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-dened 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.

The success of a business enterprise depends to a greater extent upon how efficiently and effectively it has controlled its cost. In a broader sense the cost figure may be ascertained and recorded in the form of Historical costing and Predetermined costing. The term Historical costing refers to ascertainment and recording of actual costs incurred after completion of production .. One of the important objectives of cost accounting is effective cost ascertainment and cost control. Historical Costing is not an effective method of exercising cost control because it is not applied according to a planned course of action. And also it does not provide any yardstick that can be used for evaluating actual performance. Based on the limitations of historical costing it is essential to know before production begins what the cost should be so that exact reasons for failure to achieve the target can be identified and the responsibility be fixed. For such an approach to the identification of reasons to evaluate the performance, suitable measures may be suggested and taken to correct the deficiencies.

1.1 DEFINITION Standard Cost is dened as, a pre-determined cost which is calculated from managements standard of efcient operation and the relevant necessary expenditure. It may be used as a basis for price xation and for cost control through variance analysis. [CIMA UK] Standard Costing is de ned as, preparation and use of standard costs, their comparison with actual costs and analysis of variances into their causes and points of incidences. [CIMA UK] From the de nitions given above, the following features of standard cost and standard costing emerge. Meaning of both the terms will be clearer by going through carefully these features.

1.2 MEANING OF STANDARD COST AND STANDARD COSTING Standard Cost The word "Standard" means a "Yardstick" or "Bench Mark." The term "Standard Costs" refers to Predetermined costs. Brown and Howard define Standard Cost as a Pre-determined Cost which determines what each product or service should cost under given circumstances. This definition states that standard costs represent planned cost of a product. Standard Cost as defined by the Institute of Cost and Management Accountant, London "is the Predetermined Cost based on technical estimate for materials, labour and overhead for a selected period of time and for , a prescribed set of working conditions." Standard Costing Standard Costing is a concept of accounting for determination of standard for each element of costs. These predetermined costs are compared with actual costs to find out the deviations known as "Variances." Identification and analysis of causes for such variances and remedial measures should be taken in order to overcome the reasons for Variances. 598 A Textbook of Financial C~st and Management Accounting Chartered Institute of Management Accountants England defines Standard Costing as "the Preparation and use of standard costs, their comparison with actual costs and the analysis of variances to their causes and points of incidence."

2.STANDARD COSTING
2.1 Features of Standard Cost and Standard Costing

The following are the features of standard cost:

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 rm 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 ef cient operation. Thus standard cost xed on the assumption of 80% ef ciency will be different from what it will be if the assumption is of 90% ef ciency. Standard cost can be used as a basis for price xation as well as for exercising control over the cost. Standard Costing is a technique of costing rather than a method and has the following features:

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 351 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 pro ts. 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 nd out the reasons behind the same. After the ascertaining of the variances, analyzing them to nd 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 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 scienti c 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 scienti cally 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.

2.2 Difference between Estimated Costs and Standard Costs Although, Pre-determination is the essence of both Standard Costing and Estimated Costing, the two differ from each other in the following respects: Standard Costing (1)It is used on the basis of scientific. Estimated Costing(1) It is used on the basis of statistical facts and figures.

(2)It emphasises "what the cost should be." (2) It emphasises "what the cost will be." production. work. (3 (3)it is used to evaluate actual performance and it (3) It is used to cost ascertainment for fixing sales price. serves as an effective tool of cost. (4)It is applied to any industry engaged in mass (4) It is applicable to concern engaged in construction production. work. (5) It is a part of accounting system and standard (5) It is not a part of accounting system because it is costing variances are recorded in the books of based on statistical facts and figures. accounts. Compare and Contrast between Standard Costing and Budgetary Control : Relationship: The following are certain basic principles common to both Standard Costing and Budgetary Control: (1) Determination of standards for each element of costs in advance. (2) For both of them measurement of actual performance is targeted. (3) Comparison of actual costs with standard cost to .find out deviations. (4) Analysis of variances to find out the causes. (5) Give the periodic report to take corrective measures. Differences : Though Standard Costing and Budgetary Controls are aims at the maximum efficiencies and Marginal Cost, yet there are some basic differences between the two from the objectives of using the two costs. 2.3 Difference between Budgetary Control Standard Costing

Budgetary Control (1) Budgets are projections of financial accounts. .. (2) As a statement of both income and expenses it forms part of budgetary control. (3) Budgets are estimated costs. They are "what the cost will be."

Standard Costing

(1) Standard Costing is a projection of cost accounts. Standard costing is not used for the (2) purpose of forecasting. Standard Cost are the "Norms" or "what (3) cost should be." (4) Standard Costing cannot be used (4) Budget can be operated with standards. without budgets (5) In budgetary control variances are not (5) Under standard costing variances are revealed revealed through

through the accounts. (6) Budgets are prepared on the basis of historical facts and figures.

different accounts. Standard cost are planned and prepared (6) on the basis of technical estimates.

2.4 Advantages of Standard Costing (3) Standard Cost are the "Norms" or "what cost should be." (4) Standard Costing cannot be used without budgets (5) Under standard costing variances are revealed through different accounts. (6) Standard cost are planned and prepared on the basis of technical estimates. The following are the important advantages of standard costing : (1) It guides the management to evaluate the production performance. (2) It helps the management in fixing standards. (3) Standard costing is useful in formulating production planning and price policies. (4) It guides as a measuring rod for determination of variances. (5) It facilitates eliminating inefficiencies by taking corrective measures. (6) It acts as an effective tool of cost control. (7) It helps the management in taking important decisions. (8) It facilitates the principle of "Management by Exception." (9) Effective cost reporting system is possible. 2.5 Limitations of Standard Costing Besides all the benefits derived from this system, it has a number of limitations which are given below: (1) Standard costing is expensive and a small concern may not meet the cost. (2) Due to lack of technical aspects, it is difficult to establish standards. (3) Standard costing cannot be applied in the case of a- concern where non-standardised products are produced. (4) Fixing of responsibility is'difficult. Responsibility cannot be fixed in the case of uncontrollable variances. (5) , Frequent revision is required while insufficient staff is incapable of operating this system.

(6) Adverse psychological effects and frequent technological changes will not be suitable for standard costing system. 2.6 Determination of Standard Costs The following preliminary steps must be taken before determinatio.n of standard cost : (1) Establishment of Cost Centres. (2) Classification and Codification of Accounts. (3) Types of Standards to be applied. (a) Ideal Standard (b) Basic Standard (c) Current Standard (d) Expected Standard (e) Normal Standard

3. SETTING OF STANDARD

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 dif cult 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

I. Ideal Standard: An ideal standard is a standard, which can be attained under the most favourable conditions. The expected performance can be achieved only if all factors, such as material and labour prices, level of performance of employees, highest output with best possible equipment and machinery, highest level of ef ciency and so on. In practice, it is very dif cult to achieve this, as the combination of all favourable factors is almost impossible. Hence the utility of this standard is that it can be used for relatively long period of time without alteration. However, as the achievement is nearly impossible, the employee may be frustrated due to the constant adverse variances.

II. Normal Standard: This standard is the average standard, which is attainable during the future period of time, which may be long enough to cover one business cycle. This standard will be revised only after one business cycle is over and thus frequent revision is not required. Normal standard may be useful for management in long term planning.

III. Basic Standard: Basic Standard is the standard, which is established for an unaltered use for an inde nite period, which may be a very long period of time. Basic standards are revised very rarely, and hence the uctuations in the costs and prices are not re ected in this standard.

IV. Expected Standard: An Expected Standard is a standard, which, it is anticipated, can be attained during a future speci ed standard period. This standard is quite attainable, it is consistent and hence ful ls 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 ef cient 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 decision-making.

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 inef ciencies, 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 lengthof 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 xing the level, due considerations should be given to the constraints if any, on the production, level of ef ciency, availability of skilled manpower, sales potential and so on.

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, 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 nd 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 xing 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 xing the standard prices. Similarly stock on hand, purchase orders already placed and likely uctuations in the price should also be taken into consideration while xing the material price standards.

Direct Labour: Labour is also an important element of cost and the standard labour cost indicatesthe labour cost that should be incurred. Two factors need to be taken into consideration while xing the standard labour cost.

The rst 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 xed after considering the level of rates in the market, the degree of s kill 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 ef cient utilization of the same. After this the standard overheads are xed. In case of variable overheads, since they remain constant per Cost and Management AccountingStandard Costing unit of the production, it is necessary to calculate only standard variable overhead rate per unit or per hour. In case of xed overheads, budgeted xed overheads and budgeted production are to be taken into consideration. A standard rate of xed overhead per unit is then computed by dividing the budgeted xed 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.

3.1 Standard for Direct Material Cost The following are the standard involved in direct materials cost: (i) Material Quantity or Usage Standard. (ii) Material Price Standard.

(i) Material Usage Standard: Material Usage Standard is prepared on the basis of material specifications and quality of materials required to manufacture a product. While setting of standards proper allowance should be provided for normal losses due to unavoidable occurrence of evaporation, breakage etc. (ii) Material Price Standard: Material Price Standard is calculated by the Cost Accountant and the Purchase Manager for each type of materials. When this type of standard is used, it is essential to consider the important factors such as market conditions, forecasting relating to the trends of prices, discounb etc. 3.2 Standard for Direct Labour Cost The following standards are established: (i) Fixation of Standard Labour Time (ii) Fixation of Standard Rate (i) Fixation of Standard Labour Time: Labour Standard time is fixed and it depends upon the nature of cost unit, nature of operations performed, Time and Motion Study etc. While determining the standard time normal ideal time is allowed for fatigue and other contingencies. (ii) Fixation of Standard Rates: The standard rate fixed for each job will be determined on the basis of methods of wage payment such as Time Wage System, Piece Wage System, Differential Piece Rate System and Premium Plan etc. 3.3 Setting Standards for Overheads The following problems are involved while setting standards for overheads: (1) Determination of standard overhead cost (2) Estimating the production level of activity to be measured in terms of common base like machine hours, units of production and labour hours. Setting of overhead standards is divided into fixed overhead. variable overhead and semi-variable overhead. The determination of overhead rate may be calculated as follows : (a)Standard Overhead Rate = Standard overhead for the budget period / Standard Production for the budget period (b)Standard Variable Overhead Rate = Standard overhead for the budget period/ Standard Production for the budget period

Standard Hour: Usually production is expressed in terms of units, dozen. kgs, pound, litres etc. When productions are of different types, all products cannot be expressed in one unit. Under such circumstances, it is essential to have a common unit for all the products. Time factor is common to all the operation. ICMA, London, defines a Standard Time as a "hypothetical unit pre-established to represent the amount of work which should be performed in one hour at standard performance." Standard Cost Card: After fixing the Standards for direct material, direct labour and overhead cost, they are recorded in a Standard Cost Card. This Standard cost is presented for each unit cost of a product. The total Standard Cost of manufacturing a product can be obtained by aggregating the different Standard Cost Cards of different proceses. These Cost Cards are useful to the firm in production planning and pricing policies.

4.MATERIAL VARIANCES In the material variances, the main objective is to nd out the difference between the standard cost of material used for actual production and actual cost of material used. Thus the main variance in this category is the cost variance, which is thereafter broken down into other variances. These variances are given below.

Material Cost Variance Material cost variance = (AQ x AP) (SQ x SP) where AQ AP SQ SP = Actual quantity = Actual price = Standard quantity for the actual output = Standard price

Materials Usage Variance Materials quantity variance = (Actual quantity Standard quantity) x Standard price Materials Price Variance Materials price variance = (Actual price Standard price) x Actual quantity Materials Mix Variance Materials mix variance = (Actual mix Revised standard mix of actual input) x Standard price Revised standard proportion is calculated as follows:

Standard mix of a particular material x Actual input Total standard quantity

Materials Yield Variance Yield variance = (Actual yield Standard yield specified) x Standard cost per unit OR Yield variance = (Actual loss Standard loss on actual input) x Standard cost per unit I] Material Cost Variance: As mentioned above, this variance shows the difference between the standard cost of material consumed for actual production and the actual cost. The following formula is used for computation of this variance. Material Cost Variance: Standard Cost of Material Consumed for Actual Production Actual CostIf the actual cost of material consumed is less than the standard cost of material consumed, the variance is favourable, otherwise it is adverse.

Material Price Variance: One of the reasons for difference between the standard material cost and actual material cost is the difference between the standard price and actual price. Material Price Variance measures the difference between the standard price and actual price with reference to the actual quantity consumed. The computation is as shown below: Material Price Variance: Actual Quantity [Standard Price Actual Price]

Material Quantity [Usage] Variance: This variance measures the difference between the standard quantity of material consumed for actual production and the actual quantity consumed and the same is multiplied by standard price. The computation is as shown below.

Material Quantity [Usage] Variance: Standard Price [Standard Quantity Actual Quantity]

The total of Price Variance and Quantity Variance is equal to Cost Variance Material Cost Variance = Material Price Variance + Material Quantity Variance

Material Mix Variance: In case of several products, two or more types of raw materials are mixed to produce the nal product. In such cases, standard proportion of mixture is decided in advance. For example, in manufacturing one unit of product P, material A and B may have to be mixed in a standard proportion of 3:2. This is called as a standard mix. However, when the actual production begins, the actual proportion of mix may have to be changed due to several reasons like non-availability of a particular material etc. In such cases material mix variance arises. The mix variance is computed

in the following manner. Material Mix Variance = Standard Cost of Standard Mix Standard Cost of Actual Mix

Material Yield Variance: In any manufacturing process, some unavoidable loss always takes place.

Thus if the input is 100, output may be 95, 5 units being normal or unavoidable loss. The normal loss is always anticipated and taken into consideration while determining the standard quantity. Yield variance arises when the actual loss is more or less than the normal loss. The computation of yield variance is as given below. Material Yield Variance = SYR [Actual Yield Standard Yield]

SYR = Standard Yield Rate, i.e. standard cost per unit of standard output.

Reconciliation: Quantity Variance = Mix Variance + Yield Variance.

5.LABOUR VARIANCES

Like the material variances, labour variances arise due to the difference between the standard labour cost for actual production and the actual labour cost. The following variances are computed in case of direct labour. Labour Variances can be classified into:

(a) Labour Cost Variance (LCV) (b) Labour Rate Variance or Wage Rate Variance (c) Labour Efficiency Variance (d) Labour Idle Time Variance (e) Labour Mix Variance (0 Labour Revised Efficiency Variance (g) Labour Yield Variance Labour Cost Variance Labour cost variance = (AH x AR SH x SR) where AH AR SH SR = Actual hours = Actual rate = Standard hours = Standard rate

Labour Efficiency Variance Labour efficiency variance = (Actual hours Standard hours for the actual output) x Std. rate per hour. Labour Rate Variance Labour rate variance = (Actual rate Standard rate) x Actual hours Labour Mix Variance Labour mix variance = (Actual labour mix Revised standard labour mix in terms of actual total hours)

x Standard rate per hour

Labour Yield Variance Labour yield variance = (Actual loss Standard loss on actual hours) x Average standard labour rate per unit of output I] Labour Cost Variance: This variance is the main variance in case of labour and arises due to the difference between the standard labour cost for actual production and the actual labour cost. The following formula is used for computation of this variance. Labour Cost Variance = Standard Labour Cost for Actual Production Actual Labour Cost

This variance will be favourable is the actual labour cost is less than the standard labour cost and adverse if the actual labour cost is more than the standard labour cost.

II] Labour Rate Variance: One of the reasons for labour cost variance is the difference between the standard rate of wages and actual wages rate. The labour rate variance indicates the difference between the standard labour rate and the actual labour rate paid. The formula for computation is as under. Labour Rate Variance: Actual Hours Paid [Standard Rate Actual Rate]

This variance will be favourable if the actual rate paid is less than the standard rate. The labour rate variance is that portion of direct labour cost variance, which is due to the difference between the labour rates. III] Labour Ef ciency Variance: It is of paramount importance that ef ciency of labour is measured. For doing this, the actual time taken by the workers should be compared with the standard time allowed for the job. The standard time allowed for a particular job is decided with the help of time and motion study. The ef ciency variance is computed with the help of the following formula. Labour Ef ciency Variance = Standard Rate [Standard Hours for Actual Output Actual Hours worked]

This variance will be favourable is the actual time taken is less than the standard time.

IV] Labour Mix Variance or Gang Composition Variance: This variance is similar to the material mix variance and is computed in the same manner. In doing a particular job, there may be a particular combination of labour force, which may consist of skilled, semi skilled and unskilled workers. However due to some practical dif culties, this composition may have to be changed. How much is the loss caused due to this change or how much is the gain due to this change is indicated by this variance. The computation is done with the help of the following formula. Labour Mix Variance = Standard Cost of Standard Mix Standard Cost of Actual Mix.

V] Labour Yield Variance: This variance indicates the difference between the actual output and the standard output based on actual hours. In other words, a comparison is made between the actualproduction achieved and the production that should have been achieved in actual number of working hours. The variance will be favourable is the actual output achieved is more than the standard output. The computation is done in the following manner. Labour Yield Variance = Average Standard Wage Rate Per Unit [Actual Output Standard Output] VI] Idle Time Variance: This variance indicates the loss caused due to abnormal idle time. While xing the standard time, normal idle time is taken into consideration. However if the actual idle time is more than the standard/normal idle time, it is called as abnormal idle time. This variance will be always adverse and will be computed as shown below.

Idle Time Variance = Abnormal Idle Time X Standard Rate.

6. OVERHEAD VARIANCES Overhead may be defined as the aggregate of indirect material cost, indirect labour cost and indirect expenses. Overhead Variances may arise due to the difference between standard cost of overhead for actual production and the actual overhead cost incurred. The Overhead Cost Variance may be calculated as follows: Total Overhead Cost Variance (Actual overhead incurred Standard hours for the actual output x Standard overhead rate per hour) OR (Actual overhead incurred Actual output x Standard overhead rate per unit) Variable Overhead Variance (Actual overhead cost Actual output x Variable overhead rate per unit) OR (Actual overhead cost Standard hours for actual output x Standard variable overhead rate per hour) Fixed Overhead Variance (Fixed overhead variance = Actual overhead cost Fixed overhead absorbed) OR (Actual overhead cost Standard hours for actual output x Standard fixed overhead rate per hour) Variable Overhead Expenditure (Spending or Budget) Variance (Actual variable overhead Budgeted variable overhead) Variable Overhead Efficiency Variance (Actual hours Standard hours for actual output x Standard variable overhead rate per hour) Fixed Overhead Expenditure (Spending or Budget) Variance (Actual fixed overhead Budgeted fixed overhead)

Fixed Overhead Volume Variance (Budgeted overhead applied to actual output Budgeted fixed overhead based on standard hours output) OR (Actual production Budgeted production) x Standard fixed overhead rate per unit Fixed Overhead Efficiency Variance Fixed overhead efficiency variance = (Actual hours Standard hours for actual production) x Standard fixed overhead rate per hour OR Fixed overhead efficiency variance = (Actual production Standard production as per actual time available) x Standard fixed overhead rate per unit Fixed Overhead Capacity Variance Capacity variance = (Actual capacity hours Budgeted capacity hours) x Standard fixed overhead rate per hour allowed for actual

The overhead variances show the difference between the standard overhead cost and the actual overhead cost. In case of direct material and direct labour variances, there is no question of dividing them into xed and variable as the direct material and direct labour costs are variable. However, in case of overheads, it is necessary to divide them into xed and variable for computation of variances. We will take up the xed overhead variances rst and then the variable overhead variances. The xed overhead variances are discussed in the following paragraphs. I] Fixed Overhead Variances: The following variances are computed in case of xed overheads.

A. Fixed Overhead Cost Variance: This variance indicates the difference between the standard xed overh eads for actual production and the actual xed overheads incurred. Actually this variance indicates the under/over absorbed xed overheads. If the actual overheads incurred are more than the standard xed overheads, it indicates the under absorption of xed overheads and the variance is favourable. On the other hand, if the actual overheads incurred are more than the standard xed overheads, it indicates the over absorption of xed overheads and the variance is adverse. The following formula is used for computation of this variance. Fixed Overhead Cost Variance: Standard Fixed Overheads for Actual Production Actual Fixed Overheads.

B. Fixed Overhead Expenditure/Budget Variance: This variance indicates the difference between the budgeted xed overheads and the actual xed overhead expenses. If the actual xed overheads are more than the budgeted xed overheads, it is an adverse variance as it means overspending as compared to the budgeted amount. On the other hand, if the actual xed overheads are less than the budgeted xed overheads, it is a favourable variance. This variance is computed with the help of the following formula. Fixed Overhead Expenditure Variance: Budgeted Fixed Overheads Actual Fixed Overheads C] Fixed Overheads Volume Variance: This variance indicates the under/over absorption of xed overheads due to the difference in the budgeted quantity of production and actual quantity of production. If the actual quantity produced is more than the budgeted one, this variance will be favourable but it will indicate over absorption of xed overheads. On the other hand, if the actual quantity produced is less than the budgeted one, it indicates adverse variance and there will be under absorption of overheads. The formula for computation of this variance is as shown below: Fixed Overhead Volume Variance: Standard Rate [Budgeted Quantity Actual Quantity]

Reconciliation I = Fixed Overhead Cost Variance = Expenditure Variance + Volume Variance D] Fixed Overhead Ef ciency Variance: It is that portion of volume variance which arises due to the difference between the output actually achieved and the output which should have been achieved in the actual hours

worked. This variance will be favourable it the actual production is more than the standard production in actual hours. The formula for computation of this variance is as follows: Fixed Overhead Ef ciency Variance: Standard Rate [Standard Production Actual Production]

E] Fixed Overhead Capacity Variance: This variance is also that portion of volume variance, which arises due to the difference between the capacity utilization, i.e. the capacity actually utilized and the budgeted capacity. If the capacity utilization is more than the budgeted capacity, the variance is favourable, otherwise it will be adverse. The formula is as follows: Fixed Overheads Capacity Variance: Standard Rate [Standard Quantity Budgeted Quantity] Reconciliation II = Volume Variance = Ef ciency Variance + Capacity Variance

F] Fixed Overhead Revised Capacity Variance: This variance indicates the difference in capacity utilization due to working for more or less number of days than the budgeted one. The computation of this variance is done by using the following formula. Fixed Overhead Revised Capacity Variance = Standard Rate [Standard Quantity Revised Budgeted Quantity]

G] Fixed Overheads Calendar Variance: This variance indicates the difference between the budgeted quantity of production and actual quantity of production achieved arising due to the difference in the number of days worked and budgeted. The formula for computation of this variance is as follows. Fixed Overheads Calendar Variance = Standard Rate [Budgeted Quantity Revised Budgeted Quantity]

II] Variable Overhead Variances: The following variances are computed in case of variable overheads.

A] Variable Overhead Cost Variance: This variance indicates the difference between the standard variable overheads for actual overheads and the actual overheads. The difference between the two arises due to the

variation between the budgeted and actual quantity. The formula for the computation of this variance is as follows: Variable Overhead Cost Variance = Standard Variable Overheads for Actual Production Actual Variable Overheads.

B] Variable Overheads Expenditure Variance: This variance indicates the difference between the standard variable overheads to be charged to the standard production and the actual variable overheads. If the actual overheads are less than the standard variable overheads, the variance is favourable, otherwise it is adverse. The formula for the computation is as follows: Variable Overhead Expenditure Variance = Standard Variable Overheads for Standard Production Actual Variable Overheads. C] Variable Overheads Ef ciency Variance: It indicates the ef ciency by comparing between the output actually achieved and the output that should have been achieved in the actual hours worked. [Standard Production] This variance will be favourable if the actual output achieved is more than the standard output. The formula for computation is given below: Variable Overheads Ef ciency Variance: Standard Rate [Standard Quantity Actual Quantity]

Important note: All the formulae mentioned above are with reference to the quantity. All overhead variances can also be computed with relation to number of hours. In one of ths illustrations, this is demonstrated. (B)

7.SALE VARIANCES The Variances so far analysised are related to the cost of goods sold. Quantum of profit is derived from the difference between the cost and sales revenue. Cost Variances influence the amount of profit favourably or adversely depending upon the cost from materials, labour and overheads. In addition, it is essential to analyse the difference between actual sales and the targeted sales because this difference will have a direct impact on the profit and sales. Therefore the analsysis of sales variances is important to study profit variances. Sales Variances can be calculated by Two methods: I. Sales Value Method. II. Sales Margin or Profit Method. III. Sales Value Method The method of computing sales variance is used to denote variances arising due to change in salesprice, sales volume or the sales value. The sales variances may be calssified as follows : Sales Value Variance Sales value variance = (Actual value of sales Budgeted value of sales) Actual sales = Actual quantity sold x Actual selling price Budgeted sales = Standard quantity x Standard selling price OR Sales value variance = (Actual quantity x Actual selling price) (Standard quantity x Standard selling price) Sales Price Variance Sales price variance = (Actual selling price Budgeted selling price) x Actual quantity Sales Volume Variance Sales volume variance = (Actual quantity Budgeted quantity) x Budgeted selling price

Sales Mix Variance Sales mix variance = (Actual mix quantity sold Actual quantity in standard proportion) x Standard selling price Sales mix variance = (Budgeted Price per unit of actual mix Budgeted price per unit of budgeted mix) x Total actual quantity Sales Quantity Variance Sales quantity variance = (Total actual quantity Total budgeted quantity) x Budgeted price per unit of budgeted mix Total Sales Margin Variance Total sales margin variance = Actual profit Budgeted profit Sales Margin Price Variance Sales margin price variance = (Actual margin per unit Budgeted margin per unit) x Actual quantity

Sales Margin Volume Variance Sales margin volume variance = (Actual quantity Budgeted quantity) x Budgeted margin per unit (a) Sales Value Variance (b) Sales Price Variance (c) Sales Volume Variance (d) Sales Mix Variance (e) Sales Quantity Variance (a) Sales Value Variance: This Variance refers to the difference between budgeted sales and actual sales. It may

be calculated as follows : Sales Value Variance = Actual Value of Sales - Budgeted Value of Sales Note: If the actual sales is more than the budgeted sales, the variance will be favourable and vice versa. (b) Sales Price Variance: This is the portion of Sales Value Variance which is due to the difference between standard price of actual quantity and actual price of the actual quantity of sales. The formula is : Sales Price Variance = Actual Quantity x (Standard Price - Actual Price) Note : If the actual price is more than standard price the variance is favourable and vice versa. (c) Sales Volume Variance: It is that part of Sales Value Variance which is due to the difference between the actual quantity or volume of sales and budgeted quantity or volume of sales. The variance is calculated as : Note: If the actual quantity sold is more than the budgeted quantity or volume of sales, the variance is favourable and vice versa. (d) Sales Mix Variance: It is that portion of Sales Volume Variance which is due to the difference between the standard proportion of sales and the actual composition or mix of quantities sold. In other words it is the difference of standard value of revised mix and standard value of actual mix: It is calculated as : (e) Sales Quantity Variance: It is a sub variance of Sales Volume Variance. This is the difference between the revised standard quantity of sales and budgeted sales quantity. The formula for the calculation of this variance is Note: If the Revised Standard Quantity is greater than the standard quantity, the variance is favourable and vice versa. II. Sales Margin or Profit Method Under this method of variance analysis, variances may be computed to show the effect on profit. The sales variance according to this method can be classified as follows : (1) Sales Margin Value Variance (2) Sales Margin Volume or Quantity Variance (3) Sales Margin Price Variance

(4) Sales Margin Mix Variance (1) Sales Margin Value Variance: This is the difference between the actual value of sales margin and budgeted value of sales margin. It is calculated as follows : Sales Margin Value Variance = Budgeted Profit - Actual Profit Note: If the actual profit is more than budgeted profit the variance is favourable and vice versa. (2) Sales Margin Volume Variance: It is that portion of Total Sales Margin Variance which is due to the Note: If the actual quantity is more than standard quantity. the variance is favourable and vice versa. (3) Sales Margin Price Variance: This variance is the difference between the standard price of the quantity of the sales effected and the actual price of those sales. It is calculated as follows : Sales Margin Price Variance = Standard Profit - Actual Profit Note: If the actual profit is greater than the standard profit. the variance is favourable and vice versa. (4) Sales Margin Mix Variance: This is that portion of the Sales Margin Volume or Quantity Variance which is due to the difference between the actual and budgeted quantities of each product of which the sales mixture is composed valuing the difference of quantities at standard margin. Thus, this variance arises only where more than one product is sold. It is calculated as follows: Note: If the actual quantity is greater than the revised standard quantity, the variance is favourable and vice versa.

8.CONCLUSION

Standard costing is an important subtopic of cost accounting. Standard costs are usually associated with a manufacturing company's costs of direct material, direct labor, and manufacturing overhead.

Rather than assigning the actual costs of direct material, direct labor, and manufacturing overhead to a product, many manufacturers assign the expected or standard cost. This means that a manufacturer's inventories and cost of goods sold will begin with amounts reflecting the standard costs, not the actual costs, of a product. Manufacturers, of course, still have to pay the actual costs. As a result there are almost always differences between the actual costs and the standard costs, and those differences are known as variances.Standard costing and the related variances is a valuable management tool. If a variance arises, management becomes aware that manufacturing costs have differed from the standard (planned, expected) costs.

If actual costs are greater than standard costs the variance is unfavorable. An unfavorable variance tells

management that if everything else stays constant the company's actual profit will be less than planned.

If actual costs are less than standard costs the variance is favorable. A favorable variance tells

management that if everything else stays constant the actual profit will likely exceed the planned profit.The sooner that the accounting system reports a variance, the sooner that management can direct its attention to the difference from the planned amounts.

If we assume that a company uses the perpetual inventory system and that it carries all of its inventory accounts at standard cost (including Direct Materials Inventory or Stores), then the standard cost of a finished product is the sum of the standard costs of the inputs:

1. Direct material 2. Direct labor 3. Manufacturing overhead a. Variable manufacturing overhead b. Fixed manufacturing overhead