All manufacturing activities and service-related processes should have predetermined standard cost targets. Standards are revenue or cost goals that are used to assess performance and create financial estimates. The budgeting cost formulas are regarded as standard. However, in practice, actual costs rarely match the standards perfectly, leading to what's known as cost variances.
In this article, we’ll explore 10 common causes of variances in standard costing, along with deep insights on how to manage or reduce them effectively.
What is Standard Costing?
Standard costing is the method of replacing an actual cost in accounting records with an expected cost. Any differences between these expected costs and the actual expenses in accounting are called variances. Standard costs are used because they are quicker and easier to work with than real costs. They save time and make accounting more efficient.
Because standard costs often differ from actual costs, the cost accountant checks for discrepancies, such as changes in wages or material prices. They may also update the standard costs to more closely match actual costs.
What Variances Appear in Standard Costing?
The most common variances in standard costing are:
1. Material Variances
The material variance is the variation between the amount of materials the business really utilises and the amount it expects to need during the production process. If there's a big difference in material costs, the company needs to look closely at how things are made. They might find ways to work more efficiently or choose better materials to use.
2. Labour Variances
A significant amount of any business's cost base is made up of labour expenses. It is essential to monitor labour variance in order to detect early warning signs of excessive cost increases. By closely tracking variances, businesses can uncover productivity issues and take corrective action before they impact profitability.
3. Overhead Variances
Controlling overheads is particularly crucial because they play a significant role in fixed expenses. Managers get notified of any possible issues that can reduce profit margins by tracking the overhead variance over time. Monitoring overhead variances also helps ensure that resources are being used efficiently and not wasted.
4. Cost Variances
Cost variance looks at the gap between what a company expected to spend and what it actually spent. Tracking these costs helps a business stay financially stable. If spending isn’t controlled, it can lead to serious cash flow problems. Regularly monitoring cost variance can notify management of new cost-related problems, enabling them to deal with them before they become more significant issues.
5. Profit Variances
Since profit variance is a metric that all parties involved in the firm will be interested in, it is crucial to keep an eye on it. Also, it can be very important in financial forecasting. One of the main goals of any company's management is to maintain strong profit margins. Regularly monitoring variance helps identify areas where the business is performing well or needs improvement, ensuring better decision-making and long-term success.
6. Sales Variances
Sales variance shows the difference between actual sales and expected sales. If the numbers are close, that’s good. But if they’re very different, higher or lower, it’s important to find out the reason, so the company can learn and improve. Understanding the reason behind the difference helps the company make better plans and decisions for the future.
10 Main Causes of Variances in Standard Costing
Variances in standard costing happen when actual costs or results differ from what was planned or expected. These differences can be caused by changes in prices, inefficiencies or inaccurate estimates. For example:
- Material Prices Variance - Raw material costs can go up or down due to market changes. This causes a difference between the expected and actual material costs.
- Material Waste Variance - Sometimes, more material is used than planned because of damage or mistakes. This leads to higher costs than expected.
- Labour Rate Changes - Employers might be paid more or less than the set wage rate. This creates a difference in labour cost from the standard.
- Labour Efficiency Variance - If workers take more or less time to finish a job than expected, it affects labour costs, causing labour efficiency variance.
- Variable Overhead Spending Variance - This happens when the actual variable overhead costs are more or less than expected. It can be caused by changes in utility rates, indirect materials or other variable costs.
- Variable Overhead Efficiency Variance - If workers take more or less time than expected, it affects how much overhead is used. This difference creates a variance in overhead efficiency.
- Fixed Overhead Budget Variance - This occurs when the actual fixed overhead costs (like rent or salaries) are different from the budgeted amount. It often results from cost changes that weren't planned.
- Fixed Overhead Volume Variance - If the company produces more or fewer units than expected, fixed overhead costs are spread differently.
- Sales Price Variance - This variance happens when products are sold at a different price than planned. Selling at a higher or lower price affects total revenue.
- Sales Volume Variance - Selling more or fewer units than expected creates this variance. It shows how changes in sales quantity impact overall performance.
You can make smart selections if you take a strategic approach to better understand the causes of the differences between the real and expected costs.
How to Manage Variance Analysis?
Conducting and managing variance analysis requires a clear, concise step-by-step approach to identify, understand and respond to cost differences. Here’s how it can be done efficiently:
1. Define Realistic Goals
Using accurate and up-to-date data is the key to setting standard costs and targets. Regularly reviewing and updating standards to reflect current market conditions, labour rates and production methods is the key to better variance analysis.
2. Collect and Calculate Variances
The second thing to do is to collect the budgeted and actual data and compare them. Once collected, compare the actual results and identify and categorise variances. However, certain variance analysis methods require a few additional stages before the final result is achieved.
3. Analyse the Causes
Look deeper into significant variances to find out why they occurred. Consider both internal and external factors. Before proceeding to the last stage, make sure you understand the root of the causes.
4. Monitor and Report the Results
Make regular checks to see if corrective actions have an impact. This involves tracking future variances that decrease or improve. After all this, make a report and include as many details as possible that can be useful. A proper documentation is a strong basis for adapting your next strategy.
Final Words
The causes of variances in standard costing arise from a variety of factors such as changes in material prices, labour rates, inefficiencies and unexpected overhead costs. Understanding these causes helps businesses identify areas where costs differ from expectations, allowing them to take corrective actions, improve efficiency and maintain better control over their financial performance. Regularly monitoring and addressing these causes ensures a more accurate financial close and supports stronger decision-making.