Standard costing and variances under IAS 2

Most manufacturers run their costing on standards, which makes daily accounting and performance measurement easier. But inventory in the financial statements must be at cost, not at a standard that may be out of date. This guide works through a month's variances for a product and shows which ones belong in inventory under IAS 2.

By Hamza Fida, Chartered Accountant. Reviewed by Mirza Fahad Baig, Chartered Accountant. 3 minute read.

Short answer

Standard costing values production at predetermined costs per unit for materials, labour and overheads, with the differences from actual costs recorded as variances. IAS 2 allows standard costs for measuring inventory only if they approximate actual cost, which means standards must reflect normal levels of materials, labour, efficiency and capacity and be reviewed regularly. At the period end, significant variances that reflect normal costs, such as a market price increase, are allocated between inventory and cost of sales; abnormal waste and unabsorbed overheads are expensed. In this guide's example, 320 of net variances is added to closing inventory.

At a glance

Standard costs
Allowed if close to actual cost
Review
Regularly, at least annually
Normal variances
Allocated to inventory and cost of sales
Abnormal variances
Expensed
Low production
Unabsorbed overhead expensed
Purpose
Inventory at approximately actual cost
Standard costing and variances under IAS 2Standard costs: Allowed if close to actual cost; Review: Regularly, at least annually; Normal variances: Allocated to inventory and cost of sales; Abnormal variances: Expensed; Low production: Unabsorbed overhead expensed; Purpose: Inventory at approximately actual cost.KEY FACTS AT A GLANCEStandard costing and variances under IAS 2Standard costsAllowed if close toactual costReviewRegularly, at leastannuallyNormal variancesAllocated to inventoryand cost of salesAbnormal variancesExpensedLow productionUnabsorbed overheadexpensedPurposeInventory atapproximately actual costTax BakersStandard costing and variances under IAS 2Standard costs: Allowed if close to actual cost; Review: Regularly, at least annually; Normal variances: Allocated to inventory and cost of sales; Abnormal variances: Expensed; Low production: Unabsorbed overhead expensed; Purpose: Inventory at approximately actual cost.KEY FACTS AT A GLANCEStandard costing and variancesunder IAS 2Standard costsAllowed if close to actual costReviewRegularly, at least annuallyNormal variancesAllocated to inventory and cost of salesAbnormal variancesExpensedLow productionUnabsorbed overhead expensedPurposeInventory at approximately actual costTax Bakers
Key facts at a glance, as set out in this guide.

A standard cost card

Per unitStandardCost
Materials2 kg x 5.0010.00
Labour0.5 hours x 20.0010.00
Fixed overhead0.5 hours x 16.008.00
Standard cost28.00

Standard costing variances for the month

The factory produced 10,000 units. It used 21,000 kg of material at 5.20 a kg and 5,200 labour hours at 19.50 an hour, and fixed overheads were 84,000, exactly as budgeted for the plant's normal capacity of 10,500 units, against 80,000 absorbed on the 10,000 units actually made.

VarianceAmount (A = adverse)CauseIAS 2 treatment
Material price4,200 ANormal: market price roseAllocate to inventory
Material usage5,000 AAbnormal: machine fault scrapExpense
Labour rate2,600 FNormal: new pay grade lowerAllocate to inventory
Labour efficiency4,000 AAbnormal: line stoppageExpense
Overhead volume4,000 AOutput below normal capacityExpense
Variances for the month (adverse positive)Variances for the month (adverse positive)4,200Material|price5,000Material|usage-2,600Labour|rate4,000Labour|efficiency4,000Overhead|volumeAdverseFavourable
Only normal variances are shared with closing inventory.

20% of the month's production is still in closing inventory. The material price and labour rate variances reflect what the materials and labour actually cost under normal conditions, so 20% of their net amount, 320, is added to inventory and the rest goes to cost of sales. The usage and efficiency variances came from a machine fault and a stoppage, abnormal events, so they are expensed in full, as is the under-absorbed overhead caused by low production.

How are variances recorded?

Production is recorded in inventory at standard cost, and each variance is posted to its own account. At the period end, the normal variances to be allocated are split: the share for closing inventory is added to inventory, and the rest goes to cost of sales with the abnormal variances. In the example, Dr Inventory 320, Dr Cost of sales for the rest, Cr the variance accounts, clearing them.

What happens when standards are revised?

When a new standard cost is set at the start of a year, closing inventory valued at the old standard is revalued to the new one if the new standard better reflects actual cost, with the difference treated like a variance. Under US GAAP, the same principle applies: standard costs are acceptable if they approximate actual costs.

When do variances need allocating to inventory?

When they are significant enough that inventory at standard would differ materially from actual cost. Small, offsetting variances can be expensed. Persistent variances in the same direction are a sign the standards themselves are out of date and should be revised, rather than adjusted at every period end.

How do you tell normal variances from abnormal costs?

Normal variances reflect the actual cost of producing under normal conditions: changes in purchase prices, pay rates or normal levels of scrap. Abnormal variances arise from unusual events, such as machine breakdowns, strikes or quality failures, and IAS 2 requires abnormal wastage to be expensed. The distinction needs documented reasons, not just the size of the variance.

Auditors usually ask for an analysis of variances by type and cause, so keeping that analysis as part of the monthly close makes the year-end allocation much easier.

How often should standards be reviewed?

At least annually, and whenever prices, processes or volumes change significantly. Many manufacturers update standards at the start of each financial year, and the revaluation of inventory to new standards is itself an adjustment to bring stock to actual cost.

Where to go next

See overhead absorption and normal capacity, IAS 2 explained and manufacturing accounting.

Need help applying the standards?

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Questions people ask

Can standard costs be used under IAS 2?

Yes, if they approximate actual cost, reflecting normal levels of materials, labour, efficiency and capacity, and are regularly reviewed.

Which variances are allocated to inventory?

Significant variances that reflect the normal cost of production, such as purchase price changes, are allocated between inventory and cost of sales.

Which variances are expensed?

Abnormal variances, such as waste from breakdowns, and unabsorbed fixed overheads from low production.

How often should standard costs be updated?

At least annually and whenever prices, processes or volumes change significantly.

Sources

Every fee, date and rule on this page was taken from these official and primary sources.

  1. IFRS Foundation: IAS 2 Inventories

Rules and fees change. If you are reading this long after October 4, 2026, confirm the figures with the source before you rely on them.

ManufacturingOverhead absorption and normal capacityIAS 2IAS 2 inventories explainedManufacturingManufacturing accounting: the key IFRS issues

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This guide is general information. It is not tax or legal advice for your situation.