Standard costing

What it means

Standard costs are predetermined norms for the consumption of materials, labour and overheads per unit of product or service, valued at planned prices. They define what a product should cost under normal conditions and efficient work, and serve as the benchmark against which actual costs are compared.

Standard costing belongs to management accounting and is closely linked to costing. Based on the standards, a company sets prices, prepares its budget and values its own-produced inventory where its accounting policy permits.

The main value of standards is variance analysis. The difference between standard and actual is split into a usage variance, whether more material or time was used, and a price variance, whether purchase prices or wage rates changed. Management then knows where to look for the cause.

How it works in practice

For manufacturing clients, we help set standards for the main products: a bill of materials, time norms for each operation and overhead rates. We base them on historical data and process specifications and set them realistically rather than ideally.

Each month we compare actual costs with standards and, where variances are significant, look for the cause with management. Often it is a change of supplier, higher scrap with a new technology or unrecorded downtime. Early detection allows a response before the problem hits profit.

Standards must be updated regularly, especially when input prices or technology change. Outdated standards produce systematic variances that lose their informational value, and inventory valuation or price calculations may be distorted.

What to watch out for

Standards that are too strict to achieve in practice demotivate staff and generate constant adverse variances. Standards that are too loose hide inefficiency. The goal is a norm a good team can meet under normal conditions.

If a company values own-produced inventory at standard cost, variances must be correctly allocated between expenses and inventory at period-end. Otherwise the balance sheet valuation will drift from reality, leading to adjustments at audit.