Businesses utilize standard costing and variances as a method to monitor their expenses. In other words, it entails establishing a “standard” cost for each good or service and measuring actual costs to these benchmarks. Additionally, you can track direct and indirect expenses using standard costing.

On the other hand, variance analysis is a method for contrasting actual costs with standard costs. This comparison can assist managers in finding areas where costs are greater than anticipated and, if necessary, take corrective measures.

To have a career in Finance, you need to know how to calculate standard costing and variances.

Below is an extract of the lesson on standard costing included in my course.

Defining Standard Costing and Variances

Method
With the standard cost method, you value your product using expected costs rather than actual costs. This simplifies the accounting of producing units.
Definition
The Standard cost of a finished product is composed of the following:

• Direct material
• Direct labor
• Manufacturing overhead

Direct material = Material standard price x standard material quantity for one product
Direct labor = Labor standard price (hourly rate) x standard number of hours used for one product
Manufacturing overhead = Overhead (indirect costs of manufacturing) allocated to one material using an allocation key.

Variance

For each of the three components listed above, there are 2 sources of variance: the usage and the price.
For example:

• Direct material will have a usage variance: how many quantities were used vs the standard quantity
• Direct Material will also have a material price variance: actual price vs standard price multiplied by actual quantity

Also, here is an example, and you can find this template in the course.

Other Types of Cost Accounting

• Activity Based Cost Accounting
• Marginal Cost Accounting
• Lean Accounting

The Bottom Line – Standard Costing and Variances

In every manufacturing or production process, standard cost variances are a necessary component. Therefore, to find out what is causing these variations and how to fix them, variance analysis is utilized.

Furthermore, an instrument for managing these variances is standard costing. As a result, they are very important to learn if you are pursuing a career as a finance professional.

In my online course I have 77 other chapters where you can learn from me the concepts to accelerate your career in finance.

The manufacturing sector uses activity-based costing (ABC) most frequently because it improves the accuracy of cost data. Also, it is effective in identifying the expenses a firm incurs throughout the production process.

Therefore, here is everything you should know about activity-based costing if you are a finance professional.

Definition of Activity-Based Costing

Activity Based Costing (ABC) is a cost accounting method.

ABC is a method of assigning costs to products or services based on the specific activities or resources that are consumed in their production or delivery. Also, it is an alternative to traditional costing methods, such as job costing or process costing, which assign costs based on a more general allocation of overhead costs.

Specificities

In traditional cost accounting, overhead costs are allocated using only one arbitrary rate. But, ABC allocates the overhead more accurately.

How?
By arranging overhead activities in cost pools.

Cost pools

A cost pool is a group of costs either based on the following:

• a cost center,
• a group of cost centers or
• a measurable activity (measured as a % of the total time spent by a group of people).

For example, cost pools can be:

• Warehouse management
• Customer service
• Maintenance
• R&D
• Technical training
• Warranty costs

Measures

After defining cost pools, you need to define the unit measures. Additionally, you will use the unit measures to allocate the cost pools to the products.
For example, unit measures can be:

• number of units produced
• number of orders
• amount of material used
• percentages
• square meters used

Advantages and disadvantages of the Activity-Based Costing Method

Pros

• More Accurate
• Also, you can use multiple rates
• Yet, a better view of the profitability of a product
• Furthermore, it can help reduce the structure cost by choosing activity having a heavy impact on product cost

Cons

• Difficult to implement
• In addition, you can not use it for external reports as you mix COGS and SGA in the product costs
• Needs to have the right level of details
• Moreover, needs consistency of the methods
• Overhead costs not directly allocated

Case study

#1: Let’s imagine a manufacturing company called “TOP DESK.” They produce desks for offices. They have two products: a standard desk and an electric standing desk.

#2: They have 10M€ overheads related to the products:

• Logistics: 5M€
• R&D: 2M€
• Customer service: 2M€
• Warranty & repairs: 1M€

#3: Traditional cost accounting:

Overhead is allocated to each direct hour. Let’s say there are 500,000 direct hours worked.

• 10,000,000€ / 500,000 = 20€ overhead per hour

#4: Activity-Based Costing accounting:

#5: Comparison:

Traditional Cost accounting: overhead allocated based on total direct hours worked for each product.

#6: Comparison: ABC: overhead allocated based on activity:

#7: Conclusion:

Finally, having a more accurate overhead allocation method helped improve the transparency of the profitability of each product.

The case study I presented here shows how two different products can have different profitability based on the type of cost accounting you use.

On the one hand, in traditional cost accounting, the electric desks had a lower overhead allocation as the allocation was based on the number of direct hours used to produce electric desks.

On the other hand, in the ABC method, the allocation was more precise and accounted for the fact that electric desks used more R&D and warranty costs than the standard desks due to their complexity. As a result, the electric desks were less profitable using the ABC method than using traditional cost accounting.

Critics of The Activity-Based Costing Method

However, like everything in Finance, ABC is not the perfect method that fits all businesses (see cons). Additionally, some other methods allocate the overhead directly to specific activities.

The Bottom Line

To sum up, use this method when you have difficulties understanding the profitability of your products and you notice that using an arbitrary overhead allocation key penalizes or favorite too significantly one product.

Then, make sure you use this information for your Go-To-Market Strategy in order to maximize the profit of the business based on its resources.

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What do you need to do in the year-end closing process? If you are working in Finance just like me, chances are that it’s getting busy.

In addition to the day-to-day activities, there are three things you should do to finish the year well.

Assess Your Balance Sheet Positions

One of the main accounting principles is the accrual principle. First, the transactions need to be recorded in the right period. After that, you need to review your balance sheet positions and book any impact on your profit and loss.

For assets: Review their value, and if needed, you need to book an impairment.
For provisions: Update your assumptions to your best knowledge to have an accurate provision.
Most importantly, remember to document these steps!

Furthermore, here are some areas to have a specific focus on at year-end:

• Personnel/HR provisions
• Litigations
• Bad debts
• Stock
• Warranty
• Invoices not received
• Any fixed or immaterial assets no more in use

Prepare Your Landing Scenario for The Year-End Closing

Now that you are closing in November start working on forecasting December. As a result, identify the risks and opportunities on your last forecasting. Then, discuss it with your business partners and your management. Moreover, in your exchanges, you will identify what are the key levers to make opportunities happen and mitigate risks.

Collect Cash

Most certainly, a lot of companies have included their operating cash flow as part of their objectives. Therefore, this means that the management can request the finance team to make an additional effort to maximize the cash collection.

The Bottom Line – Year-End Closing Process

Ultimately, being prepared, organized, and proactive with accounting practices throughout the fiscal year is the key to a smoother year-end closing process.

Also, let me know if you have any remarks or questions on this topic!

Moreover, if you want to receive more finance tips like this, feel free to sign up for my newsletter. If you subscribe, every two weeks, you will receive an email from where I share best practices, career advice, templates, and insights for Finance Professionals.

The timing when revenue and expenses are recorded is the key distinction between the cash vs. accrual method. Therefore, do you understand the difference?

Also, based on these two principles, you can define the two different accounting methods to use.

Cash Vs. Accrual Method

Here are the differences, benefits, and accounting of the cash vs. accrual method.

Cash Method

Cash movement is recorded when a payment from a client is received (cash in) or when a payment from a supplier is made (cash out).

Furthermore, cash-based accounting recognizes revenues when cash is received and when expenses are paid. However, this method does not recognize accounts receivable or accounts payable.

Additionally, it’s easy to understand and display your current cash balance. Taxes are only due on money that has been received rather than on invoices that have been issued, which may improve the cash flow.  Contrary to its name, cash basis accounting is unrelated to the payment method you accept.

As a result, you may do cash accounting while being paid online. Finally, small businesses use the cash-based method more often due to its simplicity.

Accrual Method

The accrual principle is revenue recorded when work is done or/product changed hands legally. Furthermore, expenses are recorded when the service is incurred or when a good is received.

Accrual accounting is a method where revenues and expenses are recorded when they are earned, regardless of when the money is actually received or paid.

Moreover, you will have a lot more accurate view of the financial situation and business performance.  Alsop, you have far greater confidence while making financial judgments. Therefore, this method is used by middle and big companies to reflect the economic reality of debit and credit positions as well as the income and expenses in a specific period of time.

Conclusion – Cash Vs. Accrual Method

To sum up, I suggest you use the accrual method if your company has a large amount of inventory. If you have a smaller company that doesn’t hold inventory, you will find the cash method to be more effective.

What do you think are the advantages of each of the methods?

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Have you ever heard about deferred revenue and expenses but never clearly understood what it means?

The success of every firm or individual in finance depends on having a solid foundation in accounting. As a result, recording deferred revenue and expenses on the accrual method of accounting may aid in matching income and expenses to the dates they are received or spent.

Additionally, it enables you to assess the income statement and comprehend the profitability of an accounting cycle more accurately.

Learn more about it in this article.

What Is Deferred Revenue?

Deferred revenue is generally the part of the revenue you invoiced in advance for products or services that are going to be performed in the future.

Examples of deferred revenue:

Imagine you own a software company, and you invoice for a one-year subscription. Furthermore, you will recognize 1/12 of this amount as revenue each month. Therefore, the rest stays in deferred revenue on the balance sheet.

What Are Deferred Expenses?

Deferred expenses are costs that have been invoiced from your suppliers but not incurred. Usually, these expenses are for goods or services that will be used in the future.

Examples of deferred expenses:

You receive the invoice for the cost of a service (generally, it’s also when you pay in advance) that will be provided in the next 12 months. Then, the cost of the service is deferred, and each month, 1/12 be recognized as an expense.

Usually (but not always), for simplification purposes, companies recognize the invoices as deferred when they have paid or received the cash. In addition, It helps them to reduce the payable/receivables accounts for services that are not received or executed.

The Bottom Line

Did this small lesson help you? I hope you have a better picture of deferred revenue and expenses now. Also, let me know which topics you would like me to cover in the future.

For broader lessons on similar and different topics, you can take my course and improve your knowledge.