STANDARD COSTING | ACCOUNTANCY &AUDITING|L-7|

What is standard costing?

If you are working in accounting, understanding “What is standard costing?” can help you plan business budgets efficiently. Standard costing is the practice of estimating expenses in the production process since manufacturers cannot predict actual costs in advance. Manufacturers use this methodology to plan upcoming costs of various expenses, such as labour, materials, production and overhead. It helps the manufacturing team estimate expected costs so that they can budget and plan accordingly. Other terms for standard cost are estimated cost, predetermined cost, expected cost or budgeted cost.

The primary reason why companies use standard costs for budgeting is that manufacturers cannot predict actual production costs accurately until the manufacturing process is complete. There are several unknown variables, such as changes in the cost of raw materials, production delays and changing labour costs that affect the final costs. Besides budgeting, accountants also use standard costs to fix the prices of produced goods.

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Advantages of standard costing

Here are the top benefits of using standard costing:

Helps with accurate budgeting

Manufacturers rely on standard costing for creating budgets, as it is difficult to calculate the actual costs of producing an item before the production is complete. Manufacturing budgets are usually a smart estimate and not the actual price. They compare standard and actual costs once manufacturing is complete to identify the variances. They can then use this information to make the following year’s budget more accurate.

Simplifies inventory costing

Calculating the required inventory is easier when using standard costs than actual costs. Generally, during production, the cost of manufacturing varies from one batch to another. This can be due to several factors, such as production delays, variations in raw material pricing and changes in employee salaries. With standard costing, manufacturers can calculate inventory value by multiplying the actual inventory with the standard cost of each item. This helps them estimate the inventory costs that are likely to be very close to the actual costs.

Makes it easy to price products accurately

Standard costing helps manufacturers fix the prices of the end products even before manufacturing is complete. By having a clear picture of the estimated production costs, including materials, labour and overhead costs, companies can accurately price their products to make profits without overpricing them. Using standard costing also makes it easy for manufacturers to account for the changes in production costs with varying volumes while keeping the product price uniform across batches.

Provides efficient financial records management

If a company has to rely solely on actual costs, it becomes difficult to maintain its financial records. On the contrary, standard costing makes it easier for companies to produce and maintain their financial records. Since the company has an intelligent estimate of expected costs, it can conduct other financial activities, such as borrowing and overdrafts, using the numbers from standard cost calculations.

Facilitates production benchmarking

Manufacturers use standard costs to set benchmarks so that they can compare if actual costs meet these benchmarks. If the actual costs meet standard costs, it indicates that the budgeting has been successful. If there is an unfavourable variance with the actual costs exceeding standard costs, then the company works on altering its production efficiency to lower these costs in the future.