What is Standard Costing ?
Standard Costing is a sophisticated technique, under which the standards are decided in advance and the actual costs are compared with such standard costs. Causes of variations, especially the unfavorable ones, am analysed and appropriate corrective measures are initiated so as to have the optimum efficiency in production.
Definition of Standard Costing
According to Chartered Institute of Management Accountants, London has defined the Standard Costing as :
"The preparation and use of standard costs, their comparison with actual costs, and the analysis of variance to their causes, and points of incidence."
According to Institute of Cost and Works Accountants, London has defined Standard Costing as :
"An estimated cost, prepared in advance of production or supply correlating a technical specification of material, and labour to the price and wage rates estimated for a selected period of time, with an addition of the apportionment of overheads expenses estimated for the same period within a prescribed set of working conditions."
Objectives of Standard Costing
The broad objectives of standard costing are summarized in the following points:
1) Promoting and Measuring Efficiency :
Standard Costing, besides enhancing the competence and performance, also acts as a tool to measure them. If the actual cost happens to be less than the standard cost, it indicates efficiency and competency; on the other hand, if the actual cost happens to be more than the standard cost, it is indicative of inefficiency and competency.
2) Controlling and Reducing Casts :
While computing the Standard Cost, appropriate provisions are made with regard to normal wastage, normal breakdown, normal idle capacity, normal mistakes, etc. This exercise ensures proper monitoring as well as reduction in the cost.
3) Simplifying Costing Procedure :
The exercise of Standard Costing is invariably specific to a product/ process / job. For every product, or process, or job a separate exercise of standard costing is required to be undertaken. This is generally done by the professionals (cost and management accountants) after having n thorough discussion with the management and the technical specialists, which ensures smoothening of the entire process.
4) Valuing Inventories :
Undertaking the valuation exercise in respect of stock and issue of material on the basis of standard costs results in substantial savings of time and energy in the maintenance of stores ledger. Computation of stocks on the basis of standard cost is done by multiplication of the quantity of stock in hand with the standard cost.
5) Fixing Selling Price :
Selling price of a product may be fixed either on the basis of actual cost or on the basis of standard cost. It has been experienced that due to various reasons, there are lot of fluctuations in actual cost and as such the selling price cannot be fixed on the basis of actual cost, because price of a product needs to be generally stable and not volatile. Thus, the preferred basis of fixing the price of a product is standard cost, to which a suitable margin is added.
Advantages of Standard Costing
Importance of standard costing are as follows :
1) Measuring Efficiency :
Standard costing may be used as a measuring tool for the management to measure efficiency. The difference between the actual costs and standard costs reflects the level of performance of different cost centres.
2) Formulation of Production and Price Policy :
Creation of production policies is facilitated by the standard costing. On the basis of prevailing conditions, the standards are fixed. Standard costs are helpful in deciding production plans and in determining prices of different products.
3) Determination of Variance :
Variances are determined by comparing actual cost and standard cost. Such variations brings core areas of incompetence, which in turn enables the management to fix staff accountability for inefficiencies and initiate remedial steps promptly and ensure better performance in future.
4) Reduction of Work :
Under the historical costing, a number of records are required to be regulated for the determination of costs, whereas under the standard costing minimal records are required to be maintained, resulting in the reduction of clerical job to a great extent Management is provided with only relevant data and unnecessary information is skipped.
5) Management by Exception :
A system, which envisages that every individual should be given a target to be achieved within a defined time-frame, is referred to as management by exception. Day-to-day supervision of various activities and individual performance is not required under this system.
6) Facilitates Cost Control :
The twin objective of any costing system is cost control and cost reduction. Both the objectives are achieved in the system of standard costing. The standards are scrutinized and analysed on: an ongoing basis with a view to have further improvement in efficiency. Causes of variance, whenever takes place, are thoroughly studied and analysed, which is followed by initiation of prompt remedial steps.
Disadvantages of Standard Costing
The system of standard costing exhibits the following disadvantages :
1) Fixation of Standards :
Fixation of realistic standards during the introduction of standard costing system is an extremely significant and challenging job. A wrong assessment of standards may lead to a faulty system. Fixation of standards on a realistic basis requires a technical expertise, which is difficult to implement.
2) Frequent Technology Alterations :
Some of the industries are known for frequent technological alterations. Introduction of standard costing system in such industries may prove to be a costly affair, as the standards would need a frequent revision. Standard costing system, therefore, may not be suitable for such industries.
3) Expensive Technique :
Expenses involved in setting up and continuing the system of standard costing are quite heavy. It is difficult for small-sized business organisations to afford such a costly system.
4) Fixation of Responsibility :
In case of any lapse, the job of fixing staff accountability, perse, is a difficult one. In case of standard costing system, such accountability can be fixed only for the controllable variances and not for the uncontrollable variances. But to establish whether a variance is controllable or uncontrollable is also a tough exercise, due to the fact that the variances controllable at one point of time may become uncontrollable at another point of time.
5) Analysis of Historical Events :
Variance analysis involves analysis of historical events, which cannot be changed. As such it is of limited use for the management.