Standard Costing: Definition, Advantages and Variance Analysis

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1. Definition of Standard Costs

Standard costs are predetermined costs established under certain assumptions. They define the internal and external behavior, forecast both controllable and non-controllable parameters, and serve as an objective of action in management.

2. Advantages and Disadvantages of Standard Costs Compared to Historical Costs

Standard cost systems are based on standard costs rather than historical costs. Their advantages are:

  • They are a key reference instrument for management.
  • Variances allow the principle of management by exception to be applied.
  • They facilitate a priori assessment of inventories.
  • They provide a means to the initial determination of prices and the formulation of policies.
  • They require a precise definition of responsibilities for cost centers or activities.

3. Types of Standards

  • Standards based on past data: fixed from the company's data in previous years.
  • Standards based on past data corrected: fixed from past data but adjusted.
  • Standards based on technical data:
    • Optimal standards: based on optimal operating conditions.
    • Attainable standards: achievable under reasonable management conditions.

4. Advantages and Disadvantages of Standards Based on Past Data

Advantage: they are easy to establish. Disadvantage: they do not incorporate changing internal and external conditions.

5. Advantages and Disadvantages of Optimal and Attainable Technical Standards

Advantage: they stimulate the pursuit of a higher degree of efficiency.

Disadvantages:

  • They are difficult to achieve, which can cause discouragement.
  • They are useful only for controlling costs, not for management itself (they have a little structuralist character).
  • They are not useful for planning.
  • They do not allow control by exception, since all variances tend to be unfavorable.

6. In Your Opinion, What Is the Best Way to Establish Standard Costs?

In my view, the best way to establish standard costs is by applying a technical standard cost system, once structural and attainable standards have been established.

7. Is There Any Relationship Between Standard Costs and Budgetary Management?

Yes. Standard costs support budgetary management, since the forecasts used in budgetary management are based on them.

8. Steps in the Application and Implementation of Standard Costs

  1. Estimate the standards for the period.
  2. Calculate the actual costs using the same methodology and procedures.
  3. Calculate and analyze the variances.
  4. Present the results.
  5. Make decisions and take charge of the variances.

9. Types of Cost Systems Based on Standard Costs

Conventional models:

  • Full absorption costing: by process or by job order.
  • Variable costing (direct costing): by process or by job order.

Other models: activity-based costing (ABC).

10. Does Establishing a Standard Cost System Require Any Organizational Structure?

Establishing a standard cost system based on standards requires that the company be organized with:

  • A clear structure with a well-defined assignment of responsibilities.
  • Planning of the company's operations through forecasts of activity volume.
  • Forecasts of monetary and physical quantities and volumes needed to obtain the planned activity.

11. Economic Meaning of the Concept of a Filter

In economic terms, a filter is an instrument that records the real situation of variances from the forecast and allows corrective actions to be taken to correct those variances.

12. Types of Direct Cost Variances

  • Direct materials price variance.
  • Direct materials quantity (usage) variance.
  • Direct labor rate variance.
  • Direct labor efficiency variance.

13. Types of Indirect Cost Variances

  • Indirect cost variance due to technique (efficiency).
  • Indirect cost variance due to economic factors (spending/budget).

14. Differences Between Absolute and Relative Variances

The absolute variance shows the variance in monetary or physical units of the activity analyzed. To interpret it, we need the data that gave rise to it. The company can estimate it using the formula:

Absolute variance (DAB) = Actual value - Forecast value

The relative variance expresses the variance as a percentage over the forecast value. It provides information without needing to know the underlying data, and is estimated using:

Relative variance (DRL) = (DAB / Forecast value) × 100

15. Rationale for Considering an Analysis of Mixed Variance

A mixed variance shows the combined result of the synergy between technical and economic variances. If they are inversely proportional, the mixed variance will not appear.

16. Operational Requirements of the Variance System

  • Standards must be reasonable, so that variances are significant.
  • Those responsible for the variances must be identified.
  • Variances must be recorded in accounting.
  • Information must be provided to the relevant decision-makers in a timely manner.