What standard costing and variance analysis are
Standard costing sets what a product should cost under normal operating conditions: material quantities, labor hours and prices fixed before production starts. Variance analysis compares that standard with actual cost and splits the gap into causes, usually price (or rate) and quantity (or efficiency).
Without the split, management only sees that cost overran. With it, you learn whether the culprit was a pricier purchase, scrapped material, labor paid above plan, or poor line efficiency. Each cause has a different owner and a different fix.
The standard lives on a standard cost card: per unit, the standard quantity of each input and its standard price. The starting point is usually the unit production cost, and times come from a time study or standard work.
Visual map of cost variances
The map shows the standard cost card, the four variances and the numeric example from this article, from standard cost to actual cost.
Variance formulas
Every variance compares actual against what was allowed for the output actually produced. That is why the standard is restated at actual output (a flexible budget), not at planned volume.
Material price variance = (actual price − standard price) × actual quantity purchased
Material quantity variance = (actual quantity − standard quantity allowed) × standard price
Labor rate variance = (actual rate − standard rate) × actual hours
Labor efficiency variance = (actual hours − standard hours allowed) × standard rate
Standard quantity (or hours) allowed is the standard per unit times the units actually produced. A positive result means actual cost above standard: an unfavorable variance (U). A negative result is favorable (F).
The two variances for each input add up exactly to the total gap: actual cost minus standard cost of actual output. If they do not tie out, there is an arithmetic or base error.
Worked example: 1,000 units produced
Fictional example, amounts in dollars. The standard card per unit covers two inputs:
| Input | Standard quantity | Standard price | Standard cost per unit |
|---|---|---|---|
| Material | 2 kg | $5.00/kg | $10.00 |
| Direct labor | 0.5 h | $40.00/h | $20.00 |
| Total | $30.00 |
During the month the plant made 1,000 units. Allowed standard for that output is 2,000 kg of material (1,000 × 2) and 500 hours (1,000 × 0.5), a standard cost of $30,000. Actuals were:
| Input | Actual quantity | Actual price | Actual cost |
|---|---|---|---|
| Material | 2,150 kg | $5.20/kg | $11,180 |
| Direct labor | 540 h | $38.00/h | $20,520 |
| Total | $31,700 |
Actual cost came in $1,700 above standard (5.7%). Now the breakdown:
| Variance | Calculation | Result |
|---|---|---|
| Material price | (5.20 − 5.00) × 2,150 | $430 U |
| Material quantity | (2,150 − 2,000) × 5.00 | $750 U |
| Labor rate | (38.00 − 40.00) × 540 | $1,080 F |
| Labor efficiency | (540 − 500) × 40.00 | $1,600 U |
| Total | 430 + 750 − 1,080 + 1,600 | $1,700 U |
Check: material 430 + 750 = $1,180 (11,180 − 10,000); labor −1,080 + 1,600 = $520 (20,520 − 20,000). Total $1,700, equal to actual minus standard cost.
How to read each variance
The example shows why the total alone misleads. Labor was hired cheaper ($38 against $40), but it used 40 more hours than allowed, and the lost efficiency cost more than the rate saved.
| Variance | Usually answers for | Frequent causes |
|---|---|---|
| Material price | Purchasing | Alternate supplier, expedited freight, small lots, exchange rate |
| Material quantity | Production and engineering | Scrap, rework, process yield, specification error |
| Labor rate | HR and scheduling | Overtime, shift mix, operators on a different pay grade |
| Labor efficiency | Production and maintenance | Downtime, long setups, new operator, material shortages |
Favorable does not mean good. A favorable price variance from cheaper material may have caused the unfavorable quantity variance through poorer quality. Read the variances together and go to the gemba to confirm the cause before blaming anyone.
When standard costing works and when it hurts
- It works in repetitive production with stable routings and known consumption, for budgeting, pricing and inventory valuation.
- It hurts when it becomes a target to “hit the standard” at any cost: the buyer orders a huge lot to win on price and inventory grows, the opposite of what lean production aims for.
- A stale standard produces permanent variances with no information. Review prices and consumption at least yearly, or when the process changes.
- A direct-hours focus weakens on automated lines, where cost sits in the machine. There, also track OEE and capacity utilization.
To see how variances hit results, tie them to contribution margin and the break-even point. Recurring quantity variances also show up as losses in the cost of quality.
How to roll it out in 5 steps
- Set the per-unit standard: quantities from the bill of materials and routing, prices from contracts or a recent average.
- Record actual consumption per production order, with material and hour reporting.
- Compute the four variances per product and period, always on actual output.
- Investigate only what exceeds a materiality threshold (for example, a set percentage of standard cost).
- Log the cause, action and owner, and update the standard when the cause is a permanent change.
Common mistakes
- Computing variances on budgeted volume instead of actual output, which mixes volume variance with efficiency variance.
- Using quantity purchased in the material quantity variance: the price variance uses what was bought; the quantity variance uses what was consumed.
- Treating every unfavorable variance as a department’s fault without checking the cause.
- Ignoring small recurring variances, which add up to more than one large isolated deviation.
- Keeping old standards “for convenience,” with prices from two years ago.
Frequently asked questions
What is standard cost?
It is the predetermined cost of a product, built from standard quantities and prices of material, labor and overhead under normal conditions.
What are the main standard cost variances?
Price and quantity for material, rate and efficiency for labor. Overhead has its own spending, volume and efficiency variances.
Is an unfavorable variance always bad?
No. It means actual exceeded standard, but the cause may be an outdated standard, a mix change or a quality investment. Investigate before concluding.
How do you calculate the material price variance?
(Actual price − standard price) × actual quantity purchased. In the example: (5.20 − 5.00) × 2,150 = $430 unfavorable.
What is the difference between rate and efficiency variance?
Rate measures the price of the hour ($ per hour); efficiency measures how many hours were used above or below what actual output allowed.
How often should standard costs be reviewed?
At least once a year, and whenever the process, a key supplier, the routing or the bill of materials changes.
Sources
- HORNGREN, C. T.; DATAR, S. M.; RAJAN, M. V. Cost Accounting: A Managerial Emphasis. Pearson.
- GARRISON, R. H.; NOREEN, E. W.; BREWER, P. C. Managerial Accounting. McGraw-Hill.
- DRURY, C. Management and Cost Accounting. Cengage Learning.
- MASKELL, B. H.; BAGGALEY, B. Practical Lean Accounting. Productivity Press, 2004.
Keep studying: trusted sources and links
- Sebrae: gestão, custos e finanças para empresas (in Portuguese)
- CFC: Conselho Federal de Contabilidade (in Portuguese)
Save this address: Manufatura Enxuta is your school for lean manufacturing. Come back whenever you need to study, with a complete article, a visual map and trusted sources. Follow one of the learning paths or check the A–Z glossary.
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About the author
Lean Manufacturing & Behavioral Management Specialist
Over 20 years in the automotive and metalworking industries (GM and Dana), Lean Manufacturing practitioner since 2006. SENAI instructor and mentor in Brazil’s Brasil Mais Produtivo program, delivering consulting, training and audits for 50+ companies, combining quality, productivity and people development.
