Lesson 84 - Beginner accounting course

84. Standard Costing and Variance Analysis

Standard costing and variance analysis are essential tools in managerial accounting that help businesses control costs, evaluate performance, and improve decision-making. These techniques allow companies to compare actual costs with expected costs to identify inefficiencies and areas for improvement.

1. What is Standard Costing?

Standard costing is an accounting method where businesses set predetermined costs (standard costs) for materials, labor, and overhead. These costs are based on past data, industry benchmarks, and efficiency expectations.

Why Use Standard Costing?

• Helps in budgeting and forecasting.

• Provides a benchmark for measuring performance.

• Identifies cost inefficiencies.

• Simplifies inventory valuation.

• Aids in decision-making and pricing strategies.

2. Components of Standard Costing 

3. What is Variance Analysis?

Variance analysis is the process of comparing standard costs to actual costs and identifying differences (variances). These variances help businesses understand where they are overspending or saving.

Types of Variances

4. Example of Variance Analysis

Scenario:

A company produces 1,000 units of a product.

• Standard cost per unit:

  • Materials: 2 kg per unit at $5 per kg → $10

  • Labor: 1 hour per unit at $10 per hour → $10

  • Overhead: $2 per unit

  • Total Standard Cost per Unit: $22

• Actual costs:

  • Materials: 2,100 kg used at $5.50 per kg → $11,550

  • Labor: 1,100 hours at $11 per hour → $12,100

  • Overhead: $2,200

Variance Calculation

The total variance is $3,850 unfavorable, indicating higher costs than expected.

5. Causes of Variances and How to Address Them 

6. Advantages and Limitations of Standard Costing and Variance Analysis

Advantages

✔ Helps in cost control and budgeting.
✔ Provides a benchmark for performance evaluation.
✔ Identifies inefficiencies and areas for improvement.
✔ Assists in pricing and decision-making.

Limitations

✖ Standards may become outdated due to market changes.
✖ Variances do not always indicate clear problems.
✖ Overemphasis on variances may discourage innovation and flexibility.

7. Conclusion

Standard costing and variance analysis are powerful tools for businesses to control costs and improve efficiency. By regularly analyzing variances and addressing their causes, businesses can enhance profitability and operational performance. However, companies should balance these methods with flexibility to adapt to changing market conditions.