1Define the term Standard Costing and outline the steps involved therein.
According to ICMA, London, Standard Costing refers to "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 involves the following steps:
- Setting up of Standards,
- Ascertainment of Actual Costs,
- Comparison of Actual and Standard Costs to determine Variances, and
- Investigation of variances and taking appropriate action thereon wherever necessary. Installation of a Standard Costing System involves the following preliminary steps:
- Establishment of Responsibility Centers: The key areas of operation in the enterprise should be identified into responsibility centers with clearly defined roles, eg. Cost Control, Revenue Maximisation etc. Such responsibility centers may be identified either through:
- Departmentation or
- Activity Based
- Classification of Accounts: The various heads of expense accounts should be classified and codified for collection and comparison of actual costs with standard costs. This will also help the process of mechanized/computerized
- Selection of a suitable type of standard: For operational requirements, a suitable type of standard should be
- Length of the period of use: The duration, for which the standards are to be used, should be
What are the advantages of standard costing?
Advantages:
- Measuring Performance: Standards provide a basis for measurement of actual performance. Standard costing will eliminate any variations in profit due to changes in the values of stock holding from period to period and will thus provide a true basis for the measurement of profit.
- Cost control: Variance Analysis and investigation of reasons thereof, will provide the basis for appropriate control action. Adverse variances can be controlled and their recurrence avoided.
- Price Fixings: Standard costs will remain stable over a period of time, as opposed To actual cost which may fluctuate violently. Hence, where demand for a product is elastic, standard cost can be used as a basis for fixing the selling.
- Management by Exception: If the variances are negligible, it means that the performance is more or less in accordance with the standards. Significant variances that warrant the attention of the manager are brought to his knowledge. This facilities control by:
Introduction of Incentives Standard costing facilitates evaluation of jobs and introduction of incentives. Job values can be determined by the use of evaluation and scale of wages fixed according to the responsibility involved in each - Quotations and Estimates: Standard costing facilitates the estimation of the cost of new products with greater accuracy. It can also be used for jobbing
- Inventory Valuation: Standard Costs represent normal cost and are ideal for inventory valuation, when compared to actual
- Planning and Budgeting: Standard costing greatly aids business planning, budgeting and managerial decision making. Standard costs being pre-determined costs, are particularly useful in planning and
- Standardization: Standard costing aids in standardization of products, operations and processes. Since, standards are laid down for each product, its components, materials, operations, processes etc., it improves the overall production efficiency and reduces.
- Targets for Responsibility Centers: It provides objectives and targets to be achieved by each level of management and defines the responsibilities of departmental managers. Standard costs are predetermined on the basis of reasonable and achievable level of output. The departmental head, therefore, comes to know what is expected of him and his level of performance in comparison to the targets can be seen from the variance reports. Thus the system serves as an incentive to the departmental head to achieve the targets set by the company.
- Comparison facility: Standard costing sets a uniform basis for comparison of all elements of costs. Since care is taken in setting standards, the standards become unchanging units of comparison. The standard hour may be used as a basic unit to compare dissimilar products or
- Optimum Resource Utilisation:The maximum use of working capital, plant facilities and current assets is assured because wastage of materials and loss due to idle time are closely controlled.
