Standard Cost Accounting System: Benefits & Limitations

Instructor: Kevin Newton

Kevin has edited encyclopedias, taught history, and has an MA in Islamic law/finance. He has since founded his own financial advice firm, Newton Analytical.

Standard cost accounting is one of the most common forms of accounting systems. In this lesson, we will learn how it is used, as well as its benefits and limitations. We will also learn about the variances that occur using this accounting method.

What is Standard Cost Accounting?

Standard Cost Accounting is one of the easiest ways to prepare budgets for future activities. Instead of trying to figure out the exact cost of something, standard cost accounting uses estimations for what each figure should be. These figures, also called standard costs, are based on either past results or market research performed by management. Because they have set standard costs, managers can proceed with planning and budgeting. However, this system is far from perfect. In this lesson, we'll look at the advantages and disadvantages of standard cost accounting. First, though, let's look at what happens when an actual cost doesn't measure up against a standard cost.

Dealing with Variances

Standard costs are great for planning, but the truth is that budgets often differ from the real world. Sometimes, planned expenses can be accomplished for less than budgeted, and sometimes they end up costing more. Any deviation from the standard cost is called a variance. Favorable variances happen when a good or a service was purchased for a lower price, while unfavorable variances happen when that good or service ended up being more expensive than predicted. Now, don't get the wrong idea, people expect to have variances when they are using standard cost accounting. However, a crucial part of using standard cost accounting is reporting these variances as they happen, so that future budgets can take any variances into account.

What are its advantages?

By far, the biggest advantage to using a standard cost accounting system is in its simplicity for budgeting. You may not know exactly how much certain goods are going to cost, but rather than waste time and resources tracking down exact numbers, you can get right to work. Additionally, standard cost accounting lets you quickly value your inventory. Because you know the standard cost of each item in inventory, you can quickly give an estimate of its value for asset reporting. Finally, it's much easier to come up with overhead costs occasionally by using standard costs and recalculating with respect to variances than doing a complete assessment every accounting period.

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