This document provides an overview of standard costing and variance analysis. It defines key terms like standard costs, variances, and different types of variances. The document outlines the advantages and disadvantages of standard costing. It then provides details on different types of variances including sales, direct material, direct labor, variable overhead, and fixed overhead variances. An illustrative example is included to demonstrate calculating variances for a company's widget and gadget production.

1. STANDARD COSTING AND
VARIANCE ANALYSIS
Business Accounting – ACC1644/1244

2. CHAPTER OUTLINE
1. Introduction
2. A standard costing system
i. Advantages of standard costing
ii. Disadvantages of standard costing
3. Variance analysis
4. Sales variances
i. Sales price variance
ii. Sales quantity variance
5. Production cost variances
i. Direct material variances
ii. Direct labour variances
iii. Variable manufacturing overheads variances
iv. Fixed manufacturing overheads variances

3. INTRODUCTION
 In a manufacturing environment, it can be difficult to
tract down the causes of variances unless a detailed
analysis is carried out.
 These variances can be identified and quantified by using
a standard costing system

4. A STANDARD COSTING SYSTEM
 Used to improve planning and control, and to facilitate product costing.
 Forces planning, resulting in a more efficient operation with less waste,
eliminating overspending, excessive inventory, wasted time, etc.
 A standard is a benchmark or a norm for measuring performance.
 Standards fall into two categories:
 Ideal standards – which allow for no breakdown or other work interruptions.
 Practical or currently attainable standards – which can be reached under efficient
operating conditions without extraordinary effort by properly trained and
experienced employees.
 A standard cost prescribes performance and minimum allowable costs.
 Each element of cost of production is broken-down and costed.
 Standard cost card is drawn up for each product.
 Setting standards
 Historical data provide a good starting point for determining standards for
materials, labour and overheads.
 This data must be adapted for changes in technology, production methods, etc.
 Effective standard setting requires a combined effort and experience of all
concerned to predict future trends.
 These standards must be revised regularly.

5. ADVANTAGES OF STANDARD COSTING
 Provides a good basis for cost comparisons, in particular
with the use of flexible budgets.
 Enables managers to use management by exception
whereby their attention is focused only on those
variances that are significant, thereby saving
management time.
 Provides a basis for managerial performance evaluation
and determining bonuses.
 Participation in setting standards and assigning
responsibility can have motivational effects on
employees

6. DISADVANTAGES OF STANDARD COSTING
 Tend to focus too heavily on cost minimisation.
 May encourage cost reduction, which can adversely
affect other areas of strategic importance.
 Controlling one department’s costs may increase costs in
other departments.
 Places too much emphasis on the cost and efficiency of
direct labour, which can be insignificant in the face of
increasing automation.
 Variance analysis does not explicitly encourage
continuous improvement due to 12-month standards.
 Standard costs become outdated quickly due to shorter
product life cycles.

7. VARIANCE ANALYSIS
 The overall variance as learnt in flexible budgets can be
broken down in order to identify the effects on the volume and
price of resource inputs.
 Variances arise when the actual quantity or price of a
production component differs from the standard quantity or
price.
 Each production component can have a price (rate, budget or
spending) variance, and a quantity (efficiency or usage)
variance.
 Costs that should have been incurred at the actual level of
activity according to the standard are compared with actual
costs incurred. The difference is the variance.
 A favourable variance occurs when actual costs are less than
the standards costs at actual volume.
 An unfavourable variance occurs when actual costs are more
than the standard costs at actual volume.

8. Figure 14.1 - Diagrammatic illustration of variances
VARIANCE ANALYSIS

9. SALES VARIANCES
Sales price variance
(AP – SP) × AQ
Sales quantity variance
(AQ – SQ) × Standard gross profit per unit
(Standard gross profit per unit = Standard selling price –
Standard cost price)
See ILLUSTRATIVE EXAMPLE page 256

10. ILLUSTRATIVE EXAMPLE
WG Ltd Manufactures products Widget and Gadget. The following information
is relevant to the two products:
Required:
Calculate the following variances for each product and in total:
1. Sales price variance
2. Sales quantity variance
Where necessary round off to two decimal places
Budgeted
sales
(units)
Budgeted
productio
n cost per
unit (R)
Standard
sales
price per
unit (R)
Actual
sales
(units)
Actual
sales in
rands
Widget 1 200 10 20 1 100 19 800
Gadget 800 5 10 720 7 920
2 000 1 820 27 720

11. ILLUSTRATIVE EXAMPLE -
SOLUTION
1. Sales price variance: (AP – SP) * AQ
Widget = (R18* – R20) X 1 100 units = R2 200 U
Gadget = (R11* – R10) x 720 units = R720 F
Total sales price variance = R2 200 – R720 = R1 480 U
*R19 800/1 100 units = R18
*R7 920/720 units = R11
You sold each unit of widget for R2 less and you sold each unit of gadget for R1
more
2. Sales quality variance: (AQ – SQ) x Standard gross profit
Widget = (1 100 – 1 200) * (R20 – R10) = R1 000 U
Gadget = (720 – 800) x (R10 – R5) = R400 U
Total sales quantity variance = R1 000 + R400 = R1 400 U
You sold fewer units than expected for both widget and gadget

12. PRODUCTION COST VARIANCES
Direct materials variances
• Price variance
(SP – AP) × AQ
• Usage (quantity) variance
(SQ – AQ) × SP
• Total direct materials variance
(AP × AQ) – (SP × SQ) or Price variance + Usage variance

13. Direct labour variances
• Rate variance
(SR – AR) × AH
• Efficiency variance
(SH – AH) × SR
• The total labour variance
(AR × AH) – (SR × SH) or
Rate variance + Efficiency variance
PRODUCTION COST VARIANCES

14. Variable manufacturing overheads variances
• Spending (rate) variance
(AR – SR) × AH
• Efficiency variance
(SH – AH) × SR
• Total variable manufacturing overhead variance
(AR × AH) – (SR × SH) or
Spending variance + Efficiency variance
PRODUCTION COST VARIANCES

15. Fixed manufacturing overheads variances
• Marginal costing system
AFO – BFO
• Absorption costing system
(BH – SH) × SR or
(Actual units – Budgeted units) × SR
PRODUCTION COST VARIANCES

16. COMPREHENSIVE ILLUSTRATIVE EXAMPLE
The following information has been extracted from the records of
Senayshia’s Beautiful Baskets for the month of March 20x1:
Standard cost card:
R
Materials 1,40 kg @ R4,10/kg 5,74
Direct labour 0,90 hours @ R4,50/hour 4,05
Variable overheads R2,20/hour @ 0,90 hours 1,98
Fixed overheads 6,34
18,11

17. COMPREHENSIVE ILLUSTRATIVE EXAMPLE
Senayshia’s Beautiful Baskets
Performance report
Original
budget
Flexible
budget
Actual Variance F/U
Volume 240 000 220 000 220 000
Sales R6 000 000 R5 500 000 R5 060 000 R440 000 U
Less: Cost of sales R4 346 400 R4 111 000 R4 049 698 R61 302 F
Direct materials R1 377 600 R1 262 800 R1 252 240 R10 560 F
Direct labour R972 000 R891 000 R857 648 R33 352 F
Variable overheads R475 200 R453 600 R438 570 R2 970 U
Fixed overheads R1 521 600 R1 521 600 R1 501 240 R20 360 F
Profit R1 653 600 R1 389 000 R1 010 302 R378 698 U

18. COMPREHENSIVE ILLUSTRATIVE EXAMPLE
Variable overheads allocation is based on direct labour hours, while
fixed manufacturing overheads are allocated on the basis of units
produced, all at predetermined rates based on budgeted costs and
volumes.
Actual production costs:
Material 313 060 kg @ R4 per kg
Direct labour 194 920 hours @ R4,40 per hour
Required
Prepare a comprehensive variance analysis.

19. DIRECT MATERIAL VARIANCES
Material price variance = (SP – AP) * AQ
= (R4,10 – R4) * 313 060
= R31 306 (F)
Material usage variance = (SQ – AQ) * SP
= [(220 000 * 1,40) – 313 060] * R4,10
= R20 746 (U)
Total material variance = R31 306 – R20 746
= R10 560 (F)

20. DIRECT LABOUR VARIANCES
Direct labour rate variance = (SR – AR) * AH
= (R4,50 – R4,40) * 194 920
= R19 492 (F)
Direct labour efficiency variance = (SH – AH) * SR
= [(220 000 * 0,90 hours) – 194 920] x R4,50
= R13 860 (F)
Total labour variance = R19 492 + R13 860
= R33 352 (F)

21. VARIABLE OVERHEADS VARIANCE
Variable o/h expenditure variance = (SR – AR) x AH
= (R2,20 – R2,25) x 194 920
= R9 746 (U)
Variable o/h efficiency variance = (Standard hours – Actual hours)
x Standard rate
= (198 000 – 194 920) x R2,20
= R6 776 (F)
Total variable overheads = (AH x AR) – (SH x SR)
= (194 920 x R2,25) – (220 000 x
0,90 x R2,20)
= 438 570 – 435 600
= R2 970 (U)

22. FIXED OVERHEADS VARIANCE
Fixed o/h expenditure variance = Budgeted cost – Actual cost
= R1 521 600 – R1 501 240
= R20 360 (F)
Fixed o/h volume variance = (Actual units – budget units) x
Standard rate
= (220 000 – 240 000) x R6,34
= R126 800 (U)
Total fixed o/h variance = Actual cost – (Actual units x SR)
= R1 501 240 – (220 000 x R6,34)
= R1 501 240 – R1 394 800
= R106 440 (U)

23. SALES VARIANCES
Sales price variance = (AP – SP) x AQ
= (R23 – R25) x 220 000
= R440 000 (U)
Sales volume variance = (AV – BV) x Standard profit
= (220 000 – 240 000) x (R25 – R18,11)
= R137 800 (U)

24. Senayshia’s Beautiful Baskets
Standard cost operating statement
R R
Budgeted net profit 1 653 600
Add/(less): Sales volume variances (137 800) U
Standard profit (flexed budget profit) 1 515 800
Add/(less): Favourable/adverse variance (505 498) U
Sales price (440 000) U
Material price 31 306 F
Material usage (20 746) U
Labour rate 19 492 F
Labour efficiency 13 860 F
Variable overhead rate (9 746) U
Variable overhead efficiency 6 776 F

25. Fixed overhead expenditure 20 360 F
Fixed overhead volume (126 800) U
Actual profit 1 010 302