COVENANT UNIVERSITY

COLLEGE OF BUSINESS AND SOCIAL SCIENCES

DEPARTMENT OF ACCOUNTING
WEEK 8

COURSE CODE: ACC322

STANDARD COSTING 1:

This is an important control technique which establishes predetermined estimate of cost of

products or services, collect actual cost and output data and compares the actual result with
predetermined estimates.

STUDY OBJECTIVES:

At the end of this topic, participants would have:

i) Understood the technique of standard costing and master the terminologies

associated with the topic.
ii) Known different types of standards.
iii) Appreciated the advantages and disadvantages of standing costing.
iv) Understand the problem of setting standards.

STANDARD COSTING TECHNIQUES AND VARIANCE ANALYSIS.

Standard costing is an important control technique which follows the feedback control cycle.
Standard costing establishes predeter mined estimates of the cost of products or services,
collects actual costs and output data and compares the actual results with the predetermined
estimates. The predetermined costs are known as standard costs, and the difference between
standards and actual is known as variance analysis.

OBJECTIVES OF STANDARD COSTING:

A) To provide a formal basis for assessing performance and efficiency.

B) To control costs by establishing standards and analyzing Variances.
C) To enable the principles of ‘management by exception’ to be effectively practiced at
operational level.
D) To assist in setting budgets.
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 E) To motivate staff and management.
F) To provide guidance on possible way of improving performance.
G) To assist in assigning responsibility for non-standard performance in order to correct
deficiencies or to capitalize on benefits.

STANDARD COST:

This can be defined as “a predetermined unit cost of how much cost should be, under specific
work and conditions. It may include administrative, selling and distribution cost. But in many
organizations, the assessment of standard is confined to production cost only.

Budgeted Cost:

In contrast to standards, budgeted costs are in total rather than in unit cost.

Standard cost may be used in both marginal and absorption cost system:

1) Variable cost for direct materials and direct labour are usually established on a unit
batch bases.
2) Variable overhead may be identifiable on a unit bases but are most likely to be
budgeted in totals, from which an hourly cost and unit cost can be derived.
3) Fixed cost are budgeted in totals and then absorbed into the standard unit cost on a
direct labour machine hour basis.

Standard Cost Card or Sheet:

This is a document which provides for the assembly of detailed standard cost of a unit or batch
or product. The selling price and contribution or profit may also be shown.

STANDARD COSTING:

This is the preparation of standard cost for use in the cost accounting system as a means of
valuing stock and cost of production and sales. It is also defined as a budgetary control
technique which compares actual results with the budgeted and taking corrective action as may
be revealed by such comparison.

TYPES OF STANDARDS:

1) Ideal Standards:
This may be described as an established standard specifically designed on the basis of
maximum productive capacity of the organisation. Here no allowance is provided for
any negative circumstance(s) capable of inhibiting the attainment of the standard. It is a
standard based on perfect operating condition i.e. no wastage, no inefficiency, no idle
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 time, no machine breakdown etc. Obviously, this standard is likely to have an
unfavourable motivational effect on the employees and such, they may ignore the
standard since they it unattainable.
2) Expected or Attainable Standard:
This is by far the most commonly encouraged standard. It is based on normal efficient
operating condition and consequently, some allowances are made for wastages,
inefficiency etc. Attainable standard provides a useful psychological incentive by giving
employee a realistic but challenging target of efficiency.
3) Current Standards:
This is a standard which is set for use over a relatively short period of time to reflect
current condition. E.g. current season (for seasonal product or market), current
inefficiency etc. the uniqueness of this standard is that it does not attempt to improve
on current level of efficiency.
Where conditions are stable, current standard will be the same as attainable standard.
However where temporal challenge exists with material quality or there is an
unexpected price in rise, then a current standard could be set covering, say, two or
three months to deal with the particular circumstance.
4) Basis Standards:
These are standards established for use over a long period of time. They could be used
to show trends over time for such item as material prices, labour rates and efficiency,
and the long term effect of changing methods.
5) Loosed Standards :
These are standards that are so easy to achieve as no effort is required for its
accomplishment.

The Benefits of Standard Costing

i) Standard costing provides a yardstick against which the actual cost can be measured.
ii) Variance can be calculated which enable the principles of management by Exception
(MBE).
iii) The setting of standards involves determining the best materials and methods which
may lead to economies.
iv) Costing procedures are often simplified.
v) A target of efficiency is set for employees to attain, and cost consciousness is
stimulated.
vi) It provides a valuable aid to management in determining prices and in formulating
policies.
vii) The valuation of stock is facilitated.

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 viii) Where firms are in similar industry and are willing to compare, a meaningful bases of
comparison might be established.

Limitations of Standard Costing Technique:

a) Establishment of unattainable standard.

b) It may be expensive to maintain.
c) In volatile condition, with rapidly changing methods, rates, prices etc, standards quickly
become out-dated and hence lose their control and motivational effect.
d) Variance analysis is an analysis of past event, and the past does not always paint a true
picture of neither the present nor the future.
e) Standards setting involve a high degree of subjectivity with inherent possibility of errors.

FACTORS TO BE CONSIDERED IN VARIANCE ANALYSIS:

The factors must be considered before a variance can be investigated.

i) The cost and benefit analysis of the variance.

ii) The actual amount involved in the variance.
iii) The trend of the variance.
iv) Materiality aspect of the variance to the organisation.
v) Size of the variance.
vi) Proportionate significance of the variance.

PROBLEMS OF SETTING STANDARDS:

The following are the likely problems to be encountered while attempting to set up variance:

a) Forecasting errors;
b) Decisions on how to incorporate inflation into planned unit cost.
c) Agreeing on labour efficiency standards (hourly and /or units)
d) Deciding on the quality of materials to be used because better quality materials may
cost more but perhaps reduce material wastage.
e) Deciding on the approximate mix of component material ( where some changes in the
mix is possible, e.g. manufacturing of food and drinks)
f) Estimating material prices where seasonal price variation or bulk purchase discount may
be significant.

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PYRAMID OF VARIANCE
OPERATING PROFIT VARIANCE

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TOTAL SALES VARIANCE TOTAL COST
VARIANCE

Price volume Materials Labour Overhead

Mix Quantity Price usage Rate Efficiency

Mix Yield Idle

Time

Variable Fixed

Expenditure Efficiency

Expenditure Volume

Capacity Efficiency

OR

Productivity

Illustration 1.

The following data are available from the spraying department of “TUST AND OBEY” Nig. Ltd, a
furniture manufacturer which has established standard cost of producing a cabinet styled
PARALLELISM.

N
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Labour 4.50

Materials (15meters at N8) 120.00

Indirect costs:

Variable charges (3hrs at N1) 3.00

Fixed Charges (3hrs at N0.5) 1.50

129.00

The actual costs of producing 400 of these cabinets during October 2007 are stated below:

Materials (7,500 Meter at N9) 67,500

Material cost (7,200) Metre

Direct Labour (1,100 hours at N1.70) 1,870

Variable charges 950

Fixed charges 600

Fixed Charges rate had been set by using 1,400 direct labour hrs of operation as the monthly
activities level. There were no opening stocks of raw materials.

You are required to compute the following Variances:

i) Material price and usage Variances.

ii) Direct labour rate Variances.
iii) Variable Overhead Variances.
iv) Fixed Overhead Variances.

CANAAN LTD.
STANDARD COST CARD
N
Material 15 meters @ N8 120.00
Labour 3 hours @ N1.50 4.50

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 Variable 3hours @ N1.00 3.00
Fixed Over 3 hours @ N0.50 1.50
129.00

MATERIAL COST VARIANCE

N
Actual materials cost (7,500 m XN9) 67,500
Standard material cost (400 X N120) 48,000

19,500 A

MATERIAL PRICE VARIANCE

Actual material @ Actual price ( 7,500 X N9) 67,500

Actual material @standard price (7,500 X N8) 60,000

7,500A

MATERIAL USAGE VARIANCE

METRES

Actual materials quantities consumed 7,500

Standard material quantities allowed 6,000

1,500 A

1,500 M @ standard material price/ meters (1,500 X N8) N 12,000 A

LABOUR COST VARIANCE

Actual Labour cost (1,100 hrs X N1.70) 1,870

Standard Labour Cost ( 400 X N4.50) 1,800

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 70 A

LABOUR RATE VARIANCE

Actual labour hrs @Actual labour rate (1,100 X 1.70) 1,870

Actual labour Hrs @ Standard labour rate (1,100 X 1.50) 1,650

220 A

LABOUR EFFICIENCY VARIANCE

HRS

Actual Labour Hours Consumed (taken) 1,100

Standard Labour hours allowed ( 3 X 400) 1,200

100 F

100 Hrs @ standard labour rate ( N1.50) N150 F

VARIABLE OVERHEAD COST VARIANCE

Actual variable cost ( 1,100 hrs X 0.864) 950

Standard Variable cost ( 400hrs X N3) 1,200

250 F

VARIABLE EXPENDITURE VARIANCE

Actual Variable Hrs @ Actual VOAR (1,100 hrs X 0.864) 950

Actual Variable Hrs @ Standard VOAR (1,100hrs X N1) 1,100

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 150 F

VARIABLE OVERHEAD EFFICIENCY VARIANCE

HRS

Actual Hrs taken 1,100

Standard Hrs Allowed (3hrs X 400 ) 1,200

100 hrs
F

100 hrs @ standard price N1 N 100 F

FIXED OVERHEAD COST VARIANCE

Actual Fixed O/H cost 600

Standard Fixed O/H cost 600

NIL

FIXED OVERHEAD EXPENDITURE VARIANCE

Actual Fixed O/H Expenses 600

Budgeted Fixed O/H Expenses (1,400 X N0.5) 700

100 F

OR ( 1.5 X 1,400/3)

= ( 1.5 X 466.67)

FIXED OVERHEAD VOLUME VARIANCE

Units

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Actual Volume 400

Budgeted Volume 466.67

66.67 A

66.67 units @ Standard FOC /unit (1.50) 100 A

FIXED OVERHEAD CAPACITY VARIANCE

HRS

Actual Hour ( capacity) 1,100

Standard Hour ( capacity) 1,400

300hrs A

300 hrs @ Standards FOAR / hr (0.5) N 150 A

FIXED OVEADHEAD EFFICIENCY VARIANCE

HRS

Actual hours taken 1,100

Standard hours allowed ( 3hrs X 400) 1,200

100F

100 hrs @ Standard FOAR /hrs (0.50k

SELLING PRICE VARIANCE

Actual Qty sold @ Actual selling price XXXX

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Actual Qty Sold @ Standard selling price XXXX

XXXX

SALES VOLUME CONTRIBUTION VARIANCE

UNITS

Actual Qty Sold XXXX

Budgeted Sales Qty XXXX

XXXX

XXXX Units @ Standard Contribution Margin N XXXX

ILLUSTRATION 2

FAITH Manufacturing company operates a standard marginal costing system. It makes a single
product, MIRACLE , using a simple raw material PRAYER.

Standard costs relating to MIRACLE are calculated as follows:

Standard Cost schedule – MIRACLE Per Unit

Direct Material, PRAYERS, 100 Kg at N10 per Kg 1,000

Direct Labour, 10 hours at N16 per hour 160

Variable Production Overhead, 10 hours at N4per hour 40

1,200

During the year ended 31st December2007, 1,000 units of MIRACLE were produced. Relevant
details of this production are as follows:

Direct Materials PRAYER:

90,000 Kg costing N1, 440,000 were bought and used.

Direct Labour:
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8,200 hours were worked during the month and total wages were N126,000

Variable Production Overhead:

The actual cost for the period was N50,000.

Stocks of the direct material PRAYER are valued at the standard selling price of N10 per Kg.

The standard selling price of a MIRACLE is N1,800 and FAITH is expected to produce 1,020 units
during the period.

Each MIRACLE was sold for N1,950

Required:

Calculate the following for the period:

(a) Direct material cost Variance analyzed into price and usage Variances.
(b) Direct Labour cost Variance analyzed into rate and efficiency variances.
(c) Variable production overhead Variance analyzed into expenditure and efficiency
variance.
(d) Selling price Variance
(e) Sales Volume contribution Variance.

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