Key Takeaways:
- Grasp the meaning and role of standard costing in managerial control.
- Understand the main types of material, labour, and overhead variances, including their formulas.
- Apply variance calculations through practical, step-wise examples.
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Definition and Purpose
Standard costing is a technique in which predetermined costs, known as standards, are established for materials, labour, and overheads. These standards serve as benchmarks for measuring actual performance. The difference between actual costs incurred and standard costs is called a variance.
Why do businesses use standard costing?
It sets clear cost expectations and helps managers quickly identify areas needing attention. When variances arise, they serve as early warning signals, prompting corrective action before costs spiral out of control.
Variance Analysis
Importance in Cost Control
Variance analysis is the systematic process of comparing actual costs with standard costs to pinpoint deviations. This aids in:
- Identifying reasons for cost overruns or savings
- Evaluating the effectiveness of cost control measures
- Holding departments accountable for their performance
The true value of variance analysis lies in its ability to convert raw data into actionable insights. It doesn't just highlight problems—it guides managers to their root causes and solutions.
Types of Variances
a. Material Variances
Material variances analyze the difference between standard and actual costs associated with raw materials. There are two primary types:
| Variance | What It Measures | Formula |
|---|---|---|
| Material Cost Variance (MCV) | Difference between standard cost of actual output and actual cost | MCV = (Standard Quantity × Standard Price) – (Actual Quantity × Actual Price) |
| Material Price Variance (MPV) | Impact of paying more or less than expected for materials | MPV = (Standard Price – Actual Price) × Actual Quantity |
| Material Usage Variance (MUV) | Impact of using more or less material than planned | MUV = (Standard Quantity – Actual Quantity) × Standard Price |
b. Labour Variances
Labour variances reveal how efficiently human resources are being used, both in terms of rate (wage) and efficiency (productivity):
| Variance | What It Measures | Formula |
|---|---|---|
| Labour Cost Variance (LCV) | Difference between standard cost of labour for actual output and actual cost | LCV = (Standard Hours × Standard Rate) – (Actual Hours × Actual Rate) |
| Labour Rate Variance (LRV) | Difference in wage rates paid | LRV = (Standard Rate – Actual Rate) × Actual Hours |
| Labour Efficiency Variance (LEV) | Efficiency in time taken | LEV = (Standard Hours – Actual Hours) × Standard Rate |
| Labour Idle Time Variance | Lost time due to unavoidable idle hours | Idle Time Variance = Idle Hours × Standard Rate |
c. Overhead Variances
Overhead variances are split into variable and fixed components:
| Variance | What It Measures | Formula |
|---|---|---|
| Variable Overhead Cost Variance | Difference between standard and actual variable overheads | (Standard Hours × Standard Rate) – Actual Variable Overheads |
| Variable Overhead Expenditure Variance | Overspending/underspending on variable overheads | (Standard Rate – Actual Rate) × Actual Hours |
| Variable Overhead Efficiency Variance | Efficiency in use of variable overhead resources | (Standard Hours – Actual Hours) × Standard Rate |
| Fixed Overhead Cost Variance | Difference between absorbed and actual fixed overheads | Absorbed Fixed Overheads – Actual Fixed Overheads |
Example: Material Variance Calculation
Suppose a company sets the following standards for its product:
- Standard quantity per unit: 5 kg
- Standard price per kg: ₹10
- Actual output: 100 units
During the period:
- Actual quantity used: 520 kg
- Actual price paid: ₹11 per kg
- Calculate Standard and Actual Costs
Standard quantity for actual output = 100 units × 5 kg = 500 kg
Standard cost = 500 kg × ₹10 = ₹5,000
Actual cost = 520 kg × ₹11 = ₹5,720 - Material Cost Variance (MCV)
MCV = Standard cost – Actual cost = ₹5,000 – ₹5,720 = ₹720 (Adverse) - Material Price Variance (MPV)
MPV = (Standard Price – Actual Price) × Actual Quantity
= (₹10 – ₹11) × 520 kg = (–₹1) × 520 = ₹520 (Adverse) - Material Usage Variance (MUV)
MUV = (Standard Quantity – Actual Quantity) × Standard Price
= (500 kg – 520 kg) × ₹10 = (–20) × ₹10 = ₹200 (Adverse)
Notice how the total adverse variance of ₹720 is split between price and usage issues. This tells managers not just that costs went up, but why.
Example: Labour Variance Calculation
Assume a company sets:
- Standard hours allowed: 200 hours
- Standard rate: ₹50 per hour
- Actual hours worked: 220 hours
- Actual rate paid: ₹55 per hour
- Calculate Standard and Actual Labour Costs
Standard cost = 200 hours × ₹50 = ₹10,000
Actual cost = 220 hours × ₹55 = ₹12,100 - Labour Cost Variance (LCV)
LCV = Standard cost – Actual cost = ₹10,000 – ₹12,100 = ₹2,100 (Adverse) - Labour Rate Variance (LRV)
LRV = (Standard Rate – Actual Rate) × Actual Hours
= (₹50 – ₹55) × 220 = (–₹5) × 220 = ₹1,100 (Adverse) - Labour Efficiency Variance (LEV)
LEV = (Standard Hours – Actual Hours) × Standard Rate
= (200 – 220) × ₹50 = (–20) × ₹50 = ₹1,000 (Adverse)
By breaking down labour variances, managers see if higher wage costs are due to overtime, inefficiency, or higher wage rates. Each cause demands a different managerial response.
You can use our Tools to calculates these variances: