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Standard Costing- Introduction

Standard Costing- Introduction

         Standard costing system is not a distinct system of accounting but it is a technique which is applicable in all types of costing such as process costing or job costing. The standard costing technique consists in- (a) element wise standard costs are predetermined; (b) standard costs are compared with actual costs; & (c) with reference to causes & points of incidence, variances are measured & analyzed.

         Thus, standard cost is a pre-determined cost, the calculation of which is done after taking into consideration, on the basis management’s standards of efficient operation, the relevant necessary expenditure.

         The standard costing technique was evolved for the purpose of eliminating the short comings of historical costing. 

The Techniques of standard costing:

         The techniques of standard costing are the following:

  1. There is a pre-determination of data which are related to production. Thus pre-determination of materials & labour operations in details which is necessary for each product; pre-determination of losses which are unavoidable, level of expected efficiency, level of activity etc are involved in standard costing.

  2. For each element i.e., material, labour & overhead, standard costs are setup in detail.

  3. Ascertainment of variances, which arises as a result of differences between the actual costs & corresponding standard cost in detail & element wise; is done by the comparing the actual costs & performance with corresponding standards.

  4. For the purpose of determining the causes for the differences between the actual costs & standard costs, analysis of variances are done.

  5. Presentation is made in a most suitable manner to the appropriate management, of the information which is available from the above
    analysis so that it becomes possible to take remedial measures or the revising the standards, if it is necessary.

         In the concerns which manufacture standard products repeatedly, standard costing can be most suitably applied, because in those concerns, the standards which are realistic & attainable can be set easily. This does not mean that the benefit from the standard costing technique cannot be available to the industries which does jobs of non-repetitive nature e.g., manufacture of automobiles, ships etc because many operations & processes are there which is undertaken by these industries for which it becomes possible to set standard & apply standard costing technique.

Advantages of standard costing:    

The main advantages of standard costing are:

  1. Comparison is made between actual performance & pre-determined standard, thereby exposing favorable or adverse variances. Establishment of variances which arises due to external influences, for instance, increase in price over which management has little control; & which arises due to internal influences, becomes possible. Hence, indication can be made of places where remedial action has become necessary & how the same can be done.

  2. Standard costing is an example of ‘management by exception’, in that management’s attention can be directed by studying variances towards the items those are not performing according to plan. Management, by confining its attention to the deviations from the plans, can use its energies in the directions which is most profitable.

  3. As under standard costing system variances can be reported, cost control is more effective under this system. Reappraisal of working methods, materials used, etc. gets encouraged by the whole procedure of setting, revising & monitoring standards; thereby leading to cost reduction.

  4. As opposed to average of past performances, what cost should be assigned to the parts & products is represented by standard costing, & as such, compared to historical costs, standard costing are a better guide to pricing.

  5. A simple basis of valuation of stock is provided by standard costing.

  6. Identification of responsibilities for performances is enabled by standard costing.

  7. Being a pre-determined costs, standard costing are particularly useful in planning & budgeting. Since information regarding deviations of actual costs from standard costs is provided continuously, for the coming year’s preparation of a more accurate & effective budget becomes possible.

  8. A positive, cost-effective attitude can be created among all levels of management through properly developed standard costing system with full participation & involvement.

Limitations of standard costing:

The limitations of standard costing are:

  1. Installation & maintenance of standard costing system may be expensive & time-consuming. A high level of skill & expertise is required for standard costing system. Hence, small concerns may find establishing this system difficult.

  2. For fixing responsibilities, segregation of variances into two categories –controllable, which are caused by internal factors & uncontrollable, which are caused by external factors, becomes essential. Such segregation is not always an easy task.

  3. Standards rapidly becomes out of date in situations where rates, prices & methods change quickly, thereby they lose their control & motivational effects.

  4. For all kind of industries standard costing system is not suitable. Industries producing non-standardized products or jobs which are made according to specifications of the customers, may find the system costly & unsuitable.

  5. Standards set at too high a level will be unattainable. In such a situation, morale & motivation of the employees are adversely affected & thereby lead to resistance by standard costing.

Distinction between Standard Costing & Budgetary control:

         Controlling of business operations is the common objectives of both the systems of standard costing & budgetary control. Accounting of variances between actual results & a pre-determined plan is involved in both the techniques. Investigation of variances & taking of corrective action is done in both the cases.

         There are inter-relations between the two systems & both are complementary to each other but they are not inter-dependent. Operation of one without the other is possible. However, if the two systems are operated together, the control system of an organization will be most effective.

         Although, in principle, the two systems are similar; but in scope & technique of operation, they are different. The important points of difference are:

  1. Estimation of costs of products & services is involved in standard costing process. Only to cost the scope of standard costing is limited. Whereas, budgetary control is concerned with all the functional areas of business & estimation of revenues as well as expenditure is involved by it. Thus for activities like production, purchases, sales & distribution, cash flows, capital expansion etc. the budgets are prepared. Thereby, the scope of the budgetary control is much wider.

  2. In standard costing, comparison of actual cost with standard costs is made for the purpose of exercising control whereas in budgetary control by comparing actual figures with those budgeted, control is exercised.

  3. By nature wise, standard costing is more intensive in nature while budgetary control is more extensive in nature.

  4. Operation in parts or elements is not possible under standard costing. All expenditure items which are included in cost units are needed to be accounted for. Whereas, depending upon the attitude of the management, operation in parts, sections or even departments is possible under budgetary control. Preparation of budgets only for certain key areas of the business is also possible.

  5. Concept wise, standard costing is a unit concept while budgeted cost is a total concept.

  6. Under the standard costing system, usually through double entry accounts, standards & the resulting variances are usually revealed. However, budgets are memorandum figures & in double entry accounting system they do not form part.

  7. Standard costing is a projection of cost accounts while budgetary control is a projection of financial accounts.

  8. Standardization of products is required by standard costing whereas; standardization of products does not necessarily involve under budgetary control.

  9. Standard costing is a far more technically improved system by which analysis in minute details can be done of the causes of the variances & in a more specific & effective manner, exercise of control is possible. However, budgeting & control of expenses are by nature more broad & elementary.

  10. Only when standard costing becomes inappropriate for current operating conditions, they are revised. Such kind of revision may take place more or less frequently than budget revisions. However, revision of budgets is done periodically normally on annual basis.

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