Meaning of Standard Cost
It is a method of costing by which standard costs are employed. According to ICMA, London, Standard Costing is “the preparation and use of standard costs, their comparison with actual cost and the analysis of variances to their causes and points of incidence”.
According to Wheldon, it is a method of ascertaining the costs whereby statistics are prepared to show:
(i) The standard cost;
(ii) The actual cost;
(iii) The difference between these costs which is termed the variance.
But W. Bigg expresses:
“Standard Costing discloses the cost of deviations from standards and clarifies these as to their causes, so that management is immediately informed of the sphere of operations in which remedial action is necessary.”
Thus, from the above, it becomes clear that Standard Costing involves:
(i) Ascertainment and use of Standard Costs;
(ii) Recording the actual costs;
(iii) Comparison of actual costs with standard costs in order to find out the variance;
(iv) Analysis of variance; and
(v) After analysing the variance, appropriate action may be taken where necessary.
Objectives of Standard Costing:
The objectives of Standard Costing for which it is implemented are:
(a) It helps to implement budgetary control system in operation;
(b) It helps to ascertain performance evaluation.
(c) It supplies the ways to utilise properly material, labour and also overhead which will be economic in character.
(d) It also helps to motivate the employees of a firm to improve their performance by setting up a ‘standard’.
(e) It also helps the management to supply necessary data relating to cost element to submit quotations or to fix up the selling price of a firm.
(f) It also helps the management to make proper valuations of inventory (viz., Work-in- progress, and finished products).
(g) It acts as a control device to the management.
(h) It also helps the management to take various corrective decisions viz., fixation of price, make-or-buy decisions etc. which will be more beneficial to the firm.
Development of Standard Costing:
Importance of Standard Costing cannot be ignored for the following and that is why the same is well-developed in the present-day world:
(i) Compilation of Historical Cost is very expensive and difficult:
A manufacturing firm making large number of parts requires too much clerical work which is required in order to compile the materials, labour and overhead charges to each and every cost of parts produced for ascertaining the average cost of the product.
(ii) Historical Costs are inadequate:
In order to measure the manufacturing efficiency, historical costs are not practically adequate. It fails to explain the reasons of increased cost or any change in cost structure.
(iii) Historical Costs are too old:
In many firms, costs are determined and selling prices are ascertained even before the production starts—which is not desirable.
(iv) Historical Costs are not typical:
This is due to the wide fluctuation in market for which there is no relation between the selling price per unit and cost price per unit.
Advantages of Standard Costing:
The following advantages may be derived from Standard Costing:
(i) Standard Costing serves as a guide to the management in several management functions while formulating prices and production policies etc.
(ii) More effective cost control is possible under standard costing if the same is reviewed and analysed at regular intervals for improvements and immediate action can be taken if deviations from standards are found out which, ultimately, leads to cost reduction.
(iii) Analysis of variance and its measurement helps to detect inefficiencies and mistakes which enable the management to investigate the reasons.
(iv) Since standard costs are predetermined costs they are very useful for planning and budgeting. It also helps to estimate the effect of changes in Cost-Price-Volume relationship which also helps the management for decision-making in future.
(v) As standard is fixed for each product, its components, materials, process operation etc. it improves the overall production efficiency which also ultimately reduces cost and thereby increases profit.
(vi) Once the Standard Costing System is implemented it will lead to saving cost since most of the costing work can be eliminated.
(vii) Delegation of authority and responsibility becomes effective by setting up standards for each cost centre as the supervisors or executives of each cost centre will know the standard which they have to maintain.
(viii) This system also helps to prepare Profit and Loss Account promptly for short period in order to know the trend of the business which helps the management to take decisions promptly.
(ix) Standard costing also is used for inventory valuation purposes. Stock can be valued at standard cost which can reduce the fluctuation of profit for different methods of valuation for the same.
(x) Efficiency of labour is promoted.
(xi) This system creates cost-consciousness among all employees, executives and top management which increase efficiency and productivity as well.
Disadvantages of Standard Costing:
(i) Since Standard Costing involves high degree of technical skill, it is, therefore, costly. As such, small organisations cannot, introduce the system due to their limited financial resources. But, once introduced, the benefits achieved will be far in excess to its initial high costs.
(ii) The executives are liable for those variances that are found from actions which are actually controllable by them. Thus, in order to fix up the responsibilities, it becomes necessary to segregate variances into non-controllable and controllable portions although that is not an easy task.
(iii) Standards are always changing since conditions of the business are equally changing. So, standards are to be revised in order to make them comparable with actual results. But revision of standards creates many problems, particularly in inventory adjustment.
(iv) Standards are either too liberal or rigid since the same are based on average past results, attainable good performance or theoretical maximum efficiency. So, if the standards are very high, it will adversely affect the morale and motivation of the employees.