Effective Standard Costing

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on April 29, 2023

What Is Standard Costing?

The efficiency of management depends on the control of costs, among other factors. To control costs effectively, management needs to know the actual cost, as well as the variation between the expected cost and actual cost.

Standard costing is the most effective way to control costs. It provides criteria that can be used to evaluate and compare the operating performance of executives.

Essentially, standard costing is a technique of cost calculation and control. Standard costs are prepared and used to clarify the final results of a business.

This is often achieved by measuring the difference between actual and standard cost, as well as analyzing the causes to improve efficiency through executive action.

Definitions of Standard Costing

Several definitions of standard costing have been published in the literature.

One view sees standard cost as a special type of cost that is used for comparison. In this sense, a standard cost is something that is established as a rule or basis of comparison in measuring or judging a quantity, quality, or value.

Other definitions given by experts and institutions are quoted below:

1. H. J. Weldon: "Standard costs are pre-determined or forecast estimates of the cost to manufacture a single unit or a number of units of product, during a specific immediate future period."

2. Bloker & Weltmer: "Predetermined costs, based upon engineering specifications and representing highly efficient productions for quantity standard and forecast of future market trends and price standards.

With a fixed amount expressed in dollars for material, labor, and for an estimated quantity of production."

3. I.C.N.T.A. London: "The preparation and use of standard costs, their comparison with actual costs and the analysis of variances to their causes and points of incidence."

4. W. B. Lawrence: "A standard cost system is a method of cost accounting in which standard costs are used in recording certain transactions, and the actual costs are compared with the standard costs to learn the amount and reason for any variation from standard."

5. W. Strachan: "The underlying idea of standard cost is to be shown what the cost production of maximum efficiency at every stage of manufacture and to compare this with the actual cost as shown by costing records."

6. W. W. Bigg: "Standard costing discloses the cost of durations from standard and classifies these as to their causes, so that management is immediately informed of the sphere of operations at which remedial action is necessary."

Features of Standard Costing

The key features of standard costs are:

1. Standard costs are determined for different elements of costs, including the standard cost of direct materials, direct labor, and various overheads.

2. Comparison of standard costs and actual costs of production.

3. Finding differences (variances) between actual costs and standard costs. These variances may be favorable as well as unfavorable or adverse.

4. Analyzing variances to identify causes.

5. Remedial steps are suggested to avoid repeating unfavorable variances in the future.

6. Reporting problematic variances to top management for corrective action.

Essentials of an Effective System of Standard Costing

The elements of a sound system of standard costing are described as follows:

1. Standard costing is ideal for organizations that follow the same inputs and outputs repeatedly.

2. Standard costing is a technical process of operation that must be coordinated, enabling acceptance from other employees in the organization.

3. The system design must give the cost of operation rather than products, and the standard should be simple.

4. Management must take an interest in controlling costs and have an awareness of the merits.

5. Standard costs must be established properly, thereby promoting confidence between management and operations.

6. Management must be informed at all levels of the process.

7. The system should be simple.

8. The standard must be set to enable variances to be identified easily and quickly.

Effective Standard Costing FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.