Standard Costing and Variance Analysis in Project Manufacturing

Standard and Actual Costs

In an Automation World post titled “Proper Use of Standard Cost Methods Enhances Efficiency,” Sean M. Parker explains that standard costing methods, while they should be regularly compared to actual costs, enable manufacturers to “more efficiently measure cost of goods sold.”  This in turn puts them in a better positon when setting prices on future jobs.

When comparing standard cost to actual cost, variances can be seen as favorable or non-favorable.  Variances are most commonly affected by changes in the prices of your inventory.  The cost of labor or wages are often another significant factor.

The true benefit of comparing standard and actual costs, Mr. Parker explains, comes into play when variances are continually evaluated and their causes reveal inefficiencies. These inefficiencies can then be addressed and costs and prices adjusted accordingly.

Manufacturers benefit from using standard costs when computing inventory costing, aggregating cost pools and formulating prices. Variance calculations are key in ensuring that the decisions made, whether to adjust a production cycle, for example, or to increase the inventory order size, are based on the latest data. The finance team and the production or operations teams must work off of the same data and be able to generate reports on the latest data as needed.

Cost Variance Analysis and Reporting

There are a number of variance reports that operations managers can use to ensure they are pricing inventory correctly, capturing cost element variances, and analyzing purchase price variances.

Variance reports to consider include:

• Standard cost transfer variance
• Inventory reconciliation
• Purchase price variance
• Manufacturing order work in progress variance

Capturing standard costs on an item level, as well as a project level, allow for an analysis that may reveal the need for a change in inventory or a change in process. Setting up standard costs on an item level also enables manufacturers to adjust all affected products easily with the right manufacturing software.

A known benefit of standard costing is the ability to use the standard costs when planning production process budgets. Calculating future standard costs puts you in a position to address, say the expected rise in steel.

Another benefit manufacturers gain with using standard costs is to be able to plan the next years’ budget costs and then compare the actuals to the standard costs on a regular basis. If the actual costs are nearly matching the standard costs, the cost portion of the budget is on track. However, if the actual costs vary significantly from the standard costs, materials and overhead variances act as an alert to management. When this happens, management must take action, whether it be by changing a manufacturing process, using different resources, or raising the selling price. If no action is taken when variances arise, the planned profit target may be missed.

An ERP system that can handle both standard costing and actual costing methods benefits many manufacturers as those manufacturing products for both the commercial and government sectors may need both to keep up with the compliance and unique requirements of both sectors. Manufacturers that utilize both inventory valuation methods would be able to designate certain items or items and projects to be valued with the standard costing or the average actual costing method, depending on the projects.

Learn More About Project Manufacturing

If you’re in the manufacturing business and your work is driven by project requirements, you can’t miss this book. Learn the project manufacturing basics, understand the value of going paperless, and discover how a total manufacturing system will help your overall business.