Cost is divided into two broad categories: historical cost and predetermined cost.

Historical costs are computed after the production of goods is complete. Therefore, the cost figures have value only from a historical point of view.

Although the figures obtained at the end of the production process may have a definite value in correcting past practices if they are carefully analyzed, a key limitation is that inefficiencies and errors in production are not identified until after the damage is done.

Cost analysis requires the use of predetermined cost estimates, which are made on a more or less scientific basis, to generate standard costs.

These costs are prepared in advance of production or supply, and they are based on a correlation of the technical specification of materials and labor to the prices and wage rates estimated for a selected period of time.

The following differences exist between historical costing and standard costing:

1. Costs used: Standard costing includes cost figures that are predetermined based on past experience and expert advice. In historical costing, data are included from costs that have actually been incurred.

2. Cost calculation: Standard costs are determined and known before the start and completion of production, but historical costs are known only after production is finished.

3. Cost control: Standard costs are helpful to control costs, judge efficiency, and improve the operations of the organization. By contrast, historical costing does not provide these advantages to the management.

Frequently Asked Questions

Are historical costs the same as standard costs?

No, historical costs are not the same as Standard Costs. Standard Costs are estimates that are made up front for materials, labor and overhead needed to produce goods or services. Historical costs can be obtained after production because they represent what actually occurred during the manufacturing process.

What is the difference between standard costing and job order costing?

Standard Costing is used in a job order or Process Costing environment while actual costing is used in a batch or mass production environment.

What is the difference between standard costs and variances?

Standard Costs are better to control costs, judge efficiency and improve operations of an organization. Variances can be calculated from either Standard Costs or historical costs. Historical costing is simply the process of determining costs after production.

What is the difference between actual costs and standard costs?

Actual costs are determined by recording how much was actually spent on materials, labor and other expenses while Standard Costs are estimates that are calculated in advance based on data from past periods or expert advice.

Can historical costs be used to test the reasonableness of standard costs?

Yes, historical costs can be used in testing whether or not Standard Costs are in line with expected direct material and labor rates. Actual costs cannot however because they are simply what occurred during production.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

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