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CHAPTER 1 INTRODUCTION
Two vital functions of management of any organization are planning and controlling. While planning helps the management to make systematic efforts to achieve the well-defined objectives, control enables them to review the actual performance and locate the difference between the planned performance and actual performance. Thus for evaluating performance, it is necessary to compare the actual performance with some pre-determined or pre planned targets. One of the important parameters of performance is the cost of production. According to M. Porter, for achieving sustainable competitive advantage it is necessary to establish cost leadership. For achieving this, it is of paramount importance that the various costs are monitored closely and there is a constant comparison of the actual costs with some pre-determined targets. Standard Costing is an important tool in the hands of management for improving the management control by providing parameters for comparison of actual with these parameters. The concept of standard cost, standard costing, variance analysis and other relevant aspects of the same are discussed in this chapter in detail in the subsequent paragraphs.

Standard Costing
Various authorities have defined the term. Standard costing... A few important definitions have been reproduced below: (a) The Chartered Institute of Management Accountants, London. .Standard costing is the preparation and use of standard costs, their comparison with actual costs and the analysis of variances to their causes and points of incidence... (b) J. Batty. .Standard costing is a system of cost accounting which is designed to show in detail how much each product should cost to produce and sell when a business is operating at a stated level of efficiency and for a given volume of output...1

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(c) Weldon. .Standard costing is a method of ascertaining costs, whereby statistics are prepared to show the standard cost, the actual cost and the difference between these costs which is termed as variance. Thus under standard costing, there is a planned and co-ordinate arrangement of all matters relating to costing. There are carefully planned and organised accounting procedures and through them the differences between actual and standard costs, technically known as variances, are analysed. There is a prompt reporting of these variances to the management so that it can take corrective and preventive action together with employing the data for planning, co-ordination and control. Standard costs are determined for each element of cost-direct materials, direct labour, overheads (fixed and variable) separately and then variations from actual costs are computed in respect of each element distinctly so as to detect, which part of the costs needs control and to which department, process or operation, the responsibility may be placed. The standard costs are organised to uncover and report off standard conditions. The management should strive for the attainment of standard costs because they are attainable ideal costs and are practical from the point of view of business. The system of standard costing covers the measurement and attainment of a high level of efficiency and a constant review of methods employed in production. If necessary, standards are revised to reflect realistic current conditions and practices. The system is always forward looking, and it is a part of a fully co-ordinated management accountancy system.

Standard Costs
A few important definitions have been given below : (a) The Chartered Institute of Management Accountants, England. .Standard cost is a pre-determined cost which is calculated from management standards of efficient operation and the relevant necessary expenditure. It may be used as a basis for price fixing and for cost control through variance analysis..

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(b) J. Batty. .Standard costs represent anticipated costs under given conditions and for an expected volume of output.. (c) Blacker and Weltmer. .Standard cost of a product is the pre-determined cost based upon engineering specifications and representing highly efficient production for quantity standards and forecasts for future markets trends for price standards, with a fixed amount expressed in rupees for materials, labour and overhead for an estimated quantity of production. Thus, standard costs are the costs which should be there. They are to be predetermined on the basis of certain stated conditions, according to management standards of efficient operation. The questions like what these conditions should be and what the management standards of efficient operation should be pose serious problems before the management. Should standards represent ideal or faultless performance, or, easily attainable or low effort performance ? Should standards be based on normal conditions ? The following discussion would help answering these questions

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CHAPTER 2 FEATURES OF STANDARD COST AND STANDARD COSTING

Standard cost is a pre planned or pre-determined cost. This means that the standard cost is determined even before the commencement of production. For example, if a firm is planning to launch a product in the year 2009, the standard cost of the same will be determined in the year 2008. Standard cost is not an estimated cost. There is a difference between saying what would be the cost and what should be the cost. Standard cost is a planned cost and it is a cost that should be the actual cost of production. It is calculated after taking into consideration the managements standard of efficient operation. Thus standard cost fixed on the assumption of 80% efficiency will be different from what it will be if the assumption is of 90% efficiency. Standard cost can be used as a basis for price fixation as well as for exercising control over the cost. Standard Costing is a technique of costing rather than a method. Standard costing involves setting of standards for various elements of cost Thus standards are set for material costs, labour costs and overhead costs. Setting of standard is the heart of standard costing and so this work is done very carefully. Setting of wrong standards will defeat the very purpose of standard costing. Standards are not only set for costs, but also for sales and profits. The objective behind setting of standards is to have a basis for comparison between the standard performance and the actual performance. Another feature of standard costing is to continuously record the actual performance against the standards so that comparison between the two can be done easily. Standard costing ensures that there is a constant comparison between the standards and actual and the difference between the two is worked out. The difference is known as variance and it is to be analysed further to find out the reasons behind the same. After the ascertaining of the variances, analyzing them to find out the reasons for the variances and taking corrective action in order to ensure that the variances are not repeated, are the two important actions of

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management. Thus standard costing helps immensely in evaluation of performance of the organization. Estimated costs should not be confused with standard costs. Though both of them are future costs, there is a fundamental difference between the two. Estimated cost is more or less a reasonable assessment of what the cost will be in future while on the other hand, standard cost is a pre planned cost in the sense it denotes what the cost ought to be. Estimated costs are developed on the basis of projections based on past performance as well as expected future trends. Standard costs are pre determined in a scientific manner through technical analysis regarding the material consumption and time and motion study for determining labour requirements. Estimated costs may not help management in decision making as they are not scientifically pre determined costs but standard costs are decided after a comprehensive study and analysis of all relevant factors and hence provide reliable measures for product costing, product pricing, planning, co-ordination and cost control as well as reduction purposes. Under estimated costing, the cost is estimated in advance and is based on the assumption that costs are more or less free to move and that what is made is the best estimate of the cost. Under standard costing, a cost is established which is based on the assumption that cost will not be allowed to move freely but will be controlled as far as possible so that the actual cost will be close to the standard cost as far as possible and any variation between the standard and actual cost will be capable of reasonable explanation.

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CHAPTER 3 ADVANTAGES & LIMITATIONS OF STANDARD COSTING

ADVANTAGES OF STANDARD COSTING
The utility of standard help the management in fixation of prices and in laying down production policies. 1. Standards costs help the management in fixation of prices and in laying down production policies. 2. The help in readily showing up and then elimination of avoidable wastages and losses. 3. They provide constant and uniform bases for management on the operational efficiency of workers and other members of the staff. 4. Management, through the study of variances, needs to concentrate only areas and problems which call for its attention i.e., the system management by exception can be practiced. 5. Delegation of authority becomes effective the concerned men know what they have to achieve and by what standard they will be judged. 6. The whole concern in stimulated with a dynamic forward looking mentality. 7. Performance of employees at all levels can be judged objectively, this enables the concern to promote and regard the right person. 8. Standards act as a yardstick to measure the actual performance and the efficiency of labour and other factors. 9. Valuation of closing stock is facilitated by the standard cost of production. 10. As standards are set for every element of cost, the costing procedures are simplified.

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LIMITATIONS OF STANDARDS COSTING

Standard costing technique has the following short comings. 1. Setting of standards is a difficult task as it involves technical skill. 2. The fixation of inaccurate standards especially those that are incapable of achievement adversely affects the morale of the employees and act as hindrances to increased efficiency. 3. The system is not suitable for the jobbing type of industries producing articles according to customers specifications even if it is installed, the fixation of standards for type of job becomes difficult and expensive. 4. It is necessary to distinguish between controllable and uncontrollable variances in order to localize deviations and fixing responsibilities. 5. The system may not be suitable even in the case of industries that are liable to frequent technological changes affecting the conditions of production even if it is installed, a constant revision of standards become necessary. 6. Small concern cannot afford this system due to higher cost associated with standard costing. 7. There is no unanimity regarding the circumstances to be taken as the basis for setting standard costs. Even if there is unanimity a revision of standard is essential to suit to the changing circumstances. The revision of standards becomes expensive. If they are not revised, they become outmoded.

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CHAPTER 4 TYPE OF STANDARDS

The heart of the standard costing is setting of standards. Standard setting should be done extremely carefully to ensure that the standards are realistic and neither too high nor too low. If very high standards are set, it will be impossible to attain the same and there will be always an adverse variance. This will result in lowering the morale of the employees. On the other hand, if standards are set too low, they will be attained very easily and the favourable variances will create complacency amongst the employees. In view of this, the standards should be set very carefully. The following aspects should be taken into consideration before setting the standards.

Type of Standard: The important aspect is that what should be the level of standard from the point of attainment? Whether it should be very difficult to achieve or too easy to achieve? In other words whether the standards set should be too high or too low? Thus from the standard of attainment, there can be the following types of standards. I. Ideal Standard: The standards based on ideal conditions are ideal standards. The assumptions are that the most favourable production conditions will be attained, the plant will operate at maximum possible efficiency and the management will be such as to be capable of the highest performance. Ideal standards are also theoretical standards, representing perfect

performance. Such perfection exists only in the mind of the most zealous industrial engineer, and it is rarely attained in actual practice. Even if machines are cent percent efficient, which is a rare occurrence, the human element will usually ensure that maximum efficiency is not attained. Perfection is a myth and it can never be achieved when one has to deal with men, materials and machines, and not simply figures. Under ideal conditions, to produce a particular product, an absolute minimum of direct materials, at lowest possible prices is assumed; whereas, the prices are subject to both internal and external influences. Similarly, the time and rates of direct labour are assumed to be at very high standard of efficiency attainable with perfect conditions; and the attitudes of management and men are always unpredictable. The
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psychological impact of never reaching the targets set may result in a deterioration of morale which, in turn, reduces efficiency still further, thus commencing a chain reaction of ill-effects. Overhead costs are also set with maximum efficiency in mind. Extremely careful use of all services is anticipated, which is humanly impossible. Thus, in practice, ideal conditions rarely operate and therefore ideal standards cannot be regarded as standards for managerial control. II. Normal Standard: If standards are determined on the basis of the assumption that plant is working at normal level of capacity and efficiency, workers are engaged in production activities performing their normal functions and the normal efficiency operations are being carried out, the standards are regarded as normal standards. Normal standards take into consideration normal price level standards i.e., the prices which are expected to characterise the average over an entire business cycle. Standards should not be fixed on the basis of normal conditions, since there will be no scope left for control. III. Basic Standard: Basic Standard is the standard, which is established for an unaltered use for an indefinite period, which may be a very long period of time. Basic standards are revised very rarely, and hence the fluctuations in the costs and prices are not reflected in this standard. IV. Expected Standard: An Expected Standard is a standard, which, it is anticipated, can be attained during a future specified standard period. This standard is quite attainable, it is consistent and hence fulfils all the purposes of a good standard. It provides incentive to improve performance and get the better of the adverse conditions. These standards are formulated after making allowance for the cost of normal spoilage, cost of idle time due to machine breakdowns, and the cost of other events, which are unavoidable in normal efficient operations. Thus all the normal losses are taken into consideration. These standards are most accurate and very useful to the management in product costing, inventory valuations, estimates, analyses, performance evaluation, planning, and employee motivation for managerial decisionmaking.

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V. Historical Standard: This is the average standard, which has been achieved in the past. This standard tends to be a loose standard because there is a possibility that the average past performance may include inefficiencies, which will be passed on the new standards. However the utility of these standards is that past performance can be used as a basis for setting of standard in future.

Length of the period of use: The management has to take another crucial decision about the length of the period for which the standard will remain valid. In other words, it will have to be decided whether the standards should be revised too frequently or after a long time. In the types of standards, we have seen that there are basic standards, which remain unaltered for a long period of time while the current standards, and expected standards are revised more frequently. Thus it will have to be decided as to what should be the frequency of revision. Attainment Level: Before setting of standards, the management has to ascertain the level of attainment as regards to the output. While fixing the level, due considerations should be given to the constraints if any, on the production, level of efficiency, availability of skilled manpower, sales potential and so on.

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CHAPTER 5 SETTING OF STANDARD COSTS

In the previous paragraphs, we have seen the establishment of standards and the care to be taken for the same. Now we have to see the setting of standard costs for various elements of cost like material, labour and overheads and subsequently the computation and analysis of variances. It should be remembered that setting of standard costs is not the job of cost accounting department only, it is a task which is to be completed with the co-operation of departments like production, sales, manpower planning, personnel, and works study engineer and the cost accounting department. Without the co-operation and active participation of all the departments, setting of standard cost will be impossible and hence it is rightly said that techniques like standard costing and budgeting promotes co-ordination and team work in an organization. The setting of standard costs is discussed in the following paragraphs. Direct Material Cost Standard: Direct material is an important element of cost and in several industries; the direct material cost is 50% - 55% of the total cost. In case of industry like sugar, the material cost is nearly 65 70 % of the total cost. In view of this, there is a need to monitor the cost of material closely and take steps to control and reduce the same. Standard for direct material cost is set with this particular objective. The standard direct material cost indicates as to how much the material cost should have been and then it is compared with the actual cost to find out the difference between the two. The establishment of standard cost for direct materials involves the determination of, a] standard quantity of standard raw materials and b] standard price of raw material consumed. The standard quantity of materials is determined with the help of production department and while fixing the same; normal or inevitable losses are taken into consideration. The cost accounting department in co-operation with the purchase department determines standard price of material consumed. Recent prices, past prices and the likely trend of prices in the future are taken into consideration while fixing the standard prices. Similarly stock on hand, purchase orders already placed and likely fluctuations in the price should also be taken into consideration while fixing the material price standards.

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Direct Labour: Labour is also an important element of cost and the standard labour cost indicates the labour cost that should be incurred. Two factors need to be taken into consideration while fixing the standard labour cost. The first one is the standard time and the second one is the standard rate. For setting the standard time, it is necessary to conduct time and motion study with the help of Work Study Engineer. Firstly motion study is conducted to identify unnecessary motions and then to eliminate them. After elimination of unnecessary motions, standard time is allotted to the motions that are required to be performed for producing the product. While determining the standard time, allowance is made for normal idle time to cover mental and physical fatigue. The standard wage rate is fixed after considering the level of rates in the market, the degree of skill required for performing the job, the availability of manpower and the wage structure in the concerned industry. Concept of Standard Hour is extremely important in setting the standards for labour. It is a hypothetical hour, which represents the amount of work, which should be performed in one hour under standard conditions. Factory Overhead Standards: Setting of standard for overhead costs, there is a need to determine, a] standard capacity and b] standard overhead cost for that capacity. The standard overhead cost can be computed using normal capacity. Normal capacity is not the total installed capacity but it is the practical capacity, which is based on the resources available and efficient utilization of the same. After this the standard overheads are fixed. In case of variable overheads, since they remain constant per unit of the production, it is necessary to calculate only standard variable overhead rate per unit or per hour. In case of fixed overheads, budgeted fixed overheads and budgeted production are to be taken into consideration. A standard rate of fixed overhead per unit is then computed by dividing the budgeted fixed overheads by the budgeted production. Direct Expenses: If at all there are some items of standard expenses, rate per unit of the same may be determined on the basis of budgeted output and budgeted direct expenses.

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Reasonably attainable standards Standards, which can be attained reasonably if the management strives for them i.e. it makes a sincere and integrated effort to achieve the targets set in, can be regarded as satisfactory standards. It assumes a level of operation which is above the normal level of efficiency. So, it is an attainable good performance standard. According to National Association of Accountants, .the attainable good performance standard does not eliminate all waste, spoilage, lost time, etc., but includes these elements to the extent that management considers them impractical of elimination during the time the standard is to be in effect. The management by fixing costs at such a level can make wholehearted efforts to bring down the actual cost to the level of standards and can achieve better efficiency in the field of business operations. Too idealistic standards, that are not capable of being achieved, are a wasteful exercise since nobody attempts to achieve them; too loose standards only perpetuate inefficiency. Standards, therefore, should be such as to provide an incentive to the people concerned to achieve them and maximise efficiency. Thus, standard costs are very careful estimates of what the costs should be in respect of each element of cost for a given product or a given job. Such standards are not a myth, a miracle or a moon for a baby but are practical, realistic, capable of being attained if conditions are improved, strict control is exercised, wastes and in economies are checked and the utilisation of the present capacity is at the maximum possible level of efficiency. Such costs can be adopted for comparison with actual costs. The standards should, however, be elastic and dynamic. Flexibility and adaptability according to needs is one of the important characteristics of good standards. If circumstances warrant, standards should be capable of being revised. It does not mean that frequent change in standards is favored. As far as possible, stability should be tried to be maintained in standards so that they can serve as a basis for long term planning and control. It must not, however, be misunderstood that ideal standard can never be reasonably attainable standard. In an automated factory, having an efficient system of
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production control, including preventive maintenance, and also enjoying the trust and confidence of all personnel, ideal standard may be feasible. Standard costs, therefore, reflect the best judgment of management as to what costs ought to be if the plant were operated with a high degree of efficiency with the standards for material, labour and overhead set as to be possible of attainment. Standards Costing and Budgetary Control Standard costing and budgetary control both provide a powerful tool to the management for efficient performance of its functions. Both the systems have the common objectives of controlling business operations by establishment of predetermined targets, measuring the actual performances and comparing it with the targets, for the purpose of having better efficiency and of reducing costs. Standard Costing and Historical Costing Under historical costing, the costs are the actual costs and therefore, the question of exercising control does not arise at all. It is simply an analysis of costs after they have been incurred and, therefore, pertain to past data. Standard costing refers to that systems of costing where under the costs which ought to be there and should be attained are determined in advance. The following limitations of historical costing have led to the emergence of the technique of standard costing: 1. Data is obtained too late for price quotations and production planning. 2. Actual costs include abnormal expenses, avoidable wastes, ineffective use of labour etc. Therefore, historical cost is not a proper yardstick and is ineffective as a means of measuring performance efficiency. 3. The cost information obtained after completion of the job is of no practical utility for control purposes. 4. Historical costs may be very expensive to compile. If present actual costs are compared with the past actual costs, and if the past performance was bad, no useful purpose is going to be served. There may be movement of prices also, which will vitiate comparison. It is necessary for measurement of efficiency that price changes

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are separated from changes in the use of inputs in terms of quantity. This is fully ensured in standard costing. Standard Costing and Estimated Costing Estimated costing refers to that system of costing under which costs are estimated in advance meaning thereby that the costs which are likely to be incurred during a given period of time are conceived of well before their being incurred. This is done with reference to historical costs and the prevailing conditions of the business. It is an estimation of the actual costs or historical costs of a business in anticipation. Estimated cost and standard cost both are determined before the process of production commences, but they differ in regard to their purpose.

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CHAPTER 6 VARIANCE ANALYSIS

The main aim of the standard costing is the control of the cost. So the management is provided with the information about situations where in the actual results are not as they were planned to be. Hence management is informed of only the deviations or variances from the original plans, their favourable or unfavorable nature and the causes of such deviations. In this context standard costing subscribes to the principles of management by exception. Variance is the difference between standard cost and actual cost. It is expressed by a simple formula as follows: Variance = actual cost standard cost. Variance analysis is therefore the process of analysis variance by dividing the total variance in such a way that management can assign responsibility for off standard performance. If variance is to increase the profit it is said to be favourable shown as (F). It would result when the actual cost are lower than the standard costs. It is also known as positive or credit variance and viewed only as savings. If variance is not to increase the profit it is adverse or unfavorable shown as (A) it would result when actual costs exceed the standard costs. It is also known as negative or debit variance and viewed as additional costs or losses.

1. MATERIAL COST VARIANCE (MCV)

This is the difference between the standard cost of materials specified for the output achieved and the standard cost of the materials used Material Cost Variance = Total std. Total Actual Cost. MCW = (SQ*SP) (AQ * AP) Where : SQ = Standard Quantity SP = Standard Price AQ = Actual Quantity AP = Actual Price
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a) MATERIAL PRICE VARIANCE (MPV) This is the difference between the standard price specified and the standard price paid. MPV = AQ (SP AP) CAUSES 1. Change in basic purchase price of material. 2. Change in quantity of purchase or uneconomical size of purchase order. 3. Rush order to meet shortage of supply or purchase in less or more favourable market. 4. Failure to take advantage of off season price, the failure to purchase when price is cheaper. 5. Failure to obtain cash and trade discounts or change in the discount rates. 6. Weak purchase organisation. 7. Payment of excess or less freight 8. Transit losses and discrepancies if purchase price is inflated to include the loss. 9. Change in quality or specification or materials purchased. 10. Use of substitute material having a higher or lower unit price. 11. Change in materials purchase, upkeep and store keeping cost (this is applicable only when such charges are allocated to direct material costs on a predetermined or standard cost basis.) 12. Change in the pattern or amount of taxes and duties. b) MATERIAL USAGE VARIANCE (MUV) This is the difference between the standard quantity specified and actual quantity used. MUV = SP (SQ AQ) Material usage variance is subdivided into i) ii) Material mix variance Material yield variance or scrap variance

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i)

MATERIAL MIX VARIANCE (MMV) This is the portion of the direct material usage variance which is due to the

difference between the standard and the actual composition of a mixture. a) When the ratio of mix is different but the total quantities of standard mix and the total quantities of actual mix are the same. MMV = SP (SQ AQ)

b) When the total actual quantity and total standard quantity and the ratio of mix are different, then the standard quantity of the each material will be revised. MMV = (RQ AQ) * SP Where RQ denotes revised standard quantity, which is equal to

Total weight of actual mix --------------------------------- * Standard Quantity Total weight of standard mix

ii)

MATERIAL YIELD OR SCARP VARIANCE This is the portion of the direct material usage variance which is due to the

difference between standard yield specified and actual yield obtained. MYV = SP * Abnormal Loss / Gain Or MYV = SP (SY AY) The difference between standard yield and actual yield is called abnormal loss or gain. If the standard yield is less than the actual yield, the difference is called abnormal gain, and if the standard yield is higher than the actual yield the difference is called abnormal loss.

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CAUSES FOR MATERIAL USAGE VARIANCE The causes of material usage variance are: 1. Variation is usage of materials due to inefficient or careless use or economic use of materials. 2. Change in specification or design of product. 3. Inefficient and inadequate inspection of raw materials. 4. Purchase of inferior material or change in quality of materials. 5. Rigid technical specification and strict inspection leading to more rejections which require more materials for rectifications. 6. Inefficiency in production resulting in wastages. 7. Use of substitute materials. 8. Theft or pilferage of materials. 9. Inefficient labour force leading to excessive utilization of materials. 10. Defective machines, tools, and equipments, and bad or improper maintenance leading to breakdown and more usage of materials. 11. Yield from materials in excess of or less than that provided as the standard yield. 12. Faulty materials processing. Timber for example, if not properly seasoned may be wasted while being used in subsequent processes. 13. Accounting errors, e.g. when materials returned from shop or transferred from one job to another are not properly accounted for . 14. Inaccurate standards 15. Change in composition of a mixture of materials for a specified output.

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II

LABOUR COST VARIANCE (LCV)

It is the difference between standard direct specified for the activity achieved

and the actual direct wages paid. LCV SLC ALC (Standard Labour Cost Actual Labour Cost) Labour cost variance is sub-divided into 1) Rate or pay variance and 2) Efficiency variance, which is further sub divided into a. Idle time b. Calendar variance c. Mix variance d. Yield variance

1. LABOUR RATE OF PAY VARIANCE (LRV) This is that portion of labour cost variance which is due to the difference between the standard rates of pay specified and the actual rate paid. LRV = AT (SR - AR) = Actual time (standard rate actual rate)

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CAUSES FOR LABOUR COST VARIANCE Direct labour rate variance occurs due to the following: 1. Change in basic wage structure or change in piece work rate. This will give rise to the variance till such time the standards are not revised. 2. Employment of workers of grades and rates of pay different from those specified due to shortage of labour of the proper category, or through mistake, or due to the retention of surplus labour. 3. Payment of guaranteed wages to workers who are unable to earn their normal wages if such guaranteed wages form part of direct labour cost. 4. Use of a different method of payment e.g. payment of day rates while standards are based on piece work method of remuneration. 5. Higher to lower rates paid to casual and temporary workers employed to meet seasonal demands or urgent or special work. 6. 7. New workers not being allowed full normal wage rates. Over time and night shift work in excess of or less than the standard, or where no provision has been made in their standard. This will be applicable only if overtime and shift differential payments form that laid down in the standard.

2) LABOUR EFFICIENCY VARIANCE (LEV) This is also that portion of labour cost variance which is due to the difference between the standard labour hours specified for the outputs achieved and the actual labour hours expended. This is otherwise known as labor time variance. Labour spending variance, labour usage variance, labour quantity variance. LEV = SR (ST AT)

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CAUSES FOR LABOUR EFFICIENCY VARIANCE The causes giving rise to direct labour efficiency variance as follows: 1. 2. 3. Lack of proper supervision or stricter supervision that specified. Poor working conditions Delay due to, waiting for materials tools, instructions etc. if not treated as idle time. 4. 5. 6. Defective machine tools, and other equipments. Machine break down if not booked to idle time. Work on new machines requiring fewer tikes then provided for as long as the standard is not revised. 7. Basic inefficiency of workers due to low morale, insufficient training, faulty instructions, incorrect scheduling of jobs etc. 8. 9. Use of non standard material requiring more or less operation wages. Carrying our operations not provided for and booking them as direct wages. 10. 11. In correct standards Wrong selection of workers, e.g. no employing the right type of man for doing the job. 12. 13. Increase in labour turnover. Incorrect recording of performances, i.e. time and output.

LABOUR IDLE TIME VARIANCE (LITV) This is that the portion of labour cost variance which is due to the abnormal idle time of workers on account of failure of power supply, machine break down, shortage of materials etc. LITV = IH * SR (Idle hours * standard rate per hour)

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LABOUR CALENDAR VARIANCE (LCV) This arises only when workers are paid for the days for which they have not worked and for which no provision was made while determining standards. This will happen only when some special public holidays are declared. LCV = SR * Holidays

LABOUR MIX VARIANCE (LMV) It is due to the difference in the standard output specified and actual output obtained. LYV = Standard labor cost per unit (actual output standard output)

PROBLEM 1 The standard cost of the chemical mixture PQ is as follows: 40% of material P@ Rs. 400 per kg. 60% of material Q@ Rs. 600 per kg. A standard loss of 10% is normally anticipated in production. The following particulars are available for the month of September 1984. A standard loss of 10% is normally anticipated in production. The following particulars are available for the month of September 1984. 180 kgs. of material P have been used @ Rs. 360 per kg. 220 kgs. of material Q have been used @ Rs. 680 per kg. The actual production of PQ was Rs. 369 kgs. Calculate the following variance: a. Materials price variance b. Materials usage variance c. Materials mix variance d. Materials yield variance

Also show the reconciliation of standard cost with actual cost with actual cost with help of the above variance.
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Solution Standard loss is 10% Hence for productions of 90 kgs require input of 100 kgs. Therefore production of 369 kgs requires input of? 369 / 90 * 410 kgs.

MCV = (Standard cost of input of (410 kgs of production) (actual cost of production of 369 kgs)

P40% of 410 = 164 kgs at 400 Q60% of 410 149,600 ----Input Loss 410 kgs 41 ----Production 369 kgs = 246 kgs at 600

= 65600 P 180*360

64,800

= 147600 Q 220*680 =

-------------- ------213200 31 -------------- ------213200 369 400

---------214400 ------------214000

1. Material Cost Variance (MCV) = SC AC = 213200 214400 = Rs. 1200 (A)

2. Materials Price Variance (MPV) = AQ (SP-AP) P = 180 (400 360) = Q = 220 (600 680) = 7200 (F) 17600 (A)

--------------------10400 (A) --------------------3. Material Usage Variance (MUV) = SP (SQ-AQ) P = 400 (164 180) = 6400 (A) Q = 600 (246-220) = 15600 (F) ---------------------9200 (F)
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----------------------

Material Usage Variance is to be analysed into Mix Variance and yield variance as follows: SP (RSQ AQ)

(i)

Material Mix Variance (MMV) = = 400 (164 * 400 / 410 180) = 400 (160-180) Q = 600 (246*400/410 220) = 600 (246-220)

8000 (A)

12000 (F) --------------40000 (F) ---------------

Material yield variance (MY) Standard Cost per unit at output

= = =

SYR (SY-AY) 213200/369 Rs. 577.1778 per kg.

For an input of 410 Kgs. Standard yield is 369 kg For an input of 400 Kgs. Standard yield is ?

400 / 410 * 369 = 360 kgs. Standard yield for actual input MY = Rs. 577.1778 (360-368) =Rs. 5200(F)

(ii)

Labour Efficiency Variance (LEV) = SR (SH-AHP) = 3.00 (7000-8000) = 3000 (A)

(iii)

Labour Cost Variance (LCV) = SCAP AC = 21,000 24160 = 3160 (A)

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Note:- When there is difference between actual hours paid (AHP) and Actual Hours Worked (AHW) there will be Labour Efficiency Sub-variance and Idle time Variance which are calculated as follows:

Labour Efficiency Sub Variance = SR (SH-AHW) = 3.00 (7000-8000) = Rs. 2400 (A)

Labour Idle Time Variance

SR * No. of Hours lost

= 3.00 * 200 = Rs. 600 (A) -------------Rs. 3000 (A) --------------

This is reconciled with Labour Efficiency Variance as calculated above.

Reconciliation:

MUV 9200(F)

= =

MMV + MYV 400 (F) + 5200 (F)

Final Reconciliation: MCV 1200 (A) = = MPV + MMV + MYV 10400 (A) + 4000(F) + 5200(F)

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PROBLEM 2 The following details are available from the records of ABC Ltd. engaged in manufacturing Article A for the week ended 28th September. The Standard Labour hours for the week 1000 hrs and rates of payment per article A were as follows:

Hours

Rate per hour Rs.

Total Rs. 30 12 16 58

Skilled Labour Semiskilled Labour Unskilled Labour

10 8 16

3.00 1.50 1.00

The actual labour hours and rates of pay per hour were given below:

Hours

Rate per hour Rs.

Total Rs. 36000 12600 18000 66,600

Skilled Labour Semiskilled Labour Unskilled Labour

9000 8400 20000

4.00 1.50 0.90

From the above set of data you are asked to calculate:

a. Labour Cost Variance b. Labour Rate Variance c. Labour Efficiency Variance d. Labour Mix Variance

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Solution

SCSM SM Hours Rate Amount AM Rs. Skilled 1000 x 10 = 3,00 30000 10000 Semiskilled Unskilled 1000 x 8 = 1.50 12000 8000 1000 x 16 = 1.00 16000 16,000 Semiskilled Unskilled 8400 Skilled 9000

SCAM Hours Rate Amount Rs. 3.00 27,000

1.50 12,600

20000 1.00 20,000

34,000

58000

37400

59,600

(SCSM) a. Labour Cost Variance (LCV) = SC-AC = 58000-66600 = 8600(A)

b. Labour rate Variance (LRV) = AHP (SR-AR) Skilled = 9000 (3-4) = 9000(A) Semi-Skilled = 8400 (1.50 1.50) = Nil Un-Skilled = 20,000 (1 - .90) = 7000 (A)

c. Labour Efficiency Variance (LEV) = SR (SH-AHP) = 3.00 (10000 9000) = 3000(F) = 1.50 (8000 8400) = 600(A) = 1.00 (16000 20000) = 4000(A) ---------------1600(A)

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d. Labour Mix Variance (LMV) = SCSM SCAM = 58000 59600 = 1600(A)

OVERHEAD VARIANCE

Overhead Variance can be classified into (A) Variable Overhead Variance and (B) Fixed Overhead Variance.

OVERHEAD COST VARIANCE

Fixed Overhead Variance Expenditure Variance Volume Variance Variable Overhead Variance Expenditure Variance Efficiency Variance

Efficiency

Capacity

Calendar

Seasonal

1. Variable Overhead Variance: They are caused by difference between the actual variable overhead expenditure incurred and the standard allowed: VOHC = SOHC AOHC

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Variable Overhead = Standard Variable Overhead Cost on Cost Variance Actual Output Actual Variable Overhead Cost = (Actual output Standard Overhead Rate Actual Overhead udgeted Variable verhead udgeted utput in Units

Standard verhead Rate

Alternatively, the following variable overhead variance may be computed to make the position more clear:

(i)

Variable Overhead Expenditure Variance (VCHE x V) Cost This is the difference between standard variable Overhead allowance of actual

output, and the standard variable overhead of actual time. VOHE efficiency Variance = Standard Overhead Rate (Actual Time Standard time for actual production)

Total Variable Overhead = Expenditure Variance + Efficiency Variance

Fixed Overhead Cost Variance (FOHCV) : It is that portion of overhead variance which is due to the difference between fixed overhead recovered and the actual fixed overhead cost incurred. FOHCV = (Actual output * Standard fixed overhead Rate) Actual Overhead udgeted fixed verhead udgeted utput Units

Standard ixed verhead Rate

This variance is divided into (i) fixed Overhead Expenditure Variance and (ii) Fixed Overhead Volume Variance

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(i)

Fixed Overhead Expenditure (FOHEV) : It is the difference between actual overhead expenditure and the budgeted expenditure.

FOHEV = Budgeted fixed Overhead Actual Fixed Overhead = (Standard Recovery Rate * Budgeted Production) Actual Fixed Overheads

If the actual output is more than the budgeted output, it leads to over-recovery of overheads costs and a favourable variance results and vice versa. This variance is also known as Budget Variance or Cost Variance or Spending Variance.

(ii)

Fixed Overhead Volume Variance (FOHVV) : It is the difference between the standard cost of overhead absorbed in actual output and the standard allowance allowed for the output. This variance is caused due to the difference between the budgeted output and the actual output.

FOHVV = Standard Fixed Overhead Rate (Actual Quantity Budgeted Quantity) Or = Actual output * Standard Rate Budgeted Fixed Overhead

If the actual output is more than the budgeted output, it leads to over-recovery of overhead costs and favourable variables results and vice versa. The Volume Variance can further be analysed as under

(a) FIXED OVERHEAD EFFICIENCY VARIANCE (FOHEff.V)

It is that portion of volume variance which is due to the difference between the budgeted efficiency (in standard unit) and the actual efficiency achieved. This variance is like labour efficiency variance. FOHEff.V = Standard Overhead Rate per unit (Actual Quantity Standard Quantity)

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When the actual output is more than the standard quantity of output. Overhead Cost Variance: Causes Controllability

A.

Overhead 1.

Rise

in

prices, Uncontrollable

Expenditure Variance

wages 2. Lack of control over Dept. Manager Expenditure 3. Change in Production Manager

production 4. Change in nature of --do-service e.g. Use gas in lieu of electricity B. Volume Variance 1. Declining Sales Sales Manager

(Lack of orders) or Customer demands 2. Lack of proper Foreman

supervision 3. Defect in Machinery Maintenance Engineer (Breakdown) 4. Low efficiency of Foreman / Personnel worker 5. Poor Manager quality Purchase Manager

material 6. Abnormal idle time Foreman (if not booked as part Uncontrollable of time spent on jobs) 7. More or days less Uncontrollable / /

working Calendar

8. Strikes, absenteeism Personnel Manager including lateness

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PROBLEM 4

The following figures have been extracted from the cost records for the month of March 1997.

Standard Number produced Capacity Number worked Fixed overheads Variable overheads Rs. 22500 Rs. 15000 of 100% days 25 of units 7500

Actual 8000

105% 26

Rs. 23500 Rs. 15750

Analyse the total overhead variance into (i) (ii) (iii) Fixed overhead variance, Variable overhead variance, and Sub-variances under each head

Solution Overhead Cost Variance = Std. cost for Actual production Actual cost = 40,000 - 38,900 = Rs. 1,100 (F) 3 00 00

ote :

Overhead Cost Variance = FOHCV + VOHCV Rs. 1100 (F) = Rs. 850 (F) + 250 (F) = (AP * SOHR) APOH = 8000 x 3 23150 = Rs. 850 (F)

(a) FOHCV

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(b) Expenditure Variance = Budgeted Fixed Overheads Actual Fixed Overheads = Rs. 22500 Rs. 23150 = Rs. 650 (A) = BOHR AP * SOHR = 8000 x 3 Rs. 22500 = Rs. 1500 (F) Or SOHR (Budgeted output Actual output) = 3 x (7500 8000) = Rs. 1500(F) (d) Capacity variance Fixed Overhead Standard Rate per unit (Standard Quality for actual hours) For actual hours / days

(c) FOHVV

ixed overhead Rate

22 00 00

= Rs. 3

Standard production for actual hours =

00 100

= 7875 units (e) Calendar Variance = per unit Standard Fixed Cost (Actual Quantity Standard Quantity for actual capacity)

= Rs. 3 (8000-7875) = Rs. 375 (F)

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= 7875

FOHCV

= FOHEV + FOHVV = Rs. 650(A) + Rs. 1500 (F) = Rs. 850 (F)

Proof

FOH V.V. Rs. 1500(F)

= Cal. V. + Cap. V. + Eff. V. = Rs. 900(F) + Rs, 225 (F) + Rs. 375(F)

(i)

Variable overhead Variance = SC AC

Where

SC

= Rs. 16000 Rs. 15750 = Rs. 250(F)

(ii) Variable overhead Expenditure variance = BC AC = 26 x 600 = 15600 15750 = Rs. 150(A)

(iii) Variable overhead efficiency variance Where standard overhead rate per hour / day is given

Variable overhead
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Efficiency variance = SR (AT ST) = 600 (26 26.67) = Rs. 400 (F)

Where standard overhead rate per unit is given:

Variable overhead Efficiency variance = SR (AP SP) = 2 (8,000 7,800) = Rs. 400(F)

Check : VOHCV = VOH EX. V. + VOH Eff. V.

Rs. 250(F) = Rs. 150(A) + Rs. 400(F)

SALES VARIANCE
The cost variance so for explained ultimately affects profit favorably or adversely. Budgeted profit may be affected due to increase or decrease i) in the selling price and ii) the quantum of sales.

There are two distinct methods of computing and presenting sales variance.

i) ii)

Sales value or turnover method and Sales margin profit method.

The first method shows the effect of variance in terms of turnover. The second shows the effect in terms of profit. SALES VALUE VARIANCE

Price Variance

Volume Variance Mix Variance Quantity Variance

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Sales Value Method

(i)

Sales Value Variance: It is difference between standard

Or

Budgeted sales and the actual sales = Standard sales Actual sales

Sales Value Variance

Note: Standard Sales = Standard sales * Actual quantities of sales If actual sales are more than the budgeted or standard sales, a favourable variance would result and vice versa.

ii) Sales Price Variance: If is that portion of the sales value variance which is due to the difference between standard price specified and the actual price charged.

Sales Price Variance = Actual quantity Sold (Standard Price Actual

Price)

iii) Sales Volume Variance This is the difference between the budgeted sales and the standard value of the actual mix of sales. Sales Volume Variance = Standard Price (Actual Quantity Standard Quantity)

Or = Budgeted Sales Standard Sales

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If actual sales at standard price exceed the budgeted sales, there is a favourable variance and vice versa.

Thus, Sales Value Variance = Price Variance + Volume Variance

The volume variance can further be analyzed into (a) Mix Variance and (b) Quantity Variance

(a) Mix Variance: It is that portion of the sales value variance which is due to the difference between the standard and the actual interrelationship of the quantities of each product or product group of which sales are composed, where products are homogeneous. Total Quantity of Actual ix Total Quantity of Standard ix

ix Variance

Standard Cost of Standard mix

- Standard Cost of Actual Mix

Sales Margin Quantity Variance: This is the difference between sales margin volume variance and sales margin mix variance. Margin Quantity Variance = Standard Margin Rate (Standard Quantity Actual Quantity)

Sales Margin Due to Sales Allowance: It is that portion of total margin variance which is due to the difference between the budgeted rebates, discounts, etc., allowance on those sales:

Profit (or Loss) Variance:

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It is the difference between the budgeted profit (or Loss) and the actual profit (or loss).

Types A. Sales

Causes Price 1. Unexpected Competition

Controllability Uncontrollable

Variance

2. Rise in general price - Do level 3. Poor quality of material - Do Uncontrollable Publicity Manager

B. Sales Volume 1. Unexpected Competition Variance 2. Ineffective Sales

Proportion 3. Ineffective Supervision Sales Manager and control of salesman

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CHAPTER 7 CONCLUSION
There is difference of opinion among accountants as regards disposal of cost variance. However, the following methods are usually used to close the Standard Cost Variances: i) ii) iii) Transfer to profit and loss account. Allocation of finished stock, work in progress, and cost of sales; Transfer to Reserve Account i.e., to carry forward to the next financial year and to be set off in the subsequent year of years The standard costs are also incorporated in the accounting system so as to increase its statistical utility. The following are the methods for accounting based on standard costing. i) ii) iii) Partial plan method, Single plan method and Dual plan method.

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BIBLOGRAPHY

Books Referred
MANAGEMENT ACCOUNTING
STANDARD COSTING, VARIANCE ANALYSIS AND DECISION - MAKING By Bhattacharyya Debarshi

By Alexander Berger

Website Visited
www.caclubindia.com www.futureaccountant.com www.accountingtools.com www.globusz.com www.accountingcoach.com

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