Standard costing

Standard costing is a technique of costing which is used to compare the costs and revenues associated with a product with the actual results and determining the variances. It analyses the productivity of an organization.

Standard costing focuses on measuring the performance, controlling the deviations, inventory valuation, and deciding the selling price of the product.

Need for Standard Costing

  1. Standard costing helps in estimating the future costs for the company because it is prepared after considering all the possibilities that may arise in the future. It also tells whether a company should undertake a project or not.

  2. It helps in doing a performance check of the work. It helps in comparing the performance with actual results.

  3. Standard costs help in preparing a budget and evaluate the performance on the basis of this budget.

Process of Standard Costing

Following are the steps which are to be taken while doing standard costing-

  1. Establishing Standards – The first step is to set the standards on the basis of management’s estimation. Basically standards are set considering the past data, future trends, and production plan.

  2. Determination of Actual Costs – When the standards are set the second step is to determine the costs for each element like material, labor, and overhead.

  3. Comparison of Actual Costs and Standard Cost – The next step is to compare the standard cost with the actual cost to determine the variances.

  4. Determination of Causes – Once the comparison is done, the next step is to find out the reason for the variance so that corrective measures can be taken.

  5. Disposition of Variances – The last step involves the disposition of variances by transferring it to the profit and loss account.

Difference between Standard Cost and Estimated Cost Estimated Cost Standard Cost Estimated costs are primarily the result of an attempt to determine what the actual cost will be. Standard costs are intended to tell what the actual cost should be Estimated cost can be used in any business which is running under a historical costing system. The standard costs can be applied in business under a standard costing system. The estimated costs are used as statistical data only. Standard costs are used as regular system accounts from which variances are found out.Estimated costs can be ascertained for a part of the business also and for a practical purpose. Standard costs are to be fixed in respect of every element of cost and therefore, it incorporates the whole of the manufacturing process. Estimated costing simply plans the affairs. Standard costing besides planning acts as a dynamic instrument of measurement of performance, comparison, and control.

Establishing Standard Costing System

Establishing a standard costing system requires the following requisites for accomplishing the desired results.

  1. Acceptance of the system – The standard costing systems only give desired results when it is acceptable by both management and the workers. Both parties should take enough interest in the system to make it effective.

  2. The judicious setting of standards – The standards should be fixed after a careful study of all technical processes and operations of a business. They should be fixed judiciously and they should neither be too high nor be too low. It should be achievable.

  3. Reasonable size – The system can prove to be an advantage in businesses that are of reasonable size. The system may not be suitable for small businesses since in their case careful scheduling of production may not be possible.

  4. Competent staff – The successful operation of the technique requires the existence of well-qualified staff for fixing the standards and measuring performance and reporting variances at different levels.

  5. Existing of budgetary control system – Existence of budgetary control system is a prerequisite for the standard costing system. The Budget sets the targets which the executive has to achieve. They create a sense of discipline among all the employees.

  6. Proper delegation of authority – Standard costing system requires proper delegation of authority and responsibility at different levels. This can be done by drawing an organization chart clearly dictating the responsibilities and authority of all the employees.

Read Next: Variance Analysis, CVP Analysis

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