Definition of Standard Costing
Standard costing is a cost accounting system used by some manufacturers to assist in planning and controlling its manufacturing operations. When standard costing is used, the manufacturer’s general ledger accounts for inventories (materials, work-in-process, finished goods) and the cost of goods sold will contain the standard costs. (Think of the standard costs as the “should be” costs which are tied to the amounts in the company’s profit plan.) Any differences between the actual costs and the standard costs will be recorded in cost variance accounts. For external financial reporting, the variances must be allocated to the inventories and the cost of goods sold.
Definition of GAAP
GAAP is the acronym for the phrase generally accepted accounting principles or US GAAP. GAAP is required for a U.S. company’s external financial statements. One of the basic underlying principles in GAAP is the cost principle. This means that the inventories, the cost of goods sold, and the resulting net income must reflect the manufacturer’s actual historical costs.
Example of Standard Costing and GAAP
Assume that a corporation’s profit plan for the year uses $2 as the cost for every pound for its main raw material. Therefore, its standard costing system uses $2 per pound. Due to shortages, the corporation’s actual cost for the 1,000,000 pounds of materials it purchased was $2.60 per pound. This means the general ledger accounts for its inventories and cost of goods sold contain $2 per pound for the materials and its materials purchase price variance account contains an unfavorable variance of $600,000 [1,000,000 X ($2.60 – $2.00)]. To comply with GAAP’s cost principle, the corporation must allocate the $600,000 to the inventories and cost of goods sold when reporting its financial results. (If the corporation turned over its inventory many times during the year, most of the variance will be allocated to the cost of goods sold, since that is where most of the materials are.)
FAQs
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.
Which costing method is allowed under GAAP? ›
Under generally accepted accounting principles (GAAP), absorption costing is required for external reporting. Absorption costing is an accounting method that captures all of the costs involved in manufacturing a product when valuing inventory.
What is standard cost vs actual cost GAAP? ›
While standard cost is an estimate of the expected cost, actual cost is what was actually spent to produce the product. Actual cost includes the total cost of materials, direct labor, and overhead costs that are incurred due to production.
Is cost accounting based on GAAP? ›
Cost accounting is not GAAP-compliant, and can only be used for internal purposes.
What method of accounting is not allowed under GAAP? ›
If you want an audit done under GAAP, you should use the accrual method of accounting. ► The modified accrual method works well when inventory is accounted for using the accrual method, and the cash method is used for recording income and expenses. This method does not adhere to GAAP.
What falls under GAAP? ›
Generally accepted accounting principles, or GAAP, are standards that encompass the details, complexities, and legalities of business and corporate accounting. The Financial Accounting Standards Board (FASB) uses GAAP as the foundation for its comprehensive set of approved accounting methods and practices.
Why is ABC costing not GAAP? ›
ABC, unlike traditional based costing, rarely complies with GAAP. ABC does not comply with GAAP because it does not assign all manufacturing costs, specifically fixed overhead, to products. ABC does not allocate these costs because these costs do not change with regards to the amount of goods being produced.
What is the average cost method in GAAP? ›
Average cost method assigns a cost to inventory items based on the total cost of goods purchased or produced in a period divided by the total number of items purchased or produced. Average cost method is also known as weighted-average method.
What is standard costing formula? ›
The formula to calculate standard costs: Standard Cost = Material Cost + Direct Labour + Manufacturing Overhead.
Is standard costing the same as budget? ›
Standard Costing is a micro-level analysis focusing on cost control in production, while Budgetary Control is a macro-level financial planning tool setting broader financial targets.
The different types of cost accounting include standard costing, activity-based costing, lean accounting, and marginal costing.
Does GAAP allow FIFO or LIFO? ›
One of the most basic differences is that GAAP permits the use of all three of the most common methods for inventory accountability—weighted-average cost method; first in, first out (FIFO); and last in, first out (LIFO)—while the IFRS forbids the use of the LIFO method.
Which method of accounting is required for GAAP? ›
If an organization is using the accrual method, it must continue using this method, unless it acquires approval from the Internal Revenue Service to switch. Organizations should have appropriate internal controls for checks and balances and to keep everyone in their accounting process honest.
Does GAAP allow direct or indirect method? ›
Although both cash flow reporting methods meet Generally Accepted Accounting Practices (GAAP) and International Financial Reporting Standards (IFRS), the guidelines encourage the direct method.
Can you use FIFO under GAAP? ›
The FIFO method is allowed by both GAAP and IFRS. The LIFO method is practiced in the U.S. only, as it's allowed by GAAP. It's not recognized in other countries because IFRS prohibits it. The FIFO method is a logical practice for companies that don't want to use spoiled or expired goods in their production or selling.
