per hour

SOFR– std fixed overhead rate per hour

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