40 Standard Costing and Variance Analysis

40.1 What is Standard Costing?

Standard costing is a costing system in which pre-determined costs (standards) are set for materials, labour and overhead, and actual costs are compared against these standards to identify variances and act on them. The Indian standard text — M.N. Arora — defines it as “a technique which uses standard costs for the purpose of cost control and performance evaluation” (arora2020?). CIMA defines a standard cost as “the planned unit cost of a product, component or service in a period” (cima2005?).

Standard costing is the control counterpart of budgeting: budgets set targets for the whole organisation; standard costing sets targets per unit.

Three Working Definitions

Source	Definition	What it foregrounds
CIMA	“Standard cost = planned unit cost of a product, component or service in a period.”	Planned unit cost
ICMA	“The pre-determined cost which is calculated from management’s standards of efficient operation and the relevant necessary expenditure.”	Efficiency basis
M.N. Arora	“A technique which uses standard costs for the purpose of cost control and performance evaluation.”	Control

40.1.1 Why standard costing?

Five Reasons for Standard Costing

Reason	What it does
Cost control	Quickly highlights deviations from plan
Performance evaluation	Gives a clear basis to judge each cost centre
Pricing	Provides a defensible per-unit cost
Inventory valuation	Used in some entities to value stock
Motivation	Standards become aspirational targets

40.2 Types of Standards

Standards differ on how tight they are:

Four Types of Standards

Standard	What it assumes	Use
Ideal / Theoretical	Perfect efficiency, no breakdowns, zero waste	Aspirational; rarely achievable
Basic	Long-run benchmark; rarely revised	Long-term trend analysis
Current	Reflects current attainable conditions	Most useful for short-term control
Normal	Average over a normal cycle	Smooths cyclical variations

The current attainable standard — tight but achievable — is the textbook recommendation for performance evaluation.

40.3 Setting Standards

For each unit of product, three families of standards are set.

Standards by Cost Element

Element	Standard for quantity	Standard for price
Material	Standard quantity per unit	Standard price per unit of material
Labour	Standard hours per unit	Standard wage rate per hour
Overhead	Standard hours per unit	Standard overhead rate per hour

The standard cost of a unit is the product of standard quantity × standard price across these elements.

40.4 Variance Analysis — the Big Picture

A variance is the difference between actual cost and standard cost (or between actual outcome and budget). Variances are classified as favourable (F) when actual is better than standard (lower cost or higher revenue) and adverse (A) when actual is worse.

Cost vs Sales Variances

Variance type	Driver	Sub-variances
Material cost variance	Material price + material usage	Price + Usage (= Mix + Yield in multi-material processes)
Labour cost variance	Labour rate + labour efficiency	Rate + Efficiency (+ Idle-time + Mix in some texts)
Overhead cost variance	Variable overhead + fixed overhead	Variable: Spending + Efficiency. Fixed: Budget (Spending) + Volume
Sales variance	Sales price + sales volume	Price + Volume (= Mix + Quantity)

flowchart TB
  TCV[Total Cost Variance] --> M[Material Variance]
  TCV --> L[Labour Variance]
  TCV --> O[Overhead Variance]
  M --> MP[Material Price]
  M --> MU[Material Usage]
  MU --> MMix[Mix]
  MU --> MYield[Yield]
  L --> LR[Labour Rate]
  L --> LE[Labour Efficiency]
  LE --> Idle[Idle-time]
  LE --> LMix[Mix]
  O --> VO[Variable Overhead]
  O --> FO[Fixed Overhead]
  VO --> VS[Spending]
  VO --> VE[Efficiency]
  FO --> FB[Budget]
  FO --> FV[Volume]
  style TCV fill:#FCE4EC,stroke:#AD1457

40.5 Material Variances

Material Variance Formulas

Variance	Formula
Material Cost Variance (MCV)	(Standard Quantity × Standard Price) − (Actual Quantity × Actual Price)
Material Price Variance (MPV)	Actual Quantity × (Standard Price − Actual Price)
Material Usage Variance (MUV)	Standard Price × (Standard Quantity − Actual Quantity)
Material Mix Variance (MMV)	Standard Price × (Revised Standard Quantity − Actual Quantity)
Material Yield Variance (MYV)	Standard Price × (Standard Quantity − Revised Standard Quantity)

The relationship: MCV = MPV + MUV and MUV = MMV + MYV.

40.6 Labour Variances

Labour Variance Formulas

Variance	Formula
Labour Cost Variance (LCV)	(Standard Hours × Standard Rate) − (Actual Hours × Actual Rate)
Labour Rate Variance (LRV)	Actual Hours × (Standard Rate − Actual Rate)
Labour Efficiency Variance (LEV)	Standard Rate × (Standard Hours − Actual Hours)
Labour Idle-time Variance	Idle Hours × Standard Rate (always Adverse)
Labour Mix Variance	Standard Rate × (Revised Standard Hours − Actual Hours)
Labour Yield Variance	Standard Rate × (Standard Hours − Revised Standard Hours)

The relationship: LCV = LRV + LEV.

40.7 Overhead Variances

Overhead variances split into variable and fixed. The standard formulas:

Variable Overhead Variances

Variance	Formula
Variable Overhead Cost Variance	Standard VO − Actual VO
Variable Overhead Spending (Expenditure) Variance	(Actual Hours × Standard VO Rate) − Actual VO
Variable Overhead Efficiency Variance	Standard VO Rate × (Standard Hours − Actual Hours)

Fixed Overhead Variances

Variance	Formula
Fixed Overhead Cost Variance	Standard FO − Actual FO
Fixed Overhead Budget (Spending) Variance	Budgeted FO − Actual FO
Fixed Overhead Volume Variance	Standard FO Rate × (Actual Output − Budgeted Output)
Fixed Overhead Capacity Variance	Standard FO Rate × (Actual Hours − Budgeted Hours)
Fixed Overhead Efficiency Variance	Standard FO Rate × (Standard Hours − Actual Hours)

A useful sanity check — Volume Variance = Capacity + Efficiency (when expressed in standard rate × hours).

40.8 Sales Variances

Sales variances are computed in two ways — profit-based and value-based. The formulas (profit-based):

Sales Variance Formulas (Profit-based)

Variance	Formula
Sales Value Variance	Actual Sales − Budgeted Sales
Sales Price Variance	Actual Quantity × (Actual Price − Standard Price)
Sales Volume Variance	Standard Price × (Actual Quantity − Budgeted Quantity)
Sales Mix Variance	Standard Price × (Actual Quantity − Standard Mix Quantity)
Sales Quantity Variance	Standard Price × (Standard Mix Quantity − Budgeted Quantity)

40.9 Reconciliation of Profit

The standard end-of-period exercise — reconcile the standard profit to the actual profit through variances:

\[\text{Standard Profit} \pm \text{Sales Variances} \pm \text{Cost Variances} = \text{Actual Profit}\]

The reconciliation is the output of variance analysis — and the input to managerial action.

40.10 Limitations

Five Limitations of Standard Costing

Limitation	Implication
Setting standards	Difficult and expensive — needs technical study
Frequent revision	Standards become outdated as technology and prices change
Unsuitable for non-standard work	Job-shop and bespoke work have no repeating standards
Variance can mislead	Adverse usage variance may reflect investment in better quality
People issues	Tight standards can demotivate; lax standards mean little control

Modern responses include kaizen costing (continuous improvement targets), target costing (set cost backwards from a target price), and activity-based costing (drive overhead allocation by activities, not just hours).

40.11 Practice Questions

Q 01 Definition Easy

A "standard cost" is best described as:

AThe actual cost incurred
BThe pre-determined unit cost based on management's standards of efficiency
CThe historical average of past costs
DThe market price of finished goods

View solution

Correct Option: B

A standard cost is a pre-determined, planned unit cost — set under stated conditions of efficiency.

Q 02 Types Medium

Which standard assumes perfect efficiency with no breakdowns or waste?

ABasic standard
BCurrent attainable standard
CIdeal / theoretical standard
DNormal standard

View solution

Correct Option: C

Ideal standards assume zero idle time, zero scrap, perfect efficiency. Current attainable is the textbook recommendation.

Q 03 Material Price Medium

The Material Price Variance is computed as:

A(SQ − AQ) × SP
B(SP − AP) × AQ
C(SP × SQ) − (AP × AQ)
D(AP − SP) × SQ

View solution

Correct Option: B

MPV = (Standard Price − Actual Price) × Actual Quantity.

Q 04 Material Cost Identity Medium

The relationship between Material Cost Variance, Material Price Variance and Material Usage Variance is:

AMCV = MPV − MUV
BMCV = MPV + MUV
CMCV = MPV × MUV
DMCV is independent of MPV and MUV

View solution

Correct Option: B

MCV = MPV + MUV. Similarly LCV = LRV + LEV.

Q 05 Labour Idle Medium

A labour idle-time variance is:

AAlways favourable
BAlways adverse
CSometimes favourable, sometimes adverse
DNever recorded

View solution

Correct Option: B

Idle time = paid hours during which no work was done. The variance is the wage cost of that idle time and is always adverse.

Q 06 Volume Medium

The Fixed Overhead Volume Variance arises because:

AActual fixed overhead differs from budgeted fixed overhead
BActual production differs from budgeted production at the standard fixed overhead rate
CWage rates differ from standards
DMaterial prices change

View solution

Correct Option: B

Volume variance = (Actual Output − Budgeted Output) × Standard FO rate. It captures the under- or over-absorption of fixed overhead because of volume.

Q 07 Sales Volume Medium

The Sales Volume Variance measures the impact on profit / sales of:

AA change in selling price
BA change in quantity sold against budget
CA change in production cost
DA change in tax rate

View solution

Correct Option: B

Sales volume variance = (Actual Quantity − Budgeted Quantity) × Standard Price (or Std contribution per unit, in profit-based form).

Q 08 Modern Variants Medium

"Target costing" — a modern alternative / complement to standard costing — is best described as:

AAdd cost + desired profit to set the price
BSet a target price first, subtract desired profit, design within the resulting cost
CReconcile actual profit to budgeted profit
DApportion overheads by activities

View solution

Correct Option: B

Target costing: target price → minus required profit → permissible target cost → design and procure within it. Originated in Japanese manufacturing (Toyota).

Quick recall

Standard cost = pre-determined unit cost. Standard costing = control technique using standards.
Four types: ideal · basic · current attainable · normal. Use current attainable for performance evaluation.
Three families of cost variances: Material · Labour · Overhead. Plus Sales variances.
Material: MCV = MPV + MUV; MUV = MMV + MYV.
Labour: LCV = LRV + LEV. Idle-time variance is always adverse.
Overhead — variable: spending + efficiency. Fixed: budget + volume; volume = capacity + efficiency.
Sales: price + volume; volume = mix + quantity.
Reconciliation: Standard profit ± sales variances ± cost variances = Actual profit.
Modern: kaizen costing, target costing, activity-based costing.