What is Standard Costing?

Standard costing is the practice of substituting an expected cost for an actual cost in the accounting records. Subsequently, variances are recorded to show the difference between the expected and actual costs. This approach represents a simplified alternative to cost layering systems, such as the FIFO and LIFO methods, where large amounts of historical cost information must be maintained for inventory items held in stock.

Standard costing involves the creation of estimated (i.e., standard) costs for some or all activities within a company. The core reason for using standard costs is that there are a number of applications where it is too time-consuming to collect actual costs, so standard costs are used as a close approximation to actual costs. This results in significant accounting efficiencies.

Is Standard Costing Allowable in GAAP and IFRS?

Both Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) require that an entity report its actual costs incurred when reporting expenses. This initially appears to be at odds with standard costing, where the industrial engineering staff typically derives standard material and labor costs. Standards are used instead of actual costs, because it is considerably easier to compile standard costs.

The cost accountant should be calculating the variances between the actual cost of goods sold and recording the variances within the cost of goods sold in every reporting period. As long as these variances are being recorded, there is no difference between actual and standard costs; in this situation, you can use standard costing and still be in compliance with both GAAP and IFRS.