Purpose and procedure of standard costing
Standard cost is the planned cost of one unit under normal, efficient work. It is set before production using past records, time studies and supplier quotes.
Why use it?
- Control: compare real cost with a target and spot waste.
- Planning: it helps budgets and price setting.
- Simpler records: stock can be valued at standard cost.
- Motivation: people know what is expected.
Procedure:
- Set standards (quantity and price for material, hours and rate for labour, overhead).
- Record the actual cost.
- Compare to find variances.
- Analyse the causes.
- Report to managers and act.
A standard cost card lists all standards for one unit.
Material cost variances
A variance is the difference between standard and actual. Mark it F (favourable, profit rises) or U (unfavourable, profit falls).
- Material price variance = (Standard price − Actual price) × Actual quantity. Cause: supplier price, bulk discount, buying quality.
- Material usage variance = (Standard quantity − Actual quantity) × Standard price. Cause: wastage, poor quality, theft, careless cutting.
- Total material variance = Standard cost − Actual cost = price + usage.
Standard quantity means the quantity allowed for the actual output made.
Labour cost variances
- Labour rate variance = (Standard rate − Actual rate) × Actual hours. Cause: overtime, higher grade workers, new pay deal.
- Labour efficiency variance = (Standard hours − Actual hours) × Standard rate. Cause: slow or untrained workers, machine breakdown, poor material.
- Total labour variance = Standard cost − Actual cost = rate + efficiency.
Overhead variances follow the same idea: spending (paid more than planned) and efficiency or volume (used time or capacity differently from plan).
Reading variances: by cause and action
A variance only helps if someone acts on it.
| Variance | Likely cause | Who acts |
|---|---|---|
| Material price | Supplier or buying choice | Purchasing |
| Material usage | Waste, quality | Production, quality control |
| Labour rate | Overtime, pay grade | Production planning, HR |
| Labour efficiency | Skill, machines | Supervisors |
Causes can link: a cheap material (price F) may raise waste (usage U). Look at the pair together, and report only large variances (management by exception).
Key formulas and definitions
- Material price variance = (SP − AP) × AQ
- Material usage variance = (SQ − AQ) × SP
- Labour rate variance = (SR − AR) × AH
- Labour efficiency variance = (SH − AH) × SR
- Total variance = Standard cost − Actual cost (positive = F, negative = U)
Worked examples
1. Standard: 2 kg at 10 per unit. What is the standard material cost for 100 units?
Standard quantity = 200 kg. 200 × 10 = 2,000.
2. Actual: 230 kg at 9. Find the actual cost and total variance.
Actual = 230 × 9 = 2,070. Variance = 2,000 − 2,070 = 70 unfavourable.
3. Find the material price and usage variances.
Price = (10 − 9) × 230 = 230 F. Usage = (200 − 230) × 10 = 300 U. Total = 230 − 300 = 70 U.
4. Labour: standard 100 hours at 20; actual 110 hours at 22. Find rate, efficiency and total.
Rate = (20 − 22) × 110 = 220 U. Efficiency = (100 − 110) × 20 = 200 U. Total = 420 U. Check: standard 2,000, actual 2,420, difference 420.
5. Add all four variances. What is the net result?
Price 230 F − usage 300 − rate 220 − efficiency 200 = −490, so 490 unfavourable.
6. A bakery: standard 100 kg flour at 5, actual 110 kg at 4.8. Price, usage and total variance?
Price = (5 − 4.8) × 110 = 22 F. Usage = (100 − 110) × 5 = 50 U. Total = 28 U. Check: actual 528 − standard 500 = 28.
Common mistakes
- Using standard quantity in the price variance. Price variance uses actual quantity.
- Mixing the signs: actual below standard is favourable, not unfavourable.
- Forgetting that standard quantity is for the actual output, not the planned output.
- Blaming only the supplier for a material variance when usage and price may pull in opposite directions.