Chapter 4.

Standard Costing
 Meaning of Standard Costing
According to CIMA London, Standard Costing is, ‘ 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 discloses the cost of
deviations from standard and classifies these as to their
causes, so that management is immediately informed of the
sphere of operations in which remedial action is necessary.
Thus Standard Costing is a method of ascertaining costs whereby
statistics are prepared to show :
 The standard costs
 The actual costs
 The difference between these costs which is termed as
variance
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 Budgetary Control Vs. Standard Costing
 Concerned with the operation
of the business as a whole and
hence more extensive.
 Budget is a projection of
financial accounts.
 It does not necessarily involve
standardization of products.
 Budgetary control can be
adopted in part also.
 Budgeting can be operated
without standard costing.
 Budgets determine the
ceilings of expenses above
which actual expenses should
not rise.
 Related with the control of
expenses and hence it is more
intensive.
 Standard cost is the projection
of cost accounts.
 It requires standardization of
products.
 It is not possible to operate
this system in parts.
 Standard costing cannot exist
without budgeting.
 Standards are minimum
targets which are to be
attained by actual
performance a t a specific
efficiency level.
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 Estimated Cost Vs. Standard Cost
 Estimated cost can be used in
any business which is running
under historical costing
system.
 Computation of estimated
costs may be made at any time
for any specific purpose and
may reflect approximation.
 Primary emphasis is on
ascertainment of costs which
depend on expected actuals of
average of past performance.
 Estimated costs can be
ascertained for a part of the
business also for a particular
purpose.
 Standard cost can be applied
in a business operating under
the standard costing system.
 Calculation on scientific basis
is to be made for arriving at
standard costs.
 Cost control is the main aspect
involved under this system.
Standard costs serve as
yardsticks for performance
measurement.
 Standard costs are to be fixed
in respect of every element of
cost and, therefore, it
incorporates the whole of the
manufacturing process.
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 Standard Costing As A Management Tool
The utility of standard costing to management is as under :
 Formulation of price and production policies: Assists
management in the field of inventory pricing, profit
planning and also reporting to higher levels.
 Comparison and Analysis of Data : Provides a stable and
sound basis for comparison of actual with standard costs,
according to different elements separately, thus indicating
places where remedial action is necessary and how far
improvement is possible in the long run.
 Cost Consciousness: Provides incentives to workers, middle
and top executive personnel for efficient work.
 Better Capacity to anticipate: Data are available at an early
stage and the capacity to anticipate about changing
conditions is developed.
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 Standard Costing As A Management Tool
 Delegation of Authority and Responsibility :The sphere of
operation of adverse variations is disclosed and particular
production department or centre can be held accountable.
The delegation of responsibility and authority can be made
by the management to control the affairs in different
departments.
 Management by ‘Exception’: Management by exception can
be made applicable in the business and the management can
concentrate on cases which are off standard.
 Better Economy, Efficiency and Productivity: Managerial
review of costs is more effective as the operations are
scrutinized carefully and inefficiencies are disclosed.

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 Limitations of Standard Costing
 Heavy costs :Fixation of standards may be costly and may
require high skill and competence.
 Frequent Revision Required :Revision of standards is a
tedious and costly process.
 Unsuitable for Non-standardized Products: Industries
dealing in non- standardized products may find the system
unsuitable and costly.
 Fixation of Responsibility Difficult: Responsibility can be
fixed only when controllable and non controllable factors
are distinctly known
 Adverse Psychological Effects: Standards may be fixed at a
high level which is unachievable, resulting in frustration or
building up of resistance.

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 Meaning of Standard Costs
Different meanings may be attached to the term ‘ Standard Cost’:
 Ideal Costs :These are costs which should be there under
ideal working conditions, ideal management and ideal plant
capacity. Such ideal is a myth, and far from reality.
 Normal Costs: Such costs can be determined on the basis of
the prevailing conditions of the business. It is assumed that
the plant is working at normal level of capacity and
efficiency, workers are engaged in production activities
performing their normal functions and the normal efficiency
operations are being carried out. The cost shall thus be an
average standard cost which is normally there in business.
 Cost based on ‘ Average Past performance’: The costs which
have been incurred during the past three or five years, for
instance, are averaged out and the same may be taken as the
standard costs for the following period. However, past results
are not enough and self sufficient to constitute standards.
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 Meaning of Standard Costs ( Contd )
 Current Costs : These are costs which are currently being
incurred. They are not a useful guide for standard costs
since they are neither in rhythm with past trends nor are
inclusive of factors and conditions following ahead.
 Expected or Anticipated Costs: These are costs which
closely follow the pattern of present costs, though adjusted
according to past behavioural patterns as well a future
tendencies.
 Reasonably attainable costs: Costs which can be attained
reasonably if the management tries for them i.e it makes a
sincere and integrated effort to achieve the targets set in,
can be regarded as the satisfactory yardstick or benchmark
for standards.

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 Determination of Standard Costs
Preliminaries to setting of Standards:
 Establishment of Cost Centres : Though all the processes
combined together manufacture the final product, but for
measuring productivity and controlling labour and
overheads, classification into cost centres becomes
necessary.
 Classification and Codification of Accounts: Helps in quick
collection and analysis of cost information.
 Period of Use: This involves the length of the operating
period for which standards are to be used. The standards,
which may be long term or short term, may be categorized
as :
a) Basic Standards: Not altered over a long period of time,
revisions are not frequent and there is a stability and
stagnancy in standards fixed.
b) Current Standards: These are short term standards. 10
 Determination of Standard Costs ( Contd )
 Reasonable or Desired Level of Attainment :Standards are
to be set assuming efficient working conditions and
reasonable good performance.
 Active Level: The level of activity or performance required
must be decided upon before establishing any standards. It
should be computed keeping in mind the capacity of the
plant and the marketability of the products.

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 Setting of Standards
The Standard Cost is determined for each and every element of
cost distinctly.
Standards for Direct Material Cost: Here two standards will have
to be fixed up :
 Quantity Standards : The factors that should be considered
while determining the quantity that should be consumed for
manufacturing one unit of commodity:
- Past experience
- Technical estimates based on mathematical or scientific
computation.
- Test runs and experiments
- Standard bills of materials
 Price Standards: The standards regarding the price at which
material should be available can be fixed by considering:
- Price prevailing in the past
- Current prices and prevalent market trends
- Experience of similar concerns 12
 Setting of Standards ( Contd )
Standards for Direct Labour Cost:
 Time Standards : The time which a worker should take in
completing a particular job can be fixed up by taking into
consideration:
- Trial Runs
- Time and Motion Studies
- Technical Estimates
- Past Experience
- Experience of Similar Concerns
- Other factors like standardization of products, efficient plant
and equipments, efficient tools to handle, efficiency and skill
of workers etc.
 Rate Standards: The following factors must be considered:
- Type of labour required for performing a specific job
- Past experience
- Current Market Rates
- Trends 13
 Setting of Standards ( Contd )
Standards for Overhead Cost:
 Standard Level Of Activity : It should be carefully fixed
and should represent a reasonably attainable level.
 Fixed, variable and semi-variable overheads:
- Fixed Overheads: Remain constant irrespective of the
quantum of output ex rent, insurance etc.
- Variable Overheads: Vary in proportion with output ex.
Power, selling commission etc.
- Semi-variable overheads: Vary according to output but not
in direct proportion. Include an element of fixed as well as
an element of variable cost ex. Depreciation and repairs.
 Fixed Overhead Standards: Can be determined on the basis
of past experience and current market trends.
 Variable Overhead Standards: Standards for variable
overheads are fixed on the basis of trial runs, technical
estimates, past experience and experience of other people in
the same line.
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 Setting of Standards ( Contd )
Standards for Sales:
 Quantity Standards: Quantity standards regarding sales will
have to be fixed up for each of the products in which the
business deals. Past sales figures, orders in hand, production
capacity, presence of competitors etc. should be taken into
consideration while determining quantity standards.
 Price Standards: Price standards should be fixed up
regarding each product in which the business deals. Past
experience, current market trends, cost of product, price at
which other manufacturers are selling the goods etc. should
be considered while fixing the standard.
The standard quantity multiplied by the standard price will give
us ‘Budgeted Sales’. It is different from ‘Standard Sales’
which stands for actual quantity of sales multiplied by
standard selling price.

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 Summary
In this chapter you have studied :
 Meaning of Standard Costing
 Difference between budgetary control and standard costing
 Difference between estimated costing and standard costing
 Utility of standard costing as a management tool
 Limitations of standard costing
 Meaning of standard costs
 Familiarization with setting of standards for costs and sales.

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