According to CIMA, standard costing "is a control technique which compares standard cost and revenues with actual results to obtain variances which are used to stimulate improved performance." Therefore, this definition underscores that a standard cost is equivalent to a planned cost. When planned or standard costs are compared with actual costs or results, this yields a variance that can be used to analyze performance with a view to improving it.

A critical aspect of standard costing is identifying the resources necessary for producing outputs, whether goods or services. The planned cost used in the standard costing technique is an example of a budgeted cost. In using the standard costing technique, the following steps are necessary:

1. There must be an established estimate of the cost of goods or services

In other words, there must be planned unit costs for each product or service. This could be based on historical data and/ or the choice of standards. For instance, management can used basic, ideal, attainable or current standards, which would affect the estimated costs. Part of scientific management dealt with establishing routines and estimates of time and other resources for production. Determining standards might involve some intensive research, particularly when ideal or attainable standards are utilized.

2. Information about actual costs must be collected

Since standard costing is essentially a control technique, it relies on a comparison between planned and actual costs. Accurately estimating actual costs of production is critical in this process. Although it might seem as though actual cost data is easy to establish, one should remember that the actual cost of a product or service is dependent on the costing method used (for example, marginal versus absorption costing). Apart from the conceptual differences, determining actual costs in a continuous production environment can be tricky in a dynamic business environment, where costs of resources fluctuate widely.

3. The variance between the actual and planned costs must be evaluated

The entire reason for using standard costing is the ability to compare expected results with actual results. Through this comparison, variances are established. Variance analysis techniques can then come into play to establish the reasons that these variances exist. One should note that actual costs generally differ from expected costs. Managers would have concerns about the degree of variance, regardless of if the variance seems favourable. For instance, if actual costs are significantly lower than standard costs, this may seem like great news. However, if it is the result of improper usage of resources - such as usage of cheaper materials than those recommended - then that variance must be addressed.

Standard costing is a useful control technique that, like any other, has its merits and demerits. Using the technique seems simple enough, but the groundwork behind it is rather intensive. For instance, there must be agreement on what standard to use and managers must be aware of the impact of the standard on employee morale and behaviour. However, that standard costing helps with budgeting, control, improved efficiency and another method of valuing stock, among other benefits, makes it a valuable technique.

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