Standard Costing and Variance Analysis

 

Standard costs are realistic estimates of costs based on analyses of both past and

projected operating costs and conditions. They are usually stated in terms of cost

per unit. They provide a standard, or predetermined, performance level for use in

standard costing, a method of cost control that also includes a measure of actual

performance and a measure of the difference, or variance, between standard and

actual performance. This method of measuring and controlling costs differs from

the actual and normal costing methods in that it uses estimated costs exclusively

to compute all three elements of product cost—direct materials, direct labor, and

overhead.

Standard costing is especially effective for managing cost centers. You may

recall that a cost center is a responsibility center in which there are well-defined

links between the cost of the resources (direct materials, direct labor, and overhead)

and the resulting products or services.

A disadvantage to using standard costing is that it can be expensive because

the estimated costs are based not just on past costs, but also on engineering estimates,

forecasted demand, worker input, time and motion studies, and type and

quality of direct materials. However, this method can be used in any type of

business. Both manufacturers and service businesses can use standard costing in

conjunction with a job order costing, process costing, or activity-based costing

system.

Standard Costs and Managers

As we noted in the introduction to this chapter, standard costs are useful tools

for management. Managers use them to develop budgets, to control costs, and

to prepare reports. Because of their usefulness in comparing planned and actual

costs, standard costs have usually been most closely associated with the performance

evaluation of cost centers.

In recent years, the increasing automation of manufacturing processes has

caused a significant decrease in direct labor costs and a corresponding decline in

the importance of labor-related standard costs and variances. As a result, managers

at manufacturing companies, which once used standard costing for all three

elements of the product cost may now apply this method only to direct materials and

overhead.

Today, many service organizations’ managers also use standard costing.

Although a service organization has no direct materials costs, labor and overhead

costs are very much a part of providing services, and standard costing is an effective

way of planning and controlling them. 

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