Standard costing
Also known as: standard cost system
Standard costing is a cost accounting method that assigns predetermined costs to materials, labor, and overhead, then compares them with actual costs. The differences, called variances, help managers spot and investigate performance problems.
Standard costing is a management accounting system in which a company sets predetermined costs — standards — for direct materials, direct labor, and manufacturing overhead before production begins. Each standard has two ingredients: a quantity standard (how much input a unit should require) and a price standard (what each unit of input should cost). Multiplying the two gives the standard cost of producing one unit.
As actual results come in, accountants compare them against the standards and compute variances. A materials price variance shows whether purchasing paid more or less than planned; a materials quantity (usage) variance shows whether production used more or less input than it should have. Labor has parallel rate and efficiency variances, and overhead variances split into spending, efficiency, and volume effects. Variances are labeled favorable when actual costs run below standard and unfavorable when they run above.
The payoff is management by exception: rather than scrutinizing every transaction, managers focus attention on significant variances and investigate their causes — a supplier price increase, waste on the production line, or an outdated standard. Standard costs also simplify budgeting, inventory valuation, and product pricing, though standards must be updated periodically to stay meaningful, and an overemphasis on favorable variances can encourage buying cheap materials or cutting corners.
Standard costing is a staple of the CMA Part 1 exam, which tests setting standards, calculating price, rate, quantity, and efficiency variances, and applying management by exception. Candidates should be comfortable computing each variance and interpreting whether it is favorable or unfavorable.
Key takeaways
- Standard costing assigns predetermined costs to materials, labor, and overhead based on quantity and price standards.
- Differences between standard and actual costs are variances, labeled favorable or unfavorable.
- Materials variances split into price and quantity; labor variances split into rate and efficiency.
- Variance analysis enables management by exception — investigating only significant deviations.
- The CMA Part 1 exam tests variance calculations and their interpretation in depth.