4.2 Standard Costing

2026 Syllabus Objectives

By the end of this topic, you should be able to:

  1. Explain the meaning of a standard costing system in an organisation
  2. Describe the advantages and disadvantages of a standard costing system
  3. Explain how standard costing can be used to improve business performance
  4. Calculate the following variances: direct material price and usage, direct labour rate and efficiency, fixed overhead expenditure and volume, fixed overhead capacity and efficiency sub-variances, sales price and volume
  5. Identify possible causes of favourable or adverse variances and their relationship to each other
  6. Make business decisions and recommendations using supporting data
  7. Explain the significance of non-financial factors

4.2.1 What is Standard Costing?

https://cambridgeassistant.com

Standard costing is a system where a business works out, in advance, what costs should be for making a product or delivering a service. These pre-planned costs are called standard costs.

Think of it like a budget for a single unit of production. Before a factory makes one chair, the managers estimate:

  • How much wood (material) it should use
  • What that wood should cost
  • How many hours of labour it should take
  • What the workers should be paid per hour

Once the product is actually made, the business compares:

  • Standard cost (what it should have cost) vs.
  • Actual cost (what it actually cost)

The difference between the two is called a variance.

Variance = Standard Cost − Actual Cost (or Standard figure − Actual figure, depending on what is being measured)

A variance can be:

  • Favourable (F) — actual cost is less than standard, which is good for profit (or actual revenue is more than standard)
  • Adverse (A) — actual cost is more than standard, which is bad for profit (or actual revenue is less than standard)

4.2.2 Advantages and Disadvantages of a Standard Costing System

https://cambridgeassistant.com

Advantages

  • Sets clear targets — Workers and managers know what is expected of them. There is a benchmark (a point of comparison) for performance.
  • Helps control costs — By comparing standard costs to actual costs, management can quickly spot where money is being wasted.
  • Motivates staff — Realistic targets can encourage employees to work efficiently.
  • Aids decision-making — Managers can use variance information to decide whether to investigate a problem, change a supplier, or retrain workers.
  • Simplifies bookkeeping — Recording inventory and costs at standard prices reduces complexity in the accounts.
  • Helps with pricing — Knowing what a product should cost makes it easier to set a selling price.

Disadvantages

  • Time-consuming and expensive to set up — Setting accurate standards requires research, expert knowledge, and time. This costs money.
  • Standards can become out of date — Prices of materials and wages change over time. If standards are not updated, comparisons become meaningless.
  • Can be demotivating — If standards are set too high (too difficult to achieve), workers may feel pressure or lose motivation.
  • Does not suit all businesses — Standard costing works best in manufacturing where products are identical and repetitive. It is less useful for businesses where every job is unique (e.g. a custom furniture maker).
  • Focuses only on cost, not quality — Workers might cut corners to meet cost targets, reducing product quality.
  • Variances can mislead — A favourable variance is not always good (e.g. buying cheaper, lower-quality materials may save money but damage customer satisfaction).

Sign in to view full notes