A standard cost variance is the difference between a baseline cost and an actual cost. This variance is used to monitor the costs incurred by a business, with management taking action when a material negative variance is incurred. The standard from which the variance is calculated may be derived in several ways. For example:
- The standard cost of a component is based on the expected purchasing volume under a specific contract with a supplier.
- The standard cost of labor is based on a time and motion study, adjusted for down time.
- The standard cost to operate a machine is based on expected capacity levels, utility costs, and scheduled maintenance charges.
A standard cost variance can be unusable if the standard baseline is not valid. For example, a purchasing manager may negotiate a high standard cost for a key component, which is easy to match. Or, an engineering team assumes too high a production volume when calculating direct labor costs, so that the actual labor cost is much higher than the standard cost. Thus, it is essential to understand how standard costs are derived before relying upon the variances that are calculated from them.
There are many types of standard cost variances, including the following:
- Fixed overhead spending variance
- Labor rate variance
- Purchase price variance
- Variable overhead spending variance