Control Through Standard Costs

Summary :

This chapter discusses the nature of standard costs and how they are set, and the advantages and disadvantages of using a standard cost system alongside budgets. It explains how to calculate the six cost variances and determine whether each is favorable or unfavorable, and prepare the journal entries that record them.

Standards, budgets, and their trade-offs

A standard cost represents what a unit of product should cost under efficient operating conditions, set in advance for materials, labor, and overhead, and it works alongside a company's budgets to plan and control operations. Using standard costs offers advantages such as simplifying inventory valuation and highlighting inefficiencies quickly, but it also carries disadvantages, including the cost of setting and revising standards and the risk that outdated standards mislead managers about current performance.

Computing and recording the six variances

Comparing actual costs to standard costs produces six variances covering materials, labor, and overhead, each of which can be favorable, when actual cost is less than standard, or unfavorable, when it is more. The chapter shows how to calculate each variance and prepare the journal entries needed to record it, isolating the difference between actual and standard cost directly in the accounts rather than leaving it buried in a single actual-cost figure.

Investigating and disposing of variances

Not every variance is worth investigating, so managers apply selection guidelines, generally based on the size of the variance and whether it appears to be a recurring or one-time deviation, to decide where to spend their limited investigative time. Once a period ends, the accumulated variances must also be disposed of in the accounting records, using either a theoretical approach that allocates them to inventory and cost of goods sold or a more practical approach that closes them directly to cost of goods sold.