Standard Costing: Definition and How it Works

What is standard costing? What is Variance? Advantages, Disadvantages.

Advantages of standard costing

Standard costing offers managers a number of benefits that can improve the efficiency of their business. Here are a few examples:


A quick estimation of projected costs is provided by a standard costing system. Although having accurate reports is nice, they are not delivered on time. A good estimate of costs provided promptly is highly preferable.

Allows for cost control

Managers are permitted to make any necessary corrections in the event of variances. This will then allow them to improve cost control. They can now be more conscious of their spending patterns and aim for little to no variances in the future.

Helps management make decisions

Standard costing may have an impact on a company’s overall operations. Managers can take action and improve current business practices and spending once they have identified any variances.

A difference of $40,000 would result, for instance, if the actual cost of materials is $50,000 and is higher than the standard cost of $10,000.

Managers can then start looking into what caused the variable and how to avoid it in the future. Inflation or the inefficient use of purchased goods are just two possibilities for the large variance in this situation.

Accurate budgets

When managers use the standard costing system to control costs, future actual costs should be relatively close to the standard costs. This result is extremely positive because it indicates that the profit plan was successful. This can lead to more accurate budgets in the future.

Lower production costs

Implementing a standard cost system may have the benefit of lowering production costs. Employees may become more cost-conscious, efficient, and performance-focused as a result of standard costing’s ability to help others visualize their spending patterns. This could result in lower production costs overall.

What is standard costing?

The process of estimating the cost of a production process is known as standard costing. A manufacturer might use this branch of cost accounting to forecast costs for the upcoming year for things like direct material, direct labor, or overhead. Additionally, these manufacturers will be in a position to contrast the standard cost with the actual cost.

A variance is the difference between the standard cost and the actual cost. A variance’s presence indicates a departure from the information recorded in the profit plan. In the event that actual costs exceed standard costs, management should probably expect a lower profit than anticipated. However, management might anticipate a higher profit than they had initially planned for if actual costs are less than standard costs.

Disadvantages of standard costing

Standard costing has some drawbacks even though it can be advantageous for business operations. Here are some disadvantages of implementing a standard costing system:

Slow feedback

Due to the fact that variance reports are only created monthly and that it takes time for this information to be made public, by the time it is at last made public, the information may no longer be useful. By producing reports on time and more frequently, this can be avoided.

Low morale

The majority of managers frequently prioritize challenges over successes. Instead of praising workers for a job well done, they might spend more time correcting standard cost variances. Positive reinforcement is necessary for staff members to feel valued and to enjoy their work. The likelihood of low employee morale could increase if a standard costing system is used.

Employee backlash

Employees may potentially conceal any unfavorable variance reports if morale is low in order to avoid any potential consequences in the future. Managers would receive a false sense of their profit plan as a result. Additionally, employees may act in a way that negatively impacts the company if they are aware of the outcomes of previous variance reports. Employees may increase output at the end of the month to prevent receiving a negative review. This could then lead to a lower quality product.

How to create a standard cost

Knowing how to calculate a cost accurately is the first step in developing a standard cost. Consider the following steps when creating a standard cost:

1. Determine the cost of direct materials, direct labor and overhead

You must multiply the rate of each by the quantity (in units or hours) to calculate these costs.

For instance, if the standard quantity is 20 pounds per unit and the direct materials price is $10, you would multiply $10 by 20 to get $200. This would be the typical price for just the direct materials. Let’s say the direct labor rate is $15 and the unit’s standard direct labor hours are 10. This would imply that $150 is the typical price for direct labor. Let’s assume that the overhead is $10 and that there are 5 hours in a day. As a result, the standard overhead expense would be $10 multiplied by 5 to equal $50.

2. Calculate the standard cost

Once you have established the standard price for each of these, add them up to obtain the total standard price.

According to the example given above, the production’s standard cost is $400 because it is equal to $200 for direct materials, $150 for direct labor, and $50 for overhead.


What is meant by standard costing?

Standard costing is the practice of recording an expected cost instead of an actual cost. Variances are then recorded to demonstrate the discrepancy between the anticipated and actual costs.

What is standard costing and its types?

Examples include payments for rent, utilities, insurance, office staff salaries, and supplies, among others. is $15 per hour, with $100,000 as the typical fixed cost. Consequently, 10 hours are needed to produce one unit in total. Find the standard cost of the company.

What is standard costing and its importance?

In order to compare predetermined cost estimates to actual costs, standard costing involves setting those estimates. A standard cost is an anticipated price for a single unit of a product or service. It is widely acknowledged that standard costing is an efficient tool for cost control in industries.

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