Standard Costing and Variance Analysis: A Complete Guide

What Is Standard Costing?

Standard costing assigns a predetermined cost to each unit of product or service. At period end, actual costs are compared to standard costs and the differences — variances — are analysed. It is a core management accounting control tool, most useful in manufacturing and repetitive production environments.

Setting Standard Costs

A standard cost per unit includes: direct materials (standard quantity x standard price), direct labour (standard hours x standard rate), variable overhead (standard hours x variable overhead rate), and fixed overhead (standard hours x fixed overhead absorption rate).

Key Variances

Material price variance = (Standard price - Actual price) x Actual quantity purchased. Material usage variance = (Standard quantity for actual output - Actual quantity used) x Standard price. Labour rate variance = (Standard rate - Actual rate) x Actual hours. Labour efficiency variance = (Standard hours for actual output - Actual hours) x Standard rate. Favourable variances mean actual performance was better than standard; adverse means worse.

Overhead Variances

Fixed overhead variances include: expenditure variance (actual vs budgeted fixed overhead) and volume variance (arising when actual output differs from budgeted output, causing over or under-absorption of fixed overhead). Under-absorption means fixed costs are spread over fewer units than planned — reducing reported profit.

Limitations

Standard costing works best in stable, repetitive environments. In flexible or highly variable production it can become misleading. Standards that are not regularly updated become irrelevant as cost structures change. The technique is examined in ACCA PM and CIMA P1.

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