Without a standard there is no control, only record-keeping. A standard turns accounting from a narration of what happened into a tool that shows where and why performance went wrong.
1 What is a standard cost?
It is a cost estimated in advance for a single unit under normal operating conditions, and it is built from two parts: a standard quantity and a standard price.
| Element | Standard quantity | Standard price | Standard cost |
|---|---|---|---|
| Materials | 3 kg per unit | SAR 20 per kg | 60 |
| Labour | 1.5 hours per unit | SAR 40 per hour | 60 |
| Variable overhead | 1.5 hours | SAR 12 per hour | 18 |
| Total | — | — | 138 |
A realistic standard, not an ideal one
An ideal standard (no waste, no downtime) demoralises the team because it is never reached. A lax standard hides waste. What you want is a standard attainable with reasonable effort that allows for normal waste and usual downtime.
2 Material variances
The two formulas
- Price variance = (actual price − standard price) × actual quantity purchased
- Quantity variance = (actual quantity − standard quantity for actual output) × standard price
- A negative result means a saving (favourable); a positive one means an overrun (unfavourable)
1,000 units were produced. Standard: 3 kg at SAR 20. Actual: 3,200 kg consumed at SAR 19 per kg.
| Variance | Calculation | Result |
|---|---|---|
| Price variance | (19 − 20) × 3,200 | (3,200) favourable |
| Quantity variance | (3,200 − 3,000) × 20 | 4,000 unfavourable |
| Net | — | 800 unfavourable |
Reading them together: the buyer bought material one riyal cheaper and looked like a hero (a saving of 3,200). But the lower-grade material caused 200 kg of waste costing 4,000. The net outcome is a loss of SAR 800 — and if each variance were read alone, the buyer would be rewarded and the production supervisor blamed, and both would be wrong.
3 Labour variances
The two formulas
- Rate variance = (actual rate − standard rate) × actual hours
- Efficiency variance = (actual hours − standard hours for actual output) × standard rate
For the same output (1,000 units), the standard is 1.5 hours at SAR 40. Actual: 1,400 hours at SAR 44.
| Variance | Calculation | Result |
|---|---|---|
| Rate variance | (44 − 40) × 1,400 | 5,600 unfavourable |
| Efficiency variance | (1,400 − 1,500) × 40 | (4,000) favourable |
| Net | — | 1,600 unfavourable |
The reading: higher-paid labour was used (an overrun of 5,600) but it finished the work in fewer hours (a saving of 4,000). The net is 1,600 unfavourable — and the management response is not “stop using skilled labour”, but weighing pay against productivity case by case.
4 Management by exception
Not every variance is investigated. Thresholds are set by amount or by percentage — for instance, any variance above 5% of standard or SAR 10,000. Anything below that is recorded but not investigated, to save effort.
A favourable variance is not always good news
A large saving in labour may mean quality steps were skipped. A saving in materials may mean a lower specification. Investigate a large favourable variance as you would an unfavourable one.
Chapter 1 summary
- Standard cost = standard quantity × standard price, built on a realistic basis.
- Material variances split into price and quantity; labour variances into rate and efficiency.
- Variances are read together, because the cause of one may sit in another.
- Management by exception: investigate only what exceeds an agreed threshold.
- A large favourable variance deserves investigation too.
5 Test yourself
Three quick questions
Choose the answer you think is correct — the result appears immediately.
1. The standard is 2 kg at SAR 15. 500 units were produced and 1,100 kg consumed. What is the quantity variance?
Standard for actual output = 500 × 2 = 1,000 kg · the difference of 100 kg × 15 = 1,500 unfavourable.
2. A large favourable material price variance with a larger unfavourable quantity variance. What is the likeliest explanation?
This is the classic pattern of linked variances: a saving in purchasing paid for in waste on the shop floor.
3. What is the purpose of investigation thresholds for variances?
Management by exception directs limited time to the variances that matter instead of scattering it over small differences.