Standard costing is a cost accumulation method that makes use of predetermined amounts known as standard costs.
Standard costing makes us of predetermined costs. Instead of recording costs at the actual amounts, they are recorded using standard costs initially. Then later in the process, they are adjusted to match the actual amounts.
This allows managers to analyze variances, i.e. the differences between predetermined costs and actual costs, and decide on further actions.
Standard costs may be based on historical data, past experiences, market averages, and other relevant sources of information.
1. Emphasizes control over costs. Analysis of variances between standard costs and actual costs provide vital information useful in improving and maintaining efficiency of operations.
2. Serves as a key element in responsibility accounting. In responsibility accounting, managers are evaluated based on their performance over things they can control. Actual performance is compared with expectations or established standards.
3. Supports management by objectives and management by exception. Management by objective is an approach where a manager and his or her subordinates are evaluated based on achievement of set goals. Management by exception is another managerial approach in which management gives attention to matters that materially deviate from established standards.
4. Promotes efficiency among workers and employees. Though not perfect, established standards set the acceptable amount of cost to be spent.
5. Simplifies and speeds up the recording process, especially when actual cost data are not readily available.
The difference between actual costs and standard costs is known as "variance". There is a favorable variance when actual costs are less than standard costs. An unfavorable variance occurs when actual costs are higher than the standard.
The standard costing and variance analysis process is as follows:
Sometimes, established standards are too high, or too low, or are not applicable in the current situation. In such cases, the standards may need to be revised.
Standard costing system may be used in both job order costing and process costing. Standards may be established for materials, labor, and factory overhead.
In an actual cost system, all manufacturing costs are recorded at actual costs. In a normal cost system, materials and labor are recorded at actual costs while factory overhead is recorded using standard costs. In a full standard cost system, materials, labor, and factory overhead are all recorded at standard costs.
Variances are recorded later in the accounting process. Hence, the financial statements would still reflect the actual costs incurred.