Management Accounting · Standard costing system

Standard Costing: Purpose and Setting Standards

Updated 11 October 2026 · Fact-checked

Standard costing sets a predetermined unit cost for materials, labour and overheads, then compares it with actual cost to find variances. Organisations use it for budgeting, control, performance measurement and simpler bookkeeping. To set a standard, you decide the quantity and the price of each input, then multiply them.

Understand Standard Costing: Purpose and Setting Standards

A standard cost is a carefully planned unit cost for a product or service. It is built from the quantity of each input you expect to use and the price you expect to pay. It is set before production starts.

Why bother? Actual costs only tell you what happened. A standard tells you what should have happened. The gap between the two is a variance, and that gap is what managers investigate. This is management by exception: you focus on the big differences and ignore the small ones.

Organisations use standard costing for several reasons:
- To set budgets and selling prices.
- To control costs by comparing actual with standard.
- To measure and motivate performance.
- To value inventory simply, at standard cost.
- To simplify record keeping.

Standard costing suits businesses with repetitive, standardised output, such as a factory making the same product again and again. It works poorly where output is unique, like one-off jobs, or where the environment changes fast. Standards then go out of date quickly.

Standards are set for each cost element. For materials, you need the standard quantity per unit (including normal waste) and the standard price per unit of material (including delivery and net of expected discounts). For labour, you need the standard hours per unit (including normal idle time allowance) and the standard rate per hour. For overheads, you set an absorption rate, usually per labour hour or machine hour, from budgeted overhead divided by budgeted activity.

There are four levels of standard. An ideal standard assumes perfect conditions with no waste, no idle time and no breakdowns. It is rarely achieved and can demotivate. An attainable standard is tough but achievable, allowing for normal waste, rest and delays. It usually motivates best. A current standard reflects present conditions and is only suited to a short period. A basic standard stays unchanged for a long time, so it is useful for showing trends but not for current control.

Key formulas to remember

Standard cost per unit: Standard cost = Σ (standard quantity × standard price) for materials + labour + overheads; Build the card by adding each element's cost per unit.
Standard material cost per unit: Standard kg per unit × standard price per kg; Standard kg includes normal waste allowance. Price includes carriage inwards and is net of expected discounts.
Standard labour cost per unit: Standard hours per unit × standard rate per hour; Standard hours include allowance for normal idle time and rest.
Overhead absorption rate: Budgeted overhead ÷ budgeted activity (labour hours or machine hours); Standard overhead per unit = standard hours per unit × this rate.
Gross input for a given output with normal loss: Gross input = Net output ÷ (1 − normal loss %); Use this to find the standard material quantity per good unit when waste is a percentage of input.
Types of standard: Ideal = perfect conditions; Attainable = tough but achievable; Current = present conditions; Basic = unchanged long term; Ideal standards assume perfect efficiency, so they give a lower standard cost per unit than attainable standards, all else equal. Attainable is the usual recommended basis.

How to solve Standard Costing: Purpose and Setting Standards questions

Most questions ask you to build a standard cost, pick a type of standard, or judge a statement about standard costing. Use this order.

1Identify what is asked: a calculation, a definition, a type of standard, or an advantage or disadvantage.
2For a calculation, split the cost into materials, labour and overheads. Treat each separately.
3For each input, find the standard quantity or hours per unit. Adjust for normal waste or idle time if the question gives it.
4Find the standard price or rate per unit of input. Include delivery costs and deduct expected discounts if stated.
5Multiply quantity by price for each element, then add the elements to get the total standard cost per unit.
6For overheads, divide budgeted overhead by budgeted activity, then multiply by standard hours per unit.
7For a type-of-standard question, match the clue words: perfect means ideal, tough but achievable means attainable, present conditions means current, long unchanged means basic.
8Check units and decimal places before you enter or select your answer.

Quickest way: Clue-word method for standards and a table method for cost cards

When to use it: Use this in the objective test when you have about three minutes per two-mark question.

For theory questions, scan for clue words: perfect, no waste, tough but achievable, long period, current conditions.
Link each clue to ideal, attainable, current or basic and eliminate the other options.
For cost cards, write three lines: material, labour, overhead. Put quantity × price on each.
If waste is given as a percentage of input, divide by (1 − waste %) rather than adding the percentage.
Add the three lines once and re-read what the question asked for, such as cost per unit or per batch.

Common mistakes in Standard Costing: Purpose and Setting Standards

Choosing ideal standards as the best basis for motivation.
Ideal sounds like the best target to aim for.
Fix: Remember that ideal standards are almost never met, so they create adverse variances and can demotivate. Attainable standards are usually the best for motivation.
Adding normal waste as a percentage of output instead of input.
Students multiply by 1.10 when waste is 10% of input.
Fix: If 10% of input is lost, gross input = net output ÷ 0.90. Read whether the percentage refers to input or output.
Leaving delivery costs out of the standard material price, or ignoring expected discounts.
Students use the list price alone.
Fix: Standard price = list price + carriage inwards − expected trade discounts. Use the full cost of getting materials ready for use.
Confusing current and basic standards.
Both sound like ordinary everyday standards.
Fix: Current reflects today's conditions and is updated. Basic stays fixed for years, mainly to show trends.
Saying standard costing suits every business.
Students learn only the advantages.
Fix: State that it suits repetitive output. It is weak for unique jobs or fast-changing conditions where standards become outdated.
Using actual overhead instead of budgeted overhead to set the absorption rate.
Actual figures are more familiar.
Fix: Standards are set in advance, so use budgeted overhead and budgeted activity.

Worked examples

Example 1

A product needs 4 kg of material at $5 per kg, and 3 labour hours at $12 per hour. Budgeted fixed overhead is $90,000 for 15,000 budgeted labour hours. Calculate the standard cost per unit.

Show the solution

Material: 4 kg × $5 = $20.
Labour: 3 hours × $12 = $36.
Overhead absorption rate: $90,000 ÷ 15,000 = $6 per labour hour.
Overhead per unit: 3 hours × $6 = $18.
Total: $20 + $36 + $18 = $74.

Answer: The standard cost per unit is $74.

Example 2

Each good unit must contain 18 kg of material. Normal loss is 10% of input. Material costs $4 per kg. What is the standard material cost per good unit?

Show the solution

Loss is 10% of input, so good output is 90% of input.
Gross input = 18 ÷ 0.90 = 20 kg.
Cost = 20 kg × $4 = $80.

Answer: The standard material cost per good unit is $80.

Exam tips

Learn the four standards by their clue words. Questions often describe the standard and ask you to name it.
Attainable is usually the answer when a question asks which standard best motivates staff.
In multiple response questions, select exactly the stated number of advantages or disadvantages and watch for statements that fit only unique, non-repetitive output.
For number entry, work to the decimal places asked and enter the figure without currency signs or commas unless told otherwise.
Check whether waste is a percentage of input or of output before you calculate.

Practice questions from Standard costing system

Standard Costing: Purpose and Setting Standards in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Standard Costing: Purpose and Setting Standards: frequently asked questions

What is standard costing in simple terms?

It is a system that gives each product a planned cost for materials, labour and overheads. You then compare actual costs with the plan. The differences are called variances and show where to investigate.

What is the difference between ideal and attainable standards?

An ideal standard assumes perfect conditions with no waste or idle time. An attainable standard allows for normal waste, delays and rest. Attainable standards are more realistic and usually more motivating.

What are the advantages and disadvantages of standard costing?

Advantages include better budgeting, cost control, performance measurement, management by exception and simpler inventory valuation. Disadvantages include the time and cost of setting standards, standards becoming outdated, and unsuitability for non-repetitive output. Poorly set standards can also demotivate staff.

How do you set a standard price for materials?

Use information from suppliers, purchasing records and expected market trends. Include delivery costs and deduct discounts you expect to receive. Purchasing managers usually provide the price, while production managers or technical staff provide the quantities.