41  Standard Costing and Variance Analysis

41.1 What is Standard Costing?

Standard Costing is the technique of pre-determining costs of products or operations, comparing them with actual costs, and analysing the differences (variances) to take corrective action. It grew out of the scientific management movement of Frederick W. Taylor and Frank Gilbreth in the early 20th century, and was systematised by G. Charter Harrison in the US (1911) and Sir John Mann in the UK.

TipWorking definitions
Author / body Definition
CIMA “The preparation and use of standard costs, their comparison with actual costs and the analysis of variances to their causes and points of incidence.”
ICMA London “The pre-determined cost calculated in relation to a prescribed set of working conditions.”
Charles T. Horngren “Carefully determined cost per unit of input or output, usually expressed per unit of finished product.”
Brown & Howard “A technique of cost accounting which compares the standard cost of each product/service with the actual cost to determine the efficiency of operations.”
Wheldon “A pre-determined cost which is calculated from management’s standards of efficient operations and the relevant necessary expenditure.”
NoteStandard Cost vs Estimated Cost

Standard cost is what cost should be — based on engineered standards. Estimated cost is what cost is likely to be — based on past data. Standards are normative; estimates are predictive.

41.2 Objectives of Standard Costing

TipObjectives of standard costing
  • Cost control — pinpoint variances and act.
  • Performance evaluation — by responsibility centres.
  • Cost reduction — through analysis.
  • Pricing decisions — reliable benchmark.
  • Inventory valuation — at standard cost.
  • Management by Exception — focus on significant variances.
  • Budgeting — building block.
  • Productivity measurement and incentives.

41.3 Types of Standards

TipFour types of standards
Type Description
Ideal / Theoretical Perfect conditions; no waste; rarely achievable
Basic Long-term, unchanging; for trend analysis
Normal / Expected Based on expected average performance under normal conditions
Attainable / Current Tight but achievable with reasonable effort — most used
NoteMost-used: Attainable

Attainable / Current standards allow for normal idle time, wastage and inefficiencies — making them motivating and realistic. Ideal standards demotivate; normal are too loose.

41.4 Setting Standards

TipSetting standards for each element
  • Direct Material standards — quantity (engineering/BOM) × price (market study, supplier quotes).
  • Direct Labour standards — time (time-and-motion study) × rate (wage agreements).
  • Variable Overhead standards — variable OH rate × activity level.
  • Fixed Overhead standards — budgeted FOH ÷ budgeted output (or hours).
  • Sales standards — price × volume × mix.

41.5 Variance Analysis — The Heart of Standard Costing

A variance = the difference between standard (or budgeted) cost/revenue and actual cost/revenue. Variances can be:

  • Favourable (F) — actual better than standard (lower cost, higher revenue).
  • Adverse / Unfavourable (A or U) — actual worse than standard.

Variances are first split by element (material, labour, overhead, sales), then within each element into price and quantity (or rate and efficiency) components.

flowchart TB
  TV[Total Cost<br/>Variance]
  TV --> MV[Material<br/>Variances]
  TV --> LV[Labour<br/>Variances]
  TV --> OV[Overhead<br/>Variances]
  TV --> SV[Sales<br/>Variances]
  MV --> MPV[Price]
  MV --> MUV[Usage]
  LV --> LRV[Rate]
  LV --> LEV[Efficiency]
  OV --> VOH[Variable OH]
  OV --> FOH[Fixed OH]
    classDef default fill:#003366,color:#ffffff,stroke:#ffcc00,stroke-width:3px,rx:10px,ry:10px;

41.6 Material Variances

TipMaterial variances — formulas
Variance Formula
Material Cost Variance (MCV) (SQ × SP) − (AQ × AP)
Material Price Variance (MPV) (SP − AP) × AQ
Material Usage / Quantity Variance (MUV) (SQ − AQ) × SP
Material Mix Variance (MMV) (RSQ − AQ) × SP
Material Yield / Sub-usage Variance (MYV) (SQ − RSQ) × SP
Identity MCV = MPV + MUV; MUV = MMV + MYV

Where SQ = Standard Quantity for actual output, AQ = Actual Quantity, SP = Standard Price, AP = Actual Price, RSQ = Revised Standard Quantity in actual proportion.

NoteCauses of MPV and MUV

MPV — market price change, change of supplier, transport, bulk discount, quality grade. MUV — wastage, pilferage, scrap, quality of material, employee skill.

41.7 Labour Variances

TipLabour variances — formulas
Variance Formula
Labour Cost Variance (LCV) (SH × SR) − (AH × AR)
Labour Rate Variance (LRV) (SR − AR) × AH
Labour Efficiency Variance (LEV) (SH − AH worked) × SR
Idle Time Variance (LITV) Idle Hours × SR (always Adverse)
Labour Mix Variance (LMV) (RSH − AH) × SR
Labour Yield Variance (LYV) (SH − RSH) × SR
Identity LCV = LRV + LEV; LEV = LMV + LYV + LITV

Where SH = Standard Hours, AH = Actual Hours, SR = Standard Rate, AR = Actual Rate, RSH = Revised Standard Hours.

41.8 Overhead Variances

41.8.1 Variable Overhead Variances

TipVariable OH variances
Variance Formula
Variable OH Cost Variance Standard VOH − Actual VOH
Variable OH Expenditure / Spending Variance (SR × AH) − Actual VOH
Variable OH Efficiency Variance (SH − AH) × SR

41.8.2 Fixed Overhead Variances

TipFixed OH variances (the seven sub-variances)
Variance Formula
Fixed OH Cost Variance Absorbed FOH − Actual FOH
Fixed OH Expenditure / Budget Variance Budgeted FOH − Actual FOH
Fixed OH Volume Variance Absorbed FOH − Budgeted FOH
Capacity Variance (AH − Budgeted Hours) × SR
Efficiency Variance (SH − AH) × SR
Calendar Variance (Actual Working Days − Budgeted Working Days) × SR per day
Identity Cost = Expenditure + Volume; Volume = Capacity + Efficiency + Calendar
NotePYQ cue — Fixed OH variance triangle

FOH Cost Variance = FOH Expenditure + FOH Volume FOH Volume = FOH Capacity + FOH Efficiency + FOH Calendar This nested identity is a frequent NTA stem.

41.9 Sales Variances

Two approaches — value-based (Sales Value Method) and profit-based (Margin Method).

TipSales variances — value method
Variance Formula
Sales Value Variance Actual Sales − Budgeted Sales
Sales Price Variance (AP − SP) × AQ
Sales Volume Variance (AQ − SQ) × SP
Sales Mix Variance (Actual Mix − Standard Mix) × SP
Sales Quantity Variance (Total Actual Qty − Total Standard Qty) × Standard Avg Price

41.10 Marginal Costing Variances (Contribution Method)

When marginal costing is used, sales variances are based on contribution, not sales value:

TipSales variances under marginal costing
  • Sales Margin Variance = Actual Contribution − Budgeted Contribution.
  • Sales Margin Price Variance = (AP − SP) × Actual Qty.
  • Sales Margin Volume Variance = (Actual Qty − Standard Qty) × Standard Contribution per unit.

41.11 Disposition of Variances

TipThree methods of disposing of variances
  • Write off to P&L — small or non-recurring variances.
  • Prorate to WIP, FG, and COGS — for material, large variances.
  • Carry forward to next period — if variance is temporary.

41.12 Causes and Responsibility

TipTypical responsibility for variances
Variance Likely responsibility
Material Price Purchasing Manager
Material Usage Production Manager
Labour Rate HR / Personnel
Labour Efficiency Production Supervisor
VOH Expenditure Department Manager
FOH Volume Top Management (capacity)
Sales Price Marketing
Sales Volume Marketing + Production

41.13 Management by Exception (MbE)

Peter Drucker popularised Management by Exception — managers focus only on variances above a threshold (often ±5 % or ±10 % of standard). Saves time and aligns with control needs.

41.14 Advantages of Standard Costing

TipAdvantages of standard costing
  • Cost control through variance analysis.
  • Performance evaluation and responsibility accounting.
  • Inventory valuation at standard.
  • Budgeting building block.
  • Pricing decisions.
  • Pinpoints inefficiencies.
  • Motivates managers through targets.
  • Forces organisational thinking about cost drivers.

41.15 Limitations of Standard Costing

TipLimitations of standard costing
  • Setting standards is difficult and costly.
  • Standards become obsolete quickly in dynamic environments.
  • Discourages continuous improvement if standards are static.
  • Volume-based — fits poorly with overhead-heavy modern firms.
  • Limited use in service industries.
  • May lead to dysfunctional behaviour — buying cheap, low-quality material to beat MPV.
  • Frequent revision is expensive.
  • Misalignment with JIT and lean philosophy.

41.16 Beyond Standard Costing — Kaizen and Lean

Modern critiques (Kaplan, Robert Cooper, Brian Maskell) argue standard costing is incompatible with lean environments where continuous improvement (Kaizen) is the goal.

TipModern alternatives
  • Kaizen Costing — costs reduce continuously; standards updated each period.
  • Throughput Accounting (Goldratt) — focus on bottleneck-driven contribution.
  • Lean Accounting / Value-Stream Costing (Maskell).
  • Activity-Based Costing with ABM.
  • Target Costing with continuous design improvements.

41.17 Practice Questions

Q 01 Harrison Hard

Standard costing was systematised in 1911 by:

  • AG. Charter Harrison
  • BF.W. Taylor
  • CWheldon
  • DHorngren
View solution
Correct Option: A
G. Charter Harrison — credited as the originator of modern standard costing.
Q 02 Standard types Medium

The most-used type of standard in practice is:

  • AIdeal
  • BBasic
  • CNormal
  • DAttainable / Current
View solution
Correct Option: D
Attainable / Current — tight but achievable; motivating and realistic.
Q 03 MCV Medium

Material Cost Variance = Material Price Variance + ___:

  • AMaterial Yield Variance
  • BMaterial Mix Variance
  • CMaterial Usage Variance
  • DMaterial Sub-usage Variance
View solution
Correct Option: C
MCV = MPV + MUV; further, MUV = MMV + MYV.
Q 04 MPV Medium

Material Price Variance equals:

  • A(SP − AP) × AQ
  • B(SQ − AQ) × SP
  • C(SP − AP) × SQ
  • D(SQ − AQ) × AP
View solution
Correct Option: A
MPV = (SP − AP) × AQ. If positive, favourable.
Q 05 LEV Medium

Labour Efficiency Variance is:

  • A(SR − AR) × AH
  • B(SH − AH) × SR
  • C(SH − AH) × AR
  • D(SR − AR) × SH
View solution
Correct Option: B
LEV = (SH − AH) × SR; values labour time difference at standard rate.
Q 06 Idle time Medium

The Idle Time Variance is always:

  • AFavourable
  • BAdverse
  • CZero
  • DEither favourable or adverse
View solution
Correct Option: B
Idle time always represents lost productive hours — Adverse.
Q 07 FOH cost variance Medium

Fixed Overhead Cost Variance is split into:

  • APrice and Usage
  • BExpenditure and Volume
  • CMix and Yield
  • DRate and Efficiency
View solution
Correct Option: B
FOH Cost = Expenditure (Budget) + Volume. Volume further = Capacity + Efficiency + Calendar.
Q 08 Volume variance Hard

Fixed Overhead Volume Variance is further split into:

  • ACapacity, Efficiency, Calendar
  • BMix, Yield, Quantity
  • CRate, Efficiency, Spending
  • DPrice, Usage, Idle time
View solution
Correct Option: A
FOH Volume = Capacity + Efficiency + Calendar.
Q 09 Sales price variance Medium

Sales Price Variance is:

  • A(SP − AP) × AQ
  • B(AP − SP) × AQ
  • C(AQ − SQ) × SP
  • D(AQ − SQ) × AP
View solution
Correct Option: B
Sales Price = (AP − SP) × AQ. Higher actual price → favourable.
Q 10 Material yield Hard

Material Usage Variance = Mix Variance + ___:

  • APrice Variance
  • BYield Variance
  • CCost Variance
  • DVolume Variance
View solution
Correct Option: B
MUV = MMV + MYV.
Q 11 MbE Easy

"Management by Exception" focuses on:

  • AEvery transaction
  • BSignificant variances only
  • CYear-end reports
  • DRoutine activities
View solution
Correct Option: B
MbE focuses on significant variances only.
Q 12 Standard vs estimate Hard

Standard cost differs from estimated cost in that:

  • AStandard is what cost should be; estimate is what cost is likely to be
  • BStandard is past-based; estimate is future-based
  • CStandard is rough; estimate is precise
  • DBoth are identical
View solution
Correct Option: A
Standard is normative ("should be"); estimate is predictive ("likely to be").
Q 13 MUV responsibility Medium

Material Usage Variance is typically the responsibility of:

  • APurchase Manager
  • BProduction Manager
  • CHR Manager
  • DMarketing Manager
View solution
Correct Option: B
Production Manager — controls usage. MPV → Purchase Manager.
Q 14 Adverse interpretation Easy

An adverse Material Usage Variance most likely indicates:

  • ALower than standard price paid
  • BMore material consumed than standard
  • CHigher labour rate paid
  • DLower idle time
View solution
Correct Option: B
Adverse MUV → actual usage exceeds standard → wastage, pilferage, defects.
Q 15 Calendar Hard

FOH Calendar Variance arises because of:

  • ADifferent actual & budgeted working days
  • BDifferent rate of overhead
  • CDifferent mix of products
  • DDifferent supplier
View solution
Correct Option: A
Calendar Variance = (Actual Working Days − Budgeted Working Days) × Daily SR.
Q 16 Ideal standard Medium

"Ideal standards" assume:

  • ASome wastage and idle time
  • BPerfect conditions; no wastage
  • CHistorical performance
  • DAverage performance over 5 years
View solution
Correct Option: B
Ideal = perfect conditions; rarely achievable; demotivating.
Q 17 Sales volume variance Medium

Sales Volume Variance is:

  • A(AP − SP) × AQ
  • B(AQ − SQ) × SP
  • C(AQ − SQ) × AP
  • DActual Profit − Budgeted Profit
View solution
Correct Option: B
Sales Volume = (AQ − SQ) × SP.
Q 18 Kaizen Hard

In a lean environment, standard costing is often replaced by:

  • AKaizen costing
  • BAbsorption costing
  • CJob costing
  • DProcess costing
View solution
Correct Option: A
Kaizen costing — continuous improvement; standards updated each period.
Q 19 Disposition Medium

A common method of disposing variances is:

  • AWrite off to P&L
  • BAdd to share capital
  • CCapitalise as goodwill
  • DDistribute as dividend
View solution
Correct Option: A
Three methods: Write off to P&L · Prorate · Carry forward.
Q 20 Match variances Hard

Match the variance with its formula:

(i) MPV (a) (SH − AH) × SR
(ii) MUV (b) (SR − AR) × AH
(iii) LRV (c) (SP − AP) × AQ
(iv) LEV (d) (SQ − AQ) × SP
  • A(i)-(c), (ii)-(d), (iii)-(b), (iv)-(a)
  • B(i)-(a), (ii)-(b), (iii)-(c), (iv)-(d)
  • C(i)-(d), (ii)-(c), (iii)-(a), (iv)-(b)
  • D(i)-(b), (ii)-(a), (iii)-(d), (iv)-(c)
View solution
Correct Option: A
MPV → (SP−AP)×AQ; MUV → (SQ−AQ)×SP; LRV → (SR−AR)×AH; LEV → (SH−AH)×SR.

41.17.1 Advanced Format Questions

AR 1Assertion-ReasonHard

A: Variance = Standard − Actual.
R: A favourable variance arises when actual is better than standard.

  • ABoth true; R explains A
  • BBoth true; R does not explain A
  • CA true, R false
  • DA false, R true
View solution
Correct Option: A
S 1Statement-basedMedium

Material variances: (i) Price. (ii) Usage. (iii) Mix. (iv) Yield.

  • AAll four
  • B(i) and (ii) only
  • C(iii) only
  • D(i), (ii), (iii) only
View solution
Correct Option: A
N 1NumericalMedium

Standard 10 kg @ ₹5/kg; Actual 12 kg @ ₹4.50/kg. Material Cost Variance:

  • A₹4 Adverse
  • B₹4 Favourable
  • C₹54 Adverse
  • D₹6 Favourable
View solution
Correct Option: A
SC ₹50 − AC ₹54 = ₹4 Adverse.
N 2NumericalHard

In above, Material Price Variance = (SP − AP) × AQ:

  • A₹6 Favourable
  • B₹4 Adverse
  • C₹10 Favourable
  • D₹10 Adverse
View solution
Correct Option: A
(5 − 4.50) × 12 = ₹6 Fav.

41.18 Quick Recall

ImportantQuick recall
  • Standard Costing origin: Scientific management (Taylor, Gilbreth); G. Charter Harrison (1911) systematised in US; Sir John Mann in UK.
  • Definitions: CIMA · ICMA · Horngren · Brown-Howard · Wheldon.
  • Standard vs Estimate — should-be vs likely-to-be.
  • 8 objectives — cost control, performance evaluation, cost reduction, pricing, inventory valuation, MbE, budgeting, productivity.
  • 4 standards: Ideal (perfect, demotivating) · Basic (long-term, trends) · Normal (average) · Attainable / Current (tight but realistic — most used).
  • Setting standards — DM (qty × price), DL (time × rate), VOH, FOH (budgeted FOH / budgeted output), Sales.
  • Variance = Standard − Actual; Favourable / Adverse.
  • Material variances: MCV = MPV + MUV; MUV = MMV + MYV.
  • MPV = (SP − AP) × AQ; MUV = (SQ − AQ) × SP.
  • Labour variances: LCV = LRV + LEV; LEV = LMV + LYV + LITV.
  • LRV = (SR − AR) × AH; LEV = (SH − AH) × SR; LITV = Idle Hours × SR (always Adverse).
  • Variable OH: Expenditure + Efficiency.
  • Fixed OH: Cost = Expenditure + Volume; Volume = Capacity + Efficiency + Calendar.
  • Sales variances (value): Price = (AP − SP) × AQ; Volume = (AQ − SQ) × SP; further split Mix + Quantity.
  • Sales variances (contribution/margin method) under marginal costing.
  • Responsibility: MPV → Purchase · MUV → Production · LRV → HR · LEV → Production Supervisor · FOH Volume → Top Mgmt · Sales → Marketing.
  • Disposition: Write off · Prorate · Carry forward.
  • MbE (Drucker): focus on significant variances (±5-10 %).
  • Advantages: cost control · performance evaluation · inventory valuation · budgeting · motivation.
  • Limitations: setting costly · obsolete fast · poor in service · dysfunctional behaviour · misaligned with lean.
  • Modern alternatives: Kaizen Costing · Lean Accounting (Maskell) · Throughput Accounting (Goldratt) · ABC · Target Costing.