Cost accounting records all the financial transactions relating to the cost incurred in a given year. It is prepared to keep an account of the price so that management can take the necessary measure in the direction of cost reduction or, in general, to keep an eye on the cost of production and another related price.
What Is Standard Costing Accounting And Variance?
Standard costing is the part of cost accounting that deals with manufacturing costs like overhead, direct material, and labour. It is assigning the expected cost to the materials rather than valuing the material at the original cost. Therefore, the standard cost is the standardization of cost; the inventories and the cost of goods sold reflect the normal cost, not the actual cost. But, the manufacturers still have to pay the exact cost. The difference between the standard cost and the actual cost is called variance.
Cost variance analysis and standard costs are essential management tools. They help the management recognize the difference between planned or expected costs and manufacturing costs. It is called unfavourable variance if the standard manufacturing cost exceeds the actual cost. In such a situation, the management analysis that if all things remain unchanged and constant, the business's profit will reduce than the planned profit. If the actual cost is less than the standard, it is a favourable variance, and the business's profit will exceed the estimated yield.
Cost Variance Analysis
Purpose of Standard Costing
As discussed earlier, this standard costing method is essential to the management because it allows the administration to analyze the favourable financial condition well in advance. To clarify the purpose, we will explain some more purposes of standard costing.
- Improved Cost Control – It allows the company to have greater cost control by allocating different standards to different costs and then emphasizing variance. If everything does not go as planned, managers can be held responsible for poor performance based on the conflict.
- Effective Managerial Planning – The standard cost system is helpful in managerial planning as it helps the management recognize the cost-to-profit ratio. The increase in actual price tells the management that there is a need to reduce the cost and plan accordingly.
- Efficient Inventory Management – This costing method helps the management value the inventory more accurately; under the actual pricing method, units of batches of a particular product can differ significantly.
- Cost Saving In Record Keeping – This method might be more financially burdensome, but the reverse is true.
Standard Costing- Allows The Management To Analyze The Favorable Financial Condition
Role of Costing In Managerial Decision-Making ->
Costing is essential in the functioning of any organization. Often small businesses think it to be trivial and only realize their mistake when it's too late, and they turn to cost. Costing has many advantages in the decision-making of an organization. They are especially significant for the management as it helps their decision-making. Some of the importance of costing in decision-making are described below.
- Pricing Decision – It plays a significant role in deciding the product's sales price because only after you assess the cost of production and additional expense can you decide on the product's sales price. Costing is also helpful in setting the price of special orders that many require some discounting.
- Performance Of The Company – The nature of costing rules is uniform, so managers in many companies rely on them to evaluate different segments.
- Decide To Process Further Or Sell – This is an important decision that any company can make, and this decision is based on cost. The management has to decide whether to sell a product after the entire process or sell it after doing a portion of the processing. For this, a method of relevant cost analysis comes into the picture. It tests the relevance of the cost of production.
- Financial Reporting – The generally accepted accounting principles dictate that all the manufacturing costs be assigned to products and the non-manufacturing price not be assigned to the product. This system of costing is called absorption.
Standard costing and variance analysis are important tools available to the management; they help the direction make critical decisions and enable the division managers to assign responsibility. Investigating favourable and unfavourable variances can reveal several crucial aspects of the business. Therefore, including variance analysis as an accounting practice is always good.