Standard Costing | PAPER III – ACCOUNTING & FINANCIAL MANAGEMENT FOR BANKERS | MODULE D: TAXATION AND FUNDAMENTALS OF COSTING

Standard Costing

---

Definition

Standard costing is a cost accounting method that compares standard costs with actual costs to determine variances. It helps businesses control costs and improve efficiency.

Significance and Applications

• Helps in cost control and cost reduction
• Facilitates budgeting and performance evaluation
• Improves managerial decision-making and operational efficiency

Types of Standards

• Ideal Standard: Represents perfect efficiency under ideal conditions.
• Attainable Standard: Achievable with reasonable effort under normal working conditions.
• Basic Standard: Long-term standard for comparison over time.
• Current Standard: Set for short-term operational use.

Installation of Standard Costing System

A system must define cost standards for:

• Material: Standard quantity × Standard price
• Labour: Standard hours × Standard wage rate
• Overhead: Based on predetermined rates and activity levels

Variance Analysis

Variance is the difference between standard cost and actual cost. Key variances include:

• Material Variance: Price and usage variances
• Labour Variance: Rate and efficiency variances
• Overhead Variance: Variable and fixed overhead variances

Accounting Treatment of Variances

• Favourable variances are credited; adverse variances are debited.
• Variance accounts are transferred to the Costing Profit & Loss Account.

Benchmarking for Setting Standards

Benchmarking involves comparing performance with industry best practices to set realistic standards and improve cost-efficiency.

Variance Reporting to Management

Reports include detailed analysis of variances by department or product, with root cause analysis and action plans for correction.

---

Mathematical Examples

1. Material Price Variance
   SP = ₹50, AP = ₹55, AQ = 100 units
   Variance = (SP − AP) × AQ = (50 − 55) × 100 = ₹500 (Adverse)
2. Material Usage Variance
   SQ = 90 units, AQ = 100 units, SP = ₹40
   Variance = (SQ − AQ) × SP = (90 − 100) × 40 = ₹400 (Adverse)
3. Labour Rate Variance
   SR = ₹80/hour, AR = ₹90/hour, AH = 50 hours
   Variance = (SR − AR) × AH = (80 − 90) × 50 = ₹500 (Adverse)
4. Labour Efficiency Variance
   SH = 45 hours, AH = 50 hours, SR = ₹70
   Variance = (SH − AH) × SR = (45 − 50) × 70 = ₹350 (Adverse)
5. Variable Overhead Efficiency Variance
   SH = 200 hrs, AH = 220 hrs, SR = ₹10/hr
   Variance = (SH − AH) × SR = (200 − 220) × 10 = ₹200 (Adverse)
6. Variable Overhead Expenditure Variance
   AH = 220 hrs, SR = ₹10, AR = ₹12
   Variance = (SR − AR) × AH = (10 − 12) × 220 = ₹440 (Adverse)
7. Fixed Overhead Volume Variance
   Budgeted output = 500 units, Actual output = 450 units, Standard rate = ₹20/unit
   Variance = (Budgeted − Actual) × SR = (500 − 450) × 20 = ₹1,000 (Adverse)
8. Fixed Overhead Expenditure Variance
   Budgeted FOH = ₹20,000, Actual FOH = ₹22,000
   Variance = Budgeted − Actual = 20,000 − 22,000 = ₹2,000 (Adverse)
9. Total Material Cost Variance
   Std Cost = SQ × SP = 90 × ₹40 = ₹3,600
   Actual Cost = AQ × AP = 100 × ₹45 = ₹4,500
   Variance = Std − Actual = ₹3,600 − ₹4,500 = ₹900 (Adverse)
10. Total Labour Cost Variance
    Std Cost = SH × SR = 45 × ₹80 = ₹3,600
    Actual Cost = AH × AR = 50 × ₹90 = ₹4,500
    Variance = Std − Actual = ₹3,600 − ₹4,500 = ₹900 (Adverse)

---

MCQs with Answers

1. Which of the following is NOT a type of standard in standard costing?
   a) Ideal
   b) Attainable
   c) Static
   d) Basic
   Answer: c) Static
2. Material Price Variance is calculated as:
   a) (AQ − SQ) × SP
   b) (SP − AP) × AQ
   c) (AR − SR) × AH
   d) None
   Answer: b) (SP − AP) × AQ
3. The accounting treatment of adverse variances is to:
   a) Credit the variance account
   b) Debit the variance account
   c) Ignore it
   d) Reverse it
   Answer: b) Debit the variance account
4. Which of the following best defines Benchmarking?
   a) Setting budget
   b) Setting ideal performance
   c) Comparing with best industry practices
   d) Costing method
   Answer: c) Comparing with best industry practices
5. If the actual labour hours are more than standard hours, the variance is:
   a) Favourable
   b) Adverse
   c) Neutral
   d) None
   Answer: b) Adverse
6. Standard Costing is most useful for:
   a) External auditing
   b) Strategic decisions only
   c) Cost control and performance analysis
   d) Tax reporting
   Answer: c) Cost control and performance analysis
7. Labour Efficiency Variance is:
   a) (SR − AR) × AH
   b) (SH − AH) × SR
   c) (SH − AH) × AR
   d) (AH − SH) × AR
   Answer: b) (SH − AH) × SR
8. Which of the following is a favourable variance?
   a) Price increased
   b) Usage more than standard
   c) Efficiency higher than standard
   d) Cost overrun
   Answer: c) Efficiency higher than standard
9. Fixed Overhead Variance does NOT include:
   a) Efficiency Variance
   b) Volume Variance
   c) Expenditure Variance
   d) Material Variance
   Answer: d) Material Variance
10. Standard Costing is generally applied in:
    a) Trading companies
    b) Service industries
    c) Manufacturing companies
    d) All of the above
    Answer: c) Manufacturing companies