Introduction
Cost
control is a basic objective of cost accountancy. Standard costing is the most
powerful system ever invented for cost control. Historical costing or actual
costing is nothing but, a record of what happened in the past. It does not provide
any ‘Norms’ or ‘Yardsticks’ for cost control. The actual costs lose their
relevance after that particular accounting period. But, it is necessary to plan
the costs, to determine what should be the cost of a product or service. It the
actual costs do not conform to what the costs should be, the reasons for the
change should be assessed and appropriate action should be initiated to
eliminate the causes.
Standard
costing fulfills the need to compensate the short comings of Historical costing
from the point of view of cost control.
(a) It provides
the norms or yardsticks in the form of standards- specifying what costs should
be or yardsticks in the form of standards- specifying what cost should be
(b) Comparison of
actual costs with standards is facilitated to ascertain variances for each
element of cost.
(c) The variances
are further analysed for contributory reasons. Responsibility is fixed on the
basis of the reasons for each variance.
(d) Corrective
measures are under taken to eliminate the unfavorable variances wherever
possible. Thus, standard costing is a costing technique specifically evolved to
provide complete ‘Infrastructure’ and ‘Systematic approach’ for cost control.
DEFINITION:
STANDARD, STANDARD COST, STANDARD COSTING
Standard:
According to Prof. Eric L.Kohler, “Standard is a desired attainable objective,
a performance, a goal, a model”. Standard may be used to a predetermined rate
or a predetermined amount or a predetermined cost.
Standard Cost:
Standard cost is predetermined cost or forecast estimate of cost. I.C.M.A.
Terminology defines Standard Cost as, “a predetermined cost, which is
calculated from management standards of efficient operations and the relevant
necessary expenditure. It may be used as a basis for price-fixing and for cost
control through variance analysis”. The other names for standard costs are
predetermined costs, budgeted costs, projected costs, model costs, measured
costs, specifications costs etc. Standard cost is a predetermined estimate of
cost to manufacture a single unit or a number of units of a product during a
future period. Actual costs are compared with these standard costs.
Standard
Costing is defined by I.C.M.A. Terminology 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”. “Standard costing is a
method of ascertaining the costs whereby statistics are prepared to show
(a)
the
standard cost
(b)
the
actual cost
(c)
the
difference between these costs, which is termed the variance” says Wheldon.
Thus the technique of standard cost study comprises of:
a.
Pre-determination
of standard costs;
b.
Use
of standard costs;
c.
Comparison
of actual cost with the standard costs;
d.
Find
out and analyse reasons for variances;
e.
Reporting
to management for proper action to maximize efficiency.
Advantages of Standard costing:
a. Cost control: Standard
costing is universally recognised as a powerful cost control system. Controlling
and reducing costs becomes a systematic practice under standard costing.
b. Elimination of wastage and inefficiency: Wastage
and inefficiency in all aspects of the manufacturing process are curtailed,
reduced and eliminated over a period of time if standard costing is in
continuous operation.
c. Norms: Standard
costing provides the norms and yard sticks with which the actual performance
can be measured and assessed.
d. Locates sources of inefficiency: It pin
points the areas where operational inefficiency exists. It also measures the
extent of the inefficiency.
e. Fixing responsibility: Variance
analysis can determine the persons responsible for each variance. Shifting or
evading responsibility is not easy under this system.
f.
Management by exception: The
principle of ‘management by exception can be easily followed because problem
areas are highlighted by negative variances.
g. Improvement in methods and operations: Standards
are set on the basis of systematic study of the methods and operations. As a
consequence, cost reduction is possible through improved methods and
operations.
h. Guidance for production and pricing policies: Standards
are valuable guides to the management in the formulation of pricing policies
and production decisions.
i.
Planning and Budgeting: Budgetary
control is far more effective in conjunction with standard costing. Being predetermined
costs on scientific basis, standard costs are also useful in planning the
operations.
j.
Inventory valuation: Valuation
of stocks becomes a simple process by valuing them at standard cost.
Limitations of
Standard Costing:
a. Variation in price: One
of the chief problems faced in the operation of the standard costing system is
the precise estimation of likely prices or rate to be paid.
b. Varying levels of output: If
the standard level of output set for pre-determination of standard costs is not
achieved, the standard costs are said to be not realised.
c. Changing standard of technology: In
case of industries that have frequent technological changes affecting the
conditions of production, standard costing may not be suitable.
d. Applicability:
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.
e. Difficult to set
standard: 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.
f.
Problem in fixing Responsibility:
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.
Essentials or Preliminaries
Before Setting Standard
While setting standard cost for operations,
process or product, the following Preliminaries must be gone through:
a. There must be
Standard Committee, similar to Budget Committee, in which Purchase Manager,
Personnel Manger, and Production Manager are represented. The Cost Accountant
coordinates the functions of the Standard Committee.
b. Study the
existing costing system, cost records and forms in use. If necessary, review
the existing system.
c. A technical
survey of the existing methods of production should be undertaken so that
accurate and reliable standards can be established.
d. Determine the
type of standard to be used.
e. Fix standard
for each element of cost.
f.
Determine standard costs for each product.
g. Fix the
responsibility for setting standards.
h. Classify the
accounts properly so that variances may be accounted for in the manner desired.
i.
Comparison of actual costs with pre-determined
standards to ascertain the deviations.
j.
Action to be taken by management to ensure
that adverse variances are not repeated.
Introduction of Standard Costing
System:
Introducing standard costing in any
establishment requires the fulfillment of following preliminaries:
a. Establishment
of cost centers;
b. Classification
and codification of accounts;
c. Determining
the types of standards and their basis;
d. Determining
the expected level of activity;
e. Setting
standards
a) Establishment of cost centers: A
cost centre is a location, person or item of equipment for which costs may be
ascertained and used for the purpose of cost control. The cost centers divide
an entire organisation into convenient parts for costing purpose. The nature of
production and operations, the organisational structure, etc. influence the
process of establishing cost centres. No hard and fast rule can be laid down in
this regard. Establishment of the cost centres is essential for pin pointing
responsibility for variances.
b) Classification and codification of accounts: The
need for quick collection and analysis of cost information necessitates
classification and codification. Accounts are to be classified according to
different items of expenses under suitable headings. Each of the headings is to
be given a separate code number. The codes and symbols used in the process
facilitate introduction of computerization.
c) Determining the types of standards and their basis: Standards
can be classified into two broad categories on the basis of the length of use:
i.
Current
standards: These are standards which are related to
current conditions, particularly of the budget period. They are for short-term
use and are more suitable for control purpose. They are also more amenable for combining
with budgeting.
ii. Basic standards: These are
long-term standards; some of them intended to be in use for even decades. They
are helpful for planning long-term operations and growth.
Basic for standards: There can be significant difference
in the standards set depending on the base used for them. The following are the
different bases for setting standard, whether they are current standards for
short-term or basic standards for long-term use.
i.
Ideal
standards: These standards reflect the best performance
in every aspect. They are like 100 marks in a paper for students taking up
examinations. What is possible under ideal circumstances in all aspects is
reflected in theses standards. They are impractical and unattainable in
practice. There utility for control purpose is negligible.
ii. Past performance based standards: The actual
performance attained in the past may be taken as basis and the same may be
retained as standard. Such standards do not provide any incentive or challenge
to the employees. They are too easy to attain. Their value from cost control
point of view is minimal.
iii. Normal standard: It is
defined as “the average standard which, it is anticipated can be attained over
a future period of time, preferably long enough to cover one trade cycle”. They
are average standard reflecting the average performance over a complete trade
cycle which may take three to five years. For a specific period, say a budget
period, their relevance is negligible.
iv. Attainable high performance standards: They are
based on what can be achieved with reasonable hard work and efforts. They are
based on the current conditions and capability of the workers. These standards
are considered to be of great practical value because they provide sufficient
incentive and challenge to the workers to attain them. Any variances from such
standard are really significant because the standard which is attainable with
effort is not attained.
d) Determining the expected level of activity: Capacity of
operation or level of activity expected over a future period is vital in fixing
current or short-term standards. When the activity level is decided on the basis
of sales or production, whichever is the limiting factor; all standard can be developed
with the activity level as the focal point. The purchase of material, usage of material,
labour hours to be worked, etc. are solely governed by the planned level of activity.
e) Setting standards: Standards may be either too strict or too liberal because they may
be based on theoretical maximum efficiency attainable good performance or
average past performance. Setting standards may also be called
developing standards or establishment of standard cost because as a consequence
of setting standards for various aspects, standard cost can be computed.
Material quantity standards: The following
procedure is usually followed for setting material quantity standards.
(a)
Standardization
of products: Detailed specifications, blueprints, norms for normal wastage
etc., of products along with their designs are settled.
(b)
Product
classification: Detailed
classified list of products to be manufactured are prepared.
(c)
Standardization
of material: Specifications, quality, etc., of materials to be used in the
standard products are settled.
(d)
Preparation
of bill of materials: A
bill of material for each product or part showing description and quantity of
each material to be used is prepared.
(e)
Test
runs: Sample or test runs under regulated conditions may be useful in
setting quantity standards in a precise manner.
Labour quantity standards: The following are the
steps involved in setting labour quantity standards:
(a)
Standardization
of products: Detailed specifications, blueprints, norms for normal wastage
etc., of products along with their designs are settled.
(b)
Product
classification: Detailed
classified list of products to be manufactured are prepared.
(c)
Standardization
of methods: Selection of proper machines to use proper sequence and method of
operations.
(d)
Manufacturing
layout: A plan of operation for each product listing the operations to be
performed is prepared.
(e)
Time and motion study
is conducted for selecting the best way of completing the job.
(f)
The operator is given training to
perform the job or operations in the best possible manner.
Estimated Cost
Estimates
are predetermined costs which are based on historical data and are often not
very scientifically determined. They
usually compiled from loosely gathered information and therefore, they are
unsafe to use them as a tool for measuring performance. Standard costs are a predetermined cost which
aims at what the cost should be rather then what it will be. Both the standard costs and estimated costs
are used to determine price in advance and their purpose is to control
cost. But, there are certain differences
between these two costs as stated below:
The following are some of the important differences between
standard cost and estimated cost:
Standard Cost
|
Estimated Cost
|
Standard
cost emphasizes as what the cost ‘should
be’ in a given set of situations.
|
Estimated
cost emphasizes on what the cost ‘will
be’.
|
Standard costs
are planned costs which are determined by technical experts after considering
levels of efficiency and production
|
Estimated
costs are determined by taking into consideration the historical data as the
basis and adjusting it to future trends.
|
It is used
as a devise for measuring efficiency
|
It cannot
be used as a devise to determine efficiency.
It only determines expected costs.
|
Standard
costs serve the purpose of cost control
|
Estimated
costs do not serve the purpose of cost control.
|
Standard
costing is part of cost accounting process
|
Estimated
costs are statistical in nature and may not become a part of accounting.
|
It is a
technique developed and recognised by management and academicians.
|
It is just
an estimate and not a technique
|
It can be
used where standard costing is in operation
|
It may be
used in any concern operating on a historical cost system.
|
Budgetary Control and Standard Costing
Budgeted Cost
|
Standard Cost
|
It is extensive in its application, as it
deals with the operation of department or business as a Whole.
|
It is
intensive, as it is applied to manufacturing of a product or providing a
service.
|
Budgets are
prepared for sales, production, cash etc.
|
It is
determined by classifying recording and allocating expenses to cost unit.
|
It is a
part of financial account, a projection of all financial accounts.
|
It is a
part of cost account, a projection of all cost accounts.
|
Control is
exercised by taking into account budgets and actual. Variances are not revealed
through accounts.
|
Variances
are revealed through difference accounts.
|
Budgeting
can be applied in parts.
|
It cannot
be applied in parts.
|
It is more
expensive and broad in nature, as it relates to production, sales, finance
etc.
|
It is not
expensive because it relates to only elements of cost.
|
Budgets can
be operated with standards.
|
This system
cannot be operated without budgets.
|