What Is Standard Costing, And How Does It Work?

Standard costing is a branch of cost accounting that involves estimating the total expense of a particular production process. Manufacturers use it to calculate the costs for an incoming year; these costs cover expenses like overhead, direct labor, and material.

In this article, we aim to discuss everything you need to know about standard costing. Stick to the end to learn more.

Benefits Of Standard Costing

These are a few benefits of operating a  standard costing system:

• More Efficient.

Over the years, standard costing has proven to be more efficient than accurate reports. Even though it is beneficial to have a detailed report, it takes time to prepare it. So, standard costing is preferable and more efficient. 

More so, if the standard cost is more than the actual cost, it means there are loopholes in the company that need to be resolved quickly! Therefore, the company needs to set up standard costing to ascertain if they are operating reliably or not.

• Ensures cost control.

If the management discovers variances, they can correct any differences; this enables them to improve cost control. Consequently, they will be more aware of their spending habits and determine ways to prevent future variances.

• Allows management to make decisive decisions.

Standard costing will enable a company’s management to control variance and make effective decisions to prevent it in the future. For example, if the actual cost (AC) of material is $100,000, and the standard price is $70,000. The variance amounts to $30,000.Once the management notices that, they can decide to investigate what caused it and prevent it in the future.

• Accurate budgets

When the management of a firm can effectively crumb the variance between actual cost and standard cost, it ensures that the profit margin rises. When the profit margin increases, there wouldn’t be an issue of having an inaccurate budget. 

• Lower production costs

Achieving a lower production cost is achievable with standard costing. Standard costing allows employees to put their spending habits in check. Consequently, they become more cost-conscious, work harder, and become more efficient. 

Disadvantages Of Standard Costing

• Delayed feedback

It takes time for a variance report to be prepared. They are usually prepared monthly and might not be helpful as of the time presented. However, this can be avoided by creating the variance reports timely and making them frequent.

• Reduced morale

When managers are more focused on the problems rather than the company’s success, it will eventually lead to low morale among the employees. The employees need enough motivation and pats on the back to keep going and working more effectively.

On a final note, How Does Standard Costing Work?

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

To determine the costs of direct materials, labor, and overhead, you need to multiply the charge of each (could be in units or hours). 

For example, if the cost for direct materials is $70, and the standard quantity is 30 pounds per unit, you multiply$70 by 30. You get $2,100 for the standard cost of direct materials.

2 Calculate the standard cost

Once you’ve calculated the cost of direct materials, labor, and overhead, you calculate the standard cost. What you do here is add them all up to get the overall standard cost.