Standard Cost Accounting - Why Use It?

The main goal of alternative types of cost accounting is to provide the organization an realistic view of the cost of goods that it sells. Although Standard cost accounting offers this, it differs because it also focuses on performance measurement and management. standard costing provides a cost objective that Leadership is able to use to evaluate the performance of the firm and its' processes.

Many companies which use standard cost accounting utilize it to manage by variance. This approach requires thorough variance analysis at all levels. The types of variances which are routinely measured are:

Purchase price Variance (PPV): Dependant upon the software program, PPV may have numerous components. Typically, it is the difference between the price on the Purchase Order (PO) and the standard cost of the item. The other most typical element of PPV is the difference between the invoice from the supplier and the PO.

Standard Cost Accounting - Why Use It?

Closed Work Order Variance (CWO): The CWO variance will be the difference between the standard cost associated with the item being produced and the actual costs charged to the work order. Depending on the system CWO variances might have numerous components, as well. Most computer systems that handle work orders will distinguish between the types of costs issued to the work order. These are typically Materials, Direct Labor, Factory Burden, and Outside Processing. Within Factory Burden, some systems also distinguish between Variance Burden, Fixed Burden and Material Burden.

Direct Labor Application Variance: The Direct Labor variance will be the difference between the actual Direct Labor incurred and the Direct Labor charged to work orders.

Factory Burden Application Variance: The Factory Burden variance will be the difference between the actual Factory Burden incurred and the Factory Burden charged to work orders. In most systems Factory Burden is split up into a number of sub-categories such as variable overhead, fixed overhead and material burden and each of the sub-categories need its' own analysis to look for the drivers of the variances.

Management by Variance

Management by variance is the method of financial review in which the emphasis of the analysis is on the variances from budget and standard.

The flow of the review is driven by how the firm sees its' products and markets. Among the most common classifications to go through during the review are product line/family/group, job, or location. For the sake of discussion, let's assume that product line will be the logical group. For every product line, the person doing the anaysis will have to present production & sales data relating to the specific groups in addition to variance analysis tables much like those listed in the prior section.

Numbers, on the other hand, are nearly meaningless with no narrative to paint the picture behind the numbers. The person preparing the analysis must not only show the numbers, but examine the drivers of the variances, both positive and negative. This allows the business to plan and carry out modifications to offset ongoing drivers of negative variances or, maybe, to further capitalize on operational changes which have shown positive variances by rolling them out into other areas.

For example, utilizing the illustrations from the prior section, if the decrease from the standard 2 hour to produce a widget to the actual 1.75 hours was because of the purchase of newer, faster machines, then it quantifies the cost savings associated with the improvement that was put in place. On the other hand, the rise in materials usage could be because of training issues associated to employee turnover, or changes in materials to improve yield, quality or cost and is in need or rigorous analysis.

At the end of the review, all participants should be clear on where the financial statements stand, exactly what the drivers are (both positive and negative), and know all of the action items to be tackled at a later meeting.

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Standard Cost Accounting - Why Use It?
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John Leonard

With more than twenty years experience in accounting & finance, with several companies, John has been in manufacturing, distribution, retail, transportation and financial services industries. He has seen companies with less than one inventory turn (enough inventory to last more than a year) as well as greater than 24 turns (less than two weeks worth of inventory). He has been in situations with over 120 days in Accounts Receivable (four months worth of sales) and has been in organizations where there was Hell to pay if Accounts Receivable was less than 93% under 30 days.

John has been in organizations where a larger parent company manages all of the cash and has been in the position of looking between the seat cushions for change to make payroll. He prefers the former.

John has a Bachelor of Science degree in Business Administration with a Concentration in Accounting and graduated with honors from Biola University with a Masters of Business Administration.

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