1. Standard costing

2. Standard costing system
The management evaluates the performance of a company by comparing it with some predetermined measures
Therefore, it can be used as a process of measuring and correcting actual performance to ensure that the plans are properly set and implemented

3. Procedures of standard costing system
Set the predetermined standards for sales margin and production costs
Collect the information about the actual performance
Compare the actual performance with the standards to arrive at the variance
Analyze the variances and ascertaining the causes of variance
Take corrective action to avoid adverse variance
Adjust the budget in order to make the standards more realistic

4. Functions of standard costing system
Valuation
Assigning the standard cost to the actual output
Planning
Use the current standards to estimate future sales volume and future costs
Controlling
Evaluating performance by determining how efficiently the current operations are being carried out

5. Setting of selling price
Motivation
Notify the staff of the management’s expectations
Setting of selling price

6. Variance

7. Variance analysis
A variance is the difference between the standards and the actual performance
When the actual results are better than the expected results, there will be a favourable variance (F)
If the actual results are worse than the expected results, there will be an adverse variance (A)

8. Profit variance Selling and administrative Cost variance
Total production
Cost variance
Total sales margin variance
Sales margin
Price variance
Sales margin
volume variance
Materials
cost
variance
Labour
Cost
variance
Variable
Overhead
variance
Fixed
Overhead
variance

9. Materials cost variance
Material Price variance
Material Usage variance
Labour cost variance
Labour Efficiency variance
Labour rate variance

10. Variable Overhead variance
VO Expenditure variance
VO Efficiency variance
Fixed Overhead variance
Fixed Volume variance
Fixed Expenditure variance

11. Cost variance

12. Cost variance Cost variance = Price variance + Quantity variance
Cost variance is the difference between the standard cost and the
Actual cost
Price variance = (standard price – actual price)*Actual quantity
A price variance reflects the extent of the profit change
resulting from the change in activity level
Quantity variance = (standard quantity – actual quantity)*
standard cost
A quantity variance reflects the extent of the profit change

13. Three types of cost variance
Material cost variance
Labour cost variance
Variable overheads variance

14. Material and labour variance

15. Material cost variance
Material price variance
= (standard price – actual price)*actual quantity
Material usage variance
= (Standard quantity – actual quantity)* standard price
= (Standard quantity for actual production – actual quantity production) * standard price

16. Labour cost variance Labour rate variance
= (standard price – actual price)*actual quantity
Labour efficiency variance
= (standard quantity – actual quantity)*standard price
= Standard quantity for actual production – actual quantity used) * standard price

17. Example

18. ABC Ltd. makes and sells a single product. The company uses a
Standard marginal costing system. It plans to produce and sell 1000
units in May A budget statement is produced as follow:
Budgeted income statement for the month ended 31 May 2005
$ $
Sales ($50*1000)
Less: Variable cost of goods sold
Direct materials ($3*4000)
Direct labour ($5*3000)
Variable overheads ($2*3000)
Budget contribution
Fixed overhead
Budget profit

19. The actual sales and production is 800 units. The actual income
statement is shown as follows:
Income statement for the month ended 31 May 2005
$ $
Sales ($60*800)
Less: Variable cost of goods sold
Direct materials ($3.2*2400)
Direct labour ($6*3200)
Actual Variable overheads
Contribution
Fixed overhead
Net profit

20. Material cost variance
Material price variance
= (standard price – actual price)*actual quantity
= ($3 - $3.2)*2400
= $480 (A)
Material usage variance
= (Standard quantity – actual quantity)* standard price
= (Standard quantity for actual production – actual quantity production) * standard price
= (4*800 – 2400)*$3
= $2400 (F)
4000 units
1000 units

21. Material cost variance
Material price variance $480 (A)
Material usage variance $2400 (F)
Total Material cost variance $1920 (F)

22. Labour cost variance Labour rate variance
= (standard price – actual price)*actual quantity
= ($5 - $6)*3200
= $3200 (A)
Labour efficiency variance
= (standard quantity – actual quantity)*standard price
= Standard quantity for actual production – actual quantity used) * standard price
= (3* 800 – 3200)*$5
= $4000 (A)
3000 units
1000 units

23. Labour cost variance Labour rate variance $3200 (A)
Labour efficiency variance $4000 (A)
Total labour cost variance $7200 (A)

24. Overheads variance

25. Overheads variance Variable overheads variance
Fixed overheads variance

26. Variable overheads variance
Variable overheads variance is the difference between the standard variable overheads absorbed into the actual output and the actual overheads incurred

27. Absorbed VO
(SP* standard
hours for actual
output
Actual VO
Budgeted VO
(SP * Actual
hours worked
VO expenditure variance/
VO spending variance
VO efficiency variance
Total VO variance
(under-/over- absorbed)

28. Calculation on overhead absorbed
Step 1
Step 2
Budgeted overheads
POAR =
Budgeted activity level in standard hours
Overhead absorbed = POAR * Standard hours for actual
number of units produced

29. Variable overheads variance
= variable overheads absorbed – actual variable overheads incurred
Variable overheads expenditure variance
= standard variable overheads for actual hours worked – Actual variable overheads incurred
Variable overheads efficiency variance
= Standard variable overheads for standard hours of output – Actual variable overhead absorbed
= (standard hours for actual output – Actual hours worked)* standard price

30. Example

31. ABC Ltd. makes and sells a single product. The company uses a
Standard marginal costing system. It plans to produce and sell 1000
units in May A budget statement is produced as follow:
Budgeted income statement for the month ended 31 May 2005
$ $
Sales ($50*1000)
Less: Variable cost of goods sold
Direct materials ($3*4000)
Direct labour ($5*3000)
Variable overheads ($2*3000)
Budget contribution
Fixed overhead
Budget profit

32. The actual sales and production is 800 units. The actual income
statement is shown as follows:
Income statement for the month ended 31 May 2005
$ $
Sales ($60*800)
Less: Variable cost of goods sold
Direct materials ($3.2*2400)
Direct labour ($6*3200)
Actual Variable overheads
Contribution
Fixed overhead
Net profit

33. Budgeted overheads
POAR =
Budgeted activity level in standard hours
= $6000
3000
= $2
Overhead absorbed = POAR * Standard hours for actual
number of units produced
= $2 *3 hr per unit * 800 units
Standard hr per unit = 3000 hr /1000 units

34. Variable overheads variance
= variable overheads absorbed – actual variable overheads incurred
= $ $5500
= $700 (A)
Variable overheads expenditure variance
= standard variable overheads for actual hours worked – Actual variable overheads incurred
= ($2* 3200 hr) - $5500
= $900 (F)

35. Variable overheads efficiency variance
= Standard variable overheads for standard hours of output – Actual variable overhead absorbed
= (standard hours for actual output – Actual hours worked)* standard price
= (3 hr *800 units – 4 hr *800 units)*$2
= $1600 (A)
Actual hour per unit = $3200 hr/800 units

36. Variable overheads variance
Variable overheads expenditure variance $900 F
Variable overheads efficiency variance $1600 A
Total Variable overhead variance $400 A

37. Sales variance

38. Budgeted
contribution
(Standard margin*
Standard volume)
Actual contribution
Budgeted contribution
(Standard margin * Actual
Volume)
Sales margin price variance
Sales margin volume variance
Total sales margin variance

39. Sales variance (Marginal costing)
Total sales margin variance
= actual contribution – budgeted contribution
= [(Actual selling price – Standard cost of sales )*Actual sales volume] – Budgeted contribution
Sales margin price variance
= (Actual contribution per unit – Standard contribution per unit) * Actual sales volume
Sales margin volume variance
= (Actual volume – Budget volume)* Standard contribution per unit

40. Sales variance (Absorption costing)
Sales margin price variance
= (Actual profit margin per unit – Standard profit margin per unit) * Actual sales volume
Sales margin volume variance
= (Actual volume – Budget volume)* Standard profit margin per unit

41. Example

42. ABC Ltd. makes and sells a single product. The company uses a
Standard marginal costing system. It plans to produce and sell 1000
units in May A budget statement is produced as follow:
Budgeted income statement for the month ended 31 May 2005
$ $
Sales ($50*1000)
Less: Variable cost of goods sold
Direct materials ($3*4000)
Direct labour ($5*3000)
Variable overheads ($2*3000)
Budget contribution
Fixed overhead
Budget profit

43. The actual sales and production is 800 units. The actual income
statement is shown as follows:
Income statement for the month ended 31 May 2005
$ $
Sales ($60*800)
Less: Variable cost of goods sold
Direct materials ($3.2*2400)
Direct labour ($6*3200)
Actual Variable overheads
Contribution
Fixed overhead
Net profit

44. Sales variance (Marginal costing)
Total sales margin variance
= actual contribution – budgeted contribution
= [(Actual selling price – Standard cost of sales )*Actual sales volume] – Budgeted contribution
= [($60 - $33)*800] - $17000
= $ $17000
= $4600 (F)
$33000/1000 units

45. Sales variance Sales margin price variance
= (Actual contribution per unit – Standard contribution per unit) * Actual sales volume
= [($60 - $33) – ($50 - $33)]*800
= $8000 F
Sales margin volume variance
= (Actual volume – Budget volume)* Standard contribution per unit
= ( )*$17
= $2800 (A)
$33000/1000 units
$17000/1000 units

46. Sales variance (Marginal costing)
Sales margin price variance $8000 F
Sales margin volume variance $3400 A
Total sales variance $4600 F

47. Sales variance (Absorption costing)
Sales margin price variance
= (Actual profit margin per unit – Standard profit margin per unit) * Actual sales volume
= [($60-$36) – ($50-$36)]*800
= $8000 F
Sales margin volume variance
= (Actual volume – Budget volume)* Standard profit margin per unit
= ( )*$14
= $3400 A
( )/1000 units
$14000/1000 units

48. Sales variance (Absorption costing)
Sales margin price variance $8000 F
Sales margin volume variance $2800 A
Total sales variance $5200 F

49. Fixed overhead variance

50. Absorbed VO
(SP* standard
hours for actual
output
Actual FO
Budgeted FO
FO expenditure variance/
FO spending variance
FO volume variance
Total FO variance
(under-/over- absorbed)

51. Fixed overhead variance
Fixed overheads variance
= Fixed overheads absorbed – Actual fixed overheads incurred
Fixed overheads expenditure variance
Budgeted fixed overheads – Budgeted overheads absorbed
Fixed overheads volume variance
= Absorbed fixed overheads – Budgeted overheads absorbed

52. Example

53. ABC Ltd. makes and sells a single product. The company uses a
Standard marginal costing system. It plans to produce and sell 1000
units in May A budget statement is produced as follow:
Budgeted income statement for the month ended 31 May 2005
$ $
Sales ($50*1000)
Less: Variable cost of goods sold
Direct materials ($3*4000)
Direct labour ($5*3000)
Variable overheads ($2*3000)
Budget contribution
Fixed overhead
Budget profit

54. The actual sales and production is 800 units. The actual income
statement is shown as follows:
Income statement for the month ended 31 May 2005
$ $
Sales ($60*800)
Less: Variable cost of goods sold
Direct materials ($3.2*2400)
Direct labour ($6*3200)
Actual Variable overheads
Contribution
Fixed overhead
Net profit

55. Fixed overhead variance
Fixed overheads variance
= Fixed overheads absorbed – Actual fixed overheads incurred
= ($1*3*800) - $2600
= $200 A
Fixed overheads expenditure variance
= Budgeted fixed overheads – Budgeted overheads absorbed
= $ $2600
= $400 F
Fixed overheads volume variance
= Absorbed fixed overheads – Budgeted overheads absorbed
= ($1*3*800) - $3000
= $600 A

56. FO Variance in marginal and absorption costing
In marginal costing:
Fixed overheads are charged as period costs instead of charging to product in marginal costing.
It is assumed that the fixed overheads remain unchanged with the change in the level of activity. Single fixed overhead expenditure variance will be used

57. In absorption costing
Fixed overheads are charged to the products and included in the valuation of closing stock.
Total fixed overheads variance is divided into fixed overheads price variance and fixed overheads volume variance

58. Profit reconciliation statement

59. Profit reconciliation statement
Profit reconciliation statement is used to sum up all variances
It can help the top management to explain the major reasons for the difference between budgeted and actual profits
The sales margin variance and fixed overheads variance are different between absorption and marginal costing system

60. Marginal costing

61. Profit Reconciliation Statement
$ $ $
Budgeted profit
Sales variances
Sales margin price 8000 F
Sales margin volume 3400 A F
Materials cost variance
Materials price 480 A
Material usage F F
Labour cost variance
Labour rate A
Labour efficiency 4000 A A
Variable overhead variance
VO Expenditure 900 F
VO Efficiency A 700 A
Fixed overhead expenditure variance 400F 980 A
Actual profit

62. Absorption costing

63. Profit Reconciliation Statement
Budgeted profit
Sales variances
Sales margin price 8000 F
Sales margin volume 2800 A F
Materials cost variance
Materials price 480 A
Material usage F F
Labour cost variance
Labour rate A
Labour efficiency 4000 A A
Variable overhead variance
VO Expenditure 900 F
VO Efficiency A 700 A
Fixed overhead variance
FO expenditure 400F
FO Volume A 200 A 980 A
Actual profit

64. Reasons for variances Material price variance
Price changes in market conditions
Change in the efficiency of purchasing dept. to obtain good terms from suppliers
Purchase of different grades or wrong types of materials

65. Reasons for variances Materials usage variance
More effective use of materials/ wastage arising from the efficient production process
Purchase of different grade or wrong types of materials
Wastage by the staff
Change in production methods

66. Reasons for variances Labour rate variance
Non-controllable market changes in the basic wage rate
Use of higher/lower grade of workers
Unexpected overtime allowance paid

67. Reasons for variances Labour efficiency variance
Purchase of different grade or wrong types of materials
Breakdown of machinery
High/low labour turnover
Changes in production method
Introduction of new machinery
Assignment wrong type of worker to work
Adequacy of supervision
Changes in working condition
Change in motivation methods

68. Reasons for variances Variable overheads expenditure variance
It may be caused by the non-controllable change in the price level of indirect wages or utility rates since the predetermined rate is set
It is meaningless to interpret this kind of variance on its own. One should look various components of the fixed overheads

69. Reasons for variances Variable overheads efficiency variance
Both the variable overheads and direct labour cost vary with the direct labour hours worked

70. Reasons for variances Fixed overheads expenditure
It is meaningless to interpret this kind of variance on its own.
It may be caused by the change in the price levels of rent, rates and other fixed expenses

71. Reasons for variances Fixed overhead volume variance
When the level of activity is higher than the budgeted level, there is a favourable variance

72. Reasons for variances Sales margin price variance
Change in the pricing strategies of the company
Response to the change of pricing policies of its competitors
Higher profit margin with growing demand for the product
Lower profit margin for simulating sales

73. Reasons for variances Sales margin volume variance
Change in prices and demand
Change in the market share of its competitiors