Standard Costing and Variance Analysis
The logic
A standard cost is a predetermined estimate of what a unit should cost. Variance = Standard − Actual; if standard cost exceeds actual cost the variance is favourable, otherwise adverse. Material cost variance = (SQ × SP) − (AQ × AP), which splits into price variance = AQ × (SP − AP) and usage variance = SP × (SQ − AQ). Labour: rate variance = AH × (SR − AR); efficiency variance = SR × (SH − AH).
Worked example
Standard: 2 kg per unit at ₹10 per kg. Actual output 500 units, actual material 1,050 kg at ₹9.60 per kg. Standard quantity for actual output = 1,000 kg; standard cost = ₹10,000. Actual cost = 1,050 × 9.60 = ₹10,080. Material cost variance = 10,000 − 10,080 = ₹80 adverse. Price variance = 1,050 × (10 − 9.60) = ₹420 favourable. Usage variance = 10 × (1,000 − 1,050) = ₹500 adverse. Check: 420 favourable − 500 adverse = ₹80 adverse, reconciling to the total. Reasoning: the firm bought cheaply but wasted material, and the waste outweighed the saving.
Traps that cost marks
Using budgeted output instead of actual output when computing standard quantity allowed; multiplying the usage variance by actual price instead of standard price; muddling favourable and adverse signs so the reconciliation fails; computing labour efficiency on actual hours paid rather than hours actually worked; forgetting that a favourable price variance can be the cause of an adverse usage variance (cheaper, poorer-quality material).