Standard costing – is a technique which establishes predetermined estimates of the cost of products and then compares these predetermined costs with actual costs as they are incurred. The predetermined costs are known as standard costs and the difference between standard cost and the actual cost is known as a variance. The process by which the total difference between the standard cost and actual cost is broken down into its constituent parts is known as variance analysis.
Basic standards – these are long term standards which would remain unchanged over the years. Their sole use is to show trends over time for items such as material prices, labour rates, and efficiency and to show the effect of changing methods. They cannot be used to highlight current efficiency or inefficiency and would not normally form part of the reporting system.
Ideal standards – these are based on the best possible operating conditions. Such standards therefore assume no machine breakdowns, no material wastage, no stoppage or idle time. It assumes perfect efficiency. Ideal standards are unattainable in practice and therefore not very popular.
Attainable standards – this is a standard based on efficient but not perfect operating conditions. Such a standard would include allowances for normal material losses, realistic allowances for fatigue, machine breakdowns etc. attainable standards provide a tough but realistic target and thus can provide motivation to the management.
Advantages of standard costing
- Standard costing is an example of “management by exception”. By studying the variances, management’s attention is directed towards those items which are not proceeding according to plan.
- The process of setting, revising and monitoring standards encourages re-evaluation of methods and techniques leading to cost reduction
- Standard cost provides a better guide to pricing than historical cost.
- A properly developed standard costing system with full participation and involvement creates a positive cost effective attitude through all levels of management right down to the shop floor.
Disadvantages of standard costing
- It may be expensive and time consuming to install and maintain
- In volatile conditions with rapidly changing methods, rates and prices, standards quickly become out of date and thus lose their control and motivational effects.
- Standards only focus on financial data while other significant non-financial data can also affect efficiency of operations e.g. lead times, customer satisfaction, service quality etc.
