Block 3

UNIT 9: Standard Costing: An
Overview
Structure
9.0 Objectives
9.1 Introduction
9.2 Meaning of Standard Cost
9.3 Standard Cost and Estimated Costs
9.4 Concept of Standard Costing
9.5 Objectives of Standard Costing
9.6 Standard Costing and Budgeting
9.7 Advantages of Standard Costing
98 Limitations of Standard Costing
9.9 Pre-requisites for the Success of Standard Costing
9.10 Concept of Standard Hour
9.11 Revision of Standards
9.12 Let Us Sum Up
9.13 Key Words
9.14 Answers to Check Your Progress
9.15 Terminal Questions
9.0 OBJECTIVES
After studying this unit, you should be able to:
●● understand the concept of standard costing and its importance;
●● know the pre-requisites for the success of standard costing in an
organisation; and
●● familiar with the concept of standard hour and revision of standards.
9.1 INTRODUCTION
One of the prime functions of management accounting is to facilitate
managerial control and the important aspect of managerial control is cost
control. The efficiency of management depends upon the effectiveness of
cost control. Therefore, it is very important to plan and control cost. Standard
costing is one of the most important tools which helps the management
to plan and control cost of business operations, Under standard costing,
all costs are pre-determined and pre determined costs are then compared
with the actual costs. The difference between pre-determined costs and the
actual costs is known as variance which is analysed and investigated to the
reasons. The variances are then reported to management for taking remedial
steps so that the actual costs adhere to pre-determined costs. In historical
costing actual costs are ascertained only when they have been incurred.
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They are useful only when they are compared with pre-determined costs. Standard Costing:
Such costs are not useful to management in decision-making and cost An Overview
control. Therefore, the technique of standard costing is used as a tool for
planning, decision-making and control of business operations. In this unit
you will study the basic concepts of standard costing.
9.2 MEANING OF STANDARD COST

Standard costs are pre-determined cost which may be used as a yardstick
to measure the efficiency with which actual costs has been incurred under
given circumstance. To illustrate, the amount of raw material required
to produce a unit of product can be determined and the cost of that raw
material is estimated. This becomes the standard material input. If actual
raw material usage or costs differ from the standards, the difference which
is called ‘variance’ is reported to the manager concerned. When size of the
variance is significant, a detailed investigation will be made to determine
the causes of variance.
According to the Chartered Institute of Management Accountants (C.I.M.A)
London, “Standard cost is the pre-determined cost based on technical
estimates for materials, labour and overhead for a selected period of time
for a prescribed set of working conditions.”
The Institute of Cost and Works Accountants defines standard costs
as “Standard costs are prepared and used to clarify the final results of a
business, particularly by measurement of variations of actual costs from
standard costs and the analysis of the causes of variations for the purpose of
maintaining efficiency of executive action.”
Thus standard costs is a pre-determined which determines what each
product or service ‘should be’ under given circumstances. From the above
definitions we may note that standard costs are:
i) Pre-determined Cost: Standard cost is always determined in advance
and ahead of actual point of time of incurring costs.
ii) Based on Technical Estimate: Standard cost is determined only on
the basis of a technical estimate and on a rational basis.
iii) For the purpose of Comparison: The very purpose of standard cost
is to aid the comparison with actual costs.
9.3 STANDARD COST AND ESTIMATED COSTS

Estimates are pre-determined costs which are based on historical data and is
often not very scientifically determined. They usually compiled from loosely
gathered information and therefore, they are unsafe to use them as a tool for
measuring performance. Standard costs are predetermined costs which aims
at what the cost should be rather than what it will be. Both the standard costs
and estimated costs are used to determine price in advance and their purpose
is to control cost. But, there are certain differences between these two costs
as stated below:
Differences between Standard Costs and Estimated Costs
The following are some of the important differences between standard cost
and estimated cost:
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Standard Costing and
Standard Cost Estimated Cost
Variance Analysis
1) Standard cost emphasizes on 1) Estimated cost emphasizes on
what the cost ‘should be’ in a what the cost ‘will be’.
given set of situations.
2) Standard costs are planned 2) Estimated costs are determined
costs which are determined by taking into consideration the
by technical experts after historical data as the basis and
considering levels of efficiency adjusting it to future trends.
and production.
3) It is used as a devise for 3) It cannot be used as a devise
measuring efficiency. to determine efficiency. It only
determines expected costs.
4) Standard costs serve the 4) Estimated costs do not serve
purpose of cost control. the purpose of cost control.
5) Standard costing is part of cost 5) Estimated costs are statistical
accounting process. in nature and may not become
a part of accounting.
6) It is a technique developed and 5) It is just an estimate and not a
recognised by management and technique.
academicians.
7) It can be used where standard 7) It may be used in any concern
costing is in operation. operating on a historical cost
system.
9.4 CONCEPT OF STANDARD COSTING

Standard costing is a technique used for the purpose of determining
standard cost and their comparison with the actual costs to find out the
causes of difference between the two so that remedial action may be taken
immediately. The Charted Institute of Management Accountants, London,
defines standard costing as “the preparation of standard costs and applying
them to measure the variations from actual costs and analysing the causes
of variations with a view to maintain maximum efficiency in production”.
Thus, standard costing is a technique of cost accounting which compares the
‘standard cost’ of each product or service, with the actual cost, to determine
the efficiency of the operation. When actual costs differ from standards, the
difference is called variance and when the size of the variance is significant,
a detailed investigation will be made to determine the causes of variance, so
that remedial action will be taken immediately.
Thus, standard costing involves the following steps:
1) Setting standard costs for different elements of costs.
2) Recording of actual costs.
3) Comparing between standard costs and actual costs to determine the
variances.
4) Analysing the variances to know the causes thereof, and
5) Reporting the analysis of variances to management for taking
appropriate actions wherever necessary.
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The system of standard costing can be used effectively to those industries Standard Costing:
which are producing standardised products and are repetitive in nature. An Overview
Examples are cement industry, steel industry, sugar industry etc. The
standard costing may not be suitable to jobbing industries because every
job has different specifications and it will be difficult and expensive to
set standard costs for every job. Thus, standard costing is not suitable in
situations where a variety of different kinds of tasks are being done.
9.5 OBJECTIVES OF STANDARD COSTING

1) Cost Control: The most important objective of standard cost is to
help the management in cost control. It can be used as a yardstick
against which actual costs can be compared to measure efficiency. The
management can make comparison of actual costs with the standard
costs at periodic intervals and take corrective action to maintain
control over costs.
2) Management by Exception: The second objective of standard
cost is to help the management in exercising control over the costs
through the principle of exception. Standard cost helps to prescribe
standards and the attention of the management is drawn only when
the actual performance is deviated from the prescribed standards. It
can concentrate its attention on variations only.
3) Develops Cost Conscious Attitude: Another objective of standard
cost is to make the entire organisation cost conscious. It makes the
employees to recognise the importance of efficient operations so that
costs can be reduced by joint efforts.
4) Fixing Prices and Formulating Policies: Another object of standard
cost is to help the management in determining prices and formulating
production policies. It also helps the management in the areas of profit
planning, product- pricing and inventory pricing.
5) Management Planning: Budget planning is undertaken by the
management at different levels at periodic intervals to maximise
the profit through different product mix. For this purpose it is more
convenient using standard costing than actual costs because it is done
on scientific and rational manner by taking into account all technical
aspects.
Check Your Progress A
1) Distinguish between standard cost and estimated cost.
………………………………………………………………………
………………………………………………………………………
………………………………………………………………………
………………………………………………………………………
2) What do you understand about standard cost and standard costing?
………………………………………………………………………
………………………………………………………………………
………………………………………………………………………
………………………………………………………………………
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Standard Costing and 3) Choose one of the alternatives and tick (√ ) the correct answers.
Variance Analysis
a) Standard costing involves in determining
i) Standard Costs
ii) Actual Costs
iii) Estimated Costs
b) The difference between actual costs and standard cost is known
as
i) Profit
ii) Variance
iii) Historical Cost
c) The purpose of standard costing is to
i) Reduce Costs
ii) Measure Efficiency
iii) Control Prices
4) State whether the following statements are ‘True’ or ‘False’.
a) Standard costing is suitable to job industries where different
kinds of tasks are being done.
b) Standard costing is used effectively in those industries which
are producing standardized products and are repetitive in nature.
c) Budgeting is the process of preparing plans for future activities
of an enterprise.
d) Standard costing is suitable for small business.
e) The figure based on the average performance of the past after
taking into account the seasonal/cyclical changes is called
expected standards.
f) The success of a standard costing depends upon the reliability
and accuracy of the standards.
9.6 STANDARD COSTING AND BUDGETING

Budgeting may be defined as the process of preparing plans for future
activities of the business enterprise after considering and involving the
objectives of the said organisation. This also provides process/steps of
collection and preparation of data, by which deviations from the plan can
be measured. This analysis helps to measure performance, cost estimation,
minimizing wastage and better utilisation of resources of the organisation.
Thus, budgets are prepared on the basis of future estimated production and
sales in order to find out the profit in a specified period. In other words Budget
is an estimate and a quantified plan for future activities to coordinate and
control the uses of resources for a specified period. According to Institute of
Cost and Works Accountants, “A budget is a financial and / or quantitative
statement prepared prior to a defined period of time, of the Policy to be
pursued during that period for the purpose of attaining a given objective.”
Budgeting is a process which includes both the functions of budget and
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budgetory control. Budget is a planning function and budgetory control is a Standard Costing:
controlling system or a technique. You might have already studied about the An Overview
budgeting in detail in Block 3, under Unit 8: Basic Concepts of Budgeting.
The objective of the standard costing and budgeting is to achieve maximum
efficiency and cost control. Under both the systems actual performance is
compared with predetermined standards, deviations, if any, are analysed
and reported. Budgeting is essential to determine standard costs while
standard costing is necessary for planning budgets. Both are complimentary
in nature and in determining the results. Besides similarities there are certain
differences between standard costing and budgeting which are as follows:
Standard Costing Budgeting
Standard costing is based on 1. Budgeting is based on standard
1.
technical information and is cost, historical costs and
fixed scientifically. estimates.
2. Standard costs are used mainly 2. Budgets are prepared for different
for the manufacturing function functional departments such
and also for marketing and as sales, purchase, production,
administration functions. finance, personnel department.
Therefore, it does not require Therefore, it requires functional
functional coordination. coordination.
Standard costs emphasises the 3. Budgets emphasises cost levels
3.
cost levels which should be which should not be exceeded.
reduced.
In standard costing variances 4. In Budgeting, variances are not
4.
are usually revealed through revealed through accounts and
accounts. control is exercised by putting
budgeted figures and actuals
side by side.
In standard costing, a detailed 5. No further analysis is required if
5.
analysis is needed in case of costs are within the budget.
variances.
Standard costing sets realistic 6. Budgets generally set maximum
6.
yardsticks and therefore, it is limits of expenditure without
more useful for controlling and considering the effectiveness of
reducing costs. expenditure.
Standard cost is revised only 7.
7. Budgeting is done before the
when there is a change in the beginning of each accounting
basic assumptions and basis. period.
Standard costs are based on 8. Budgets are set on the basis of
8.
the basis of standards set by present level of efficiency.
management
9. Standard costing cannot be used 9.
Budgeting can be done either
partially. Standards will have to wholly or partly.
be set for all elements of cost.
10. Standard cost is a projection of 10.
Budgeting is a projection of
cost accounts. financial accounts.
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Variance Analysis 9.7 ADVANTAGES OF STANDARD COSTING
The introduction of Standard Costing system may offer many advantages.
It varies from one business to another. The following advantages may be
derived from standard costing in the light of the various objectives of the
system:
1) To Measure Efficiency: Standard Costs provide a yardstick against
which actual costs can be measured. The comparison of actual
costs with the standard cost enables the management to evaluate
the performance of various cost centres. In the absence of standard
costing, efficiency is measured by comparing actual costs of different
periods which is very difficult to measure because the conditions
prevailing in both the periods may differ.
2) To Fix Prices and Formulate Policies: Standard costing is helpful
in determining prices and formulating production policies. The
standards are set by studying all the existing conditions. It also helps
to find out the prices of various products. It helps the management in
the formulation of production and price policies in advance.
3) For Effective Cost Control: One of the most advantages of standard
costing is that it helps in cost control. By comparing actual costs with
the standard costs, variances are determined. These variances facilitate
management to locate inefficiencies and enables the management take
remedial action against those inefficiencies at the earliest.
4) Management by Exception: Management by exception means
that each individual is fixed targets and every one is expected to
achieve these given targets. Management need not supervise each
and everything and need not bother if everything is going as per
the targets. Management interferes only when there is deviation.
Variances beyond a predetermined limit may be considered by the
management for corrective action. The standard costing enables
the management in determining responsibilities and facilitates the
principle of management by exception.
5) Valuation of Stocks: Under standard costing, stock is valued at
standard cost and any difference between standard cost and actual cost
is transferred to variance account. Therefore, it simplifies valuation of
stock and reduces lot of clerical work to the minimum level.
6) Cost Consciousness: The emphasis under standard costing is more
on cost variations which makes the entire organisation cost conscious.
It makes the employees to recognise the importance of efficient
operations so that efforts will be taken to reduce the costs to the
minimum by collective efforts.
7) Provides Incentives: Under standard costing system, men, material
and machines can be used effectively and economies can be effected
in addition to enhanced productivity. Schemes may be formulated to
reward those who achieve targets. It increases efficiency, productivity
and morale of the employees.
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Standard Costing:
9.8 Limitations of Standard Costing An Overview
In spite of the above advantages, standard costing suffers from the following
disadvantages:
1. Difficulty in Setting Standards: Setting standards is a very difficult
task as it requires a lot of scientific analysis such as time study, motion
study etc. When standards are set at high it may create frustration in
the minds of workers. Therefore, setting of a correct standards is very
difficult.
2. Not Suitable to Small Business: The system of standard costing
is not suitable to small business as it requires lot of scientific study
which involves cost. Therefore, small firms may find it very difficult
to operate the system.
3. Not Suitable to All Industries: The standard costing is not suitable to
those industries which produces non-standardised products. Similarly,
the application of standard costing is very difficult to those industries
where production process takes place more than one accounting
period.
4. Difficult to Fix Responsibility: Fixing responsibility is not an easy
task. Variances are to be classified into controllable and uncontrollable
variances because responsibility can be fixed only in the case of
controllable variances. It is difficult to classify controllable and
uncontrollable variances for the variance controllable at one situation
may become uncontrollable at another time. Therefore, fixing
responsibility is very difficult under standard costing.
5. Technological Changes: Standard costing may not be suitable to those
industries which are subject to frequent technological changes. When
there is a change in the technology, production process will require a
revision of standard. Frequent revision of standards is a costly affair
and therefore, the system is not suitable for industries where methods
and techniques of production are subject to fast changes.
In spite of the above limitations, standard costing is a very useful technique
in cost control and performance evaluation. It is very useful tool to the
industries producing standardised products which are repetitive in nature.
9.9 Pre-requisites for success

In establishing a system of the standard costing, there are a number of
preliminaries which are to be considered. These include:
1) Establishment of Cost Centres
2) Classification of Accounts
3) Types of Standards
4) Setting Standard Costs
Let us study the above in detail.
1) Establishment of Cost Centres: A cost centre is a location, person
or an item of equipment (or group of these) in respect of which costs
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Standard Costing and may be ascertained and related to cost units. A centre which relates
Variance Analysis to persons is referred to as a personal cost centre and a centre which
relates to location or to equipment as an impersonal cost centre. Cost
centres are set up for cost ascertainment and cost control. While
establishing cost centres it should be noted that who is responsible
for which cost centre. In many cases each department or function will
form a natural cost centre but there may also have a number of cost
centres in each department or function. For example, there may be
six machines in a manufacturing department, each machine may be
classified as a cost centre. Cost centres are essential for establishing
standards and analysing the variances.
2) Classification of Accounts: Accounts are classified to meet a required
purpose. Classification may be by function, revenue item or asset
and liabilities item. Codes and symbols are used to facilitate speedy
collection and analysis of accounts.
3) Types of Standards: The standard is the level of attainment accepted
by management as the basis upon which standard costs are determined.
The standards are classified mainly into four types. They are:
i) Ideal Standard: The ideal standard is one which is set up under
ideal conditions. The ideal conditions may be maximum output
or sales, best possible prices for materials, most satisfactory
rates for labour and overhead costs. As these conditions do
not continue to remain ideal, this standard is of little practical
value. It does provide a target or incentive for employees, but is
usually unattainable in practice.
ii) Expected Standard: This is the standard which is actually
expected to be achieved in the budget period, based on current
conditions. The standards are set on expected performance after
allowing a reasonable allowance for unavoidable losses and
lapses from perfect efficiency. Standards are normally set on
short term basis and requires frequent revision. This standard is
more realistic than ideal standard.
iii) Normal Standard: This represents an average figure based on
the average performance of the past after taking into account the
fluctuations caused by seasonal and cyclical changes. It should
be attainable and provides a challenge to the staff.
iv) Basic Standard: This is the level of standard fixed in relation
to a base year. The principle used in setting the basic standard
is similar to that used in statistics when calculating an index
number. The basic standard is established for a long period
and is not adjusted to the present conditions. It is just like an
index number against which subsequent price changes can be
measured. Basic standard enables to measure the changes in
cost. It serves as a tool for cost control purpose, but it cannot be
used as a yard stick for measuring efficiency.
4. Setting Standard Costs: The success of a standard costing system
depends upon the reliability and accuracy of the standards. Therefore,
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every activity should be taken into account while establishing Standard Costing:
standards. The number of people involved with the setting of standards An Overview
will depend on the size and nature of the business. The responsibility
for setting standards should be entrusted to a specific person. In a big
concern a Standard Costing Committee is formed for this purpose.
The committee consists of Production Manager, Personnel Manager,
Production Engineer, Sales Manager, Cost Accountant and other
functional heads. The cost accountant is an important person, who has
to supply necessary cost figures and coordinate the activities of budget
committee. He must ensure that the standards set are accurate and
present the statements of standard cost in most satisfactory manner.
Standard costs are set for each element of cost i.e., direct materials,
direct labour and overheads. The standards should be set up in a
systematic manner so that they can be used as a tool for cost control.
Briefly, standard costs will be set as shown below:
Standard Cost for Direct Materials: If material is used for
i)
manufacturing a product it is known as direct material. Direct
material cost involves two things (a) Quantity of materials
and (b) Price of materials. Firstly, while setting standard for
quantity of material, the quality and size of the material should
be determined. The standard quantity of material required for
producing a product is decided by the technical experts in the
production department. While fixing standard for material
quantity, a proper allowance should be given to normal loss of
materials. Normal loss will be determined after careful analysis
of various factors. Secondly, standard price for the material is
to be determined. Setting standard price for material is difficult
because the prices are regulated more by the external factors
than the company management. Before fixing the standard
price, factors like prices of materials in stock, price quoted by
suppliers, forecast of price trends, the price of materials already
contracted, provision for discounts, packing and delivery
charges etc., should be considered.
ii) Setting Standards for Direct Labour: The labour involved
in manufacture of a product is known as direct labour. The
wage paid to such workers is known as direct wages. The time
required for producing a product should be ascertained and
labour should be properly graded. Setting of standard cost of
direct labour involves fixation of standard time and fixation of
standard rate. Standard time is fixed by time or motion study
or past records or estimates. While fixing standard time normal
ideal time is to be allowed for normal delays, idle time, other
contingencies, etc. The labour rate standard refers the wage
rate applicable to different categories of workers. Fixation of
standard rate will depend upon various factors take demand
for labour, policy of the organisation, influence of unions,
method of wage payment, etc. If any incentive scheme is in
operation then anticipated extra payment to the workers should
also be included in determining standard rate. The Accountant
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Standard Costing and will determine the standard rate with the help of the Personnel
Variance Analysis Manager. The object of fixing standard time and labour rate is
to get maximum efficiency in the use of labour.
Setting Standards for Direct Expenses: Direct expenses are
iii)
those expenses which are specifically incurred in connection
with a particular job or cost unit. These expenses are also known
as chargeable expenses. Standards for these expenses must
also be determined. Standards for these may be based on past
performance records subject to anticipatory changes therein.
iv) Setting Standards Overheads : Indirect costs are called
overheads. Overhead costs are those which cannot be assigned
to any particular cost unit and are incurred for the business as
a whole. The overheads are classified into fixed, variable and
semi-variable overheads. Standard overhead rate is determined
for these on the basis of past records and future trend of prices.
It will be calculated per unit or per hour. Setting standard for
overhead cost involves the following two steps:
a) Determination of the standard overhead costs, and
b) Determination of the estimates of production
Standard overhead absorption rate is computed with the help of the following
formula:
Standard Overhead for the Period
Standard overhead Rate (per hour) =
Standard Hours for the Period
or
Standard Overhead for the Period
Standard Overhead Rate (per hour) =
Standard Production (in units) for the Period
The purpose of setting standard overhead rate is to minimise overhead costs.

Overhead rates are more useful to the management if they are divided into
fixed and variable components. When overheads are divided into fixed and
variable, separate overhead absorption rates are to be calculated with the
help of the following formulae:
Standard Variable Overhead for the Period
Standard Variable Overhead Rate =
Standard Production (in Units or Hours ) for the Period)
Standard Variable Overhead for the Period

Standard Fixed Overhead Rate =
Standard Production (in Units or Hours ) for the Period
9.10 CONCEPT OF STANDARD HOUR

Production may be expressed in different units of measurement such as
kilos, tones, litres, numbers, etc. When a concern produces different types
of products, the production will be expressed in different units. It is difficult
to aggregate the production which is expressed in different units. To over
come this difficulty, the production is to be expressed in a common measure
known as ‘Standard Hour’. The standard hour is the quantity of output which
should be produced in one hour. A standard hour may be as “A hypothetical
hour which represents the amounts of work which should be performed in
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one hour under stated conditions.” For example, if 20 units of product A are Standard Costing:
produced in 2 hour, and 40 units of product B are produced in 5 hours, the An Overview
standard hours represent 10 units of product A
 20 units   40 units 
  and 8 units of product B  
 2 hrs   5 hrs 
Therefore, standard hour is the quantity of production of a given product
for one clock hour. A measure of standard hour is useful for the purpose of
comparison of performance of one department to another. It is also useful to
compute efficiency and activity ratios.
9.11 REVISION OF STANDARDS
Standard cost is based on a number of factors. Some of these factors may
be internal or external which may vary from time to time depending upon
different situations. Standard cost may become unrealistic if it is not revised
according to the changed circumstances. Then a question arises what would
be the period in which standards should be set? If the standard is set for a
shorter period it is expensive and frequent revision of standards will impair
the utility and purpose of the standard cost. If the standard is set for a longer
period it may not be useful particularly during periods of high inflation
and rapidly changing technological environment. Therefore, standards
are normally set for a fixed period of one year and revised annually at the
beginning of accounting period. If there are major changes, a revision may
also be required within the accounting period. If there are minor changes,
the causes of difference between actual and standards may be explained
without being revised the standards. There are certain conditions which
necessitate the revision of standard costs. These conditions are:
i) Changes in price levels of materials, labour and overheads
ii) Technological changes
iii) Changes in production methods or product mixes
iv) Changes in plant capacity utilization
v) Errors discovered in setting standards
vi) Changes in designs or specification
vii) Changes in the policy of organisation
viii) Changes in government policy affecting the product or organisation, etc.
Check your progress B
1. State some of the conditions under which a revision of stand cost
takes place.
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2. Explain the concept of standard hour.
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Standard Costing and 3 State whether the following statements are True or False
Variance Analysis
a) Standard hour is a hypothetical hour which represents the amount
of work to be done in one hour under given circumstances.
b) To control cost either standard costing or budgetory control
should be used but not both the techniques.
c) Standard cost is used as a yardstick to measure the efficiency
with which actual cost has been incurred.
d) Standard cost is a projection of costs accounts whereas budgeting
is a projection of financial accounts.
e) Standards are normally set for a longer period and revised
annually.
9.12 LET US SUM UP
Standard Costs are predetermined cost which may be used as a yardstick
to measure the efficiency with which actual costs has been incurred under
given circumstances. In other words, standard costs are predetermined costs
which aims at what the cost should be rather than what it will be. Estimates
are predetermined costs which are based on historical data. Both the standard
costs and estimated costs are used to determine price in advance and then
purpose is to control cost. There are certain differences between standard
cost and estimated cost.
Standard costing is a technique used for the purpose of determining standard
cost and their comparison with the actual costs to find out the causes of
difference between the two so that remedial action may be taken immediately.
The objectives of standard costing are: Cost control, developing cost
consciousness among the employees, formulating production and pricing
policies, budget planning, etc.
Budgets are prepared on the basis of future estimated production and
sales to find out the profit in a specified period. The object of standard
costing and budgeting is to achieve maximum efficiency and cost control.
Budgeting is essential to determine standard costs while standard costing
is necessary for planning budgets. There are certain advantages and
limitations of standard costing. There are certain preliminaries which are
to be considered for establishing a successful system of standard costing.
They are i) Establishment of cost centres, ii) Classification of accounts, iii)
Types of standards, and iv) Setting standard costs. Standard costs are set for
each element of cost i.e. Direct material, direct labour, direct expenses and
overheads.
When a concern produces different types of products, the production will
be expressed in different units. It is difficult to aggregate the production
which is expressed in different units. To overcome this difficulty, the
production is to be expressed in a common measure known as standard
hour. The standard hour is the quantity of output which should be produced
in one hour. Standards are normally set for a period of one year and revised
annually at the beginning of accounting period. If there are major changes a
revision may also be required within the accounting period.
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Standard Costing:
9.13 KEY WORDS An Overview
Basic Standard : The level of standard fixed in relation to a base year.
Cost Centre : A location, person or an item of equipment (or group of
these) in
Ideal Standard : A standard which is set under ideal conditions.
Standard Cost: Pre-determined cost of a product or service.
Standard Costing : A technique of cost accounting which compares the
standard cost of each product or service with the actual cost to determine the
efficiency of an organisation in respect of which costs may be ascertained
and related to cost units.
Standard Hour: The quantity of output which should be produced in one
hour.
9.14 ANSWERS TO CHECK YOUR PROGRESS
(A) 1) a) Standards Costs, b) Variance, c) Measure efficiency
4) a) False, b) True, c) True, d) False, e) False, f) True.
(B) 3) a) True, b) False, c) True , d) True, e) False.
9.15 TERMINAL QUESTIONS
1) What is Estimate Costing and how does it differ from Standard
Costing?
2) What do you understand by Standard Costing? Give a suitable
definition to explain your answer.
3) What is Standard Costing? State the objectives of Standard Costing.
4) Give a comparative account of Standard Costing and Budgeting.
5) Write a detailed note explaining the advantages and limitations of
Standard Costing.
6) How do you ensure the success of a Standard Costing Method in your
organisation.
7) How are standards fixed ? Explain.
8) A company has decided to introduce a system of standard costing.
What are the preliminaries to be considered before developing such a
system? Explain.
9) Write notes on the following:
a) Ideal Standard
b) Expected Standard
c) Normal Standard
d) Basic Standard
e) Standard Hour
f) Revision of Standards
Note: These questions will help you to understand the unit better. Try to
write answers for them. But do not submit your answers to the University.
These are for your practice only.
199
UNIT 10: MATERIAL VARIANCES
Structure
10.0 Objectives
10.1 Introduction
10.2 Meaning and Purpose
10.3 Classification of Variances
10.4 Direct Material Cost Variance
10.4.1 Direct Material Price Variance
10.4.2 Direct Material Usage Variance
a) Material Mix Variance
b) Material Yield Variance
10.5 Let Us Sum Up
10.6 Key Words
10.0 OBJECTIVES
After studying this unit, you will be able to:
●● understand and analyse the cause of variance between planned and
actual results;
●● explain how standards for direct material are set;
●● assess the efficiency of the usage of material in a manufacturing
concern; and
●● analyse different sub - variances of material.
10.1 INTRODUCTION
You have learnt in the previous unit the basic concepts of standard costing.
You also know that the purpose of standard costing is to determine standard
costs and their comparison with the actual costs to find out the causes of
difference so that remedial action may be taken by the management in time.
The difference between the predetermined costs and actual costs is known
as ‘Variance’. The variance may be sub-divided and analysed further for
effective cost control and decision-making. In this unit you will learn about
Direct Material Rate Variances and their sub-variances in detail.
10.2 MEANING AND PURPOSE

After the standard costs have been set, the next step is to ascertain the actual
cost of each element and compare them with the standard already set. The
difference of actual from the standard is variance, while setting standard
specific method of production is to be kept in mind. If a different method
of production is adopted, it gives rise to a different amount of cost, thereby
causing variance, known as method variance. In standard costing, Variance
200
means the difference between a standard cost and the comparable actual Material Variances
cost incurred during a period. Variance analysis is the process of analysing
variances by sub-dividing the total variance in such a way that management
can assign responsibility for any off-standard performance. Thus, variance
analysis means the measurement of the deviation of actual performance
from the desired performance.
Variance may be favourable or unfavourable depending upon whether the
actual cost is less or more than the standard cost. If the actual cost is less
than the standard cost, the variance is termed as ‘favourable’ and if the actual
cost is more than the standard cost, variance is called as ‘unfavourable’ or
‘adverse’ variance. The effect of favourable variance increases the profit and
it is a sign of efficiency of the organisation. On the other hand, unfavourable
variance refers to the loss of the business and it is a sign of inefficiency of
the organisation.
Finding variance is not the ultimate objective of the standard costing.
But their analysis and finding the causes of variance is the ultimate aim
to control cost. Control of cost depends on the corrective action taken by
the management. The analysis of variance helps the management to locate
deficiency and assign responsibility to particular person or cost centre. The
next step of the management is to find out the reason for the variance to pin
points where necessary corrective action should be taken over.
10.3 CLASSIFICATION OF VARIANCES

The variance may be broadly classified as Controllable variances and
Uncontrollable variances. Variance is said to be controllable if it is
identified as the primary responsibility of a particular person or department.
The excessive use of materials or labour hours than the standards can be
attributable to a particular person. When the variations are due to the factors
beyond the control of the concerned person or department, it is said to be
uncontrolled. The rise in prices of materials, increase in wage rates, Govt.
restrictions etc., are the examples of uncontrollable variance. These factors
are not within the control of the management and the responsibility of the
variance cannot be assigned to any particular person or division. The division
of variance into controllable and uncontrollable is important from the view
point of management as it can place more emphasis on controllable variance
and thus facilitates to the principle of management by exception. Standard
costing to be more realistic, sometimes the standards set are to be revised on
account of changes in uncontrollable factors like wages, materials, etc. To
take into account these factors into variance, a ‘revised variance’ is created
and the basic standard is allowed to continue. This revision variance is the
difference between the standard cost originally set and the revised standard
cost.
Variances may be classified into two categories viz., cost variances and sales
variances. The cost variance may again be sub-divided into variances for
each element of cost and the sales variances may also be sub-divided into
sales price variance and sale volume variance as shown in the following
chart
201
Variances
Variance Analysis
Cost Variance Sales Variance
Direct Material Direct Labour Overhead Sales Price Sales Volume

Cost Variance Cost Variance Cost Variance Variance Variance
Variable Fixed
Price Usage Price Efficiency Efficiency
Overhead Overhead
Variance Variance Variance Variance Variance
Variance Variance
Mix Yield Mix Yield Idle

Variance Variance Variance Variance Variance
Sub-division of variance of each element of cost gives valuable information

to the management to control the cost.
Another classification of Variance analysis is i) Price Variance, and ii)
Volume Variance Price Variance relates to the prices of materials, rates of
labour, expenditure on overheads or selling prices of products. The price
variance may be classified as:
a) Material Price Variance
b) Labour Rate Variance
c) Variable Overhead Expenditure Variance
d) Fixed Overhead Expenditure Variance
e) Sales Price Variance
Volume Variance relates to the quantity of units in terms of raw material
consumed, number of hours worked, number of products sold. The volume
variance may be divided as follows:
a) Material Usage Variance
b) Labour Efficiency Variance
c) Fixed Overhead Volume Variance
d) Sales Volume Variance
The total of Price Variance and Volume Variance is known as the Cost
Variance.
In this unit you will study Direct Material Cost Variance and Direct Labour
Cost Variance only. The remaining cost variances you will study in Unit 13.
10.4 DIRECT MATERIAL COST VARIANCE

Materials constitute most important element of cost. Therefore, utmost care
should taken in purchasing and using the materials.
Direct Material Cost Variance is the difference between the standard cost
of materials specified for the output achieved, and the actual cost of direct
202
materials consumed. Standard cost of materials is computed by multiplying Material Variances
the standard price with the standard quantity for actual output. The actual
cost is computed by multiplying actual price with the actual quantity used.
The Direct Material Cost Variance may be calculated with help of the
following formula:
Direct Material Cost Variance = Standard Cost for actual output – Actual
Cost (DMCV)
Where,
Standard Cost = Standard Price per unit × Standard Quantity for actual
output
Actual Cost = Actual Price × Actual Quantity used.
Direct material cost variance arises due to change in price of materials
or change in the quantity of material used or both. If the standard cost is
more than the actual cost, the variance will be favourable and on the other
hand, if the actual cost is more than the standard cost the variance will be
unfavourable or adverse. Let us take an example:
Illustration 1
Calculate Direct Material Cost Variance with the help of the following
information:
Standard Output : 1600 Units
Actual Output : 2000 Units
Standard Quantity required per unit : 2 Kg.
Total Quantity actually consumed : 2400 Kg.
Standard rate per unit : Rs. 8 per Kg.
Actual rate per unit : Rs. 10 per Kg.
Solution
Direct Material Cost Variance = Standard Cost – Actual Cost
or
 Standard price   Actual price 
 × standard   × actual 
 quantity for  –  quantity 
   
 actual output   used 
= Rs. 8 × 2 kg × 2000 kg – Rs.10 × 2400 kg
= Rs. 32000 – Rs. 24000
= Rs. 8000 (Favourable)
Direct material cost variance may arise due to the following two variances:
1) Direct Material Price Variance
2) Direct Material Usage (Quantity) Variance.
10.4.1 Direct Material Price Variance
Direct Material Price Variance is the difference between actual price and
standard price of materials consumed. Material price variance may arise
due to the following reasons:
203
Standard Costing and i) Changes in the prices of materials,
Variance Analysis
ii) Uneconomical size of purchase orders,
iii) Failure to purchase materials at proper time,
iv) Fluctuations in the cost of transportation and carriage of goods,
v) Buying efficiency or inefficiency,
vi) Not availing cash discounts when setting standards,
vii) Purchase of substitute material for non-availability of specified
material,
viii) Changes in the duty structure which is forming part of price,
ix) Inefficiency of purchase department, etc.
Some of the above factors are controllable if proper care is exercised by
the management. Generally, the Purchase Manager will be held responsible
for material price variance. Material price variance will be calculated as
follows:
Direct Material Price Variance = Actual Quantity (Standard Price –
Actual Price)
= AQ (SP – AP)
If the standard price is more than the actual price, the variance would be
favourable and in case the actual price is more than the standard price, it
shows an adverse variance. Adverse material price variance shows that
unfavourable prices were paid for materials consumed and the Purchase
Manager would be asked to explain the position.
Illustration 2
Calculate the material price variance with the figures given in illustration 1.
Solution
Direct Material Price Variance = Actual Quantity (Standard Price –
Actual Price)
= 2400 (Rs. 8 – Rs. 10)
= 2400 × Rs.2
= Rs. 4800 (Adverse)
As the actual price is more than the standard price, it shows unfavourable
variance.
10.4.2 Material Usage (Quantity) Variance
Material Usage Variance is that portion of material cost which arises due to
the difference between the standard quantity specified and the actual quantity
used. In other words, it the difference between standard quantity for actual
output and actual quantity, multiplied by standard price of material. The
formula for Material Usage Variance is as follows:
Material Usage Variance = Standard Price × (Standard Quantity
for actual output – Actual Quantity)
MUV = SP (SQ-AQ)
204
This Variance will be considered favourable when standard quantity is more Material Variances
than actual quantity and vice versa. The Production Manager will be held
responsible for material usage variance. Material usage variance will arise
due to the following reasons:
i) Use of sub-standard or defective materials,
ii) Carelessness in the use of materials,
iii) Use of substitute materials,
iv) Inefficient production methods,
v) Change in designs than those specified,
vi) Pilferage of material,
vii) Use of non standard mix,
viii) Use of defective plant,
ix) Incorrect processing of materials resulting in wastages,
x) Improper inspection and supervision of work men,
xi) Incorrect setting of standards etc.
Direct Material Cost Variance is equal to the sum of Direct Material Price
Variance and Material Usage Variance. Thus,
Direct Material Cost Variance = Material Price Variance + Material Usage
Variance.
Illustration 3
Gemini Chemical Industries provides the following information from their
records:
For making 10 kgs. of GEMCO, the standard material requirement is
Material Quantity Rate per kg.
A 8 units Rs. 6.00
B 4 units Rs. 4.00
During April, 2004, 1000 kgs of GEMCO were produced. The actual
consumption of material is as under:
Material Quantity Rate per kg.
A 750 units Rs. 7.00
B 500 units Rs. 5.00
Calculate:
a) Material Cost Variance
b) Material Price Variance
c) Material Usage Variance
Solution
a) Material Cost Variance = Standard Cost – Actual Cost
Material x : Rs.4800 – Rs.5250 = Rs.450 (A)
Material y : Rs 1600 – Rs. 2500 = Rs. 900 (A)
205
Standard Costing and Material x and y = Rs. 450 (A) + Rs. 900 (A)
Variance Analysis
= Rs. 1350 (A)
= (Standard Price – Actual Price) × Actual Quantity
Material x = (Rs. 6 – Rs. 7) 750
= Rs. (–1) 750 = Rs.750 (A)
Material y = (Rs. 4 – Rs. 5) × 500 = Rs. 500 (A)
x + y Material = Rs.750 (A) + Rs.500 (A) = Rs. 1250 (A)
c) Material Usage Variance = ( Standard Quantity – Actual Quantity) ×
Standard Price for actual output
= Material x + Material y
= (800 kg. – 750 kg) Rs. 6 + (400 kg – 500 kg) Rs4
= Rs.300 (F) + Rs.400 (A)
= Rs. 100 (A)
Verification:
Material Cost Variance = Material Price Variance + Material Usage
Variance
Rs. 1350 (A) = Rs. 1250 (A) + Rs. 100 (A)
Working
Material Standard Cost Actual Cost
Quantity Rate Amount Quantity Rate Amount
(kg) (Rs.) (Rs.) (kg) (Rs.) (Rs.)
A 800 (1000 kg 8/10) 6 4800 750 7 5250
B 400(1000 kg 8/10) 4 1600 500 5 2500
6400 7750
Classification of Material Usage Variance: When more than one type of

material is used in producing a product, the total usage variance will be
classified into (a) Material mix Variance and (b) Material Yield Variance.
Let us study these two variances in detail.
a) Material Mix Variance: Material Mix Variance may be defined as that
portion of the material usage variance which arise due to the difference
between the standard and actual composition of material mixture. It means
that the cause of variance is due to a change in the ratio of actual material mix
from the standard material mix. The variance results from a variation in the
materials mix used in production. Material mix variance may arise in those
industries where a number of raw materials are mixed in order to produce a
final product. Examples are chemical industries, rubber industries, etc.
Material Mix Variance is calculated as follows:
Material Mix Variance = (Revised Standard Quantity – Actual
Quantity) × Standard Price
or
206
where, Material Variances
Standard Quantity for each material
Revised Standard Quantity = × Total Actual Quantity
Total Standard Quantity for all material
for all material
Or
RSQ = Total Actual Quantity × Standard Ratio
If the actual quantity is more than revised standard quantity, an adverse
variance will occur and vice versa.
Material mix variance may arise due to the following reasons:
i) Price actually paid for materials differs from standard prices
ii) Delay in supply of raw materials
iii) Non-availability of one or more components of the mix.
iv) Non-purchase of materials at proper time.
v) Inefficiency in production department to use proper mix.
vi) Actual mix may be different from standard mix, etc.
Illustration 4
A product made from raw materials X and Y has the following Standard
Mix:
Material Quantity (Kg.) Price (Rs.) Amount (Rs.)
A 2 2.00 4.00
B 8 1.00 8.00
10 12.00
The actual mix is as follows:
Material Quantity (Kg.) Price (Rs.) Amount (Rs.)
A 8 2.00 16.00
B 4 1.25 5.00
12 21.00
Compute Material Mix Variance.
Solution:
Material Mix Variance = (Revised Standard Quantity – Actual
here,
Total Actual Quantity
Revised Standard Mix = × Standard Quantity of each material
Total Standard Quantity
12
Material A = × 2 = 2.4 kg
10
Material B = × Standard Quantity of B
12
= × 8 = 9.6 kg
10
Alternate method for calculating RSQ:

207
Standard Costing and Material A and B Standard Ratio = 2: 8 or 1: 4
Variance Analysis
A: Total Actual Quantity = 12kg × 1/5 = 2.4 kg
B: Total Actual Quantity = 12 kg × 4/5 = 9.6 kg
Computation of Material Mix Variance
A: (Revised Standard Mix – Actual Mix) × Standard Price of A
= (2.4 kg. – 8 kg.) × Rs. 2
= 5.6 kg. × Rs.2 = Rs.11.2 (A)
B: (Revised Standard Mix—Actual Mix) × Standard Price of B
= (9.60 kg. – 4 kg.) × Rs. 1.00
= 5.60 kg. × Rs. 1.00 = Rs. 5.60 (F)
= Total Material Mix Variance = Rs. 11.2 (A) + Rs. 5.60 (F) = Rs.
5.60 (A)
Illustration 5
The following figures relates to the quantity of material required for the
production product:
Standard Actual
Quantity Price Amount Quantity Price Amount
(kgs) (Rs.) (Rs.) (kgs) (Rs.) (Rs.)
A 60 10 600 80 12 960
B 90 20 1800 60 25 1500
150 2400 140 2460
Compute
a) Material Cost Variance
c) Material Usage Variance
d) Material Mix Variance
Solution
a) Material Cost Variance = Standard Cost – Actual Cost
= Rs.2400 – Rs.2460 = Rs. 60 (A)
b) Material Price Variance = (Standard Price – Actual Price) × Actual
Quantity
A: (Rs.10-Rs.12) 80 = Rs.160 (A)
B: (Rs.20-Rs.25) 60 = Rs.300 (A)
Rs. 460(A)
c) Material Usage Variance = Standard Price (Std. Quantity – Actual
Quantity)
Material A: (60–80) Rs.10 = Rs.200 (A)
Material B: (90–60) Rs.20 = Rs.600 (F)

Rs. 400 (F)
208
d) Material Mix Variance= (Revised Standard Quantity – Actual Material Variances
Material A: (56–80) × Rs.10 = Rs. 240 (A)
Material B: (84–60) × Rs.20 = Rs. 480 (F)
Rs. 240 (F)
Revised Standard Quantity of :
Material A = × Standard Quantity of A
140
= ×60 = 56 kg
150
Material B = × Standard Quantity of B
140
= × 90 = 84 kg
150
b) Material Yield Variance (MYV): Material Yield Variance is calculated

on the basis of output while the other variance are calculated on the
basis of input. The variance is calculated as the difference between
the standard output and the actual output. If the actual output is more
than the standard output, then the variance would be favourable and
vice versa. The formula for material yield variance is as follows:
Material Yield Variance (Actual Yield – Standard Yield) Standard
output price
Where,
Standard output price is the total standard material cost per unit of
output,
Actual usage of Material
Standard Yield =
Standard Usage per unit of output
This variance arises in the case of process industries where loss of material
is inevitable in the process of production of final product. Therefore, in these
industries normal loss is to be taken into account while setting standards.
But the actual loss may be different from the normal loss during the process
of actual production. This gives rise to the variance in the standard yield.
The material yield variance may be caused due to the following reasons:
i) Defective method of operation
ii) Purchase of substandard quantity of material
iii) Lack of proper care in handling material
iv) Lack of proper supervision, etc.
It should be noted that where several types of materials are used Material
Revised Usage Variance (MRUV) and Material Yield Variance (MYV)
imply the same thing, though both are computed using different formulae.
Numerical results would give the same figure.
209
Standard Costing and Illustration 6
Variance Analysis
XY Company Ltd. a manufacturer of product P, uses standard cost system
gives you following details for 1000 kgs of product P.
Ingredients Quantity Kg Price per Kg (Rs.) Cost (Rs.)
A 800 2.50 2000
B 200 4.00 800
C 200 1.00 200
Input 1200
Output 1000
Actual Records Indicate :
Consumption in January
A 1,57,000 kgs. @Rs. 2.40
B 38,000 kgs. @ Rs. 4.20
C 36,000 kgs @ Rs. 1.10
Actual finished production for the month of January is 2,00,000 kgs.
Calculate:
1) Material Cost Variance
2) Material Price Variance
3) Material Mix Variance
4) Material Yield Variance
5) Material Usage Variance
Solution
1) Material Cost Variance = (Standard Quantity - Actual Quantity)
A = (1,60,000 kgs × Rs. 2.50) – (157000 kgs × Rs. 2.40)
= Rs. 400,000 – Rs. 3,76,800 = Rs. 23200 (F)
B = (40,000 kgs × Rs. 4) – (38000 kgs × Rs. 4.20)
= Rs. 160,000 – Rs. 159,600 = Rs. 400 (F)
C = (40,000 kg × Re. 1) – (36000 kgs × Rs. 1.10)
= Rs.40,000 – Rs.39,600 = Rs.400 (F)
M.C.V = Rs. 24000 (F)
2) Material Price Variance = (Standard Price - Actual Price) × Actual
Quantity
Material A = (Rs. 2.50 – Rs. 2.40) × 1,57,000 = Rs. 15,700 (F)
Material B = (Rs. 4.00 – Rs. 4.20) × 38,000 = Rs. 7,600 (A)
Material C = (Rs. 1.00 – Rs. 1.10) × 36,000 = Rs. 3,600 (A)
Total Material Price Variance Rs. 4,500 (F)
3) Material Mix Variance: (Revised Standard Mix – Actual Mix) ×
Standard Price
Where,
210
Material Variances
Standard Material
Revised Standard Mix = × Total Actual Material
Total Standard Materials
or
Total Actual Material × Standard Ratio
800 4
A= × 231000 = 1,54,000 kg. or 231000 kg × =1,54,000 kg
1200 6
200 1
B= × 231000 = 38,500 kg. or 231000 kg × = 38,500 kg
1200 6
200 1
C= ×231000=38,500 kg.or 231000 kg × =38,500 kg
1200 6
Material Mix Variance

Material A = (1,54,000 – 1,57,000) × Rs.2.50 = Rs.7,500 (A)
Material B = (38,500 – 38,000) × Rs.4.00 = Rs.2,000 (F)
Material C = (38,500 – 36,000) × Re. 1.00 = Rs.25,00 (F)
Rs.3,000 (A)
4) Material Yield Variance = (Standard Yield – Actual Yield) Std. output

Price
where,
Actual Usage of Material
Standard Yield =
Standard Usage per unit of Output
231000 kgs
=
1.2kg (i.e 1200 kg ÷1000 kg)
= 1,92,500 kg.
Std. material cost per unit of output = Rs. 3000 ÷1000 output
Material Yield Variance = (Actual Yield – Standard Yield) ×
Standard output price
= (200,000- 192,500) × Rs. 3
= Rs.22,500(F)
5) Material Usage Variance =
(Standard Quantity for actual output –
Actual Quantity) × Standard Price
Material A = (1,60,000kg – 1,57,000kg) × 2.50 = Rs. 7500 (F)
Material B = (4,00,00 kg – 38,000 kg) × 4.00 = Rs. 8000 (F)
Material C = (4,00,00 kg – 36,000 kg) ×1.00 = Rs. 4000 (F)
Rs.19500 (F)
The following formulae may be used for verification of material variance:

1) Material Cost Variance (MCV) = Material Price Variance + Material Usage Variance
(MPV + MUV)
Rs. 24000 (F) = Rs. 4500 (F) + Rs.19500 (F)
211
Standard Costing and 2) Material Usage Variance (MUV) = Material Mix Variance + Material Yield Variance
Variance Analysis (MMV + MYV)
Rs. 19500 (F) = Rs.3000 (A) + Rs.22500 (F)
3) Material Cost Variance = M
aterial Price Variance (MCV) + Material Mix Variance
+ Material Yield Variance (MPV + MMV + MYV)
Rs.24000 (F) = Rs.4500 (F) + Rs.3000(A) + Rs.22500 (F)
1) What do you understand about variance analysis?
………………………………………………………………………
………………………………………………………………………
………………………………………………………………………
2) State any four reasons for material price variance.
1) …………………………………………………………………
2) …………………………………………………………………
3) …………………………………………………………………
4) …………………………………………………………………
3) The production of a certain unit is assumed to require 800 kgs of
material costing Rs. 15. On completion of production of the unit, it
was found 750 kg of material costing Rs. 17.0 per kg was consumed.
Calculate the variances.
4) A Product requires 100 kg. of material at the rate of Rs. 5 per kg. The
actual consumption of material used for producing a product came to
120 kgs @Rs. 4.75 per kg. Calculate Direct Material Cost Variance.
5) From the following information calculate Material Mix Variance
Standard Standard Actual Actual
Materials
quantity price quantity Price
X 20 units Rs. 10 25 units Rs. 12
Y 30 units Rs. 5 25 units Rs. 8
6) State weather the following statements are ‘True’ or ‘False’
i) The Variance caused due to a different method of production
than those specified, is called method variance.
ii) Revision variance is the difference between the original standard
cost and the revised standard cost.
iii)
Revision variance is created when there are changes in
controllable factors.
iv) Direct cor-variance is due to the change in the price or quantity or
material or both.
v) Favouarable variance is a sign of inefficiency of the organisation.
212
Material Variances
10.5 LET US SUM UP
Variance is the difference between the standard cost and the actual cost
during a period. Variance analysis means the measurement of the deviations
of actual performance from the desired performance and finding the causes
of such deviations so that corrective action may be taken by the management
in time. Thus, variance analysis helps the management to locate deficiency
and assign responsibility to a particular cost centre.
The variance may be broadly divided into controllable and uncontrollable
variances. The division of variance into controllable and uncontrollable is
important from management point of view as it facilitates to the principle
of management by exception. Variances may also be classified into Cost
Variances and Sales Variances. The Cost Variance may be sub-divided into
Direct Material Cost Variance, Direct Labour Cost variance and Overhead
Cost Variance. The Direct Cost Material Variance is again sub-divided
as Material Price Variance and Material Usage Variances. The Material
Usage Variance may be further sub-divided into Material Mix Variance and
Material Yield Variances.
10.6 KEY WORDS

Variance : It is the difference between predetermined cost and actual cost.
Direct Material Cost Variance : It is the difference between the standard
cost of direct material specified and actual cost of material used.
Direct Material Price Variance : It is the difference between actual price
and standard price of material consumed.
Material Usage Variance : It is the difference between the standard quantity
specified and the actual quantity used.
Material Mix Variance : It is the difference between the standard and
actual composition of material mixture.
Material Yield Variance : It is the difference between the standard output
and the actual output.

A 3. MCV = Rs. 1125 (A), MPV = Rs. 1875 (A), MUV = Rs. 750 (F)
4. MCV = Rs. 30 (F), 5. Material x : Rs. 50 (A), Material y : Rs.25
(F), M.M.V = Rs. 25

1) Define Variance. What is variance analysis?
2) What are the methods of classification of variances?
3) Write a detailed note on the uses of variance analysis?
4) “Calculation of Variances in standard costing is not an end itself, but
a means to an end” Discuss.
5) What is meant by Revision of Standards? What could be the possible
reasons for Revision of Standards.
213
Standard Costing and 6) Discuss material variance and labour variances in detail.
Variance Analysis
7) Write notes on the following:
i) Material Price Variance
ii) Material Mix Variance
iii) Material Usage Variance
8) The following standards have been set to manufacture a product
Rs.
Direct materials –
2 units of A at Rs.4.00 per unit 8.00
3 units of B at Rs.3.00 per unit 9.00
15 units of C at Rs.1.00 per unit 15.00
32.00
Direct Labour: 3 hours @ Rs.8 per hour 24.00
Total Standard Prime Cost 56.00
The company manufactured and sold 6,000 units of the product during the
year.
Direct material costs were as follows:
12,500 units of A at Rs.4.40 per unit
18,000 units of B at Rs.2.80 per unit
88,500 units of C at Rs.1.20 per unit
The Company worked for 17,500 direct labour hours during the year.
For 2500 of these hours, the company paid Rs.12 per hour while for the
remaining, the wages were paid at the standard rate. Calculate Material
Price and Usage Variances and Labour Rate and Efficiency Variances.
9) The Standard Cost of Chemical mixture ~ PQ’ is as follows:
40% of material P@ Rs.400 per kg.
60% of material Q @ Rs.600 per kg.
A standard loss of 10% is normally anticipated in production. The
following particulars are available for the month of March, 2005.
180 kgs of material P have been used @ Rs.680 per kg
220 kgs of material Q have been used @ Rs.360 per kg.
The actual of production of ‘PQ’ was 369 kgs.
Calculate the following variances:
a) Material Price Variance
b) Material Usage Variance
c) Material Mix Variance
d) Material Yield Variance
10) From the following data, calculate all material variances:
Standard mix for 5 units of a product is as follows:
214
Material X : 00 Units @ Rs.15 per Unit : Rs. 4500 Material Variances
Y : 400 Units @ Rs.20 per unit : Rs. 8000

Z : 500 Units @ Rs.25 per unit : Rs.12500
1200 units Rs.25,000
During the month March, 2005 10 units were actually produced and the
actual material used was as follows:
Material X : 640 Units @ Rs.17.50 per Unit : Rs.11200
Y : 950 Units @ Rs.18 per unit : Rs.17100
Z : 870 Units @ Rs.27.50 per unit : Rs. 23925
4920 Rs. 52,225
(Ans: MCV = Rs.2225(A), MPV = Rs.1875(A), MUV = Rs.350(A),
MMV = Rs.900(F), MYV = Rs. 1250 (A), MRUV = Rs.1250)
Note : These questions will help you to understand the unit better. Try to
write answers for them. But do not submit your answers to the University,
These are for your practice
215
UNIT 11: LABOUR VARIANCES
Structure
11.0 Objectives
11.1 Introduction
11.2 Direct Labour Cost Variance
11.2.1 Direct Labour Rate Variance
11.2.2 Direct Labour Time Variance or Labour Efficiency Variance
a) Labour Idle Variance
b) Labour Mix Variance
c) Labour Revised Efficiency Variance
11.3 Let Us Sum Up
11.4 Key Words
11.0 OBJECTIVES
After studying this unit, you will be able to:
●● understand the meaning of labour cost variance;
●● explain how standards for direct labour are set;
●● assess the efficiency of the usage of labour in a manufacturing
concern; and
●● analyse different sub - variances of material and labour.
11.1 INTRODUCTION
You have learnt in the previous unit the meaning, classification of variances
and different types of material cost vaaiance. Another important type of
variance is the labour cost variance. Besides material cost variance a proper
control of the labour cost variance is imperative for the smooth running of
any manufacturing enterprise. In this unit different aspects of direct labour
cost variances will be described.
11.2 DIRECT LABOUR COST VARIANCE

The labour directly engaged in the production of a product is known as
direct labour. The wages paid to such labour is known as direct wages.
For example, the wages paid to a machine operator is a direct labour cost.
Labour variances arise when actual labour costs are different from standard
labour cost. The setting up of standard direct labour cost will depend upon
the various factors like standard methods of production, the time taken
by different categories of workers, the expected wage rate of different
categories of workers, different grades of labour mix, etc.
Direct labour variance is the difference between the standard direct labour
cost specified for the activity to be achieved and the actual direct labour cost
incurred. It is calculated as follows:
216
Direct Labour Cost Variance = Standard Labour Cost – Actual Labour Cost Labour Variances
or
= (Std. hours × Std. Rate) – (Actual hours × Actual rate)
= (SH × SR) – (AH × AR)
It is to be noted that when the actual output differs from standard output,
standard labour cost of actual output is to be worked out and then the
following formula is to be applied:
Direct Labour Cost Variance = Standard Cost of Actual Production – Actual
Cost
Let us see the following illustration how Direct Labour Cost Variance is
calculated:
Illustration 1
From the following information, calculate direct labour cost variance:
Standard wage rate per hour : Rs. 5
Standard time set : 1000 hours
Actual wage rate per hour : Rs. 6
Actual time taken : 980 hours.
Solution
Direct Labour Cost Variance = (SH × SR) – (AH × AR)
= (1000 × Rs.5) – (980 Rs.6)
= Rs.5000 – Rs.5880
= Rs.880 (A)
Direct Labour Cost Variance is sub-divided into:
1) Labour Rate Variance, and
2) Labour Efficiency Variance
Labour Efficiency or Time Variance may again sub-divided into:
a) Labour Idle Time Variance
b) Labour Mix Variance, and
The above classification may also be shown diagramatically as follows:
Labour Cost Variance
Labour Rate Labour Time Variance

Variance (Labour Efficiency Variance)
Labour Idle Time Labour Mix Labour Revised

Variance Variance Efficiency Variance
217
Standard Costing and 11.2.1 Labour Rate Variance
Variance Analysis
Labour rate variance is that portion of the labour usage variance which is
due to the difference between standard rate specified and actual rate paid. It
is calculated with the help of the following formula:
Labour Rate Variance = (Standard Rate – Actual Rate) × Actual Hours Paid
LRV = (SR – AR) AHP
The variance will be favourable if actual rate is less than the standard
rate and it will be adverse if actual rate is more than the standard rate.
The responsibility for labour rate variance lies with the production centre.
Labour rate variance is generally uncontrollable. If the variance is due to
wrong grade of labour, the responsibility lies on production foreman.
Labour rate variance arises due to the following reasons:
i) Change in the basic wage rate of piece-work rate.
ii) Employment of one or more workers of different grades than the
standard grade.
iii) Payment of more overtime than fixed earlier.
iv) Higher or lower wage rates paid to casual labourers.
v) Faculty recruitment and placement of workers.
vi) New workers not being paid at full wage rates etc.
Illustration 2
Using the data given in illustration 1, calculate Labour Rate Variance.
Solution
Labour Rate Variance = (Standard Rate – Actual Rate) × Actual Hours Paid
= (Rs.5 – Rs.6) × 980 Hours
= Re.1× 980 hours
= Rs. 980 (Adverse)
11.2.2 Labour Time Variance or Labour Efficiency Variance
Labour efficiency ratio is the difference between the standard labour hours
specified for actual output and the actual hours paid for. This variance helps
in controlling efficiency of workers and also labour cost. This variance can
be calculated as follows:
Labour Efficiency Variance
= (Standard Hours for Actual Production – Actual Hours
Worked) × Standard Rate
LEV = (SHAP AHW) SR
If actual time taken for doing a work is more than the specified standard
time, the variance will be unfavourable and vice versa. Labour efficiency
variance arises due to one or more of the following reasons:
i) Defective machinery and equipment
ii) Lack of proper supervision
iii) Use of defective or non-standard materials
218
iv) Lack of proper training to workers Labour Variances
v) Poor working conditions

vi) Labour turnover or change over of workers from one operation to
another
vii) Alterations in the methods of production
viii) Loss of time due to delay in receipt of instructions or receipt of raw
material tools.
ix) Failure of power
x) Bad industrial relations etc.
Using the data given in Illustration 1, Labour Efficiency Variance is
calculated as follows:
Labour Efficiency Variance
= (Standard Hours for Actual Output – Actual Hours) × Standard Rate
= (1000 hours – 980 hours) × Rs. 5
= 20 hours Rs.5
= Rs. 100 (Favourable)
It is to be observed that the work has been completed in 980 hours as against
1000 standard hours set for the production. This may be due to the efficiency
of workers. That is why, this variance is called Labour Efficiency Variance.
It is to be noted that the labour rate variance and labour efficiency variance
is equal to labour cost variance as these two are sub-variances of labour cost
variance.
Verification
Direct Labour Cost Variance = Labour Rate Variance + Labour
Efficiency Variance
Labour Rate Variance = Rs.980 (Adverse) as calculated in
Illustration 8
Hence, DLCV = LRV + LEV
= Rs.880 (A) = Rs.980 (A) + Rs.100 (F)
Labour efficiency variance is the responsibility of Production Manager
and is similar to materials usage variance. Both these variance measure the
difference in performance.
Labour efficiency variance can be further sub-divided into:
a) Labour Idle Time Variance
d) Labour Yield Variance
Let us study these in detail.
a) Labour Idle Time Variance: Labour Idle time variance is a sub-
variance of labour efficiency variance. It is the standard wage
payable during the idle hours due to abnormal circumstance like
219
Standard Costing and strikes, lockout, break-down or machinery, power cut, shortage or
Variance Analysis raw materials, etc. The abnormal idle time should be separated from
the labour efficiency variance as it is due to the reasons beyond the
control of workers. Otherwise it will show inefficiency on the part
of workers. This variance will always be adverse. It is calculated as
follows:
Idle Time Variance = Idle Hours × Standard Rate
ITV = IH × SR
For example, if the idle time in the data given in Illustration 7, is 20
hours, then the idle time variance would be
Idle Time Variance = Idle Hours × Standard Rate
= 20 hours × Rs.5
= Rs.100 (A)
Illustration 3
The following information is supplied to you:
Standard time for a month : 4000 Hours
Standard wage rate : Rs. 2.25 per hour
Number of labourers employed : 30
Average working days in a month : 25
No. of hours a worker works per day : 7 hours
Total wage bill in a month : Rs. 13,125
Idle time due to power failure : 100 hours
You are required to calculate the following:
a) Labour Cost Variance
c) Labour Efficiency Variance
d) Labour Idle Time Variance
Solution
To find out the above variance, we require information about the actual time
worked and actual wage rate. Actual time worked and the exact wage rate
will be calculated as follows:
Standard time = 4000 hours
Standard wage rate = Rs. 2.25
Actual time = 30 workers × 25 days × 7 hours
= 5250 hours
Total Wage Bill
Actual Wage Rate =
Actual time
Rs.13125
= = Rs.2.50
5250 hours
220
a) Labour Cost Variance = Standard Labour Cost – Actual Labour Cost Labour Variances
= (Std. Time × Std. Rate) – (Actual time × Actual Rate)

= (4000 hours × Rs. 2.25) – (5250 hours × Rs. 2.50)
= Rs.9000 – Rs. 13125
= Rs. 4125 (A)
b) Labour Rate Variance =
Actual Time (Std. Labour Rate – Actual
Labour Rate)
= 5250 hours (Rs. 2.25 – Rs.2.50)
= 5250 × 0.25
= Rs. 1312.50 (A)
c) Labour Efficiency Variance = Standard Labour Rate × (Std. Time –
Actual Time)
= Rs. 2.25 (4000 hours – 5250 hours)
= Rs. 2.25 × 1250 hours
= Rs. 2812.50 (A)
d) Labour Idle Time Variance = Idle Time × Standard Rate
= 100 hours × Rs. 2.25
= Rs. 225 (A)
a) Verification
Direct Labour Cost Variance = L
abour Rate Variance + Labour Efficiency
Variance
Rs. 4125 (A) = Rs.1312.50 (A) + Rs.2812.50 (A)
Rs. 4125 (A) = Rs.4125(A)
It is also known as Gang Composition Variance. It is similar to Material Mix
variance and is a part of labour efficiency variance. Labour mix variance
arises only when two or more different types of workers employed and the
composition of actual grade of workers differ from the standard composition
of workers. The change in the labour composition may be due to shortage of
one grade of labour. This variance indicate how much labour cost variance
is there due to the change in labour composition. It is calculated with the
help of the following formula:
Labour Mix Variance = Standard Cost of Standard Mix –
Standard Cost of Actual Mix
LMV = SCSM – SCAM,
or
Labour Mix Variance = (Revised Standard Hours – Actual Hours
Worked) × Standard Rate
Symbolically,
LMV = (RSH – AHW) × SR
221
Standard Costing and Where,
Variance Analysis
RSH = Actual Total Hours Worked × Standard Ratio of Workers
or
Standard Hours of the grade
×Total Actual Hours Worked
Total Standard Hours
Where,
Actual Hours Worked = Actual hours – Idle Time
If the actual hours taken are less than the Revised Standard Hours, the
variance is favourable, and vice versa.
Illustration 4
From the following information, calculate Labour Mix Variance:
Standard Actual
Grade A 80 workers @ Rs. 5 per hour 100 workers @ Rs 6 per hour
Grade B 120 worker Rs. 3 per hour 80 workers @ Rs. 2 per hour
200 180
Solution
Labour Mix Variance = (Revised Standard hours – Actual Hours Paid) ×
Standard Rate
Revised Standard Hour
= ×Total Actual Hours Worked
80 2
RSH for Grade A = × 180 = 72 hours OR 180 hrs × = 72 hrs.
200 5
120 2
RSH for Grade B = × 180 = 108 hours OR 180 hrs × = 108 hrs.
200 5
LMV = (RSH – AHP) SR
Grade A = (72 – 100) × Rs.5 = Rs.140 (A)
Grade B = (108 – 80) × Rs.3 = Rs. 84 (F)
LMV = Rs.56(A)
c) Labour Revised Efficiency Variance (LREV)
This variance arises due to the difference between the total actual hours
taken and the total standard hours specified for the actual output. This
variance is a sub-variance of labour efficiency variance. It arises when there
is difference between actual hours paid and actual hours worked, there will
be Revised Efficiency Variance and Idle Time variance. The formula for
Labour Revised Efficiency Variance is:
LREV = (Standard Hours for Actual output – Revised Standard
Hours) × Standard Rate
222
Where, Labour Variances
RSH = ×Total Actual hours paid
Or
= Total Actual Hours Paid × Standard Ratio
d) Labour Yield Variance (LYV)
It is similar to Material Yield Variance. It studies the impact of actual yield
on labour cost where output varies from the standard. The formula for LYV
is:
Labour Yield Variance
= (Actual yield – Standard yield) × Standard labour cost per unit of output
Where,
Std. output
Std. Yield = × AHW;
Total AH
(It is applicable where there is a difference in the actual total hours worked
and the total hours paid)
Std.cost
Std. labour cost per unit =
Std.Output (Units)
If the standard yield is more than the actual yield, the variance will be
adverse and vice versa.
Illustration 5
From the following data, calculate Labour Yield Variance
Standard time : 600 hours
Standard rate : Rs. 10 per hour
Standard output : 300 units
Actual output : 225 units
Solution
Labour Yield Variance = (Actual Yield – Standard Yield) × Std. Output cost
per unit
Standard Cost
Standard output cost per unit =
Standard Output (unit)
600 hrs × Rs. 10
=
300 units
= Rs. 20
LYV = (Actual Yield – Std Yield) × Std Output per unit
= (225 units – 300 units) × Rs.20

= Rs.1500 (A)
Illustration 6
The following information is available from the records of a Company:
223
Standard wages Actual wages
Variance Analysis
Skilled: 90 workers @ Rs.2 per hour 80 workers @ Rs.2.50 per hour
Unskilled: 60 workers @ Rs.3 per hour 70 workers @ Rs.2 per hour
Budgeted hours : 1000 Actual hours: 900
You are required to calculate the following:
i) Labour Cost Variance
ii) Labour Rate Variance
ii) Labour Efficiency Variance
iv) Labour Mix Variance
v) Revised Labour Efficiency Variance
Solution
Type of Standard Actual
workers *Hours Rate Amount **Hours Rate Amount
(Rs.) (Rs.)
Skilled 90,000 Rs.2 1,80,000 72000 Rs.2.50 1,80,000
Unskilled 60,000 Rs.3 1,80,000 63000 Rs.2.50 1,26,000
1,50,000 3,60,000 1,35,000 3,06,000
* Hours = No. of Workers × Budgeted Hours
**Hours = No. of Workers × Actual Hours
i) Labour Cost Variance
= (Std Hours of actual output × Std Rate) – (Actual Hours × Actual
Rate)
Skilled = (90,0000 × Rs.2) – (72,000 × Rs.2.50) = NIL
Unskilled = (60,0000×Rs.3) – (63,000 ×Rs.2.50) = Rs. 54,000 (F)
LCV = Rs. 54,000 (F)
ii) Labour Rate Variance
= (Std Rate – Actual Rate) × Actual Hours
Skilled = (Rs.2 – Rs.2.50) × 72,000 = Rs. 36,000 (A)
Unskilled = (Rs.3 – Rs.2) × 63,000 = Rs. F)
LRV = Rs. 27,000 (F)
iii) Labour Efficiency Variance
= (Std. Hours – Actual Hours) × Standard Rate
Skilled = (90,000 – 72,000) × Rs. 2 = Rs. 36,000 (F)
Unskilled = (60,000 – 63,000) × Rs.3 = Rs. 9,000 (A)
LEV = Rs. 27000 (F)
iv) Labour Mix Variance
= (Revised Std. hours – Actual Hours) × Standard Rate
224
Where, Labour Variances
Revised Standard Hour = × Total Actual Hours Worked
Or
= Actual Hours Worked × Std Ratio
90,000 3
Skilled = ×135000 = 81000 hours or 13500 hrs × = 81000 hrs
1,50,000 5
60,000 2
Unskilled = ×135000 = 54000 hours or 13500 hrs × = 54000 hrs
1,50,000 5
LMV : (RSH – AH) × SR

Skilled = (81000 – 72000) × Rs. 2 = Rs. 81000 (F)
Unskilled = (54000 – 63000) × Rs. 3 = Rs. 27000 (A)
LMV = Rs. 9,000 (A)
iv) Labour Revised Efficiency Variance = (Std Hrs – Revised Std Hrs.) ×
Std Rate
Skilled = (90000 – 81000) × Rs. 2 = Rs. 18000 (F)
Unskilled = (60000 – 54000) × Rs. 3 = Rs. 18000 (F)
= Rs. 36,000 (F)
Verification
LCV = LRV + LEV
Rs.54000(F) = Rs.27000 (F) + Rs.27000 (F)
Rs.54000(F) = Rs.54000 (F)
LEV = LMV + LREV
Rs.27000 (F) = Rs. 9,000 (A) + Rs. 36,000 (F)
Rs.27000 (F) = Rs.27000 (F)
Illustration 7
A gang of workers normally consists of 60 skilled, 30 semi-skilled and 20
unskilled. They are paid at standard rates per hour as under:
Skilled Re.0.80
Semi-skilled Re.0.60
Unskilled Re.0.40
In a normal working week of 40 hours, the gang is expected to produce
4000 units of output.
During the week ended 31 December, the gang consisted of 80 skilled,
20 semi-skilled and 10 unskilled. The actual wages paid were @ Re.0.70,
Re.0.65 and Re.0.30 respectively. 3200 units were produced. Four hours
were lost due to abnormal idle time.
225
Standard Costing and Calculate
Variance Analysis
i) Wage variance
ii) Wage Rate Variance
iii) Labour Efficiency Variance
iv) Idle Time Variance
v) Labour Mix Variance
vi) Labour Revised Efficiency Variance
vii) Labour Yield Variance
Solution
Type of Standard Actual
workers Hours Rate Amt Hours Rate Amt
(Rs.) (Rs.) (Rs.) (Rs.)
Skilled 60 40 = 2400 0.80 1920 80×40 = 3200 0.70 2240
Semi-skilled 30 40 = 1200 0.60 720 20×40 = 800 0.65 520
Unskilled 20 40 = 800 0.40 320 20 × 40 = 400 0.30 120
Total 4400 2960 4400 2880
Std. Cost Rs. 2960

Standard Wage Rate per hour (Group) = = = Rs 0.673
Std hours 4400
Std. Cost
Standard Coast of actual output = × Actual output
Std output
3200 units
= × Rs. 2960 = Rs. 2368
4000 units
Standard hours for actual output :

2400
Skilled = × 3200 = 1920 hours
4000
1200
Semi - Skilled = × 3200 = 960 hours
4000
800
Unskilled = × 3200 = 640 hours
4000
Actual hours paid = 4400
Actual hours worked = 3960 i.e., ( 4400 hours – 440 hours idle time)
Calculation of Variances:
i) Labour Cost Variance = (Std Cost of actual output – (Actual cost)
Skilled = Rs. 1536 – Rs. 2240 = Rs. 704 (A)
Semi-Skilled = Rs. 576 – Rs. 520 = Rs. 56 (F)
Unskilled = Rs. 256 – Rs. 120 = Rs. 136 (F)
LCV (Group) = Rs. 2368 – 2880 = Rs. 512 (A)
ii) Labour Rate Variance = (SR – AR) × AHP
Skilled = (Re. 0.80 – Rs. 0.70) × 3200 hours = Rs. 320 (F)
226
Labour Variances
Semi-Skilled = (Re. 0.60 – Re. 0.65) × 800 hours = Rs. 40 (A)
Unskilled = (Re. 0.40 – Re. 0.30) × 400 hours = Rs. 40 (F)
LRV (Group) = Rs. 320 (F)
iii) Labour Efficiency Variance = (SH for Actual Output – AHP) SR
Skilled = (1920-3200) Re. 0.80 = Rs. 1024(A)
Semi-Skilled = (960-800) Re. 0.60 = Rs. 96 (F)
Unskilled = (600-400) Re. 0.40 = Rs. 96 (F)
LEV (Group) = Rs. 832 (A)
iv) Idle Time Variance = Standard hour Rate per hour × Idle hours
Skilled = Re. 0.80 × 320 hrs = Rs. 256 (A)
Semi-Skilled = Re. 0.60 × 80 hrs = Rs. 48 (A)
Unskilled = (Re. 0.40 × 40 hrs = Rs. 16 (A)
LEV (Group) = Rs. 320 (A)
Calculation of Idle Hours
Skilled = 80 × 4 hrs = 320 hrs
Semi-skilled = 20 × 4 hrs = 80 hrs
Skilled = 10 × 4 hrs = 40 hrs
Out of the total actual hours of 4400, total idle hours are 440. Now the
labour mix variance and labour yield variance are computed on the
basis of 3960 hrs (4400 hrs – 440 hrs).
v) Labour Mix Variance = (Revised Std hrs – Actual hours worked) Std
rate.
Skilled = (2160 – 2880) × 0.80 = 576 (A)
Semi-Skilled = (1080 – 720) × 0.60 = 216 (F)
Unskilled = (720 – 630) × 0.40 = 144 (F)
LMV = 216 (A)
Std. hrs
RSH = × Total AHW or Actual Hours worked × Std Ratio (6 : 3 : 2)
Total Std hrs
2400 6
Skilled = × 3960 = 2160 or 3960 × = 2160 hrs
4400 11
1200 3
Semi-Skilled = × 3960 = 1080 or 3960 × = 1080 hrs
4400 11
800 2
Unskilled = × 3960 = 720 or 3960 × = 720 hrs
4400 11
Actual hours worked = (Normal working hours – Idle time) × No. of workers
Skilled = (40 hrs. – 4 hrs.) × 80 = 2880 hrs
Semi- skilled = (40 hrs. – 4 hrs.) × 20 = 720 hrs
Semi- skilled = (40 hrs. – 4 hrs.) × 10 = 360 hrs
Total = 3960 hrs
227
Standard Costing and vi) Labour Revised Efficiency Variance
Variance Analysis
= (Std hrs for actual output – Revised Std hrs) × Std Rate.
Skilled = (1920 – 2160) × 0.80 = 192 (A)
Semi-Skilled = (960 – 1080) × 0.60 = 72 (A)
Unskilled = (640 – 720) × 0.40 = 32 (A)
LREV = 296 (A)
4400 hrs
Std hours for actual output = × 3200 units = 3520 hrs
4000 units
6
Skilled: 3520 hrs = = 1920 hrs
11
3
Semi-skilled: 3520 hrs × = 960 hrs
11
2
Unskilled: 3520 hrs × = 640 hrs
11
Labour Yield Variance may be calculated in place of Labour Revised

Efficiency Variance as follows:
Labour Yield Variance = (Actual Yield – Std Yield) × Std. Labour cost per
unit of outputs
where,
Std Cost Rs. 2960
Std labour cost per unit of output = = = 0.74
Std Output 4000 hrs
Std Output
Std Yield = × AHW
Total AH
LYV = (3200 – 3600) × 0.74 = 296 (A)

4000
Standard Yield = × 3960 = 3600 units
4400
Check:
i) LCV = LRV + LEV : 512 (A) = 320 (F) + 832 (A)
ii) LEV = ITV + LMV + LYV : 832 (A) = 320 (A) + 216(A) + 296 (A)
1) State any two reasons for causing Labour Rate Variance.
a) …………………………………………………………………
b) …………………………………………………………………
2) What do you understand about Labour Efficiency Variance.
……………………….………………………………………………
………………………………………………………………………
3) What do you mean by Labour Mix Variance ? Why does it arise ?
………………………………………………………………………
………………………………………………………………………
228
4) State whether the following statements are ‘True’ or ‘False’ Labour Variances
i) The difference between standard labour cost and actual labour
cost is called direct labour cost variance.
ii) Labour idle time variance is the sub-variance of labour rate
variance.
iii) Direct Labour Cost Variance = Labour rate variance + Labour
efficiency variance.
(iv) Labour efficiency variance and material usage variances measure the
difference in labour performance.
(v) The idle time variance may be either favourable or unfavourable.
11.3 LET US SUM UP
The Labour directly engaged in the production of a product is known as
direct labour and the wages and to such labour are termed as the direct
wages. Labour variances arise when actual labour cost are different from
the standard labour cost.
Direct labour variance is the difference between the standard direct labour
cost specified for the activity to be achieved and the actual direct labour cost
incurred.
Direct Labour cost variance may be sub-divided into labour price and Labour
Efficiency Variances. Labour Mix Variance, Labour Yield Variance and
Labour Idle Variances are the sub-variances of Labour Efficiency variances.
The sub-division of variance of each element of cost gives valuable
information to the management to control cost and decision making.
11.4 KEY WORDS
Direct Labour Cost Variance : It is the difference between the standard
labour cost specified and the actual direct labour cost incurred.
Labour Rate Variance : The difference between the standard rate specified
and the actual rate paid.
Labour Efficiency Variance : The difference between the standard labour
hours specified and actual hour paid for.
Labour Idle Time Variance : Standard wage payable during the idle hours
due to abnormal circumstances like strikes, lockouts etc.
Labour Mix Variance : Difference between standard cost of standard mix
and standard cost of actual mix.
A. 4. i) True, ii) False, iii) True iv) True, v) False
1) What is meant by direct labour cost variance ? Explain with the help
of a suitable illustration.
2) Write notes on the following :
a) Labour Rate Variance
b) Labour Idle Time Variance
c) Labour Mix Variance
d) Labour Revised Efficiency variance
229
Standard Costing and 2) What are the methods of classification of variances?
Variance Analysis
3) A manufacturing concern which has adopted standard costing
furnishes you the following information:
Standard
Material for 70 kg Finished Products 100 kg
Price of materials Re.1 per kg
Actual
Output 2,10,000 kgs
Material used 2,80,000 kgs
Cost of materials Rs.2,52,000
Calculate:
a) Material Usage Variance
c) Material Cost Variance
4) The details about the composition and the weekly wage rate of labour
force engaged on a job scheduled to be completed in 30 weeks are as
follows:
Category No. of Standard Actual no. of Actual
of Labourers Weekly Labourers weekly
Workers wage rate wage rate
Skilled 75 60 70 70
Sem- 45 40 30 50
Skilled
Unskilled 60 30 80 20
The works get completed in 32 weeks. Calculate the Labour Variances.
5) In a factory 100 workers are engaged and the average rate of wages
is Rs.5/per hour. Standard working hours per week are 40 and the
standard performance is 10 units per gang hour.
During a week in April, 2005 wages paid for 50 workers were Rs.5
per hour, 10 workers at Rs.3.50 per hour and 40 workers at Rs.5.20
per hour. Actual output was 380 units.
The factory did not work for 5 hours due to breakdown of machinery.
Calculate:
a) Labour Cost Variance
c) Labour Efficiency Variance
d) Labour Yield Variance
e) Idle Time Variance
[Ans. LVC = Rs. 8280 (F), LRV = Rs. 280 (F), LEV = Rs. 8000 (F),
LYV = Rs. 818 (F), ITV = Rs. 1000 (A)]
write answers for them. But do not submit your answers to the University,
These are for your practice
230
UNIT 12: OVERHEAD Variances
Structure
12.0 Objectives
12.1 Introduction
12.2 Classification of Overhead Variance
12.3 Variable Overhead Cost Variance
12.4 Fixed Overhead Variances
12.4.1 Fixed Overhead Volume Variance
12.4.2 Fixed Overhead Expenditure Variance
12.5 Sales Variances
12.5.1 Sales Value Variance
12.5.2 Sales Margins or Profit Variance Method
12.6 Control Ratios
12.7 Disposition of Variances
12.8 Let Us Sum Up
12.9 Key Words
12.0 OBJECTIVES
After studying this unit, you would be able to:
●● analyse the classification of overhead variances;
●● find out fixed overhead volume and expenditure variances;
●● understand sales value and sales margin variances; and
●● comprehend the control ratios that are used in controlling operations
as well as disposition of variances.
12.1 INTRODUCTION
After having studied the first part of variance analysis consisting of material
and labour variances, let us proceed to analysis of variances relating to
overheads. The overheads variance analysis is different from variance
analysis relating to materials and labour. Here the overheads and inputs are
already determined. These predetermined overheads and inputs are called
the standard. The overhead is considered in terms of predetermined rate and
is applied to the input. There can be different bases for the absorption of
overheads like labour hours, machine hours, output (in units), etc.
Overhead variances may be classified into fixed and variable overhead
variances and fixed overhead variance can be further analysed according
to the causes. In the case of variable overheads, it is assured that variable
overheads vary directly with production so that any change in expenditure
can affect costs. Some say that a variance may arise through inefficiency,
231
Standard Costing and but as these costs are usually very small per unit of output, it is to be ignored
Variance Analysis and any variance in variable overhead is attributed to expenditure variance.
Considering the fixed overheads cost, the difficulty arises in determining
standard overhead rates because this is dependent on the volume or level
of activity. Any change in volume or level of activity causes a change in
the overhead rate. Therefore fixing the volume or level of activity is a
crucial aspect in determining standard overhead rate. Usually the normal
volume is taken as the basis for determination of standard overhead rate. If
the management decides to change the normal volume or level of activity,
without a corresponding change in the fixed amount of overheads, then a
change occurs in the overhead rate. Here it may be noted that in the case
of material or labour variances, the volume decision does not in any way
influence the fixation of standard rate. So to resolve this problem, normally
the budget is used in place of the standard.
In this unit you will study variable and fixed overheads cost variances and
its sub variances. The unit also deals with sales variance, control ratios and
finally disposition of variances.
12.2 CLASSIFICATION OF OVERHEAD

VARIANCE
The term “overhead” includes indirect material, indirect labour and indirect
expenses. It may relate to factory, office and selling and distribution centres.
Overhead variance can be classified as shown in the following diagram:
Overhead Cost Variance
Variable Overhead Fixed Overhead

Cost Variance Cost Variance
Volume Expenditure
Variance Variance
Efficiency Capacity Calender

Variance Variance Variance
Overhead Cost Variance is the difference between standard cost of overhead

absorbed in the output achieved and the actual overhead cost. Simply, it is
the difference between total standard overheads absorbed and total actual
overheads incurred. Therefore, the formula for Overhead Cost Variance is
as follows:
Overhead Cost Variance = Total Standard Overheads – Total Actual
Overheads (OHCV)
The Overhead Cost Variance may be divided into Variable Overhead Cost
Variance and Fixed Overhead Cost Variance. Fixed Cost Variance may be
further divided as Fixed Expenditure Variance and Fixed Volume Variance.
Fixed Volume Variance may again be sub-divided into Efficiency Variance,
Capacity Variance and Calendar Variance. Let us study, how these variances
are calculated.
232
Overhead Variances
12.3 VARIABLE OVERHEAD COST VARIANCE
This variance is the difference between the standard variable overhead and
the actual variable overhead. The formula is:
Variable Overhead Cost Variance
= Standard Variable Overhead for Actual Output – Actual Variable Overhead
Where,
Standard Variable Overhead
= Standard Hours allowed for Actual × Output Standard Variable Overhead
Rate
Standard Variable Overheads
Standard Output
Variable overhead cost variances arise due to the following reasons:
i) Advance payment of overheads
ii) Outstanding overheads during the current period
iii) Payment of past outstanding overheads during the current period
iv) Incurring of abnormal overheads like repairs to machinery due to
break down, expenses due to spoilage, defective workmanship or
excessive overtime work, etc.
It is stated earlier that there are two basic variances, price and volume. If
volume does not affect the cost per unit, the only variance to be calculated
is price variance known as the variable overhead variance. But when it
is assumed that variable overheads do not move directly with output, the
variable overhead variances are to be calculated on similar lines as to fixed
overhead variances which you will study later. In this unit, we are assuming
that variable overheads do change directly with the output and infact it is the
practice that many firms follow and by a number of writers on the subject.
Illustration 1
From the following information, calculate the variable overhead variance:
Standard output : 400 Units
Actual output : 500 Units
Standard variable overheads : Rs.1800
Actual variable overheads : Rs.2000
Solution
Variable Overhead Variance
= Standard Variable overhead for actual output – Actual Overhead
Where,
Standard Variable Overhead
= Standard Hours allowed for actual output × Standard Variable Overhead
Rate
Standard Output
233
Standard Costing and Rs. 1800
Variance Analysis = = Rs.4.50
400 units
Variable Overhead Variance = (500 Units × Rs.4.50) – Rs.2000
= Rs. 2250 – Rs.2000
= Rs. 250 (F)
Let us take another illustration and calculate variable overhead variance.
Illustration 2
Budgeted production for a month : 3000 kgs.
Budgeted variable overheads : Rs.15600
Standard time for one kg. of output : 20 hours
Actual production in the month : 250 kgs.
Actual overheads : Rs.14000
Actual hours : 4500 hours
Solution
Variable Overhead Variance
= Standard Variable overhead for Actual Output – Actual Variable Overhead
Standard Output
Rs.15600
= = Rs.2.60
6000 hrs.
 3000 kgs 
= × 1 kg  = 6000 hrs
 2 hrs 
Variable OH Variance = (4500 hrs × Rs. 2.60) – Rs. 14000
= Rs. 11700 – Rs. 14000
= Rs. 2300 (A)
12.4 Fixed Overhead Variances

The treatment of these variances differ from that of variable overhead
variable because of the fact that the fixed overheads are incurred anyway
and do not vary with the change in production levels. These have to be
apportioned to production on a basis. The standard recovery rate is fixed by
considering the budgeted fixed overhead by budgeted or normal volume,
regardless of actual activity. It may be on the basis of of normal volume,
which may considerably differ from actual volume or even actual time
taken. So when overheads are actually incurred, they may be over recovered
or under-recovered. This over or under recovery is known as the variance.
This variance may be on the basis of output (in units) or standard time.
Fixed Overhead Variance: It is also called fixed overhead cost variance
and represents the total fixed overhead variance. Actually it is the difference
between the Standard fixed overhead charged and the actual fixed overhead.
Symbolically we can express it as:
234
Fixed Overhead Variance Overhead Variances
= Standard Fixed Overhead – Actual Fixed Overheads

Std. hours for   Std. fixed 
=  ×  – Actual Fixed O.H.
 Actual output   O.H.Rate 
Fixed Overhead Variance may be further sub-divided into:
i) Fixed Overhead Volume Variance
ii) Fixed Overhead Expenditure Variance
12.4.1 Fixed Overhead Volume Variance
Fixed Overhead Volume Variance: It is also called as activity variance.
This is the difference between the Budgeted hours based on normal volume
and the standard hours for actual output. The variance occurs because all
the overheads cannot actually be absorbed or may be over absorbed in some
cases.
Symbolically we can compute this variance as follows:
Fixed overhead volume variance
= Standard Rate of recovery of fixed overheads × (Standard hours –
Budgeted hours) For Actual Output
Where,
Budgeted Fixed Overheads
Standard rate of recovery of Fixed Overhead =
Budgeted Hours
Fixed overhead volume variance can be sub-divided into:
i) Fixed overhead efficiency variance
ii) Fixed overhead calendar variance
iii) Fixed overhead capacity variance
i) Fixed Overhead Efficiency Variance: This is the difference between
actual hours taken to complete a work and standard hours that should
have been taken to complete the work. It measures the efficiency of
performance. Symbolically we can express it as:
= Standard fixed rate of recovery of overheads × (Standard Hours –
Actual Hours for Actual Output)
ii) Fixed Overhead Calender Variance: This variance arises due to
the actual time consumed, expressed in terms of hours or days as the
case may be, and standard time that should have been taken. In other
words, it is due to the difference between the number of working days
in the budgeted period and the number of actual working days in the
period to which the budget is applied. This variance is obtained by
multiplication of the standard rate of recovery of fixed or overhead by
difference between revised budgeted hours and budgeted hours.
Symbolically it can be expressed as:
Fixed Overhead Calender Variance
= Standard Rate of Recovery of fixed overheads (per hour) × (Revised
Budgeted Hours – Budgeted Hours)
Or
235
Standard Costing and = (Actual no. of working days – Standard no. of working days) ×
Variance Analysis Standard rate of recovery of fixed overheads (per day)
The calendar variances arises due to the extra holidays declared to
celebrate the anniversary of the firm or on the death of a national
leader or any other reason. It arises only in exceptional circumstances
otherwise normal holidays are taken into account while setting the
standards. When there is no change in the working days then there
should be no need for a calendar variance. Generally, this variance is
adverse, but sometimes it shows favoruable variance where there are
extra working days.
iii) Fixed Overhead Capacity Variance: This variance arises due to
difference between Revised Budgeted Hours and the actual hours
taken multiplied by the standard rate of recovery of fixed overheads.
Symbolically we can express this as:
Fixed overhead capacity variance
= Standard rate of recovery of fixed overheads × (Actual hours –
Revised Budgeted hours)
Where,
Revised Budgeted Hours = Standard hours per day × Actual number
of days
This variance arises when there is difference between utilization of planned
plant capacity of planned and actual utilization of plant capacity. It may be
due to the factors like idle time, strikes, power failure, etc. This variance
can be both favourable a well as unfavourable. If the actual hours worked is
more than revised budgeted hours it is favourable and vice versa.
Check:
Fixed overhead volume variance
= Fixed overhead efficiency variance + Fixed overhead capacity variance +
Fixed overhead calendar variance
Note: When there is no calendar variance, the calculation of capacity
variance has to be modified as follows:
Capacity variance = Standard Rate of recovery of fixed overheads × (Actual
hours – Budgeted Hours)
Check:
Fixed overhead Volume Variance = Efficiency Variance + Capacity Variance
12.4.2 Fixed Overheads Expenditure Variance
This variance actually measures the expenditure that is actually incurred
and the budgeted fixed overheads. It is also known as budget variance or
spending variance.
Symbolically it can be expressed as:
Fixed Overhead Expenditure Variance = Budgeted fixed OH – Actual Fixed
OH.
236
Check: Overhead Variances
Fixed OH Variance = Fixed OH Expenditure Variance + Fixed OH Volume

Variance.
Illustration 3
The following information is given to you:
Budget Actual
Production (units) 10,000 10,400
Fixed overheads (Rs.) 20,000 20,000
Man hours 20,000 20,100
Calculate the following:
i) Fixed overhead variance
ii) Expenditure variance
iii) Fixed overhead volume variance
iv) Fixed overhead efficiency variance
v) Fixed overhead capacity variance
Solution:
Budgeted Fixed Overheads
Standard Rate of Recover of Fixed Overhead =
Budgeted Hours
Rs. 20,000
= = Re.1
20,000
Budgeted Hours
Standard hours for actual output = × Actual Output
Budgeted Output
Rs. 20,000
= × 10,400
10,000
= 20,800 hours
i) Fixed Overhead Variance =
(Std hours for actual output × Std fixed O.H. rate) – Actual Fixed
overheads
= (20,800 hours × Re. 1) – 20,400
= Rs. 20,800 – Rs. 20,400
= Rs. 400 (F)
ii) Expenditure Variance = Budgeted Fixed Overhead – Actual Fixed
Overhead
= Rs. 20,000 – Rs. 20,400
= Rs. 400 (A)
iii) Fixed Overhead Volume Variance =
Std Recovery rate of Fixed OH × (Std hours for actual output –
Budgeted hours)
= Re. 1 × (20,800 – 20,000)
237
Standard Costing and = Rs. 800 (F)
Variance Analysis
iv) Fixed Overhead Efficiency Variance =
Std Recovery rate of Fixed OH × (std hours for actual output – Actual
hours)
= Re. 1 (20,800 – 20,100)
= Rs. 700 (F)
v) Fixed Overhead Capacity Variance =
Std rate of recovery Fixed OH × (Actual hours – Budgeted hours)
= Re. 1 × (20,100 – 20,000)
= 100 (F)
Check:
Fixed O.H. Volume Variance = Efficiency Variance – capacity Variance
Rs. 800 (F) = Rs. 700 (F) + Rs. 100 (F)
Illustration 4:
ABC Company Ltd. has furnished you the following information for the
month of January 2005:
Budget Actual
Output (units) 15,000 16,250
No. of Working days 25 26
Hours 30,000 33,000
Fixed Overheads (Rs.) 45,000 50,000
You are required to calculate fixed overhead variances.

Solution
Budgeted hours 30,000
Standard hours per unit = = = 2 hours
Budgeted units 15,000
Standard hours per actual output = 16,250 units × 2 hrs

= 32500 hrs
Budgeted overheads
Standard Fixed Overhead Rate (per hour) =
Budgeted hours
Rs. 45,000
= = Rs. 1.50
30,000
i) Fixed Overhead Variance =
(Std hours for Actual output × Std Fixed O.H. rate) – Actual Fixed
overheads
= (32,500 hours × Rs. 1.50) – Rs. 50,000
= Rs. 48, 750 – Rs. 50,000
= Rs. 1250 (A)
ii) Fixed Overhead Expenditure Variance = Budgeted Fixed Overhead –
238
Actual Fixed Overhead Overhead Variances
= Rs.45,000 – Rs.50,000
= Rs.5000 (A)
iii) Fixed Overhead Volume variance =
Std. Recovery rate of Fixed OH × (Std. hours for actual output –
Budgeted hours)
= Rs. 1.50 × (32,500 – 30,000)
= Rs. 1.50 × 2500
= Rs. 3650 (F)
iv) Fixed Overhead Efficiency Variance =
Std. Fixed OH Recovery rate × (Std hours for actual output – Actual
hours)
= Rs. 1.50 × (32,500 – 33,000)
= Rs. 1.50 × 500
= Rs. 750 (A)
v) Fixed overhead calender variance =
Std. rate of recovery of Fixed OH (Revised budgeted hours – Budgeted
hours)
= Rs.1.50 × (31,200 – 30,000)
= Rs.1800 (F)
Revised budgeted hours = Std. hours per day × Actual no. of days
30,000
= × 26 = 31,200 hours
25
vi) Fixed Overhead Capacity Variance =
Std Fixed OH Recovery rate × (Actual hours – Revised Budgeted
hours)
= Rs. 1.50 (33,000 – 31,200)
= Rs. 1.50
= Rs. 2700 (F)
Check :
i) Fixed O.H. Variance =
Efficiency Variance + Efficiency Variance + Capacity Variance +
Calender Variance
Rs.1250 (A) = Rs.5000 (A) + Rs.750 (A) + Rs.2700 (F) + Rs.1800 (F)
Rs.1250 (A) = Rs.1250 (A)
ii) Fixed Volume Variance =
Efficiency Variance + Calender Variance + Capacity Variance
Rs.3750 (F) = Rs.750 (A) + Rs.1800 (F) + Rs.2700 (F)
Rs.3750 (F) = Rs.3750 (F)
239
Variance Analysis 12.5 Sales Variances
The Variances so far we learnt relate to cost of goods manufactured
viz., material, labour and overheads. The purpose of variance analysis is
complete unless sales variance is included in the presentation of information
to management. Sales Variances are calculated by two methods viz., Sales
Value Method (or Turnover Method) and Sales Margin or Profit Method.
Sales variances arise due to the changes in price and changes in Sales
volume. A change in value may be due to the change in quantity or a change
in sales mix.
Sales variance can be understood with the help of the following chart:
Sales Variances
Sales Value Variance Sales Margin Variance
Sales Price Sales Volume Sales Price Sales Volume

Variance Variance Variance Variance
Sales Quantity Sales Mix Sales Mix Sales Quantity

Variance Variance Variance Variance
Sales variance may be studied under two heads, namely Sales Value
Variance and Sales Mix or Profit variances. Again Sales Value Variance is
subdivided into Sales Price Variance and Sales Volume Variances. Sales
Volume Variance may again be subdivided into Sales Quantity Variance and
Sales Mix Variance. Similarly, Sales Margin Variances may be divided into
Sales Price Variance and Sales Volume Variance. Sales volume Variance is
subdivided into Sales Mix Variance and Sales Quantity Variance. Now, let
us study these variances in detail.
12.5.1 Sales Value Variance
This Variance is also called Sales revenue variance. It is the difference
between budgeted sales and actual sales. The formula for computing this
variance is:
Sales Value Variance = Actual Sales – Budgeted Sales
If actual sales are more than the budgeted sales, a favourable variance would
be reported and vice versa. This variance is on account of difference in price
or volume of sales.
Sales Price Variance
This variance measures the impact of change in selling price on the turnover
as a whole. It is measured by the difference between Standard Sales and
Actual Sales.
The formula is :
Sales Price Variance = Actual Sales – Standard Sales
Or
= Actual Quantity Sold × (Actual Selling Price – Standard Selling Price)
240
Sales Volume Variance Overhead Variances
This variance measures the impact of changes in quantum of products sold.

Sales volume variance is the difference between the standard sales and
budgeted sales. If the standard sales are more than the budgeted sales, it
gives rise to favourable variance and vice versa.
This variance may arise due to unexpected competition, ineffective
advertising, lack of proper supervision, etc.
The formula is:
Sales Volume Variance = Standard Sales – Budgeted Sales.
Or
= Standard Price × (Budgeted Quantity – Actual Quantity)
Where,
Standard Sales = Standard Price × Actual Sales
In the case of multi product situations, Sales Volume Variance can be further
subdivided into (i) Sales Quantity Variance and (ii) Sales Mix Variance.
These two sub-variance can be calculated as follows:
i) Sales Quantity Variance
It is the difference between the Budgeted Sales and Revised standard
sales. The formula is:
Sales Quantity Variance = Revised Standard Sales – Budgeted Sales
Or
= Revised Standard Quantity – Budgeted Quantity) × Std. Price
Where,
Revised Standard Quantity (RSQ) = Total actual Quantity × Standard
Ratio of Units
Or
Actual Quantity of all products
× Standard Quantity of each product
Standard Quantity of all products
(ii) Sales Mix Variance
This variance arises when the proportion of actual sales mix is
different from that of standard sales mix. It is the difference between
Revised Standard Sales and Standard Sales. The formula is:
Sales Mix Variance = Actual Sales – Revised Sales
Or
= (Actual Quantity – Revised Standard Quantity) Std. price of each product
Where,
RSQ = Total Actual Quantity × Standard Ratio of units
Check :
Sales Value Variance = Price Variance + Volume Variance
Sales Volume Variance = Sales Mix Variance + Sales Quantity Variance
241
Standard Costing and Illustration 4
Variance Analysis
You are given the following data. Compute Sales Variance based on
Turnover.
Product A B C Total
Budget Units 3,000 2,000 1,000
Price (Rs.) 30 20 10
Total (Rs.) 90,000 40,000 10,000 1,40,000
Actual Units 3,500 2.400 500
Price (Rs.) 35 25 5
Total (Rs.) 1,22,500 60,000 2,500 1,85,000
Solution :
Rs.14000
Standard Price per unit of Standard Mix = 6000 units = Rs. 23.33
1) Revised Standard Sales =Total Actual Sales (in units) × Std Ratio
: A – 6400 × 3/6 = 3200
: B – 6400 × 2/3 = 2/33
: C – 6400 × 1/6 = 1067
2) Standard Ratio of Units = A:B:C = 3000:2000:1000
= 3:2:1

3) Computation of Standard Sales = Standard Price Actual Sales
Product A B C Total
Units 3,500 2,400 500 6,400
Price (Rs.) 30 20 10
Total (Rs.) 1,05,000 48,000 5,000 1,58,000
1) Sales Value Variance = Actual Sales – Budgeted Sales
Product A B C Total
Budgeted Sales (Rs.) 90,000 40,000 10,000 1,40,000
Actual Sales (Rs.) 1,22,500 60,000 2,500 1,85,000
Variance (Rs.) 32,500 (F) 20,000 (F) 7,500 (A) 45,000 (F)
2) Sales Volume Variance = Standard Sales – Budgeted Sales
Product A B C Total
Budgeted Sales (Rs.) 90,000 40,000 10,000 1,40,000
Actual Sales (Rs.) 1,05,000 48,000 5,000 1,58,000
Variance (Rs.) 15,000 (F) 8,000 (F) 5,000 (A) 18,000
(F)
3) Sales Volume Variance = Actual Sales – Standard Sales
Product A B C Total
Budgeted Sales (Rs.) 1,05,000 48,000 5,000 1,58,000
Actual Sales (Rs.) 1,22,500 60,000 2,500 1,85,000
Variance (Rs.) 17,500 (F) 12,000 (F) 2,500 (A) 27,000 (F)
242
4) a) Sales Quantity Variance = Overhead Variances
(Revised Standard Quantity – Budgeted Quantity ) × Standard Price

A : (3200 – 3000) × Rs. 30 = 9000 (F)
B : (2133 – 2000) × Rs. 20 = 2660 (F)
C : (500 – 1067) × Rs. 10 = 670 (F)
Total Rs. 9330 (F)
b) Sales Mix Variance = (Actual Quantity – Revised Standard Quantity)
× Std Price
A : (3500 – 3200) × Rs. 30 = 6000 (F)
B : (2400 – 2133) × Rs. 20 = 5340 (F)
C : (1067 – 1000) × Rs. 10 = 5670 (A)
Total Rs. 8670 (F)
Check :
Sales Value Variance = Sales Price Variance + Stales Volume Variance
45000 (F) = 27000 (F) + 18000 (F)
Sales Volume Variance = Sales Quantity Variance + Sales Mix Variance
18000 (F) = 9330 (F) + 8670 (F)
18000 (F) = 18000 (F)
12.5.2 Sales Margin or Profit Variances Method
Sales Margins Variance is also called Profit Variances, as sales margin
is nothing but profit. This variance helps the management for taking key
decisions based on profitability. Individually the cost variances or revenue
variances (sales variances as based on turnover) cannot convey any clear
meaning. But profit variances do so.
Sales Margin Variance
This can also be called as ‘Overall Profit Variance’. This represents the
difference between the Budgeted Sales margin or Budgeted Profit and
Actual Sales Margin or Actual Profit. The formula is: .
Sales Margin Variance = Budgeted Sales Margin – Actual Sales Margin
Sales Margin Variance can be subdivided into :
1) Sales Price Variance, and
2) Sales Volume Variance
1) Sales Price Variance (Based on Margins)
This variance arises due to the difference between the Standard Price of
quantity of sales and actual price of sales. In other words, it is the difference
between Standard Profit and Actual Profit. The formula is:
Sales Price Variance = Standard profit – Actual Profit
Or
= Actual Quantity (Standard Profit per unit – Actual Profit per unit)
Where,
Std. profit = Actual Quantity × Std Profit per unit.
If the actual profit is greater than the standard profit, the variance is
favourable and vice versa. This variance can arise due to the following
243
Standard Costing and reasons:
Variance Analysis
(i) Rise in price levels not anticipated earlier
(ii) Fall in price due to availing discounts and bulk buying
(iii) Intense competition not foreseen earlier
2. Sales volume Variance (Based on Margins)
This variance arises due to quantity of goods being sold differing from
quantity of goods budgeted to be sold. This can arise due to intense
competition unforeseen earlier or inefficiency of sales personnel.
Symbolically this can be represented as:
Sales Volume Variance = Standard Profit per unit (Standard Quantity –
Actual Quantity)
If the actual quantity is greater than standard quantity, the variance is
favourable and vice versa. In the case of multi-product this variance van be
further sub-divided into:
a) Sales Quantity Variance
b) Sales Mix Variances
a) Sales Quantity Variance
This is the difference between Budgeted Profit and Revised Standard
Profit. Symbolically:
Sales Quantity Variance = Standard Profit per unit × (Standard
Quantity – Revised Standard Quantity)
Where,
RSQ = Total Actual Quantity × Standard ratio
If RSQ is greater than SQ, the variance is favourable and vice versa.
b) Sales Mix Variance
This arises when the standard mix is different from the actual mix. It
is the difference between Revised Standard Profit and Standard Profit.
Symbolically,
Sales Mix Variance =
Standard Profit per unit × (Revised Standard Quantity – Actual
Quantity)
If the actual quantity is more than RSQ, the variance is favourable and
vice versa.
Illustration 5
A toy company gives you the following data for a month. You are required
to calculate the variances based on profit
Toy Budgeted Cost per Actual
Quantity Rate unit Quantity Rate
A 900 50 45 1000 55
B 650 100 85 700 95
C 1200 75 65 1100 78
244
Solution: Overhead Variances
Statement of Budgeted Profit and Actual Profit per unit

Toy SQ SP Total Cost Total cost Profit Total
Rs. Sales Unit (Rs.) Per unit Profit
(Rs.) (Rs.) (Rs.) (Rs.)
A 900 50 45,000 45 40,500 5 4,500
B 650 100 65,000 85 55,250 15 9,750
C 1200 75 90,000 65 78,000 10 12,000
2750 2,00,000 1,73,750 26,250
Actuals
A 1000 55 55,000 45 45,000 10 10,000
B 700 95 66,500 85 59,500 10 7,000
C 1100 78 85,800 65 71,500 13 14,300
2800 2,07,300 1,76,000 31,300
Revised Standard Quantity (RSQ) = Total Actual Quantity × Std. Ratio
= 2800 × (18:13:24)
18
A = 2800 × = 916
55
13
B = 2800 × = 662
55
24
B = 2800 × = 1222
55
Calculation of Profit Variances
1) Sales Margin Variance = Budgeted Profit – Actual Profit
Toy Budgeted Profit (Rs.) Actual Profit (Rs.) Variance (Rs.)
A 4,500 10,000 5,500 (F)
B 9750 7,000 2750 (A)
C 12,000 14,300 2,300 (F)
Total 26,250 31,300 5,050 (F)
2) Sales Price Variance = Standard Profit – Actual Profit
Where,
Standard Profit = Actual Quantity × Profit per unit
Toy Budgeted Profit (Rs.) Actual Profit (Rs.) Variance (Rs.)
A 5,000 10,000 5,500 (F)
B 10,500 7,000 3,500 (F)
C 11,000 14,300 3,300 (F)
Total 26,500 31,300 4800 (F)
3) Sales Volume Variance
= Standard Profit per unit × (Standard Quantity – Actual Quantity)
245
Toy Std. Profit Std. Quantity Variance (Rs.)
Variance Analysis
(Rs.) Actual Quantity
A 5 900-1000 500 (F)
B 15 650-700 750 (F)
C 10 1200-1100 1000 (A)
Total 250 (F)
4) Sales Quantity Variance =
Standard Profit per unit × (Standard Quantity – Revised Standard Quantity)
Toy Std. Profit Std. Quantity–RSQ Variance (Rs.)
(Rs.)
A 5 900-916 80 (F)
B 15 650-662 180 (F)
C 10 1200-1222 220 (A)
Total 480 (A)
5) Sales Mix Variance =
Standard profit per unit (Revised Standard Quantity - Actual Quantity)
Toy Std. Profit Revised Std. Variance (Rs.)
(Rs.) Quantity–Actual
Quantity
A 5 916-1000 420 (F)
B 15 662-700 570 (F)
C 10 1222-1100 1220 (A)
Total 230 (A)
Check:
Sales Volume Variance = Sales Quantity Variance + Sales Mix Variance
250 (F) = 480 (F) + 230 (A)
Sales Margin Variance = Sales Price Variance + Sales Volume Variance
5050 (F) = 4800 (F) + 250 (F)
12.6 CONTROL RATIOS

Standard costing is used by the management of an organisation as a control
technique – variance computed would given idea to the management to
study the extent of variation from the standards as are set by them. These
variances are expressed in monetary terms and do not per se give any idea
of trends over a period of time. Therefore, in order to study the trends,
Control Ratios are used, which are computed on the basis of the data used
for variance analysis and give an idea to the management about the trends
over a period of time or from period to period.
The main control Ratios are:

Standard Hours for Actual Production
1) Activity Ratio = × 100
Standard Hours for Budgeted Production
Available Working Days

2) Calender Ratio = × 100
Budgeted Working Days
246
Standard Hours for Actual Production
3) Efficiency Ratio = × 100 Overhead Variances
Actual Hours
4) Standard Capacity Usage Ratio
Budgeted Hours
= × 100
Maximisation possible hours in Budgeted Period
5) Capacity Utilisation Ratio

Actual Hours Worked
= × 100
Maximisation possible hours in Budgeted Period
12.7 DISPOSITION OF VARIANCES

The organisation, where standard costing system is not in use, accounting
records contain only actuals and there will be no variances. When standard
costing system is used then accounting records contain both standard costs
and actual costs. The management should take corrective measures for the
disposal of variances which arise at the end of the accounting period. The
accountants suggests several methods for treating the variances which were
as follows:
Allocation of Variances to Inventories : According to this method,
the variances are distributed over stocks of raw materials, wage costs,
overheads or finished stock valued at cost. In such a case the real costs only
enter the account books and consequently they are reflected in the financial
statements. The adjustment of variances is made only in the general ledger
and not in subsidiary books. The distribution of variances will not be done
to products. As variances are not actuals, losses should not be taken to Profit
and Loss Account. The standard costs and variances that are observed are
displayed for control purposes to the management.
Transfer to Profit and Loss Account : According to this method the
stocks of inventories, work in progress and finished goods are valued at
standard cost and variances are transferred to the Profit and Loss Account.
This method ensures that valuation of stock is done uniformly and all forms
of variances represent conditions of inefficiency waste and below standard
performance. When variance are shown differently, it will have effect on
profit or loss and attracts the attention of managements.
Transfer to the Reserve Account : Under this method, variances are carried
forward to the next financial year as deferred item by crediting the same to a
reserve account to be set off in the subsequent year or years. The favourable
and adverse variances may cancel each other in the course of reasonable
time. This method is useful in cases where reasonable fluctuations occurs
and the variance may be disposed off during the course of time.
Combination of (1) and (2) methods : Though the above first two methods
easy to follow, management upon their needs choose a combination of the
above two methods. The variances which are controllable and arise out of
over sight or carelessness of officials can be transferred to profit and loss
a/c, and the uncontrollable can be absorbed by the cost of inventories.
Check Your Progress
1) What do you understand about overhead cost variance?
247
Standard Costing and ………………………………………………………………………
Variance Analysis
………………………………………………………………………
………………………………………………………………………
2) What are control ratios?
………………………………………………………………………
………………………………………………………………………
………………………………………………………………………
3) What are the two methods to be used for the disposition of variances?
………………………………………………………………………
………………………………………………………………………
………………………………………………………………………
4) Find Fixed overhead volume variance where fixed OH efficiency and
capacity variances are Rs. 700. (F) and Rs. 100 (F).
5) State whether the following statements are ‘True’ or ‘False’
i) Variable overheads vary directly with the production.
ii) The difference between standard overheads and actual overheads
is called overhead cost variance.
iii) Efficiency variance and calendar variances are the sub-variances
of Fixed overhead expenditure variance.
iv) Sales variances arise due to change in price only.
v) Sales Volume Variance = Sales Mix Variance + Sales Mix
Variance + Sales Price Variance
vi) The difference between standard profit and actual profit is called
sales price variance.
12.8 LET US SUM UP

Overhead variances are to be classified as fixed and variable overhead
variances. Variable overheads are those which vary directly with the
production. Fixed overhead cost is dependent on the volume or level of
activity and any change in the volume or level of activity causes a change in
the overhead rate. Usually the normal volume will be taken as the basis for
determining standard overhead rate.
Fixed overhead cost variance may be divided into fixed overhead volume
variance and fixed overhead Expenditure Variance. Fixed Volume variance
may again be subdivided into efficiency variance, capacity variance and
calender variances. The formula for the overhead cost variances are as
follows: Overhead cost variance = Total standard overheads = Total Actual
Overheads.
Variable Overhead = Standard variable overhead for Actual output –
cost Variance Actual Variable Overheads
Fixed Overhead =
Standard Fixed Overhead – Actual Fixed
Variance Overheads
248
Overhead Variances
Fixed Overhead = Standard Rate of recovery of Fixed Overheads ×
Volume Variance (Std. Hours – Budgeted Hours)
Efficiency Variance (Std. Hours – Actual Hours)
Fixed Overhead = Standard Rate of Recovery of Fixed Overheads
Calendar Variance × (Revised Budgeted hours-Budgeted Hours)
Capacity Variance (Actual Hours – Revised Budgeted Hours)
Fixed Overhead =
Budget Fixed Overheads – Actual Fixed
Expenditure Variance Overheads.
Sales Variances may be studied under two heads: Sales value variance and
sales mix Variances. Sales value variance is sub-divided into Sales Price
Variance and Sales Volume Variances. Sales Volume Variance may again be
sub-divided into Sales Quantity Variance and Sales Mix Variance. Similarly,
Sales Margin Variances may be divided into Sales Price Variance and Sales
Volume Variance. Sales Volume Variance is sub-divided into Sales Mix
Variance and Sales Quantity Variance. The various formulae for calculating
the above variances are as follows:
Sales Value Variance = Actual Sales – Budgeted Sales
Sales Price Variance = Actual Sales – Standard Sales
Sales Volume Variance = Standard Sales – Budgeted Sales
Sales Quantity Variance = Revised Standard Sales – Budgeted Sales
Sales Mix Variance = Actual Sales – Revised Sales
Sales Margin Variance = Budgeted Sales Margin – Actual Sales Margin
Sales Price Variance (Based on Margin) = Standard Profit – Actual Profit
Sales Volume Variance (Based on Margin) = Standard Profit (Std. Quantity
– Revised Std. Quantity)
Sales Mix Variance (Based on Margin) = Std. Profit per Unit (Revised
Standard Quantity - Actual Quantity)
The above variances are expressed in monetary terms and do not give any
idea of trends over a period of time. To study the trends Control Ratios are
to be used. The control ratios are Activity Ratio, Calender Ratio, Efficiency
Ratio, Standard Capacity Usage ratio and Capacity utilization ratios.
The methods to be used for the disposal of variances are i) Allocation of
variances to inventories, ii) transfer to profit and Loss Account iii) transfer
to the Reserve Fund and a combination of i) and ii) Methods.
12.9 KEY WORDS

Fixed Overhead Variance : The difference between standard fixed
overhead and the actual fixed overhead.
Fixed Overhead Volume Variance : It is the difference between the budgeted
hours based on normal volume and the standard hours for actual output.
Fixed Overhead Expenditure Variance : Budgeted Fixed Overhead –
Actual Fixed Overhead.
249
Standard Costing and Sales Value Variance : The difference between budgeted sales and actual
Variance Analysis sales.
Sales Volume Variance : Standard Sales – Budgeted Sales.
Sales Margin Variance : The difference between budgeted sales margin
and actual sales margin.
Variable Overhead Cost Variance: The difference between standard
variance overhead and the actual overhead.

2. a) Activity Ratio, b) Calendar Ratio,
c) Efficiency Ratio, d) Capacity Utilisation Ratio.
4. Rs. 800 (F)
5. i) True, ii) True, iii) False, iv) False, v) False, vi) True

1) Explain how the variance analysis relating to overheads differ from
that relating to material and labour?
2) In what ways can we analyse Sales Variances? Explain in detail. -
3) Write short notes on the following:
i) Variable Overhead Expenditure Variance
ii) Fixed Overhead Volume Variance
iii) Fixed Overhead Calendar Variance
iv) Variable Overhead Efficiency Variance
v) Sales Margin Variance
vi) Sales Price Variance (based on turnover)
vi) Sales Volume Variance
4) A Company manufacturing two products operates standard costing
system. The Standard overhead content of each product in cost centre
101 is Product A Rs. 2.40 (8 direct hours @ Rs. 0.30 per hour) Product
B Rs. 1.80 (6 direct labour hours @ Rs.0.30 per hour). The rate of Rs.
0.30 per hour is arrived at as follows:
Budgeted overhead Rs.570
Budgeted Direct Labour Hours 1,900
For the month of October, the following data was recorded for the
cost centre 101
Output of Product A: 100 Units
Output of Product B: 200 Units
No opening or closing stock
Actual Direct labour hours worked 2,320
Actual overhead incurred Rs. 640
a) You are required to calculate total overhead variance for the
month of October .
250
b) Show its division into: Overhead Variances
i) Overhead Expenditure Variance

ii) Overhead Volume Variance
iii) Overhead Efficiency Variance
5) In a factory the standard units of production for the year were fixed at
1,20,000 units and estimated overhead expenditure were estimated to
be:
Rs.
Fixed 12,000
Variable 6,000
Semi-variable 1,800
Actual production during April of the year was 8000 units. Each month
has 20 working days. During the month in question there was one statutory
holiday. Actual overhead amounted to:
Fixed Rs. 1190
Variable Rs. 6000
Semi-variable Rs. 192
Semi variable charges are considered to include 60% expenses of fixed
nature.
Find out Expenditure, Volume, Calendar Variances.
6) The following information is provided to you:
Standard Actual
No. of working days 20 22
Man hours per day 8000 8400
Output per man hour in unit 1.0 0.9
Overhead Cost (Rs.) 1,60,000 1,68,000
Calculate Overhead Variances:
a) Overhead Cost Variances
b) Overhead Efficiency Variances
c) Overhead Capacity Variance
d) Overhead Calendar Variance
You are given the following data relating to two factories of a company. You
are required to compute all the overhead variances:
I II
Budgeted Actual Budgeted Actual
Hours 2000 18700 20000 16500
Variable Overheads 48000 46000 25000 26000
Fixed Overheads 40000 39000 27000 29000
7) You are also given that the actual hours taken in case of both departments
exceeded by 10%.
251
Standard Costing and (Ans.
I
II
Variance Analysis
V.O.H.V. = Rs.5200(A) Rs.7250 (A)
F.O.H.V. = Rs.5000(A) Rs.8750 (A)
F.O.Vol.V. = Rs.6000(A) Rs.6750 (A)
F.O.E.V. = Rs.3400(A) Rs.2025 (A)
F.O.C.V. = Rs.2600(A) Rs.4725 (A)
F.O.Ex.V. = Rs.1000(F) Rs.2000 (A)
8) The sales manager of a company engaged in the manufacture and sale
of three products P, Q and R gives you the following information for
the month of October, 2004.
Budgeted Sales
Product Units Sold Selling Price per Unit
P 2000 Rs. 12
Q 2000 Rs. 8
R 2000 Rs.5
Actual Sales
P 1500 units for Rs.15,000
Q 2500 units for Rs.17,500
R 3500 units for Rs.21,000
You are required to calculate the following variances:
a) Sales Price Variance
b) Sales Volume Variance
c) Sales Quantity Variance
d) Sales Mix Variance
e) Sales Revenue Variance
9) From the following Budgeted and Actual figures, calculate the
variances in respect of profit.
Budget
Sales 2000 units @ Rs.15 each 30,000
Cost of sales @ Rs.12 each 24,000
Profit 6,000
Actual
Sales 1900 unit @ Rs.14 each 26,600
Cost of sales @ Rs.10 each 19,000
Profit 7,600
write answers for them. But do not submit your answers to the University.
These are for your practice only.
252

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UNIT 9: Standard Costing: An

9.2 MEANING OF STANDARD COST

9.3 STANDARD COST AND ESTIMATED COSTS

9.4 CONCEPT OF STANDARD COSTING

9.5 OBJECTIVES OF STANDARD COSTING

9.6 STANDARD COSTING AND BUDGETING

9.9 Pre-requisites for success

The purpose of setting standard overhead rate is to minimise overhead costs.

Standard Variable Overhead for the Period

9.10 CONCEPT OF STANDARD HOUR

10.2 MEANING AND PURPOSE

10.3 CLASSIFICATION OF VARIANCES

Cost Variance Sales Variance

Direct Material Direct Labour Overhead Sales Price Sales Volume

Mix Yield Mix Yield Idle

Sub-division of variance of each element of cost gives valuable information

10.4 DIRECT MATERIAL COST VARIANCE

Classification of Material Usage Variance: When more than one type of

Alternate method for calculating RSQ:

b) Material Yield Variance (MYV): Material Yield Variance is calculated

Material Mix Variance

4) Material Yield Variance = (Standard Yield – Actual Yield) Std. output

The following formulae may be used for verification of material variance:

10.6 KEY WORDS

10.7 ANSWERS TO CHECK YOUR PROGRESS

10.8 TERMINAL QUESTIONS

Y : 400 Units @ Rs.20 per unit : Rs. 8000

11.2 DIRECT LABOUR COST VARIANCE

Labour Cost Variance

Labour Rate Labour Time Variance

Labour Idle Time Labour Mix Labour Revised

v) Poor working conditions

= (Std. Time × Std. Rate) – (Actual time × Actual Rate)

LMV = (RSH – AHP) SR

Grade A = (72 – 100) × Rs.5 = Rs.140 (A)

Grade B = (108 – 80) × Rs.3 = Rs. 84 (F)

= (225 units – 300 units) × Rs.20

LMV : (RSH – AH) × SR

Std. Cost Rs. 2960

Standard hours for actual output :

Labour Yield Variance may be calculated in place of Labour Revised

LYV = (3200 – 3600) × 0.74 = 296 (A)

12.2 CLASSIFICATION OF OVERHEAD

Variable Overhead Fixed Overhead

Efficiency Capacity Calender

Overhead Cost Variance is the difference between standard cost of overhead

12.4 Fixed Overhead Variances

= Standard Fixed Overhead – Actual Fixed Overheads

Fixed OH Variance = Fixed OH Expenditure Variance + Fixed OH Volume

You are required to calculate fixed overhead variances.

Standard hours per actual output = 16,250 units × 2 hrs

Sales Value Variance Sales Margin Variance

Sales Price Sales Volume Sales Price Sales Volume

Sales Quantity Sales Mix Sales Mix Sales Quantity

This variance measures the impact of changes in quantum of products sold.

(Revised Standard Quantity – Budgeted Quantity ) × Standard Price

Statement of Budgeted Profit and Actual Profit per unit

12.6 CONTROL RATIOS

The main control Ratios are:

UNIT 9: Standard Costing: An