Standard costing What is standard costing?

Some argue that standard cost is more accurate, as it considers all the factors that go into producing a product. Others argue that actual cost is more accurate, including the real costs of materials and labor. Ultimately, it is up to each company to decide which method is best for their needs. However, there are some situations where standard cost may not be the best option, such as when there is high demand for a product and companies need to quickly produce as much as possible.

While standard costing may require some initial investment of time and resources to set up, the long-term benefits can be significant. Standard costing is an essential tool for businesses that are serious about managing their costs. In any manufacturing organization, it is critical to developing a sense of ownership and accountability for results among employees. One way to promote this culture is through standard cost accounting. When everyone understands and buys into the concept of standard costs, they are more likely to be motivated to work towards achieving those costs.

What is the Difference between Standard Costs and Budgeted Costs?

If the standard cost is higher than the actual cost then this variance is to be considered as favorable to an organisation. But if the actual cost is higher than the standard cost then the result is to be considered as adverse. The standards of physical activity for various departments should be worked out. For direct materials, standard quantity has to be determined with reference to quality and size of materials required for each unit of production.

Another situation in which a variance may occur is when the cost of labor and/or material changes after the standard was established. Toward the end of the fiscal year, standards often become less reliable because time has passed and the environment has changed. It is not reasonable to expect the price of all materials and labor to remain constant for 12 months. For example, the grade of material used to establish the standard may no longer be available.

HOW IS THE STANDARD COST CALCULATED?

Standard costs may not always reflect actual costs, and companies may have difficulty setting realistic standards. Despite its limitations, it can be a helpful tool for manufacturing companies trying to improve their production processes. Standard costing is setting prices for inventory items based on their standard costs.

The standard direct labor cost is multiplied by the hours worked to produce the product. It is essential to clearly understand the difference between actual and standard costs to understand many management accounting aspects. The main difference between actual cost and standard cost is that actual cost refers to the cost incurred or paid, whereas standard cost is an estimated product cost. Once a budget is prepared, there should be a control mechanism to evaluate how successfully the budget was achieved. Standard cost is often used for production decisions, as it provides a consistent and objective way to compare the costs of different options.

Difference between Standard Cost and Estimated Cost

Direct materials refers to the materials used to create your product, such as the fabric a clothing company uses to create its garments. Manufacturing overhead includes indirect costs, such as the electricity required to power your facility. This does not mean the actual costs will never be used, typically a company’s accountant will periodically update the variances as that information becomes available.

• By the variance analysis and reporting, “the principle of management by exception” is facilitated.
• For example, suppose you are manufacturing a unique product with very little competition.
• Standards are one of the important quantitative tools in the hand of management to control and measure the performance of business operations.
• The costing reports, based on standard cost, reveal the overall result of the manufacturing side.
• However, the time has come to perform a thorough analysis of our inventory costing systems to determine if what we already have is really good enough.

Nevertheless, standard costs are still found in the vast majority of manufacturing companies and many service companies, although their use is changing. Examples include sales price variance, sales quantity (or volume) variance, and sales mix variance. A difference in the relative proportion of sales can account for some of the difference in a company’s profits.

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Prices should reflect current market prices to be used throughout the forthcoming fiscal period. By analysing the variances, management may concentrate on significant deviations What is Standard costing from the standards and take corrective action. Predetermination of standard costs in full detail under each element of cost, i.e., Material, Labour, overheads.

For example, General Motors has standards for each item on a vehicle. It can determine the cost and selling price of a power antenna by knowing the standard material cost for the antenna and the standard labor cost of adding the antenna to the vehicle. General Motors also can add up all of the standard times for all vehicles it makes to determine if too much or too little labor was used in production. Standard costs can be used as a yardstick against which actual costs can be compared. The standard cost is a predetermined or expected cost, which determines what each product or service should cost under given conditions.