Standard Costing

When you want to measure some thing, you must take some parameter or yardstick for
measuring. We can call this as standard. What are your daily expenses? An average of $50! If
you have been spending this much for so many days, then this is your daily standard expense.

The word standard means a benchmark or yardstick. The standard cost is a predetermined cost
which determines in advance what each product or service should cost under given
circumstances.

Definition

The CIMA, London has defined standard cost as “a predetermined cost which is calculated from
managements standards of efficient operations and the relevant necessary expenditure.” They are
the predetermined costs on technical estimate of material labor and overhead for a selected
period of time and for a prescribed set of working conditions. In other words, a standard cost is a
planned cost for a unit of product or service rendered.

The technique of using standard costs for the purposes of cost control is known as standard
costing.

Advantages

Standard costing is a management control technique for every activity. It is not only useful for
cost control purposes but is also helpful in production planning and policy formulation. It allows
management by exception. In the light of various objectives of this system, some of the
advantages of this tool are given below:

1. Efficiency measurement-- The comparison of actual costs with

standard costs enables the management to evaluate performance of
various cost centers. In the absence of standard costing system, actual
costs of different period may be compared to measure efficiency. It is
not proper to compare costs of different period because circumstance
of both the periods may be different. Still, a decision about base period
can be made with which actual performance can be compared.
2. Finding of variance-- The performance variances are determined by
comparing actual costs with standard costs. Management is able to
spot out the place of inefficiencies. It can fix responsibility for
deviation in performance. It is possible to take corrective measures at
the earliest. A regular check on various expenditures is also ensured by
standard cost system.
3. Management by exception-- The targets of different individuals are
fixed if the performance is according to predetermined standards. In
this case, there is nothing to worry. The attention of the management is
drawn only when actual performance is less than the budgeted
performance. Management by exception means that everybody is

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 given a target to be achieved and management need not supervise each
and everything. The responsibilities are fixed and every body tries to
achieve his/her targets.
4. Cost control-- Every costing system aims at cost control and cost
reduction. The standards are being constantly analyzed and an effort is
made to improve efficiency. Whenever a variance occurs, the reasons
are studied and immediate corrective measures are undertaken. The
action taken in spotting weak points enables cost control system.
5. Right decisions-- It enables and provides useful information to the
management in taking important decisions. For example, the problem
created by inflating, rising prices. It can also be used to provide
incentive plans for employees etc.
6. Eliminating inefficiencies-- The setting of standards for different
elements of cost requires a detailed study of different aspects. The
standards are set differently for manufacturing, administrative and
selling expenses. Improved methods are used for setting these
standards. The determination of manufacturing expenses will require
time and motion study for labor and effective material control devices
for materials. Similar studies will be needed for finding other
expenses. All these studies will make it possible to eliminate
inefficiencies at different steps.

Limitations of Standard Costing

1. It cannot be used in those organizations where non-standard products
are produced. If the production is undertaken according to the
customer specifications, then each job will involve different amount of
expenditures.
2. The process of setting standard is a difficult task, as it requires
technical skills. The time and motion study is required to be
undertaken for this purpose. These studies require a lot of time and
money.
3. There are no inset circumstances to be considered for fixing standards.
The conditions under which standards are fixed do not remain static.
With the change in circumstances, if the standards are not revised the
same become impracticable.
4. The fixing of responsibility is not an easy task. The variances are to be
classified into controllable and uncontrollable variances. Standard
costing is applicable only for controllable variances.

For instance, if the industry changed the technology then the system will not be suitable. In that
case, we will have to change or revise the standards. A frequent revision of standards will
become costly.

Determination of Standard Costs

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How should the ideal standards for better controlling be determined?

1. Determination of Cost Center

According to J. Betty, “A cost center is a department or part of a department or an item of

equipment or machinery or a person or a group of persons in respect of which costs are
accumulated, and one where control can be exercised.” Cost centers are necessary for
determining the costs. If the whole factory is engaged in manufacturing a product, the factory
will be a cost center. In fact, a cost center describes the product while cost is accumulated. Cost
centers enable the determination of costs and fixation of responsibility. A cost center relating to a
person is called personnel cost center, and a cost center relating to products and equipments is
called impersonal cost center.

2. Current Standards

A current standard is a standard which is established for use over a short period of time and is
related to current condition. It reflects the performance that should be attained during the current
period. The period for current standard is normally one year. It is presumed that conditions of
production will remain unchanged. In case there is any change in price or manufacturing
condition, the standards are also revised. Current standard may be ideal standard and expected
standard.

3. Ideal Standard

This is the standard which represents a high level of efficiency. Ideal standard is fixed on the
assumption that favorable conditions will prevail and management will be at its best. The price
paid for materials will be lowest and wastes etc. will be minimum possible. The labor time for
making the production will be minimum and rates of wages will also be low. The overheads
expenses are also set with maximum efficiency in mind. All the conditions, both internal and
external, should be favorable and only then ideal standard will be achieved.

Ideal standard is fixed on the assumption of those conditions which may rarely exist. This
standard is not practicable and may not be achieved. Though this standard may not be achieved,
even then an effort is made. The deviation between targets and actual performance is ignorable.
In practice, ideal standard has an adverse effect on the employees. They do not try to reach the
standard because the standards are not considered realistic.

4. Basic Standards

A basic standard may be defined as a standard which is established for use for an indefinite
period which may a long period. Basic standard is established for a long period and is not
adjusted to the preset conations. The same standard remains in force for a long period. These
standards are revised only on the changes in specification of material and technology
productions. It is indeed just like a number against which subsequent process changes can be
measured. Basic standard enables the measurement of changes in costs. For example, if the basic
cost for material is Rs. 20 per unit and the current price is Rs. 25 per unit, it will show an

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increase of 25% in the cost of materials. The changes in manufacturing costs can be measured by
taking basic standard, as a base standard cannot serve as a tool for cost control purpose because
the standard is not revised for a long time. The deviation between standard cost and actual cost
cannot be used as a yardstick for measuring efficiency.

5. Normal Standards

As per terminology, normal standard has been defined as a standard which, it is anticipated, can
be attained over a future period of time, preferably long enough to cover one trade cycle. This
standard is based on the conditions which will cover a future period of five years, concerning one
trade cycle. If a normal cycle of ups and downs in sales and production is 10 years, then standard
will be set on average sales and production which will cover all the years. The standard attempts
to cover variance in the production from one time to another time. An average is taken from the
periods of recession and depression. The normal standard concept is theoretical and cannot be
used for cost control purpose. Normal standard can be properly applied for absorption of
overhead cost over a long period of time.

Revision of Standards

For effective use of this technique, sometimes we need to revise the standards which follow for
better control. Even standards are also subjected to change like the production method,
environment, raw material, and technology.

Standards may need to be changed to accommodate changes in the organization or its

environment. When there is a sudden change in economic circumstances, technology or
production methods, the standard cost will no longer be accurate. Standards that are out of date
will not act as effective feed forward or feedback control tools. They will not help us to predict
the inputs required nor help us to evaluate the efficiency of a particular department. If standards
are continually not being achieved and large deviations or variances from the standard are
reported, they should be carefully reviewed. Also, changes in the physical productive capacity of
the organization or in material prices and wage rates may indicate that standards need to be
revised. In practice, changing standards frequently is an expensive operation and can cause
confusion. For this reason, standard cost revisions are usually made only once a year. At times of
rapid price inflation, many managers have felt that the high level of inflation forced them to
change price and wage rate standards continually. This, however, leads to reduction in value of
the standard as a yardstick. At the other extreme is the adoption of basic standard which will
remain unchanged for many years. They provide a constant base for comparison, but this is
hardly satisfactory when there is technological change in working procedures and conditions.

Questions on standard Costing

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Question 1
New Look Lawn Furniture Corporation uses 12 meters of aluminum pipe at Rs.0.80 per meter as
standard for the production of its Type A lawn chair. During one month’s operations, 100,000
meters of the pipe were purchased at Rs.0.78 a meter, and 7,200 chairs were produced using
87,300 meters of pipe. The materials price variance is recognized when materials are purchased.

Required:
1. Material Price Variance (at time of purchase)
2. Material Overall variance (on the basis of Usage)
3. Material Price Variance (at the time of Usage)
4. Material Quantity Variance

Question 2
The processing of a product requires a standard of 0.80 direct labour hours per unit for operation
OP2000 at a standard wage rate of Rs.6.75 per hour. The 2,000 units were produced using 1,580
direct labour hours at a cost of Rs.6.90 per hour.

Required:
1. Overall Labour Cost Variance
2. Direct labour rate variance
3. Direct labour efficiency variance.

Question 3
The Osama Corporation uses a standard costing system. The factory overhead standard rate per
direct labour hour is:

Fixed: Rs.4,500 = Rs.0.90

5,000 hours

Variable: Rs.7,000 = Rs.1.50

5,000 hours
For October, actual factory overhead was Rs.11,000. Actual labour hours worked were 4,400 and
the standard hours allowed for actual production were 4,500.

Required:
1. Controllable variance
2. Volume variance

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Question 4
From the following information, calculate the following variances:
1. Material Price Variance
2. Material Quantity Variance
3. Labour Rate Variance
4. Labour Efficiency Variance

Information: The budgeted normal monthly capacity of ABL Limited is 100,000 hours, with a
standard of 40,000 units at this capacity. Standard costs per unit are as under:

Material----------------------------------------------10 kg @ Rs.2.50
Labour----------------------------------------------- Rs.18 per hour

During December, actual units produced were 45,000 at a labour cost of Rs.2,300,000. Actual
Labour hours worked during the month were 115,000 and 427,500 Kg material was used at a
total cost of Rs.1,111,500.

Question 5
Budgeted normal capacity of Zahab Corporation is 10,000 direct labour hours, with a standard
production of 8,000 units. Standard costs are as under:

Materials ------------------------------------------------ 2 Kg @ Rs.0.50

Labour -------------------------------------------------- Rs.9.00 per direct labour hour
Factory overheads:
Fixed expenses -------------------------------------- Rs.5,000
Variable expenses ---------------------------------- Rs.1.50 per direct labour hour

During November, actual factory overheads totaled Rs.17,550 and 9,000 direct labours cost
Rs.76,500. During the month 7,000 units were produced using 14,400 Kg of materials at a cost
of Rs.0.51 per Kg.

Required:
1. Material price variance
2. Material quantity variance
3. Labour rate variance
4. Labour efficiency variance
5. Factory overheads controllable variance
6. Factory overheads volume variance.

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