Standard Cost Variance Analysis

Definition of Benchmarking

Benchmarking compares actual line items to industry standards or past results.

Benchmarking means measuring the quality of a company's products, performance, or processes against specific standards. In managerial accounting, the terms quality and cost are often used interchangeably in that they are both linked to value. Companies use benchmarking to improve the value of their products and services. The value comes from having the best prices for a quality product as perceived by the customer. These value drivers are ultimately broken down to unit costs. For instance, a furniture buyer most likely assigns a higher value to oak than to particleboard. Oak costs the manufacturer much more than particle board does, so this value will translate to higher unit material costs and greater unit prices.

Benchmarking is a cyclical process of comparison and readjustment that follows these overall steps:

  • Decide what the benchmark will be. This is necessary so managers can figure out which type of measurement the company will use to evaluate differences from the standard. For example, a furniture manufacturer might set a benchmark that a certain quality of oak should cost no more than $25 per running board foot.
  • Collect and analyze data to determine where there are differences from the standard. This analysis is not a single variance in which a manager looks at a couple of data points and concludes that the company should make more money. Instead, it is an analysis of a network of interconnected variances. The manager might compare the cost to make one chair to the cost to make one table or one bookcase. Then the manager will use these comparisons to make decisions on the product mix and the price of each item. In the scenario of the benchmark about paying for oak boards, the manager might compare the current cost of oak per board foot with the prices paid last year and five years ago as well as the cost suggested by the American Home Furnishings Alliance, an industry group.
  • Develop a plan to make changes. Managers can compare actual line items to industry standards and past results to determine which activities within the organization need to be evaluated for improvement or change. If the company needs to make significant changes, then it can develop best practices and a continuous improvement plan. Best practices are the most cost-effective or efficient ways to complete tasks. Once the best practice is developed, it becomes part of the benchmark, and the process starts anew. In the example about oak boards, the manager might analyze the data that they have gathered and then present it to vendors to see if it is possible to negotiate a lower price.
Effective benchmarking involves continuous improvement rather than an occasional or annual check of how a product line is performing. If managers seek continuous improvement, then they reevaluate progress over time to see if there has been improvement from using the new process from the benchmark study.

Standard Cost Variance Analysis

Different companies use different benchmark processes. Here are the steps that one company may take.

Overview of Standard Cost Variance Analysis

Benchmarking requires variance analysis against standard costs, and companies determine the standard cost per unit as part of the benchmarking process.

Manufacturers often analyze the standard cost variance—the difference between how much a company predicted an expense would be and how much it actually is—of their products. To find the standard cost variance, managers first figure out the standard cost per unit, a predetermined dollar amount that one unit of a finished product should cost during an accounting period. The manager then evaluates this standard cost based on the cost variance.

Assume that a company finds that the actual costs for making a table are the following:

Cost Components

Materials Cost/Quantity
Wood for legs $17.27 per leg
Wood for tabletop $24.55
Other materials (nails, screws, glue, sandpaper, and varnish) $3.55 per table
Rate $12 per hour
Hours 4.25 hours per table
Variable overhead
Rate per unit $7.25

Costs required to build a finished good may include materials, labor, and overhead.

The total per unit cost of a table would be calculated as four legs plus one tabletop plus other materials plus labor and overhead.
That means $155.43 is the actual per unit cost for this company to make a table. If the standard is $130.00 for a table, then the variance would be:
The accountant would report this as an unfavorable unit cost variance because the actual costs are greater than the standard. Accountants divide the standard cost variance into two different elements: price variance and quality variance. Price variance is the difference between the actual amount paid for an input and the standard amount that should have been paid, multiplied by the actual amount of input the company bought.
Price Variance=(Actual per Unit CostStandard per Unit Cost)×Units Produced{\text{Price Variance}}=({\text{Actual per Unit Cost}}-{\text{Standard per Unit Cost}})\times{\text {Units Produced}}
Following the standard mathematical order of operation rules, the accountant performs the calculation inside the parentheses first. The per unit variance for each table the company makes is $21.88. If the company produces 2,000 units this year, then the price variance is $43,760.
Price Variance=$21.88×2,000=$21.88×2,000=$43,760\begin{aligned}{\text{Price Variance}}&=\$21.88\times2{,}000\\&=\$21.88\times2{,}000\\&=\$43{,}760\end{aligned}
Quantity variance is the difference between how much input was actually used and how much should have been used. In our furniture example, if the company planned to sell 200 tables in a month at $1,000 each but it actually sold 220, then the quantity variance is $20,000 favorable.
Quantity Variance=(220200)×1,000=(220200)×1,000=$20,000Favorable\begin{aligned}{\text{Quantity Variance}}&=(220-200)\times1,000\\&=(220-200)\times1,000\\&=\$20{,}000\;{\text{Favorable}}\end{aligned}