Among the several methods of costing available for businesses to choose from, standard and average costing are the most popular. However, when choosing between the two, it’s imperative to make some key considerations. Here are a few differences between standard and average costing:
One of the most basic difference between and standard and average costing arises in the valuation of inventory. When it comes to average costing, inventory is valued at a moving average. What this means is that the value of inventory is an average of the different items that comprise the inventory, without taking into account their individual values. Unlike standard costing, average costing doesn’t require any predefined standards for the tracking of inventory and determination of manufacturing costs.
Standard costing, on the other hand, is usually used in such cases when companies follow a perpetual system of inventory, according to which all of its inventory accounts are valued at a standard cost. This standard cost accounts for direct material, direct labor and fixed and variable factory overheads. The actual cost will, obviously, see variances in both price and quantity.
Determination of Profit Margin
Profit margin is the ratio of your gross profit and revenue. As we all know, the calculation of gross profit requires for your Cost of Goods Sold to be subtracted from the revenue. When you talk about average costing, this figure for Cost of Goods Sold is based on an actual costing method. Since the inventory is valued at a moving average, it causes for the figure of Cost of Goods Sold to not deviate much from the actual. This is the reason why the profit margins calculated through standard costing are much more trustable.
Standard costing, on the other hand, determines the profit margin based on the standard valuation of inventory, which is nothing more than a projection. Since the Cost of Goods Sold is based on a projection in standard costing, it means that there’s a probability that the calculated profit margin won’t be as accurate. However, it can be revised by taking all of the averages into account.
Determination of Performance
When it comes to management accounting, standard costing has got an edge over average costing. Why? Well, it’s because it allows for the cost variances to be compared against the standard costs. This provides the management with an opportunity to assess the performance of its products and employees, alike, by determining why certain variances were favorable or unfavorable. This allows for the management to take more informed decisions which benefits the company in the long run. Average costing, however, doesn’t allow an opportunity for such decision taking, owing to how there are no set standards against which the actual costs may be compared.
Both standard and average costing methods have got their own sets of advantages and disadvantages. It’s important, therefore, for businesses to know which of the two would cater to their needs in the best possible manner. The experts at SKB Accounting have got the insight required to advise you not only in the matter of costing method but in the implementation of accounting software also.