Standard costing and variance analysis

Standard costing and variance analysis

Standard Costing

  • Standard costing is a method used to compare the actual costs of production against expected costs. It simplifies inventory valuation and provides a clear picture of cost control and profitability.
  • Standard costs include material cost, labour cost and overhead cost.
  • Material costs are determined based on average prices, and labour rates are based on wage rates and efficiency.
  • Overhead costs are often based on labour hours or machine hours.
  • The total standard cost is calculated as: Standard quantity x Standard price for each element of cost.

Variance Analysis

  • Variance Analysis is the systematic approach to identify the differences between actual costs and standard costs.
  • Variance can be favourable or adverse. A favourable variance indicates profits are greater than expected, whereas an adverse variance suggests the overall profit is less than expected.
  • Variances are defined as:
    • Direct Material Variance - the difference between the standard cost of direct material and the actual cost
    • Direct Labour Variance - the difference between the standard cost of direct labour and actual cost
    • Variable Overhead Variance - the difference between the standard cost of variable overhead and actual cost
    • Fixed Overhead Variance - the difference between the standard cost of fixed overhead and the actual cost.
  • Variance analysis helps to pinpoint operational issues, control costs, and make informed business decisions.

Uses of Variance Analysis

  • Variance analysis can be used in performance measurement by highlighting variances and identifying areas where performance is under or over expectation.
  • It provides critical information for management control and decision-making, allowing management to review and adjust activities as needed.
  • Variance analysis contributes to continuous improvement. By isolating areas of weakness, true costs of production can be more accurately determined, with actions taken to improve efficiency.
  • Variance analysis is useful in budgeting and forecasting. It provides a statistical basis for creating future budgets and can help identify underlying trends and variables.