What is standard costing?
Standard costing is an accounting method used by manufacturers to estimate the expected costs of a production process for the coming year. Standard costing is a subtopic of cost accounting, with the primary difference being that cost accounting assigns “standard” costs, rather than actual costs, to its cost of goods sold (COGS) and inventory. Manufacturing companies use cost accounting for estimating various expenses including direct material, direct labor, or overhead.
For managers looking to create a more precise budget, standard cost accounting can be a very useful tool. After all, a business that has accurate budgets is generally in a better position to be successful and effective. Thanks to a standard costing system, managers will have a projected idea of spending costs and can compare standard costs to actual costs, which can help guide strategic decision-making around things like implementing new business practices.
How to calculate standard costing
To calculate standard costs, you add your estimated direct materials costs, labor costs, and manufacturing overhead. These costs form the baseline from which you measure actual costs. The difference is a variance, and this variance can be favorable (the actual cost was less than the standard cost) or unfavorable (the cost actual cost was high than the standard cost).
Pros and cons of standard cost accounting
The biggest advantage to using standard cost accounting is that it helps create more precise budgets, but there are other reasons a manufacturer might use standard costs. These include:
More accurate budgeting
Effective with cost control
Helps estimate inventory costs
Useful for setting prices
Analyzing these cost variances help financial leaders and operational leaders control costs, set prices, and ultimately impact continuous improvement.
While standard costing is a useful accounting tool for manufacturers, there are a few disadvantages to keep in mind, As covered by The Ascent, the biggest cons of standard costs include:
Limits ability to provide feedback
Presents challenges to obtain information on specific units
Potentially leads to emphasizing unfavorable variances
How to track, value, and manage inventory for multiple locations
Many cloud-based inventory management systems that tie to inventory KPIs can bring consistency to calculating inventory costs across multiple locations and product lines – as well as automate recalculations for a true cost of goods. With Sage Intacct, for example, you’re empowered to make smarter decisions that optimize inventory levels, set efficient reorder points and quantities, and use working capital more efficiently.
Sage Intacct inventory management system KPI dashboard.