When should I update standard costs?

In a standard costing system, most companies go through a cost updating process once a year, in order to bring standard costs more closely in alignment with actual costs.

However, there are cases where actual costs fluctuate considerably over time, resulting in large positive or negative variances. In these cases, you can either update costs on a more frequent schedule or in response to a triggering event. Here are the options:

• Increased frequency. From a procedural perspective, it is easy enough to simply schedule a complete review of all costs semi-annually or once a quarter. However, this can result in a great deal of additional staff review time.
• Selective increased frequency. You could select certain types of commodities for an increased review schedule, and leave the majority of items on the usual annual review cycle. If you use the Pareto principle and only update costs for the 20% of the items that make up 80% of your total costs, this will keep cost variances down.
• Review when trigger activated. The most granular alternative is to trigger a cost review whenever a specific item experiences a cost variance of at least 5% (or some other figure). However, since short-term events can cause variances of this size, it may be better to only require a cost review when the cost variance continues for several months. If an item does not exceed its variance trigger all year, then review the cost under the normal review procedure at the end of the year.

Of these approaches, a general increase in review frequency is the most expensive, and is similar to applying a shotgun to a task that really requires a laser to engage in very selective cost reviews. Consequently, the second and third options are both more cost effective and more efficient in targeting only those items experiencing significant cost variances.