STANDARD COSTING

INTRODUCTION:
Standard costing is a management accounting technique used to establish
predetermined costs for various components of a product or service. It involves
setting standard costs for materials, labor, and overhead, which serve as benchmarks
against which actual costs can be compared. These standards are based on historical
data, industry norms, engineering estimates, and other relevant factors.

MEANING OF STANDARD COST AND STANDARD COSTING

Standard Cost: The word "Standard" means a "Yardstick" or "Benchmark." The

term "Standard Costs" refers to pre-determined costs. Brown and Howard define
Standard Cost as a Pre-determined Cost which determines what each product or
service should cost under given circumstances. This definition states that standard
costs represent the planned cost of a product.
Standard Cost as defined by the Institute of Cost and Management Accountant,
London "is the Predetermined Cost based on technical estimate for materials, labour
and overhead for a selected period of time and for, a prescribed set of working
conditions."
Standard Costing: Standard Costing is a concept of accounting for determination
of standard for each element of costs. These predetermined costs are compared with
actual costs to find out the deviations known as "Variances." Identification and
analysis of causes for such variances and remedial measures should be taken in order
to overcome the reasons for Variances.

DEFINITION:
Chartered Institute of Management Accountants England defines Standard Costing
as "the Preparation and use of standard costs, their comparison with actual costs and
the analysis of variances to their causes and points of incidence."
From the above definition, the technique of Standard Costing may be summarized
as follows:
(1) Determination of appropriate standards for each element of cost.
(2) Ascertainment of information about actual and use of Standard Costs.
(3) Comparison of actual costs with Standard Costs, the differences known as
Variances.
(4) Analysis of Variances to find out the causes of Variances.
(5) Reporting to the responsible authority for taking remedial measures.
STEPS IN IMPLEMENTING STANDARD COSTING:

Setting Standards: This involves establishing standard costs for materials, labor,
and overhead based on factors such as historical data, industry benchmarks, and
engineering estimates.

Recording Actual Costs: Actual costs incurred during production are recorded.

Calculating Variances: Variances are calculated by comparing actual costs to

standard costs. Variances can be favorable (actual costs lower than standard costs)
or unfavorable (actual costs higher than standard costs).

Analyzing Variances: Variances are analyzed to identify the reasons for deviations
from standard costs. This analysis helps management understand areas of
inefficiency or areas where performance can be improved.

Taking Corrective Action: Based on the variance analysis, management takes

corrective action to address any inefficiencies or deviations from standard costs. This
may involve adjusting processes, revising standards, or implementing cost-saving
measures.

IMPORTANCE OF STANDARD COSTING:

Performance Evaluation: Standard costing provides a basis for evaluating the

performance of departments, products, and individuals within an organization.
Variances highlight areas of both efficiency and inefficiency, enabling management
to take appropriate action.

Cost Control: By comparing actual costs to standard costs, standard costing helps
management identify cost overruns and take corrective action to control costs. It
provides a framework for cost control and cost reduction initiatives.

Decision Making: Standard costing provides valuable information for decision

making, such as pricing decisions, make-or-buy decisions, and product mix
decisions. By understanding the cost implications of various options, management
can make more informed decisions.

Budgeting: Standard costing facilitates the budgeting process by providing

predetermined costs that can be used as a basis for budget preparation. This helps
management set realistic budgets and monitor actual performance against budgeted
targets.

Continuous Improvement: Standard costing promotes continuous improvement by

highlighting areas were performance deviates from standards. By analyzing
variances and taking corrective action, organizations can strive for ongoing
improvement in efficiency and effectiveness.

In summary, standard costing is a valuable management tool that provides a

framework for cost control, performance evaluation, decision making, budgeting,
and continuous improvement within an organization.

ADVANTAGES OF STANDARD COSTING: The following are the important

advantages of standard costing:
(1) It guides the management to evaluate the production performance.
(2) It helps the management in fixing standards.
(3) Standard costing is useful in formulating production planning and price policies.
(4) It guides as a measuring rod for determination of variances.
(5) It facilitates eliminating inefficiencies by taking corrective measures.
(6) It acts as an effective tool of cost control.
(7) It helps the management in taking important decisions.
(8) It facilitates the principle of "Management by Exception."
(9) Effective cost reporting system is possible.

LIMITATIONS OF STANDARD COSTING: Besides all the benefits derived

from this system, it has a number of limitations which are given below:
(1) Standard costing is expensive, and a small concern may not meet the cost.
(2) Due to lack of technical aspects, it is difficult to establish standards.
(3) Standard costing cannot be applied in the case of a- concern were non-
standardized products
are produced.
(4) Fixing responsibilities is difficult. Responsibility cannot be fixed in the case of
uncontrollable variances.
(5), Frequent revision is required while insufficient staff is incapable of operating
this system. (6) Adverse psychological effects and frequent technological changes
will not be suitable for a standard costing system.

TYPES OF STANDARDS:

Standards are predetermined benchmarks or norms against which actual

performance can be measured. They help in evaluating performance, controlling
costs, and improving efficiency. There are several types of standards:

Ideal Standards: These standards assume perfect operating conditions, with no

inefficiencies or waste. Ideal standards represent the best possible performance and
are often used as long-term goals.

Attainable Standards: These standards are achievable under realistic conditions.

They consider normal levels of inefficiency and allow for some waste. Attainable
standards are more practical for day-to-day operations.

Basic Standards: Basic standards are developed considering both ideal and
attainable standards. They represent a level of performance that should be achieved
under normal operating conditions.

Current Standards: Current standards are based on current operating conditions

and reflect the current levels of efficiency and performance. They are updated
frequently to adapt to changes in technology, processes, or market conditions.

Technical Standards: These standards focus on the technical aspects of production,

such as the quality and quantity of materials used, machine efficiency, and labor
productivity.

Cost Standards: Cost standards set targets for the costs of materials, labor, and
overhead. They help in cost control and budgeting by providing benchmarks for cost
performance.
Financial Standards: Financial standards are related to financial performance
indicators such as profitability, return on investment (ROI), and liquidity ratios. They
help in evaluating the financial health and performance of an organization.

DIFFERENCE BETWEEN BUDGETARY AND STANDARD COSTING:

Budgetary Costing:

Nature: Budgetary costing focuses on preparing and using budgets to plan,

coordinate, and control activities within an organization. It involves setting targets
for revenues, expenses, and other financial aspects of the business.

Scope: Budgetary costing covers the entire organization and its various functions,
departments, and activities. It includes budgets for sales, production, marketing,
administration, etc.

Timeframe: Budgetary costing typically involves setting budgets for future periods,
such as months, quarters, or years. It helps in long-term planning and resource
allocation.

Focus: The primary focus of budgetary costing is on financial planning and control.
It helps in aligning organizational goals with financial resources and monitoring
performance against budgeted targets.

Standard Costing:

Nature: Standard costing involves setting predetermined costs for materials, labor,
and overhead and comparing them with actual costs to evaluate performance and
control costs.

Scope: Standard costing focuses on the costs of production and operations within an
organization. It establishes standard costs for each unit of product or service based
on factors like historical data, engineering estimates, and industry benchmarks.

Timeframe: Standard costing is often applied to current or ongoing operations.

Standard costs are set based on expected levels of efficiency and performance and
are used to evaluate performance in real-time.
Focus: The primary focus of standard costing is on cost control and cost
management. It helps in identifying variances between standard costs and actual
costs, investigating the reasons for these variances, and taking corrective actions to
improve efficiency and reduce costs.

In summary, while both budgetary costing and standard costing are important tools
for cost management and control, they differ in their nature, scope, timeframe, and
focus. Budgetary costing is concerned with financial planning and control using
budgets, while standard costing focuses on setting predetermined costs and
evaluating performance against these standards.

VARIANCE ANALYSIS:

Variance analysis is a tool used in management accounting to compare actual

performance against standard performance. It helps identify differences (variances)
between planned or budgeted figures and actual results. By analyzing these
variances, management can understand the reasons for deviations from the plan and
take corrective actions to improve performance. Variance analysis is crucial for cost
control, performance evaluation, and decision-making within an organization.

TYPES OF VARIANCES:

MATERIAL VARIANCES:

Material Price Variance: This variance arises due to differences between the actual
price paid for materials and the standard price per unit of material.
Material Usage Variance: It reflects differences between the actual quantity of
materials used and the standard quantity allowed for actual production.

LABOR VARIANCES:

Labor Rate Variance: This variance occurs due to differences between the actual
wage rate paid to labor and the standard wage rate.
Labor Efficiency Variance: It arises from differences between the actual hours
worked and the standard hours allowed for the actual level of production.
VARIABLE OVERHEAD VARIANCES:

Variable Overhead Spending Variance: This variance results from differences

between the actual variable overhead costs incurred and the standard variable
overhead costs allowed for actual production.
Variable Overhead Efficiency Variance: It reflects differences between the actual
level of activity (e.g., machine hours) and the standard level of activity.

FIXED OVERHEAD VARIANCES:

Fixed Overhead Spending Variance: This variance arises due to differences

between the actual fixed overhead costs incurred and the budgeted fixed overhead
costs.
Fixed Overhead Volume Variance: It results from differences between the
budgeted level of activity and the actual level of activity.

SALES VARIANCES:

Sales Price Variance: This variance occurs due to differences between the actual
selling price per unit and the budgeted selling price per unit.
Sales Volume Variance: It reflects differences between the actual quantity sold and
the budgeted quantity sold, considering the standard selling price.

CLASSIFICATION OF VARIANCES:

FAVORABLE AND UNFAVORABLE VARIANCES:

Favorable Variance: A favorable variance occurs when actual results exceed

standard or budgeted results in a way that benefits the organization, such as lower
costs or higher revenues.
Unfavorable Variance: An unfavorable variance occurs when actual results fall
short of standard or budgeted results, leading to higher costs or lower revenues.

CONTROLLABLE AND UNCONTROLLABLE VARIANCES:

Controllable Variance: Controllable variances are those that can be influenced or
controlled by the actions of management or specific individuals within the
organization.
Uncontrollable Variance: Uncontrollable variances are beyond the control of
management or individuals within the organization and may result from external
factors such as market conditions or government regulations.

VOLUME AND PRICE VARIANCES:

Volume Variances: Volume variances arise due to differences in the level of activity
(such as production volume or sales volume) from the budgeted or standard level.
Price Variances: Price variances result from differences in the prices paid or
received for inputs or outputs compared to the budgeted or standard prices.
Variance analysis provides valuable insights into the performance of an organization,
helping management make informed decisions and take appropriate actions to
improve efficiency, reduce costs, and enhance profitability.

REFERENCE:

https://umeschandracollege.ac.in/pdf/study-material/busnesslaw/STANDARD-
COSTING.pdf
https://mmhapu.ac.in/doc/eContent/Management/RaisAhmadKhan/May2020/
Standard%20Costing%20UNIT%20V.pdf