Standard costing is a management control system which is to be found in manufacturing industry in particular. Just like budgetary control, standard costing is also part of the control system. Both use variance analysis. Standard costing is a unitary concept ie. it uses standard material cost or standard labour cost. Budgeting, on the other hand uses these unit standard costs to compile total costs eg. material costs or labour costs.
Variances represent the differences between standard costs and actual costs. The standard cost is what the cost is estimated to be and this is compared to what the cost is actually.
Variances are classified as favourable if the actual costs are less than the standard costs and profit is increased as a consequence. Adverse variances decrease profits. Some variances may be controllable if the individual manager can influence the actual costs.
Some organisations operate on the principle of management by exception. The accountant presents an exception report which highlights the significant variances. This means management need only investigate certain variances which lie outside set tolerance levels.
A Standard cost is defined as ‘ a pre-determined cost calculated in relation to a prescribed set of working conditions, correlating technical specifications and scientific measurements of materials and labour to the prices and wage rates expected to apply during the period to which the standard cost is expected to relate, with an addition of an appropriate share of budgeted overhead’. It is a cost worked out in advance of production of the expected cost of a product or service.
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