Standard Costing

Overview of Standard Costing

Overview of Standard Costing

Standard costing is a management accounting control technique that sets predetermined (budgeted) costs and revenues, then compares these against actual results to identify variances.

Standard cost — the expected cost of producing one unit, set in advance, covering materials, labour and overheads.

Variance analysis — the process of identifying and investigating differences between standard and actual performance.

How a standard costing system operates

1. Set standards (budgeted information) for materials, labour and sales
2. Compare standard costs and sales with actual costs and sales
3. Identify the variances (differences between standard and actual)
4. Investigate the reasons / causes for the variances
5. Take corrective action (including potentially resetting standards)

Favourable vs Adverse variances

A variance is either favourable (F) or adverse (A):

• Favourable — actual result is better than standard (lower cost or higher revenue than expected)
• Adverse — actual result is worse than standard (higher cost or lower revenue than expected)

Causes of favourable variances:

• Actual sales higher than standard (higher volume and/or higher unit price)
• Actual material cost lower than standard (lower quantity used and/or lower unit cost)
• Actual labour cost lower than standard (fewer hours used and/or lower hourly rate)

Causes of adverse variances:

• Actual sales lower than standard (lower volume and/or lower unit price)
• Actual material cost higher than standard (higher quantity used and/or higher unit cost)
• Actual labour cost higher than standard (more hours used and/or higher hourly rate)

Labelling variances

• By deducting actual from standard, a positive figure is favourable and a negative figure is adverse
• Each variance must be labelled with a £ sign and F or A
• Adverse variances do not need to be shown in brackets (though brackets are acceptable)