Standard costing

Standard costing is an accounting method that assigns expected costs to products and services, enabling businesses to measure performance and control expenses.
Updated: Jun 6, 2024

3 key takeaways

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  • Standard costing involves setting predetermined costs for production.
  • It helps businesses identify variances between expected and actual costs.
  • This method aids in budgeting, cost control, and performance evaluation.

What is standard costing?

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Standard costing is a cost accounting method used by businesses to estimate the expected costs of production. These expected costs, or standard costs, are set based on historical data, industry benchmarks, and management’s expectations. Standard costs typically include direct materials, direct labor, and manufacturing overhead.

The primary purpose of standard costing is to provide a benchmark against which actual production costs can be compared. By analyzing variances between standard costs and actual costs, businesses can identify inefficiencies, control expenses, and improve overall financial performance. This method is widely used in manufacturing industries but can also be applied in service-oriented businesses.

How is standard costing implemented?

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Implementing standard costing involves several steps:

  1. Setting standard costs: Determine the standard cost for each component of production, including materials, labor, and overhead. These costs are based on past performance, market conditions, and management’s targets.
  2. Recording actual costs: Track the actual costs incurred during production, including any deviations from the standard costs.
  3. Calculating variances: Compare actual costs to standard costs to identify variances. Variances can be favorable (actual costs are lower than standard costs) or unfavorable (actual costs are higher than standard costs).
  4. Analyzing variances: Investigate the reasons for variances to understand the causes of cost deviations. This analysis helps in identifying areas for improvement and implementing corrective actions.

Importance of standard costing

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Standard costing offers several benefits for businesses:

  • Budgeting and planning: Standard costs provide a basis for budgeting and financial planning, helping businesses forecast future expenses and revenues more accurately.
  • Cost control: By comparing actual costs to standard costs, businesses can identify inefficiencies and implement measures to control expenses.
  • Performance evaluation: Variance analysis helps in assessing the performance of different departments, processes, or managers, providing insights into areas that need improvement.
  • Decision-making: Standard costing provides valuable information for strategic decision-making, such as pricing strategies, cost-cutting measures, and process improvements.

Examples of standard costing applications

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  • Manufacturing: A car manufacturer sets standard costs for raw materials (steel, rubber), labor (assembly line workers), and overhead (factory utilities). By comparing these standards to actual production costs, the company identifies cost overruns and areas for efficiency improvements.
  • Retail: A retail chain uses standard costing to determine the expected costs of purchasing and selling goods. Variance analysis helps the chain manage inventory levels and supplier negotiations more effectively.
  • Healthcare: A hospital applies standard costing to estimate the costs of medical procedures, including supplies, labor, and overhead. Analyzing variances helps the hospital improve resource allocation and reduce operational costs.

Interpreting variances in standard costing

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  • Favorable variance: Occurs when actual costs are lower than standard costs, indicating cost savings or efficiencies in production.
  • Unfavorable variance: Occurs when actual costs are higher than standard costs, signaling potential inefficiencies or issues that need to be addressed.

Understanding and implementing standard costing can significantly enhance a business’s ability to manage costs and improve financial performance. For further exploration, consider looking into related concepts such as variance analysis, budgeting techniques, and cost control methods.

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AI Financial Assistant
Arti is a specialized AI Financial Assistant at Invezz, created to support the editorial team. He leverages both AI and the knowledge base, understands over 100,000... read more.