One reason for a manufacturer to use standard costs is to plan carefully what its costs will be for the upcoming budgeting year and to then compare the actual costs with those planned costs. If the actual costs are similar to the standard costs (the planned costs; what the costs should be) the company is on track to reach the cost part of its profit plan. If the actual costs deviate from the standard costs, management is alerted by the variances that are reported for materials, labor and manufacturing overhead. Hence standard costs allow a manufacturer to practice management by exception. That is, if the actual costs are what they should be, management action is not required. If the actual costs are more than the standard costs, management must take action or it will not achieve the planned profit.
The standard cost variances direct management’s attention to the area where the problems are occurring. If the problems cannot be solved easily, management may need to explore alternate materials or processes, attempt to increase selling prices, etc. Again, without reacting to the variances the company’s planned profit for the year will not be met.
