Everything you need to know about standard costing. Standard costing is a technique of cost control. The CIMA Official Terminology defines it as “a control technique which compares standard costs and revenues with actual results to obtain variances which are used to stimulate improved performance.”
Standard cost is a planned cost for a unit of product, component or service produced in a period. Standard costing is introduced primarily to ascertain the efficiency of cost performance.
Accordingly, standard costing is a tool or technique of cost control. Cost variances are used to stimulate improved performance.
Standard Costing is a control device. It is not a separate method of product costing. Any activity of recurring nature is susceptible for setting standards.
The standard-cost process is mostly used to control the operating tasks. Manufacturing activities are routine and frequent and therefore easy for establishing standards.
1. Definition of Standard Costing 2. Objectives of Standard Costing 3. Classification 4. Characteristics 5. Essential Conditions 6. Steps 7. Basic Requirement
8. Applications of the Technique 9. Pre-Requisites for Installation 10. Preliminaries for Setting Up a Standard Costing System 11. Advantages 12. Disadvantages.
What is Standard Costing: Definitions, Objectives, Characteristics, Applications, Advantages and Disadvantages
- Introduction of Standard Costing
- Definition of Standard Costing
- Objectives of Standard Costing
- Classification of Standard
- Characteristics of Standard Costing
- Essential Conditions of Effective Standard Costing
- Steps in Establishing Standard Costing Costing System
- Basic Requirements of Standard Costing
- Applications of the Technique of Standard Costing
- Pre-requisites for Installation of Standard Costing System
- Preliminaries for Setting Up a Standard Costing System
- Advantages of Standard Costing
- Limitations of Standard Costing
What is Standard Costing – Introduction
Standard costing is a specialised technique of costing under which standard costs are pre-determined, actual costs are compared with such predetermined costs, the variations between the two are noted and analysed as to their causes so that corrective measures may be taken to control the factors leading to unfavourable variations. The system of standard costing, thus, involves various steps—from the setting up of standards to finally exercising control over costs.
It aims at assessing or prefixing the costs of a product, process or operation under standard operating conditions. It serves as an effective tool in the hands of the management for planning, co-ordination and control of various activities of the business. There is a continuous process of growth effected in business through the help of standard costing technique since the standard costs set in are realistic, capable of being attained and are revised from time to time according to needs and requirements of the business enterprise.
This technique, if implemented in conjunction with the system of budgetary control, provides better and more successful functions of the business.
Before one can clearly understand the concept of standard costing, the term “standard” needs to be understood. According to Webster’s New International Dictionary, standards are bases for measurement or comparison. They are established by authority, custom or general consent as a model or example of that which is proper and adequate for a given purpose.
Other dictionaries have defined ‘standard’ as a criterion of excellence, “a norm”, “a measure of comparison” and “a model or example for comparison”. “Standard” has been defined in the accounting literature, as “a yardstick”, “a benchmark”, “a gauge”, and “a sea level from which to measure altitudes”.
The term “cost standard” should now be understood in sequence. Cost standards are scientifically predetermined costs of products, components of products, processes, or operations. They are used as statistical bases for the evaluation of actual performance.
Thus the basic characteristics is of the ability to compare in a valid manner against an established baseline. Cost standards are predetermined targets, usually based on desired performance. They reflect accepted levels of effectiveness and efficiency. They provide a means of comparison that serves to evaluate actual performance.
Standard costs are the conclusions of managers and accountants as what something should cost. It is used to motivate employees to work efficiently because variances and responsibility can be identified more easily – National Association of Accountants, U.S.A.
Standard costing is a widespread and practical management tool. It represents a valuable planning and control technique. Since standard costs are determined in advance of production, they become an important yardstick for managerial planning. The control aspect of standard costs comes into play when actual production occurs.
By receiving timely reports which compare actual with standard costs, management is able to locate areas of production inefficiency. Corrective action could then be taken before too many inefficiencies occur. As Crowningshield says, “What should have happened is more important than what did happen”.
The object of standard costing is to plan operations systematically in advance to improve processes, methods and procedures. The purpose is also to secure low costs as well as keeping spoilage, waste and loss to the minimum. An analysis is made of the causes of variations. Standard costs do not represent another system.
They may be used either with a job order or process cost accumulation method, or some combination thereof. However, they are more often used in process costing. There is a greater practicability of setting standards for a continuous flow of like units than for unique job orders.
What is Standard Costing – Definitions Proposed by Eminent Authors: J. Batty, Wheldon, W.W. Bigg, Blockcr, Weltner, W.B. Lawrence, Brown, Howard and CIMA
Standard costing is a technique of cost control. The CIMA Official Terminology defines it as “a control technique which compares standard costs and revenues with actual results to obtain variances which are used to stimulate improved performance.”
According to this definition, the technique of standard costing involves:
(a) Setting or establishing standards for each element of cost;
(b) Ascertainment of actual cost;
(c) Comparison of costs and revenues with actual results;
(d) Determination and analysis of variances;
(e) Taking appropriate corrective action on the basis of ‘management by exception’; and
(f) Stimulating improved performance.
According to CIMA, London – Standard costing is the preparation and use of standard costs, their comparison with actual cost and the analysis of variance to their causes and points of incidence. Thus on the basis of above definition, It is clear that standard costing is a technique of costing, for comparison of standard cost with actual cost and analysis of variance and corrective action taken.
According to the Chartered Institute of Management Accountants, London, Standard Costing is “the preparation and use of standard costs, their comparison with actual costs and the analysis of variances to their causes and points of incidence”. The definition given by W.W Bigg makes the concept of standard costing more clear. According to him, “Standard Costing discloses the costs of deviations from standard and classifies these as to their causes, so that management is immediately informed of the sphere of operations in which remedial action is necessary.”
According to J. Batty, “Standard costing is a system of cost accounting which is designed to show in detail how much each product should cost to produce and sell when a business is operating at a stated level of efficiency and for a given volume of output.”
Thus, standard costing is a method of ascertaining costs whereby statistics are prepared to show:
(a) The standard cost;
(b) The actual cost;
(c) The difference between these costs which is termed as variance.
Standard costs are determined for each element of cost—direct materials, direct labour, overheads (fixed and variable)—separately and then variations from actual costs are computed in respect of each element distinctly so as to detect which part of the costs needs control and to which department, process or operation, the responsibility may be placed.
The standard costs are organised to uncover and report off-standard conditions. The management should strive for the attainment of standard costs because they are attainable ideal costs and are practical from the point of view of business.
The main definition of standard costing are as under:
(3) W.W. Bigg
(4) Blocker and Weltner
(7) W.B. Larence
(8) Bronn and Howard.
ICMA – “Standard cost is the preparation and use of standard costs and their comparison with actual costs.”
Wheldon – “Standard cost is a method of ascertaining the costs, whereby statistics are prepared to show the standard cost and the actual cost and difference is known as variance.”
W.W. Bigg – “A logical development of budgetary control is standard costing, in which the principles of comparing actual with forecast are applied to the operations and production.”
Blockcr and Weltner – “Standard costs is predetermined costs, based upon engineering specification and representing highly efficient production for quantity standard and forecasts of future market trends for price standards.”
J. Batty – “Standard costing is a system of cost accounting which is designed to show in detail, how much each product should cost to produce and sell when a business is operating at a stated level of efficiency and for a given volume of output.”
C. I. M. A. London – “Standard costing is the preparation and use of standard costs, their comparison with actual costs and the analysis of variances to their causes and points of incidence.”
W. B. Lawrence – “A standard cost system is a method of cost accounting in which standard costs are used in recording certain transactions and the actual costs are compared with the standard costs, to learn the amount and reason for any variations from the standard.”
Brown and Howard – “Standard costing may be defined as a technique of cost accounting which compares the standard cost of each product of service with the actual cost to determine the efficiency of the operation, so that any remedial action may be taken immediately.”
What is Standard Costing – 4 Major Objectives: Performance Measurement, Control, Stock Evaluation and Establishing Selling Price
Standard cost is a planned cost for a unit of product, component or service produced in a period. Standard costing is introduced primarily to ascertain the efficiency of cost performance. Accordingly, standard costing is a tool or technique of cost control. Cost variances are used to stimulate improved performance.
It does not, however, mean by this that standard costing is intended to control costs, and beyond this, it does not achieve anything else.
In fact, the CIMA Official Terminology, while defining the term ‘standard cost’, mentions the following objectives of standard costing:
(i) Performance measurement;
(iii) Stock valuation; and
(iv) Establishing selling prices.
Besides these, objectives of standard costing, mention may also be made of the following other objectives:
(i) Profit-planning and decision-making;
(ii) Basis of estimating;
(iii) Assisting establishment of budgets; and
(iv) To motivate operating and managerial personnel in the direction of improved efficiency.
(1) To develop forward looking and onward looking approach at each level of management.
(2) To forecast production cost, sales and profits.
(3) To make delegation of responsibility amongst the employees.
(4) To control overall elements of cost affecting sales as well as production.
(5) To apply the principle of ‘management by exception’ at operational level.
(6) To create cost consciousness amongst the workers.
(7) To provide a formal basis for asserting operational efficiency of the concern.
What is Standard Costing – Classifications of Standard: On the Basis of Operating Conditions, Time Period, Type of Cost and Type of Data
Determination of the type of standard to be used is one of the basic requirements for introducing standard costing. The effectiveness of standard costing depends upon the standards set. As such, standards should be realistic and capable of attainment. Hence, the importance of the type of standard to be used.
The CIMA Official Terminology has, while defining the term ‘standard’, observed that “standards can be set on a number of bases – (a) on an ex-ante estimate of expected performance, (b) on an ex-post estimate of attainable performance, (c) on a prior period level of performance by the same organisation, (d) on the level of performance achieved by comparable organisations, (e) on the level of performance required to meet organisational objectives.”
The Terminology further observes that “standards may also be set at attainable levels which assume efficient levels of operation but which include allowances for normal loss, waste and machine downtime, or at ideal levels, which make no allowance for the above losses, and are only attainable under the most favourable conditions.”
In the light of the above observations, standards may be classified as under:
(i) On the basis of operating conditions:
(a) Ideal standard, and
(b) Normal standard,
(ii) On the basis of time period to which they relate:
(a) Basic standard,
(b) Current standard.
(iii) On the basis of type of cost:
(a) Material cost standards,
(b) Labour cost standards, and
(c) Overhead cost standards.
(iv) On the basis of type of data:
(a) Physical (quantity or time) standards, and
(b) Monetary (price or rate) standards.
What is Standard Costing – 6 Important Characteristics
The main features of standard costing are as under:
(1) It helps in measuring the actual costs of the product.
(2) Comparison of actual costs with the pre-determined standards is made, in order to determine variances.
(3) Setting of standards for each element of cost such as material, labour and overheads.
(4) Analysis of any variances and to ascertain the reasons of such variation.
(5) Reporting the variances to management.
(6) Taking appropriate steps for their corrections.
What is Standard Costing – Essential Conditions for Effective Standard Costing
The following are the essential conditions for effective standard costing:
(1) The standard should be fixed in such a manner, so that managers and workers should rely on them.
(2) The standard costing should be in consistent with the technical process of production of enterprise.
(3) Variance analysis and its reporting should be quick.
(4) Management should take proper interest in standard costing.
(5) The technical process of operation should be susceptible to planning.
(6) The process costs of standards is more important, so that the sources of variances could be located easily.
(7) The recording process of standard costs should be easy and clear.
(8) The variance reports should be prepared in such a way that progress could be known at all levels of management.
(9) Standard costing is more suitable and useful in industries.
What is Standard Costing – 3 Important Steps: Establishing Cost Centres, Types of Standard Used and Setting of Standard
The following steps are used in establishing a standard costing system:
Step # 1. Establishing Cost Centres:
‘A Cost Centre is a location, for which costs may be ascertained and used for the purpose of-cost control.’ The determination of a suitable and appropriate cost centre is very useful for the control of costs.
Step # 2. Types of Standard Used:
It is very essential to ascertain the type of standard used in setting up of the standards.
The following types of standard may be used:
(i) Basic Standard – This standard is fixed for the base year. In it, all the principles of statistics apply which are used in Index numbers. In basic standard no change is allowed to be made. These standard can be used where routines and operations are well established and working concessions do not change. But it is not suitable for cost control.
(ii) Normal Standard – This standard is based on past experience. It is known as average standard also. In establishing these standards allowance is given to normal waste and scrap. But it cannot be used for cost control purpose.
(iii) Current Standard – This standard is fixed on the basis of current conditions and remains in force for a short period of time.
Current standards are of two types:
(a) Ideal Standard – It reflects a level of attainment on the basis of maximum possible efficiency. These standard provide no scrap and no rest period. But these standards are unreal and impracticable.
(b) Expected Standard – It reflects a level of attainment based on a high level of efficiency. In fixing the standards, realistic allowances are set for normal wastes. This type of standard is best suited from control point of view.
Step # 3. Setting of Standard:
The success of standard costing system depends upon the accuracy and reliability of standards of each element of cost. For setting the standards, it is very necessary that routine and working conditions should be studied thoroughly. Reliable relevant information are collected to ensure that standards are realistic.
Setting of standards can be divided into 2 categories as under:
(i) Quantity Standards – It implies the relationship between units produced and resources consumed.
(ii) Price Standard – It implies in money terms, the cost per unit of resources consumed.
What is Standard Costing – Basic Requirements: Organisation Structure, Preparation of Manual, Type of Standard, Fixation of Standards and a Few Others
The introduction of standard costing involves the following preliminary steps which may be considered to be the basic requirements:
(1) Organisation Structure – Standard costing demands the existence of a sound organisation structure with well-defined authority relationships. The organisation chart showing such relationships is of considerable use in supplying the basic data with regard to different operations and the personnel in-charge of those operations.
(2) Technical and Engineering Studies – It is absolutely necessary to make a thorough study of the production methods and the processes required. It is equally necessary to have a thorough knowledge of material specifications, material and labour price projections, and work study and work measurement. Losses, both normal and abnormal, in each process should be gone into for a considerable period of time.
(3) Preparation of Manual – It is necessary to prepare a detailed manual for the guidance of staff. The manual should describe the system to be introduced and the benefits thereof. It is equally necessary to specify the classification of accounts, and coding incomes and expenses to facilitate speedy collection and analysis.
(d) Type of Standard – It is also necessary to determine the type of standard to be used, whether current, basic or normal standard. The choice of the type of standard depends upon its effectiveness for control of costs.
(4) Co-operation of Executives and Staff – For the successful working of a standard costing system, it is necessary to enlist the co-operation of executives and the staff operating the system. Standards can be fixed only with the cooperation of managerial personnel. Nobody should be made to feel that system is being imposed upon him.
(5) Fixation of Standards – Standards should be set for each element of cost. The standards set should be scientific. They should neither be very high nor very low. It is also necessary to determine standard cost for each product. In setting the standards, time and motion study staff, technical and drawing office staff should come together and accomplish the work by coordinating their efforts.
(6) Review of Cost Accounting System – Standard costing is a projection of the existing system of cost accounting. It is, therefore, necessary to review the existing cost accounting system with particular reference to forms and records so that standard costing can be built upon the cost accounting system.
(7) Besides those mentioned above, the duration for which the standards are to be used should also be determined in advance.
What is Standard Costing – Top 26 Applications: Cost Consciousness, Work Motivation, Reduction of Clerical Work, Regular Checks, Greater Accuracy and a Few More
Standard Costing is a control device. It is not a separate method of product costing. Any activity of recurring nature is susceptible for setting standards. The standard-cost process is mostly used to control the operating tasks. Manufacturing activities are routine and frequent and therefore easy for establishing standards.
Industries where standardised and uniform work of repetitive nature is done are suitable for introduction of standard costing. Standard costing system is of little use or no use where works vary from job to job or contract to contract.
Standard costing is not a method of costing just as process or job or unit costing. It is a system or technique of cost accounting which can be used in conjunction with process, job or operating costing without any difficulty, whatsoever.
Where the work is not repetitive, e.g., construction work, contract work, ship-building and erection work etc., it is difficult to set standards and therefore, standard costing would not be suitable. But in certain cases, it can be applied partially though not fully, at least to some advantage of the concerns.
Industries where standard costing is more suitable can be categorised as under:
1. Cost consciousness – Since standard costing system lays down targets before executives and workmen, it infuses cost consciousness among all.
2. Work motivation – The standards provide incentive and motivation to work with greater effort and care for achieving the standard.
3. Comparison and analysis of data – Standard costing provides a stable and sound basis for comparison of actual data with standard costs according to different elements separately. It brings out clearly the impact of external factors and internal causes on the cost and performance of the concern. Thus, it indicates places where remedial action is necessary and how far improvement is possible in the long run.
4. Reduction of clerical work – The clerical work associated with costing is usually reduced and yet much more useful information is made available to management.
5. Standards useful for budgets – Standard costing is an exercise in planning. The standards are useful for preparation of budgets also, since the capacity to anticipate about changing conditions is developed. According to Matz, Curry & Frank, “Standards are almost indispensable to the work of establishing and operating a budget.”
An NAA research study points out that standard costs are especially valuable in developing the cost side of the budget “because they provide a reliable and convenient source of data for converting the budgeted production schedule into requirements for raw materials, labour and services.”
6. Regular checks – The analysis of variances ensures that regular checks are made upon expenditure incurred. There is quick localisation of deviations from the pre-determined standards. Management concentrates on matters which are not proceeding according to plan on the basis of the “principle of exception”.
7. Greater accuracy – The cost of new products can be estimated with greater accuracy.
8. Measurement of profits – Concept absorption of fixed overheads and measurement of profits is possible.
9. Product standardisation – Product, operations and processes can be standardised.
10. Better delegation of authority and responsibility – The authority can be delegated and responsibilities fixed for each department or individual on the basis of off-standard performances. Thus, there is a general toning up of organisation of the concern.
11. Easier interpretation of reports – The time taken to study management reports is reduced. Since all matters which need attention are clear prima facie, the interpretation becomes easier.
12. Cost control and cost reduction – Not only cost control is facilitated, but cost reduction is also possible if prompt action is taken on the lines indicated under the reports submitted to management on the basis of standard costing system.
13. Better economy, efficiency and productivity – Managerial review of costs is more effective as the operations are scrutinised carefully and inefficiencies are disclosed. Men, machines and materials are more effectively utilised and thus economies can be effected in business together with increased productivity.
14. Aids in product pricing – Standard costs are an important aid in pricing the products of the concern.
15. Aids to inventory costing – Inventories of raw materials, work-in-progress and finished goods may be carried at standard costs. The differences of actuals and standards may be taken to variance accounts.
16. Helpful in production planning – Production policies may be determined in advance on the basis of standard cost of production. Profit planning can also be made accordingly.
17. Basis for job evaluation and wage fixation – Once the standard costs have been compiled, they can be used as a basis for job evaluation, provision of incentive schemes of payment for employees etc.
18. Suitably deals with internal problems – With due emphasis being given to likely price changes, standard costing is likely to be the most suitable system for dealing with internal problems arising from inflation, e.g., replacement of material stocks at increased prices.
19. Integration of accounts – Integration of accounts is facilitated through standard costing so that reconciliation between cost accounts and financial accounts is eliminated.
20. Optimal use of resources – Standard costing optimises the use of plant facilities, current assets and available funds.
21. Overall improvement – When inefficiencies are eliminated, product improvement takes place. Improved methods of production may be employed. Thus, there is greater customer satisfaction.
22. Process industries where the method of production and nature of output are the same. The examples of such industries are chemical industries, distilleries, paper-making and metal processing etc.
23. Repetitive production – Industries where the methods of manufacture are repetitive and products are more or less homogeneous, e.g., agricultural and food products.
24. Service industries where operation costing is also applicable like transport, gas and water, electricity etc.
25. Engineering and textile industries where large range of products are manufactured.
26. Extraction industries such as coal, oil and timber.
What is Standard Costing – Pre-Requisites for Installation of Standard Costing System
Installation of standard costing system for accomplishing the desired objectives require existence of certain pre-requisites.
These prerequisites can be put as follows:
Pre-Requisite # 1. Acceptance of the System:
The standard costing system can have the desired effects only when the system is acceptable both to the management as well as to the workers. The management should take sufficient interest in the system to make it effective. Similarly the workers should also believe that in the long run, the system would be beneficial to all of them. This is possible by fixing the standards in a way that they are capable of being achieved by an average worker.
Pre-Requisite # 2. Judicious Setting of Standards:
The standards should be fixed after a careful study of all technical processes and operations of the business. They should be fixed judiciously and should not be ideal but capable of being achieved. Setting of standards at too high a level will create resentment among the workers and depress their performance while setting of standards at too low a level will have adverse effects on personal initiative and costs. It will be appropriate to fix the responsibility of setting standards on a committee consisting of important persons such as Production Controller, Purchase Manager, Personnel Manager, Cost Accountant etc.
Pre-Requisite # 3. Reasonable Size:
The system of standard costing can be introduced with advantage in concerns which are of a reasonable size. The system may not be suitable for small concerns since in their case careful scheduling of production may not be possible. For example, in a small concern a worker may be handling different machines and at times he may be called to handle different jobs and therefore, it may not be possible to correctly fix the standard time for different jobs or different operations handled by him. Moreover the system of standard costing requires specialisation of jobs and processes which may not be possible in a small concern.
Pre-Requisite # 4. Competent Staff:
The successful operation of standard costing system requires existence of well qualified and trained staff for fixing the standards, measuring performance and reporting variances to different levels of management. The reports submitted help the management in applying the principle of “management by exception” which means that the management pays attention only to those cases where performance is below or above the standard.
Pre-Requisite # 5. Existence of Budgetary Control System:
Existence of budgetary control system is a pre-requisite for the standard costing system. Budgets fix the targets which the executives have to achieve. They create a sense of discipline, financial or otherwise, among employees at different levels. Budgets are projections for the future and therefore they are of great use to the effective functioning of the standard costing system.
Pre-Requisite # 6. Proper Delegation of Authority and Responsibility:
Standard costing system requires proper delegation of authority and responsibility at different levels. This is possible by drawing an organisation chart clearly laying down the authority and responsibility of different executives in the organisation.
Pre-Requisite # 7. Efficient Accounting System:
An efficient accounting system is also an essential requisite for successful operation of the standard costing system. The accounting information supplied should not only be accurate but also be complete and up to date. The system of coding may be used for speedy recording and analysing the accounting information. Appropriate cost centres should also be set up in the organisation.
1. Establishing cost centres – The area of operation of a business is to be divided into various cost centres. This helps in fixing standards for various cost centres. The actual costs are collected in relation to each cost centre. Deviations between standard cost and actual cost are ascertained for each cost centre. This helps in establishing responsibility for adverse deviations. Person in charge of a cost centre knows his responsibility.
2. Degree of standard – Standards should be established scientifically. A standard which is practically useful should be established.
3. Period – Period for use of standard should be fixed clearly and a suitable standard should be selected.
4. Level of efficiency – The level of efficiency selected for fixing standards should be attainable with a reasonable standard of efficiency. Fixing a too high level of efficiency cannot be achieved and it will lead to frustration.
5. Volume of production – Fixed overhead standards will vary when volume of production varies, estimate a volume of production that can be achieved. Expected sales capacity should be considered for fixing volume of production.
6. Classification of accounts – Expenses are to be grouped under proper classifications and codes are helps in easy collection of actual cost and compare it with standard deviations.
What is Standard Costing – Preliminaries for Setting Up a System
1. Establishment of cost centres.
2. Classification and codifications of accounts.
3. Fixation of different types of standards.
The first step for the implementation of standard costing is the cost centre. According to CIMA, London, “Cost centre is a location, person, or item of equipment or group of these, for which cost way be ascertained and used for the purpose of cost control”. In simple words cost centres are subunits in an organization. The purpose of establishment of cost centre is to ascertain the cost and fixing accountability.
The next step is the classification of accounts of expenses, revenue, or assets under suitable headings and codes e.g., Direct Material OA to OA5. This is necessary for collection and analysis.
This standard is established for an indefinite long period of time some base period. The objective of setting the basic standard is same as that of index numbers against which actual performance is measured. Basic standard cannot be altered over a long period. Therefore, this standard is not suitable for cost ascertainment and control.
(ii) Current Standard:
Current standard is established for a short period and is related to current conditions. This standard is to be revised at some intervals.
This standard is more suitable for cost control, but in short period.
Further, this standard can be divided into three parts:
a. Ideal Standard:
This is also known as perfect or theoretical standard. Ideal standard is the standard which can be attained only in favorable condition not in practical one. This is because this standard is fixed with very high degree of efficiency. Due to ideal, it is difficult to achieve it. It assumes that performance of resources will always be perfect. But when actual cost is compared with such standard, huge variance arise.
b. Expected Standard (Practical or Attainable):
This is the Standard which is anticipated to be attained during a future specific period (budget period). While setting this type of standard, actual conditions and circumstances prevailing are considered. Thus this standard is better suited for cost control as compared to ideal standard.
c. Normal Standard (Past Performance Standard):
This standard is based on the average performance in the past which is attainable under normal conditions. The main objective of fixing normal standard is to eliminate variations in the cost due to trade cycles.
What is Standard Costing – Advantages: Formulation of Pricing, Production Policies, Facilitates Delegation of Authority, Yardstick for Comparison and a Few More
Standard costing technique as a management tool is an aid in making predictions and providing Standards for measuring business performance.
It helps the management in the following ways:
1) Formulation of Pricing and Production Policies – Standard Costing helps the management to formulate pricing and production policies on the basis of estimated costs to be incurred. Estimated production and its cost provide the base for pricing policy and profit planning.
2) Facilitates Delegation of Authority – With standard costing, Delegation of Authority can be successfully implemented as top managers can delegate responsibility according to the standards fixed.
3) Facilitation of Principle of Management by Exception – Standard Cost System works on the basis of principle of management by exception. Management needs to give concentration only on those areas where deviations occur, i.e., Actual performance is more or less than standards.
4) Yardstick for Comparison – Standard Costing gives a suitable base for comparison of actual performance with predetermined standards. Standards can be fixed for any element of cost e.g., material, labour, overheads etc.
5) Optimum Use of Resources – Standard Cost also helps in optimum use of resources. Different resources like raw material, plant and machinery and current assets are used according to the standards fixed in advance.
6) Uniform Valuation of Stock – Under Standard Cost System, valuation of stock is done at standard cost. The variance account is opened for transferring the deviations between standards and actual performance. This brings uniformity in valuation of stock.
7) Facilitate Co-ordination – When standards are fixed, the performance of various departments e.g., production, sales, purchase etc., is considered. In this way, standard costing enables coordination among all departments.
8) Effective Cost Control – Standard Costing is an effective tool in controlling cost because actual performance is compared with standards and in case of deviations, corrective action is taken.
9) Economy – In standard costing, standards are fixed in advance. Once standards are fixed development of cost, most of the clerical work is reduced. Thus it is an economical method of costing and brings efficiency in production.
10) Motivates Employees – When standards are fixed Incentive schemes to motivate employees can be introduced. Employees try to achieve the standards and they are remained different monetary and non-monetary incentives.
What is Standard Costing – Disadvantages: Difficulty in Fixing Standard, Estimation of Price Difficult, Apprehension of Output Change, Out-Dated Standards and a Few More
Some of the basic limitations of Standard costing are discussed below:
1. Difficulty in Fixing Standards:
Standards are difficult to set. If inaccurate standards are set, they can do more harm than good to the business. Tight standards act as disincentive to work and loose ones don’t provide any incentive at all.
If due care is taken and caution is exercised on the basis of scientific studies, correct standards may be set. It is not that difficult. However, expert knowledge and skill is required for fixing standards.
2. Estimation of Price Difficult:
Precise estimation of likely prices of material or rates of labour poses a problem. However, use of sophisticated forecasting techniques can assist to a great extent.
3. Apprehension of Output Change:
It actual output varies, standard costs can’t be realised. Again scientific techniques and market research largely solve the problem.
4. Out-Dated Standards:
Standards may become out of date very soon. Keeping standard costs up-to-date can be a major problem. It may not always be possible to change standards to keep pace with the frequent changes in the manufacturing conditions.
For solving this problem, an optimum period for keeping standards without revision should be selected. It would inspire confidence in the permanence of the measures and also avoid administrative inconvenience caused by continuous modification.
5. Not Suitable for Small Concerns:
In small concerns, production cannot be properly scheduled since frequent changes in production conditions take place. Therefore, standard costing may not be suitable for them. Detailed analysis may be meaningless and superfluous for them.
If an efficient system of production planning is established, the difficulty can be overcome and even small concerns can adopt standard costing system, thought the advantages gained by them may not be that much as availed of by large concerns.
6. Costly for Non-Standard Product Industries:
Standard costing may be found unsuitable and costly in the case of industries dealing with non-standard products and repair jobs which keep on changing in accordance with customers’ specifications.
If some of the operations applied to different products are common and repetitive, standards may be fixed for such components or operations with advantage. The cost-benefit analysis should however be made before installing a standard costing system. If the costs exceed benefits, no system can be recommended for adoption, not to talk of standard costing system.
7. Explanation of Variances Difficult:
Due to play of random factors variances cannot sometimes be properly explained and at times it is difficult to make a distinction between controllable and non- controllable variances.
A toning up of the variance analysis system can obviate this difficulty.
8. Lack of Management’s Enthusiasm:
If the management is reluctant about implementation of the system effectively, the success of the system will be in peril.
By educating management about the likely advantages of the system, management can be made interested in effectively implementing the system.
9. Administrative Inconvenience:
Carefully planned and operated procedures, as required under this system in respect of recording of prices, time, quantities etc. might not have been adopted.
However, any effective planning and control system must have a foundation on which to operate.
10. Resistance from Within:
The staff may take it as a threat to their freedom of action, feeling that they are being directed down to the last detail on how work should be performed.
It also requires proper education of personnel of the organisation.
11. Badly Designed System:
If the standard costing system has not been properly designed, many problems are likely to crop up. Supposing, in a concern, material costs are of vital importance whereas undue emphasis has been laid down on labour costs, the system would not bring desired results.
The existing problems must be taken due case of while introducing the system. The rigid marshalling of effort within a factory is a fact of like which must be accepted. Without the attention to details, there would be great difficulty in achieving a high level of efficiency.