Standard costing

A standard cost is a predetermined cost for one unit of product, built up from expected quantities of material and labour at expected prices plus an overhead rate. Manufacturers use standards to price, to value stock and, above all, to control costs by comparing actual results with what the output should have cost. FRS 102 allows standard costs to be used for stock in the accounts if the result approximates actual cost.

What is a standard cost?

A standard cost answers the question: what should one unit cost if it is made efficiently under normal conditions? It is usually set out on a standard cost card, listing each input with a quantity and a price.

FRS 102 gives a useful description in paragraph 13.16: standard costs take into account normal levels of materials and supplies, labour, efficiency and capacity utilisation, and they are regularly reviewed and, if necessary, revised in the light of current conditions. That description doubles as a practical checklist for anyone setting standards.

How are standards set?

Each element is set separately, usually by the production, purchasing and finance teams together.

• Material quantity: from the bill of materials or recipe, plus an allowance for normal waste, offcuts and evaporation. Abnormal waste should not be built in.
• Material price: from current supplier price lists and contracts, adjusted for expected changes over the period the standard will apply.
• Labour time: from timed trials, past records or engineering estimates, allowing for normal rest, setup and downtime.
• Labour rate: from the pay structure, including employer costs that vary with hours, and any agreed pay rise.
• Variable overhead: a rate per labour or machine hour based on budgeted variable overhead and budgeted hours.
• Fixed production overhead: a rate based on budgeted fixed production overhead divided by budgeted activity.

Ideal or attainable?

An ideal standard assumes perfect conditions with no waste or idle time. It produces adverse variances every month and tends to demotivate staff. An attainable standard allows for normal losses and achievable efficiency, so variances point to real problems. Most businesses use attainable standards, and they are also the kind that FRS 102 has in mind when it refers to normal levels of efficiency and capacity utilisation.

How is the overhead absorption rate set?

ACCA’s article on fixed overhead absorption explains the mechanics: the fixed overhead absorption rate is budgeted fixed production overhead divided by budgeted activity, measured in units, labour hours or machine hours. The rate converts a fixed cost into a cost per unit, so the right amount of overhead is absorbed only if both actual activity and actual spending match budget. If either differs, overhead is under or over absorbed, and in a standard costing system that difference appears as fixed overhead expenditure and volume variances.

For statutory accounts the choice of base activity is not free. FRS 102 paragraph 13.9 requires fixed production overheads to be allocated on the basis of normal capacity, meaning production expected on average over a number of periods under normal circumstances, allowing for planned maintenance. The overhead per unit is not increased because of low production or idle plant; the unabsorbed amount is expensed in the period. In abnormally high production periods the rate per unit is reduced so that stock is not measured above cost.

What does a standard cost card look like?

Illustration only. A bakery supplying a supermarket sets this standard for a case of 12 loaves:

Element	Quantity	Standard price	Standard cost
Flour and ingredients	6 kg	£0.80 per kg	£4.80
Direct labour	0.25 hours	£16.00 per hour	£4.00
Variable overhead (energy)	0.5 oven hours	£2.40 per hour	£1.20
Fixed production overhead	0.5 oven hours	£4.00 per hour	£2.00
Standard production cost			£12.00

The fixed overhead rate comes from budgeted fixed production overhead of £48,000 a year over a normal 12,000 oven hours. If the bakery makes 2,000 cases in a month, the flexed budget says they should cost £24,000. If they actually cost £25,100, the £1,100 difference is broken down into price, usage, rate, efficiency and overhead variances to find out why.

How does standard costing give control?

The value of standard costing is in the comparison. Each month, actual output is costed at standard and compared with actual cost. The difference is split into variances, each assigned to the manager who can influence it: purchasing for material prices, production for usage and efficiency, HR or payroll for labour rates. Managers then concentrate on the significant variances, an approach often called management by exception. The calculations and how to read them are set out in our page on budget variance analysis.

Standard costing also simplifies bookkeeping. Stock and work in progress can be recorded at standard throughout the period, with variances written to the profit and loss account, rather than tracking the actual cost of every batch.

Can standard costs be used to value stock in the accounts?

Yes, with conditions. FRS 102 paragraph 13.16 permits the standard cost method for measuring the cost of stock if the result approximates cost. In practice that means:

• Standards must be reviewed regularly and revised when prices or methods change. Out of date standards produce a stock value that no longer approximates cost.
• Material variances relating to items still in stock at the year end may need to be allocated back to stock rather than written off in full.
• Abnormal amounts of wasted materials, labour or other production costs must be expensed, not carried in stock, under paragraph 13.13.
• Fixed overhead must be based on normal capacity under paragraph 13.9.
• Stock must still be tested against estimated selling price less costs to complete and sell. See stock valuation.

For tax, HMRC’s Business Income Manual at BIM33115 says the valuation in accounts prepared under generally accepted accounting practice should be accepted provided it correctly applies that practice, pays sufficient regard to the facts and does not breach the taxing statutes. BIM33135 adds that where cost is not precisely ascertainable, the aim is the closest approximation to historical cost that is practically attainable. A well maintained standard costing system meets that test; one with standards several years old may not.

When does standard costing stop working well?

Standard costing suits repetitive production of a stable range: food, packaging, components, printing. It works less well where every job is different, such as bespoke engineering or construction, where job costing is more natural. ACCA’s article on activity based costing notes that traditional overhead absorption works when fixed costs are relatively small compared with material and labour, most fixed costs accrue with time, and there are long production runs of identical products. In highly automated or highly customised operations, labour based standards and a single overhead rate can misstate product costs, and activity based costing may give better information.

What mistakes come up most often?

• Leaving standards unchanged for years, so every month shows the same price variances and stock values drift from cost.
• Setting the overhead rate on a depressed level of activity, which inflates unit cost and stock. FRS 102 requires normal capacity.
• Building abnormal waste into the standard quantity, which hides inefficiency and overstates stock.
• Writing all variances off at the year end when a material proportion relates to goods still in stock.
• Producing variance reports nobody reviews. Without follow up, standard costing is just extra bookkeeping.

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Related Accountapedia entries

• Absorption vs marginal costing
• Overhead absorption rates
• Flexed budgets explained
• Process costing
• Fixed, variable and semi variable costs
• Job costing for project businesses

Sources

• Financial Reporting Council: FRS 102 September 2024 tmKYWO6
• ACCA: Overhead absorption
• GOV.UK: Manual page BIM33115
• GOV.UK: Manual page BIM33135
• ACCA: ABC

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.