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What are some best practices for reconciling the variances and adjusting the standard costs periodically?

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Standard costing and variance analysis are useful tools for product costing, budgeting, and performance evaluation. However, they also require regular reconciliation and adjustment to reflect the actual costs and conditions of the business. In this article, you will learn some best practices for reconciling the variances and adjusting the standard costs periodically.

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Hardik Vyomesh Barodia

Senior Product Manager | WorldLine | ISB | IBM

1 Why reconcile variances?

Variance analysis compares the standard costs and revenues with the actual results and identifies the sources and causes of the differences. This helps you to monitor and control the efficiency and effectiveness of your operations, identify problems and opportunities, and take corrective actions. However, variance analysis is only meaningful if the standard costs and revenues are realistic and updated. Otherwise, you may be comparing apples and oranges and making wrong decisions based on outdated or inaccurate information.

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Hardik Vyomesh Barodia

Senior Product Manager | WorldLine | ISB | IBM
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Regularly reconciling variances is vital for cost control. Suppose a company sets a standard cost for producing a product at $50, but actual costs come in at $55. Through analysis, it's revealed that raw material prices increased unexpectedly. Adjustments are made to the standard cost, reflecting the new reality. This process ensures accurate cost expectations, aids decision-making, and maintains financial health.

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2 How to reconcile variances?

Reconciling variances means adjusting the standard costs and revenues to match the actual results, or vice versa, and explaining the reasons for the adjustments. Depending on the purpose and scope of the analysis, you can reconcile variances at the total, sales, or cost level, or break them down into price, volume, mix, or efficiency components. Additionally, you can reconcile variances for individual products, departments, or activities, or for the whole business. The key steps for reconciling variances include calculating the differences by subtracting the standard costs and revenues from the actual results; analyzing the variances to identify factors that contributed to the differences; adjusting either the standard costs and revenues to reflect the actual conditions or adjusting the actual results to reflect the standard conditions; and reporting and explaining the adjusted variances with charts, tables, or narratives.

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Hardik Vyomesh Barodia

Senior Product Manager | WorldLine | ISB | IBM
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Consider a company with a standard cost of $100 for a product. Actual costs amount to $110 due to increased labor expenses. Through variance analysis, it's revealed that a new manufacturing process led to longer production times. By adjusting the standard cost to $105, the company not only reflects the current situation accurately but also establishes a basis for better cost control moving forward.

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3 When to adjust standard costs?

Standard costs are based on assumptions and estimates that may be subject to change due to external or internal factors, such as market conditions, customer demand, supplier performance, production methods, or technology. As such, it is necessary to review and update standard costs periodically to ensure accuracy and currency. The frequency and timing of adjusting standard costs depend on several factors, including the stability and predictability of the business environment and operations, the purpose and use of standard costing and variance analysis, the availability and reliability of data and information, as well as the trade-off between accuracy and simplicity. For example, if standard costing is used for complex and diverse products or processes, it should be updated more frequently to capture variations and details. On the other hand, if standard costing is used for simple and homogeneous products or processes, it can be updated less frequently to reduce complexity and cost.

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Kaushik Maitra CSM?

Senior Technical Consultant in TCS BENGALURU|| ??Certified ScrumMaster? ||??37K LinkedIn Family.|| Web Accessibility Test Lead ||Automation Tester|| PMO Operations||
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Standard costs are based on assumptions and estimates that may be subject to change due to external or internal factors, such as market conditions, customer demand, supplier performance, production methods, or technology. As such, it is necessary to review and update standard costs periodically to ensure accuracy and currency.

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4 How to adjust standard costs?

Adjusting standard costs means changing the assumptions and estimates used to calculate the standard costs and revenues. There are various methods to achieve this, depending on the nature and source of the changes. For instance, you could use actual costs and revenues as the basis for updating the standard costs and revenues, although this may not be reflective of expected performance. Alternatively, budgeted or forecasted costs and revenues can be used, though this may involve more uncertainty. Additionally, you could combine actual, budgeted, or forecasted costs and revenues with other relevant information such as market prices, industry benchmarks, or best practices. This method is more comprehensive but requires more data and analysis.

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5 What are the benefits and challenges of reconciling and adjusting standard costs?

Periodically reconciling and adjusting standard costs can have various benefits for product costing and management accounting, such as improving the accuracy of standard costing and variance analysis, reducing bias and distortion of these analyses, and aligning standard costs and revenues with the actual ones. However, this process can also pose some challenges and limitations, such as increasing complexity and cost of standard costing and variance analysis, reducing comparability and consistency of these analyses, and introducing more uncertainty into them. These issues can lead to more work for collecting and processing data, confusion in interpreting the results, difficulty in comparing performance between different products or departments, and reduced confidence in the information derived from them.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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What are some best practices for reconciling the variances and adjusting the standard costs periodically?

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1 Why reconcile variances?

2 How to reconcile variances?

3 When to adjust standard costs?

4 How to adjust standard costs?

5 What are the benefits and challenges of reconciling and adjusting standard costs?

6 Here’s what else to consider

Product Costing

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