Standard Costing 1

Introduction

According to CIMA, London, “Standard Costing is the preparation and use of standard

costs, their comparison with actual costs and analysis of variances to their causes and points of

incidence.” Standard Costing is considered as one of the most significant topic of cost

accounting. Standard costing system is generally related with manufacturing cost of the

company and it includes direct materials, direct labor and manufacturing overhead.

(Drury, C. (1998))

Standard Costing

The Standard Costing can be defined as the procedure of setting standard costs and

applying them to calculate the differences from the actual costs and evaluating the reasons for

such differences with an aim to maximize the efficiency of production functions.

It ensures comparison of actual performance with the budgeted and thus variance can be

computed. The variances identified are analyzed so as to know the reasons for the deviations so

that these mistakes can be prevented in future i.e. it helps in evaluating the past performance and

deciding for the future course of actions.

(Drury, C. (1998))

It is an instrument of costing which uses standards for costs and revenues for the purpose

of control by Variance Analysis. It is not a separate system of accounting, but only an instrument

which can be implemented in all types of costing like job costing or process costing.

Standard costing is a costing method which attaches the costs to cost objects which is

based on reasonable estimates or cost studies and by means of budgeted rates rather than

according to actual costs incurred. It is the anticipated cost of producing a unit of output. A
Standard Costing 2

predetermined cost is to be assigned to products produced. Standard cost implies a norm, or what

costs should be. Standard costing may be based on either direct or absorption costing principles,

and may apply either to all or some cost elements.

Standard costing furnishes information for cost control and as a pricing policy base. In

this method the cost of a product or service is predetermined scientifically. Any variance of

actual cost of production from the predetermined normal cost of product may indicate any

inefficiency and waste. Standard costing is used as an average target product cost and followed

up by comparing the actual cost. The purpose of standard costing is to give the targets for

product manufacturing which is different from target costing method. Standard costing is

suitable and simple methods for the actual cost follow up but may lead to inappropriate decisions

when used incorrectly in future planning. Main problem of standard costing is that it does not

provide enough information to enable management to control the overheads and other indirect

costs related to the product.

(Drury, C. (1998))

Standard Costing is considered as one of the most significant topic of cost accounting.

The standard costs are generally related with manufacturing cost of the company. It includes

direct materials, direct labour and manufacturing overhead. According to CIMA, London,

“Standard Costing is the preparation and use of standard costs, their comparison with actual costs

and analysis of variances to their causes and points of incidence.” The Standard Costing can be

defined as the procedure of setting standard costs and applying them to calculate the differences

from the actual costs and evaluating the reasons for such differences with an aim to maximize the

efficiency of production functions. It is an instrument of costing which uses standards for costs

and revenues for the purpose of control by Variance Analysis.

Standard Costing 3

Role of different persons in the management in developing the standards:-

Purchasing manager (Jack Smith): Purchase manager helps in forecasting the rate of raw

material to be used in production for the budgeted period. Purchase managers is responsible for

forecasting the price of raw material based on the past experience and future market conditions.

Role of purchasing manager is to procure the best quality required raw material at the lowest

possible price and ensure the quality of the raw material is appropriate and the delivery is always

on time.

Production manager (Amy Wilcox): Production manager is responsible for managing all the

resources like raw material, labor, and equipment and produce the finished goods in timely

manner. Production manager plays very important role in developing the standards, production

managers helps in determining the standard quantity or raw material, and total direct labor hours

and other supplies which will be required to produce budgeted units. Production manager is able

to determine the standard quantity of each input on the basis of past experience. Forecasting the

accurate amount of inputs is one of the most important functions of production manager and in

this way production manager play crucial role in development of production budget.

Management accountant (Bert Rivkin): Management accountant plays vital role in an

organization and helps it to grow and sustain itself in the industry. When a company is growing

at a fast pace it needs management accountant to help in sustaining the growth by taking

effective strategic decisions. Management accountant can be considered as the link which helps
Standard Costing 4

in bringing together all the elements which are helpful in drafting a budget. In the absence of

management accountant an effective decision cannot be taken.

Aim of standard costing

The Standard Costing ensures the determination of reasonable standards for each element

of cost and sales. The standard costing system ensures that the report is given to the management

for taking corrective action for any off-standard variance.

It provides the relevant information to the management accountant regarding the cost

control, strength and weakness of production function.

The efficiency of the actual performance can be measured and formulation of future

policies regarding production and pricing can be done. The standard costing is helpful in overall

budgeting, planning and price quotation for the products.

The standard costing increases the cost consciousness among employees by Variance

Analysis because the responsibility of favorable and unfavorable performance is assigned to

employees.

The efficiency and productivity of the employees can be increased by motivating them for the

better performance.

The standard costing ensures management by exception (MBE) as the management is

focusing on taking the corrective actions only.

Standard Costing 5

Advantages of standard costing

Management by exception:

Standard costing helps in diverting the Management attention to the items which are not

working or proceeding as per the plan. It helps in saving the time of management by directing the

attention to value adding activities.

Cost reduction:

Process of setting, revising and monitoring standards inspires review of materials,

techniques and methods resulting into reduction in cost.

Analysis of unfavorable analysis is the analysis of the factors due to which the cost exceeds the

budgeted cost which lead to cost reduction.

Inventory valuation

If actual number of physical unit’s inventory is known, standard costing makes the

inventory valuation easy and simple.

Pricing

It is a reliable base for calculating the total cost through which selling price can be

determined by adding profit margin in it.

Cost control

It acts as a yardstick which is used to determine whether the variance is favorable or

unfavorable by measuring all costs.

Standard Costing 6

Motivation

Standard costing acts as a motivation tools for all employees because it requires the full

participation of all employees and management levels.

Makes budgeting easier

Standard costing helps in setting the budgets for the department and organization thus

making budgeting easier.

Budgeted cost = Output units * standard cost per unit

Disadvantages of standard costing

Time consuming

Lot of time is required in developing and installing a reliable standard costing system.

Obsolescence

Due to the change in the economic conditions, standards become out of date quickly

resulting into loss of control and motivational effects.

Standard costing system is expensive to install

Huge amount of money is needed to study the requirement of output in terms of

overheads, materials and labor.

Difference between standard costing and standard costing system

Standard costing and standard costing system both are different from each other.

Standard costing system is the system of standard costing which records the cost of production at

standard, flow of the inventory units from work in process to finished goods to cost of goods sold

at per unit standard cost.

Standard Costing 7

Standards costing system and flexible budgeting are inter connected i.e. the units of inventory are

tracked at the flexible budget amount in standard costing system.

Standard costing system also posted adjusting entries at the end of the period which provides the

information on variance that managers use for performance evaluation and control.

Target Costing

In target costing, manufacturer adds profit margin to the actual cost. In other words,

Target cost is calculated by deducting profit margin from the market price of product. Target

costing is a reverse mechanism of estimating cost of the product. It helps in increasing the

profitability and reducing the overall cost of the product.

Management is considering variable cost because contribution is calculated after deducting

variable cost from market price of product. Variable cost is considered when other costs are

same. As the company is introducing a new product, the fixed cost will remain same, even most

of the processing is just same as its other products, however management has decided to

introduce more efficient processes for increasing the product volume, and batch size etc. thus

variable cost will change. Thus variable cost is considered by the management while computing

the target cost of the product.

Difference between target costing and traditional standard costing

Standard Costing 8

Traditional standard costing is used mainly in mass production as a tool for control.

Costs for standard parts are established by work study or experience, actual costs then being

checked against the standard costs.

Target costing is a reversed cost accounting technique. Instead of calculating costs first and then

setting the price based on these calculated costs, target costing does it the other way around.

Target costing is convenient for firms operating in perfect competition. The steps in target

costing are as follows: 1. Determine the price consumer is willing to pay for the product, say $Z.

This may be arrived at after conducting a market research; 2. Determine the profit margin the

business is willing to accept.

Actual costing Normal costing Standard costing

system system system
Direct costs: ( Actual rate or price ( Actual rate or price *(Budgeted rate or
* actual quantity of * actual quantity of piece * standard input
inputs per unit) inputs per unit) allowed for each
*actual outputs *actual outputs output )* actual
outputs
Overhead costs: Actual overhead rates Budgeted overhead Budgeted overhead
* actual quantity of rates * actual quantity rates* ( standard
the allocation base of the allocation base inputs allowed for
incurred incurred actual outputs
achieved)
Standard Costing 9

Reference

Drury, C. (1998). Standard Costing. Retrieved from

http://books.google.co.in/books?id=GBMKAAAACAAJ&dq=standard+costing&hl=en&sa=X&
ei=d0WPUqTJAo6ErQeqzYHoBw&ved=0CC0Q6AEwAA.

Drury, C. (2008). Management and Cost Accounting. Retrieved from

http://books.google.co.in/books?id=8SaARYOflPIC&printsec=frontcover&dq=standard+costing
&hl=en&sa=X&ei=d0WPUqTJAo6ErQeqzYHoBw&ved=0CDIQ6AEwAQ#v=onepage&q=stan
dard%20costing&f=false

Noriza Mohd. Jamal, Nor Hamimah Mastor, Maisarah Mohamed Saat, Mohamed Fuad Ahmad
& Dewi Fariha Abdullah @ Earnest (2007). Cost & Management Accounting. Retrieved from
http://books.google.co.in/books?id=69XAVssg9UQC&pg=PA286&dq=standard+costing&hl=en
&sa=X&ei=d0WPUqTJAo6ErQeqzYHoBw&ved=0CEMQ6AEwBA#v=onepage&q=standard%
20costing&f=false

Cave, S. R. (1995). Budgetary control, standard costing, and factory administration. Retrieved
from
http://books.google.co.in/books?id=xNBAAAAAIAAJ&q=standard+costing&dq=standard+costi
ng&hl=en&sa=X&ei=d0WPUqTJAo6ErQeqzYHoBw&ved=0CD4Q6AEwAw

Berger, A. (2011). Standard Costing, Variance Analysis and Decision-Making. Retrieved from
http://books.google.co.in/books?id=uRC5IhD0wVoC&printsec=frontcover&dq=standard+costin
g&hl=en&sa=X&ei=d0WPUqTJAo6ErQeqzYHoBw&ved=0CDgQ6AEwAg#v=onepage&q=sta
ndard%20costing&f=false