This document discusses standard costing and variance analysis. It defines standard costing as estimating production costs under normal conditions based on historical analysis and time/motion studies. Standard costs are used as targets to compare to actual costs. Variances are the differences between standard and actual costs. The document outlines the components of standard costs, advantages like planning and efficiency analysis, limitations setting standards, and the standard costing process of establishing standards, determining actual costs, comparing to identify variances, and disposition of variances.

1. UNIT - 4
STANDARD COSTING AND VARIANCE ANALYSIS

2. Meaning of Standard Cost
• Standard cost is an estimated cost determined by the company for
the production of the goods and services or operating under normal
circumstances and is derived by the company from the historical
analysis of the data or from the time and the motion studies. Such
costs pre-determined by the company are used as the target costs by
the company for comparing it with actual costs, and the difference
will be the variance.

3. Components
• In manufacturing setup, there are three main components which
include the following:
• Direct Materials – It is derived by multiplying the quantity of each
material with the per-unit material cost.
• Direct Labor – It is derived by multiplying the quantity of each labor
with the per hour labor cost.
• Overhead includes fixed overhead cost and variable overhead,
calculated by multiplying standard quantity with the standard rate of
variable overhead.

4. Advantages
• The company’s management uses these costs to plan the process of
future production and ways to increase the company’s efficiencies.
• As the standard cost is calculated using the different statistical
measures and the experiences of the management, so with the help
of this measure, management can innovate new ways to produce the
products that do not require the same type of procedures, thereby
reducing the cost of the company.

5. • The management uses it to determine the reasonability of the actual
costs of the period. The difference between the standard and the
actual cost helps the management know-how close to actual
expenses matched with what is expected and decide the future
course of action. For example, if the actual cost of the material is
much higher, then the management may investigate the reason for
the excess cost.

6. Limitations
• Setting such a cost of production is difficult as it requires a high degree of
technical skill from the person responsible for setting the same. Therefore
it requires lots of effort and cost. Also, the conditions in any business
enterprise keep on charging due to which standards have to be revised only
on a timely basis; otherwise, it will not be worth anymore.
• The situations that would prevail in the future in any company or industry
are not certain. Different factors affect the company, making it challenging
to make the correct estimation of the standardcost of the production of
goods or the provision of the services by a company. While calculating such
costs,past experiences and future expense forecastsare required.
• It is impossible to fix these costs in every type of operation as such a
systemcannot be used in industries with no production of any of the
standard products.

7. Standard Costing
• Standard Costing is a costing method, that is used to compare the standard
costs and revenues with the actual results, in order to arrive at the
variances along with its causes, to inform the management about the
deviations and take corrective measures, for its improvement.
• The term ‘standard cost’ can be defined as the expected cost per unit of
the products produced during a period, which is based on various factors. It
aims at measuring the performance, controlling the deviations, inventory
valuation and deciding the selling price of the product especially when
quotations are prepared.
• The three main elements of standardcost are Direct Material Cost, Direct
Labor Cost and Overheads.

8. Features/ Characteristics
(1) It helps in measuring the actual costs of the product.
(2) Comparison of actual costs with the pre-determined standards is
made, in order to determine variances.
(3) Setting of standards for each element of cost such as material,
labour and overheads.
(4) Analysis of any variances and to ascertain the reasons of such
variation.
(5) Reporting the variances to management.
(6) Taking appropriate steps for their corrections.

9. Advantages
• Future cost estimation: Standard Costs are determined after
considering all the possibilities that may arise in the future. It also
helps in deciding whether a particular project is to be undertaken, by
determining its profitability.
• Performance check: Standard cost acts as targets to the cost centres
which should not be transcended. In such a situation, these targets
are helpful in checking the performance through comparison with the
actual results.
• Budgeting: The standard costs are used to prepare budgets, and
evaluate the performance of the executive staff on the basis of these
budgets.

10. LIMITATIONS
• Costly System- Because the Standard Costing requires highly skillful
and competent personnel, it becomes a costly system too. For the
same experts are paid high remuneration.
• Difficulties in Fixation of Standard- It is always difficult to determine
precise standard costs in a given situation which will coincide with
actual cost when operations are over. Standard cost are determined
partly by the past experience and partly by the cost projections based
on advanced statistical techniques. Thus, uncertainties revolve
around standards.

11. • Constraint for Service Industry- Standard costing is applied for
planning and controlling manufacturing costs. Thus, it cannot be
applied in a service industry.
• Consistency of Standard- Consistency of Standard because the
standards of marginal costing fluctuate and vary time to time, it is
difficult to always sustain and continue the same standards.
• Unsuitable for Non‐standardised Products- Standard costing is
expensive and unsuitable for job manufacturing industries as they
manufacture non standardized products such as catering, tailoring,
printing, etc.

12. Process of Standard Costing
1. Establishing Standards: First and foremost, the standards are to be
set on the basis of management’s estimation, wherein the
production engineer anticipates the cost. In general, while fixing the
standard cost, more weight is given to the past data, the current
plan of production and future trends. Further, the standard is fixed
in both quantity and costs.
2. Determination of Actual Cost: After standards are set, the actual
cost for each element, i.e. Material, labour and overheads is
determined, from invoices, wage sheets, account books and so
forth.

13. 3. Comparison of Actual Costs and Standard Cost: Next step to the
process, is to compare the standard cost with the actual figures, so as
to ascertain the variance.
4. Determination of Causes: Once the comparison is done, the next
step is to find out the reason for the variances, to take corrective
actions and also to evaluate the overall performance.
5. Disposition of Variances: The last step to this process, is the
disposition of variances by transferring it to the costing profit and loss
account.