Standard costing

Accounting A2 · Cost and management accounting. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

A standard cost is the planned cost of one unit: how much material and labour it should use and what each should cost. At the end of the period actual results are compared with the standard for the actual output. Each difference is a variance.

A variance is favourable if it makes profit higher than planned and adverse if it makes profit lower. Each total variance is split in two: one part for the price paid and one part for the quantity used. This shows managers where to look and who is responsible.

Variances are often linked. Cheaper material may give a favourable price variance but more waste, so an adverse usage variance.

Rules to remember

Direct material price variance = (standard price − actual price) × actual quantity. Usage variance = (standard quantity for actual output − actual quantity) × standard price.
Direct labour rate variance = (standard rate − actual rate) × actual hours. Efficiency variance = (standard hours for actual output − actual hours) × standard rate.
Fixed overhead expenditure variance = budgeted fixed overhead − actual fixed overhead.
Fixed overhead volume variance = (actual output − budgeted output) × standard fixed overhead per unit.
Capacity variance = (actual hours − budgeted hours) × fixed overhead rate per hour. Efficiency variance = (standard hours for actual output − actual hours) × fixed overhead rate per hour. Together they equal the volume variance.
Sales price variance = (actual price − standard price) × actual units sold. Sales volume variance = (actual units sold − budgeted units) × standard profit per unit.
With the formulas written this way, a positive answer is favourable and a negative answer is adverse.

Common mistake

Students compare actual usage or hours with the standard for the budgeted output. Always use the standard quantity or hours for the actual output.

Worked example

The standard for one unit is 2 labour hours at $12 per hour. Actual output was 1500 units. The workers took 3150 hours and were paid $36 225. Calculate the labour rate and efficiency variances.

Rate variance = (3150 hours × $12) − $36 225 = $37 800 − $36 225 = $1575 favourable.
Standard hours for actual output = 1500 × 2 = 3000 hours.
Efficiency variance = (3000 − 3150) × $12 = −$1800, so $1800 adverse.
Check: standard cost 3000 × $12 = $36 000; actual $36 225; total $225 adverse = $1575 F − $1800 A.

Answer: Labour rate variance $1575 favourable; labour efficiency variance $1800 adverse.

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