Is Standard Costing Allowable in GAAP and IFRS
Yes, both Generally Accepted Accounting Principles (GAAP), used primarily in the United States, and International Financial Reporting Standards (IFRS), used in many other countries around the world, allow the use of standard costing.
Standard costing is a method of estimating the expected costs of production. Under this method, a predetermined cost (standard cost) is set for materials, labor, and overhead. These costs are then compared to the actual costs, and the differences (variances) are recorded.
Both GAAP and IFRS require that businesses report their actual costs and revenues in their financial statements. However, businesses may internally use standard costing for planning and control purposes, and then adjust to actual costs in their financial reporting.
For example, a company may use standard costing to help plan its budget for the upcoming year. Throughout the year, the company would then compare its actual costs to these standard costs. If there are any significant differences, the company would investigate to understand why these variances occurred.
Then, at the end of the accounting period, the company would adjust its books to reflect the actual costs and prepare its financial statements according to GAAP or IFRS requirements. These statements would then show the actual costs, not the standard costs.
However, keep in mind that while both GAAP and IFRS permit the use of standard costing, the specifics of how costs and variances are recorded and reported may vary between the two, as they each have their own set of detailed rules and guidelines.
Example of: Is Standard Costing Allowable in GAAP and IFRS
Let’s walk through a simplified example to illustrate how standard costing works:
XYZ Manufacturing Company makes widgets. It sets the following standard costs for producing one widget:
- Direct materials: $10
- Direct labor: $5
- Overhead: $3
- Total standard cost per widget: $18
In the first quarter, XYZ produces 1,000 widgets. So, the total standard cost for the first quarter is $18,000 ($18 per widget x 1,000 widgets).
However, when XYZ calculates its actual costs, it finds that it spent:
- $11,000 on direct materials
- $5,500 on direct labor
- $3,300 on overhead
So, the total actual cost is $19,800.
XYZ would then investigate these variances to understand why its costs were higher than expected. It might find, for example, that material prices increased unexpectedly, or that it had to pay overtime to its workers.
In its internal reports, XYZ might show these variances to highlight areas where it needs to improve its cost control. However, in its external financial statements prepared according to GAAP or IFRS, XYZ would report its actual costs. In this case, it would report the actual cost of $19,800, not the standard cost of $18,000.
Keep in mind that this is a simplified example. In practice, calculating and analyzing variances can be much more complex, and companies might have different standard costs for different products or departments. But the basic concept—that standard costing involves comparing standard costs to actual costs and analyzing the differences—remains the same.