Standard Costing
A cost accounting method that sets predetermined 'standard' costs for materials and labor, then measures variance against actual costs incurred.
What is Standard Costing?
Standard costing assigns predetermined, expected costs — standard costs — to products based on normal operating conditions. At the end of an accounting period, managers compare actual costs to standard costs and analyze variances. Variances are classified by type: a material price variance measures the difference between actual and standard material cost; a labor efficiency variance measures whether more or fewer hours were used than standard. Favorable variances (lower actual cost than standard) signal efficiency; unfavorable variances signal overruns that management must investigate. Standard costing simplifies bookkeeping because inventory is valued at standard cost throughout the period. Critics note that standard costs can become outdated quickly in volatile environments and may encourage dysfunctional behavior, such as producing excess inventory to absorb fixed overhead. It remains widely used in manufacturing, particularly alongside budgeting and performance evaluation.
Example
An auto parts manufacturer sets a standard material cost of $50 per unit and a standard labor rate of $20/hour with 2 standard hours per unit. In October, actual material cost is $53 per unit — an unfavorable material price variance of $3/unit. The production manager investigates and discovers a supplier price increase, prompting a renegotiation of the supply contract.