Standard Costing: Meaning, Features, Variance Analysis, Advantages, Limitations, Formula

standard costing system

Standard cost, or “pre-set costs,” gives the basis for budgeting and reduces unpredictability to some extent. Standard cost accounting can hurt managers, workers, and firms in several ways. For example, a policy decision to increase inventory can harm a manufacturing manager’s performance evaluation. Increasing inventory requires increased production, which means that processes must operate at higher rates.

standard costing system

The company uses standard cost to establish benchmarks for performance, cost allocation, budgeting, deciding sales price, and decision-making. When cost accounting was developed in the 1890s, labor was the largest fraction of product cost and could be considered a variable cost. Workers often did not know how many hours they would work in a week when they reported on Monday morning because time-keeping systems (based in time book) were rudimentary. Cost accountants, therefore, concentrated on how efficiently managers used labor since it was their most important variable resource. Now, however, workers who come to work on Monday morning almost always work 40 hours or more; their cost is fixed rather than variable. However, today, many managers are still evaluated on their labor efficiencies, and many downsizing, rightsizing, and other labor reduction campaigns are based on them.

Management Planning

This method tended to slightly distort the resulting unit cost, but in mass-production industries that made one product line, and where the fixed costs were relatively low, the distortion was very minor. The management in a company use costing systems to identify the operation costs and the performance costs. Costing systems mainly provide data for operation costs which offer management a list of all expenditure connected to a given operation within the company. Costing systems also return information about performance costs. Here managers are able to understand the expenditures that affect the company’s profitability (Horngren & Foster, 1991). Activities which do not contribute much to the total profits can be removed and alternative activities implemented.

These standards represent the cost performance which should normally be attained. (h) are not revised unless the products or the manufacturing operations or processes are changed. (a) These standards provide definite goals for short periods, which employees can usually be expected to reach. They also appear to be fair bases with which the current performance is measured.

See this term in action

(ii) Valuable Guidance – They provide a valuable guidance to management in the formulation of price and production policies. It is costly, as the setting of standards needs high technical skill. It facilitates timely cost reports to management and a forward-looking mentality is encouraged at all levels of the management. It is a basis for the implementation of an incentive system for the employees. It indicates the cost of capacity available but not utilised or not utilised efficiently and is considered the responsibility of the top management. Practical difficulties to be faced while setting physical standards vary from industry to industry.

Both budgets and standard costs make it possible to prepare reports which compare actual costs and predetermined costs for management. Nearly all companies have budgets and many use standard cost calculations to derive product prices, so it is apparent that standard costing will find some uses for the foreseeable future. In particular, standard costing provides a benchmark against which management can compare actual performance.

Create your free account now

Standard costing is the practice of substituting an expected cost for an actual cost in the accounting records. Subsequently, variances are recorded to show the difference between the expected and actual costs. Material cost variance is the difference between the actual direct material cost incurred and the standard direct material cost specified for the production achieved.

  • Writing this paper presented many challenges despite the numerous materials on the subject.
  • Minor changes can be taken care of by variance analysis, but major changes in method of production may necessitate prompt revision.
  • It includes (1) Determination of standard quantity of material required, and (2) Determination of standard price per unit of material.
  • In sum, managers should exercise considerable care in their use of a standard cost system.
  • These standards may be good to spotlight trends, but they cannot form basis to gauge efficiency.
  • The name of the variance is self-explanatory, denoting the differences between the standard cost of Materials and the actual cost of materials.

Budget planning is undertaken by the management at different levels at periodic intervals to maximise profit through different product mixes. To help the management in formulating production policy and helps in fixing the price quotations as well as in submitting tenders of various products. Through the application of this costing it can be ascertained whether or not the activities of production are going on according as the pre‐determined plan.

Join PRO or PRO Plus and Get Lifetime Access to Our Premium Materials

Price of material in the past, current prices and fluctuating trends are the base for determining standard of price. After establishing the standard quality of material, it is more important and necessary to establish the standard regarding quantity of each material. Generally, quantities are expressed in terms of kilograms, feet, units and so forth.

When all the standard costs have been determined, a Standard Cost Card is prepared for each product or service. The process of setting standards for materials, labour and overheads results in the establishment of the standard cost for the product. Standard costing involves setting up of benchmarks that specify the expected cost of products manufactured by a company. The standard costing system was developed in the early 1900’s and has been used as a means of control by many companies. The system generally works best in companies whose production functions are simple and repetitive e.g. manufacturing companies.