Standard Costing Overview Standard costing is the practice of substituting an expected cost for an actual cost in the accounting records, and then periodically recording variances showing the difference between the expected and actual costs.
Problems with Standard Costing Despite the advantages just noted for some applications of standard costing, there are substantially more situations where it is not a viable costing system.Here are some problem areas: The preceding list shows that there are a multitude of situations where standard costing is not useful, and may even result in incorrect management actions.However, there are cases where actual costs fluctuate considerably over time, resulting in large positive or negative variances.In these cases, you can either update costs on a more frequent schedule or in response to a triggering event.Periodic updates reflect a new frozen period and the need to update standard costs for all items.
Additional steps are required in manufacturing environments that use routing information for costing purposes.
By performing these steps, potentially material year-end adjustments to inventory and the income statement might be minimized if not avoided altogether.
What’s more, getting closer to actual costs throughout the year allows accounting to have a better handle on financial reporting and gives operations a greatly improved understanding of their actual production costs and the opportunity to adjust them if needed to save the company money—which is always a desirable result.
Being regularly involved in consulting and auditing manufacturing and distribution companies, I have become accustomed to dealing with “standard cost” accounting for inventory.
While it’s commonplace for manufacturing and distribution companies to use standard cost to value their inventories, many may not realize that if they are not regularly reviewing and updating their costs, they may create problems in accounting (especially at year-end) and/or miss opportunities for improvement and cost savings.
Every time that any component of inventory is acquired or produced at a cost different than the assigned standard cost, that variance hits the income statement and inventory is misstated.