Behavioural Aspects Of Standard Costing


A planning and operational approach to variance analysis divides the total variance into those variances which have arisen because of inaccurate planning or faulty standards (planning variances) and those variances which have been caused by adverse or favourable operational performance, compared with a standard which has been revised in hindsight (operational variances).

So far in this text we have been looking at variances which are calculated using what we will call the conventional approach to variance analysis, whereby an actual cost is compared with an original standard cost. In this section of the chapter we will be examining planning and operational variances. They are not really alternatives to the conventional approach, they merely provide a much more detailed analysis.

Basically, the planning and operational approach attempts to divide a total variance (which has been calculated conventionally) into a group of variances which have arisen because of inaccurate planning or faulty standards (planning variances) and a group of variances which have been caused by adverse or favourable operational performance (operational variances, surprisingly enough!).

Planning and operational variances may seem confusing if you do not have a really good grasp of the conventional approach and so, before you go any further, make sure that you understand everything that we covered so far in this Text. Go back over any areas you are unsure about.

Only when you are happy that you have mastered the basics should you begin on this section.

A planning variance (or revision variance) compares an original standard with a revised standard that should or would have been used if planners had known in advance what was going to happen.

An operational variance (or operating variance) compares an actual result with the revised standard.

Planning and operational variances are based on the principle that variances ought to be reported by taking as the main starting point, not the original standard, but a standard which can be seen, in hindsight, to be the optimum that should have been achievable.

Exponents of this approach argue that the monetary value of variances ought to be a realistic reflection of what the causes of the variances have cost the organisation. In other words they should show the cash (and profit) gained or lost as a consequence of operating results being different to what should have been achieved. Variances can be valued in this way by comparing actual results with a realistic standard or budget. Such variances are called operational variances.

Planning variances arise because the original standard and revised more realistic standards are different and have nothing to do with operational performance. In most cases, it is unlikely that anything could be done about planning variances: they are not controllable by operational managers but by senior management.

In other words the cause of a total variance might be one or both of:

  • Adverse or favourable operational performance (operational variance) • Inaccurate planning, or faulty standards (planning variance)


Calculating total planning and operational variances

We will begin by looking at how to split a total cost variance into its planning and operational components.

Operational price and usage variances

So far we have only considered planning and operational variances in total, without carrying out the usual two-way split. In the question above, for instance, we identified a total operational variance for materials of RWF250,000 without considering whether this operational variance could be split between a usage variance and a price variance.

This is not a problem so long as you retain your grasp of knowledge you already possess. You know that a price variance measures the difference between the actual amount of money paid and the amount of money that should have been paid for that quantity of materials (or whatever).

Operational variances for labour and overheads

Precisely the same argument applies to the calculation of operational variances for labour and overheads, and the examples already given should be sufficient to enable you to do the next question.

Planning and operational sales variances

Our final calculations in this section deal with planning and operational sales variances.

A budget revision should be allowed if something has happened which is beyond the control of the organisation or individual manager and which makes the original budget unsuitable for use in performance management.

Any adjustment should be approved by senior management who should look at the issues involved objectively and independently. Operational issues are the issues that a budget is attempting to control so they should not be subject to revision. However, it can be very difficult to establish what is due to operational problems (controllable) and what is due to planning (uncontrollable).

The value of planning and operational variances

Advantages of a system of planning and operational variances

  • The analysis highlights those variances which are controllable and those which are non-controllable.
  • Managers’ acceptance of the use of variances for performance measurement, and their motivation, is likely to increase if they know they will not be held responsible for poor planning and faulty standard setting.
  • The planning and standard-setting processes should improve; standards should be more accurate, relevant and appropriate.
  • Operational variances will provide a ‘fairer’ reflection of actual performance.


The limitations of planning and operational variances, which must be overcome if they are to be applied in practice.

  • It is difficult to decide in hindsight what the realistic standard should have been.
  • It may become too easy to justify all the variances as being due to bad planning, so no operational variances will be highlighted.
  • Establishing realistic revised standards and analysing the total variance into planning and operational variances can be a time consuming task, even if a spreadsheet package is devised.
  • Even though the intention is to provide more meaningful information, managers may be resistant to the very idea of variances and refuse to see the virtues of the approach. Careful presentation and explanation will be required until managers are used to the concepts.



The role of standards and variances in the modern business environment is open to question.

Standard costing and new technology

Standard costing has traditionally been associated with labour-intensive operations, but it can be applied to capital-intensive production too.

It is quite possible that with advanced manufacturing technology variable overheads are incurred in relation to machine time rather than labour time, and standard costs should reflect this where appropriate.

With computer aided design/computer aided manufacture (CADCAM) systems, the planning of manufacturing requirements can be computerised, so that standard costs can be constructed by computer, saving administrative time and expense while providing far more accurate standards.

Total quality management (TQM)

In the context of TQM, quality means getting it right first time and keeping ahead of the game.

Total quality management (TQM) is the process of applying a zero defects philosophy to the management of all resources and relationships within an organisation as a means of developing and sustaining a culture of continuous improvement which focuses on meeting customers’ expectations.

Mark Lee Inman listed ‘eight requirements of quality’ in an ACCA Students’ Newsletter article, which could be seen as the characteristics of total quality management programmes.

  • Organisation wide there must be acceptance that the only thing that matters is the customer.
  • There should be recognition of the all-pervasive nature of the customer-supplier relationship, including internal customers; passing sub-standard material to another division is not satisfactory
  • Instead of relying on inspection to a predefined level of quality, the cause of the defect in the first place should be prevented.
  • Each employee or group of employees must be personally responsible for defect-free production or service in their domain.
  • There should be a move away from ‘acceptable’ quality levels. Any level of defects must be unacceptable.
  • All departments should try obsessively to get things right first time; this applies to misdirected phone calls and typing errors as much as to production.
  • Quality certification programmes should be introduced.
  • The cost of poor quality, i.e. correcting mistakes as well as losing customers, should be emphasised; good quality generates savings.



Standard costing and TQM

Standard costing concentrates on quantity and ignores other factors contributing to effectiveness. In a total quality environment, however, quantity is not an issue; quality is. Effectiveness in such an environment therefore centres on high quality output (produced as a result of high quality input and the elimination of non-value adding activities) and the cost of failing to achieve the required level of effectiveness is measured not in variances, but in terms of internal and external failure costs, neither of which would be identified by a traditional standard costing analysis.

Standard costing systems might measure, say, labour efficiency in terms of individual tasks and level of output. In a total quality environment, labour is more likely to be viewed as a number of multi-task teams who are responsible for the completion of a part of the production process. The effectiveness of such a team is more appropriately measured in terms of re-working required, returns from customers, defects identified in subsequent stages of production and so on.

Traditional feedback control would seek to eliminate an adverse material price variance by requiring managers to source cheaper, possibly lower quality supplies. This may run counter to the aim of maximising quality of output.


Can standard costing and TQM co-exist?

Arguably, there is little point in running both a total quality management programme and a standard costing system simultaneously.

  • Predetermined standards are at odds with the philosophy of continual improvement inherent in a total quality management programme.
  • Continual improvements are likely to alter methods of working, prices, quantities of inputs and so on, whereas standard costing is most appropriate in a stable, standardised and repetitive environment.
  • Material standard costs often incorporate a planned level of scrap. This is at odds with the TQM aim of zero defects and there is no motivation to ‘get it right first time’.
  • Attainable standards, which make some allowance for wastage and inefficiencies are commonly set. The use of such standards conflicts with the elimination of waste which is such a vital ingredient of a TQM programme.
  • Standard costing control systems make individual managers responsible for the variances relating to their part of the organisation’s activities. A TQM programme, on the other hand, aims to make all personnel aware of, and responsible for, the importance of supplying the customer with a quality product.


Standard costing and new philosophy

It has been argued that traditional variance analysis is unhelpful and potentially misleading in the modern organisation, and can make managers focus their attention on the wrong issues, for example – over-producing and stockpiling finished goods, because higher production volumes mean that overheads are spread over more units. Here are two examples.

  • Efficiency variance. Adverse efficiency variances should be avoided, which means that managers should try to prevent idle time and to keep up production. In a TQM environment using just-in-time manufacturing, action to eliminate idle time could result in the manufacture of unwanted products that must be held in store and might eventually be scrapped. Efficiency variances could focus management attention on the wrong problems.
  • Materials price variance. In a JIT environment, the key issues with materials purchasing are supplier reliability, materials quality and delivery in small order quantities. Purchasing managers shouldn’t be shopping around every month looking for the cheapest price. Many JIT systems depend on long-term contractual links with suppliers, which means that material price variances are not relevant for control purposes.


The role of standards and variances in the modern business environment is viewed as follows by George Brown (a previous ACCA examiner).

‘The rate of change in product type and design due to technological improvement, customer requirements and increased competition has led to rapid change in how businesses operate. The need to respond to customer demands for speedy availability of products, shortening product life cycles and higher quality standards has contributed to a number of changes in the way businesses operate…just-in-time systems…total quality programmes…..greater emphasis on the value chain…..accurate product costing and pricing information……improved speed and flexibility of information availability…’ (‘Standard costing – a status check’)

Standard costing, on the other hand, is most appropriate in a stable, standardised and repetitive environment and one of the main objectives of standard costing is to ensure that processes conform to standards, that they do not vary and that variances are eliminated. This may seem restrictive and inhibiting in the business environment of the twenty first century. (In fact, in the article referred to above, George Brown attempts to show that concerns about the restrictive and inhibiting nature of standard costing have been raised since it was first used and that efforts have continuously been made (such as planning and operating variances) to redesign standards and variances to maintain their relevance in an environment of change.)

Other problems with using standard costing in today’s environment

  • Variance analysis concentrates on only a narrow range of costs, and does not give sufficient attention to issues such as quality and customer satisfaction.
  • Standard costing places too much emphasis on direct labour costs. Direct labour is only a small proportion of costs in the modern manufacturing environment and so this emphasis is not appropriate.
  • Many of the variances in a standard costing system focus on the control of short-term variable costs. In most modern manufacturing environments, the majority of costs, including direct labour costs, tend to be fixed in the short run.
  • The use of standard costing relies on the existence of repetitive operations and relatively homogeneous Nowadays many organisations are forced continually to respond to customers’ changing requirements, with the result that output and operations are not so repetitive.
  • Standard costing systems were developed when the business environment was more stable and less prone to change. The current business environment is more dynamic and it is not possible to assume stable conditions.
  • Standard costing systems assume that performance to standard is acceptable. Today’s business environment is more focused on continuous improvement.
  • Most standard costing systems produce control statements weekly or monthly. The modern manager needs much more prompt control information in order to function efficiently in a dynamic business environment.

The role in modern business of standards and variances

Two surveys ((Puxty and Lyall (1989) and Drury et al (1993)) have confirmed the continued wide use of standard costing systems. Drury et al, for instance, showed that 76% of the responding organisations operated a standard costing system.

  • Planning. Even in a TQM environment, budgets will still need to be quantified. For example, the planned level of prevention and appraisal costs needs to be determined. Standards, such as returns of a particular product should not exceed 1% of deliveries during a budget period, can be set.
  • Control. Cost and mix changes from plan will still be relevant in many processing situations.
  • Decision making. Existing standards can be used as the starting point in the construction of a cost for a new product.
  • Performance measurement. If the product mix is relatively stable, performance measurement may be enhanced by the use of a system of planning and operational variances.
  • Product pricing. Target costs may be compared with current standards, and the resulting ‘cost gap’ investigated with a view to reducing it or eliminating it using techniques such as value engineering.
  • Improvement and change. Variance trends can be monitored over time.
  • Accounting valuations. Although the operation of a JIT system in conjunction with backflush accounting will reduce the need for standard costs and variance analysis, standards may be used to value residual inventory and the transfers to cost of sales account.


  • A planning and operational approach to variance analysis divides the total variance into those variances which have arisen because of inaccurate planning or faulty standards (planning variances) and those variances which have been caused by adverse or favourable operational performance, compared with a standard which has been revised in hindsight (operational variances).
  • The role of standards and variances in the modern business environment is open to question.
  • In the context of TQM, quality means getting it right first time and improving continuously.


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