Variance analysis is the comparison of actual costs with standard costs. The purpose of this article is not to discuss the principles of standard costing as a technique but to consider the calculation of variances and their interpretation.
A standard cost can be deemed to be the expected cost for a given activity. As a general rule production costs can be sub-divided into three main elements – material, labour and overheads.
For each of these elements it is possible to set standard costs.
Consider Company A, who say, manufacture highly specialised plastic containers (Product X72) for the chemical industry. Each of the containers will require a certain amount of raw material, they will require a certain amount of labour time to produce and will incur certain production overhead costs.
SETTING STANDARD COSTS
The standard cost for the material content of a product will consist of two parts – the standard (expected) quantity of material that will be needed and the standard (expected) price of that material.
Assume that the container referred to above requires a standard of 4 kilograms of raw material and that the price of the material is expected to be £3 per kilogram.
Standard Material Cost = Standard Quantity x Standard Price = 4 kilograms x £3 per kilogram = £12
The standard cost for the labour cost of a product will consist of two parts – the standard (expected) time required to make the items and the standard (expected) rate of pay for the operatives.
Assume that the container referred to above requires a standard of 5 hours to make and that the rate of pay is expected to be £3.60 per hour
Standard Labour Cost = Standard Time x Standard Rate of Pay = 5 hours x £4 per hour = £20
Production overheads whether they are variable or fixed in nature are normally absorbed into the cost of a product on some predetermined basis.
For example, labour hours, machine hours or as a percentage of prime cost.
Assume that in the case of Company A variable overhead is absorbed at a rate of £1 per labour hour and fixed overhead is absorbed at a rate of £3 per labour hour.
The standard variable overhead cost of the container would be = 5 hours at £1 per hour = £5 and the standard fixed overhead cost of the container would be = 5 hours at £3 per hour = £15.
STANDARD COST CARD
From the above information the following standard cost card could be constructed:
|Standard Cost Card
|Product: Plastic Container X72 £