The term standard has been called by different names in accounting e.g. 'a norm', 'a model of example of comparison', a yardstick', 'a bench mark', 'a criterion of challenge', a measure of comparison', 'a gauge', etc. Standard cost is a scientifically predetermined product/service specific cost based on technical specifications, which are arrived at by correlating standard quantities of material, labour, machine utilization etc to the expected prices of materials, wage rates and cost per machine hour, etc. Standards are fixed at efficient level of performance so that achievement of standard requires some effort. However, assumptions regarding the efficiency level expected to be achieved may differ from organization to organization and from time to time. It may be average efficiency, achievable efficiency, or efficiency level achievable under ideal conditions.
CIMA defines standard cost as "a standard expressed in money. It is built up from an assessment of the value of cost elements. Its main uses are providing bases for performance measurement, control by exception reporting, valuing stock and establishing selling prices." Standard costs refer to normal standard cost. They provide for normal wastage, normal break down, normal idle capacity, normal mistakes, and so on. Standard costs are generally established by cost and management accountants in consultation with relevant technical experts and management. Standard cost is determined for each element of cost, i.e., separately for direct material, direct labour and fixed and variable overheads, for detailed analysis.
Standard cost is like a model, which provides basis of comparison for actual cost. This comparison of actual cost with standard cost reveals very useful information for cost control.
STANDARD COSTING THUS INVOLVES THE FOLLOWING
(i) The setting of standards.
(ii) Ascertaining actual results.
(iii) Comparing standards and actual costs to determine the variances.
(iv) Investigating the variances and taking appropriate action where necessary.
Standard costing in practice is a detailed process and requires considerable development work before it is a useful tool. For standard costing to be successful requires reasonable stability and the existence of repetitive work. These conditions can be found across many sectors of the economy. For example in Manufacturing, in Service Industries such as transport, computing and banking, and so on. Its major application in practice is in manufacturing and repetitive assembly work. Use of standard costing is however not confined to industries having homogeneous products only. This technique has established the advantages of its use in industries producing large range of products, e.g., engineering, textile, automobiles.
OBJECTIVES OF STANDARD COSTING
1. To discover the exact cause of deviation of actual costs from standard costs. This enables the management to remove causes of inefficiency or change the standard if necessary
2. To ascertain exact degree of efficiency of various operations through comparison of actual and standard costs.
3. Management is provided with information on those aspects of the business which are not proceeding as planned, so that corrective action can be taken promptly.
4. Management can safety delegate responsibility to the subordinates, since all concerned are told what they have to achieve and by what they will be judged. In this way control itself becomes effective.
5. To disclose the effects of fluctuation in output, sales or profits.
6. A dynamic forward looking mentality is encouraged at all levels of management.
APPLICATION OF STANDARD COSTING
Standard costing is a technique of cost accounting. It is not a method of costing. Therefore standard costing is used with all methods of costing.
In the following areas standard costing is more useful:
1. In case of industries where mass production of homogeneous products takes place, e.g., production of cement, iron and steel, bricks, chemicals, etc.
2. In industries where production processes are of repetitive character
3. In all cases where single, unit or output costing, process costing and operation costing methods are used.
4. Standard costing can be used in case of large number of service industries such as transportation, power generation, gas and electricity supply, etc.
5. Extraction industries such as mining and quarries.
6. Even in case of industries producing large range of products, e.g., engineering, textile, automobiles.
7. In terms of business functions, standard costing is most useful in production function, though it has limited use in other business functions.
8. In public utilities, such as, provision of transportation, supply of gas, electricity and water. However, standard costing is of limited use in case of specific order costing, i.e., where cost units are totally different from each other, such as,
construction of boiler houses, bridges, dams, ship-building.
ADVANTAGES OF STANDARD COSTING
Installation of standard costing system is useful for an organization in many ways discussed below:
1. Effective Cost Control: Technique of Standard Costing provides effective cost control as standard cost is a yardstick against which actual cost can be compared and action taken for variances. This facilitates cost control. Standard Costing is an important tool for achieving control on cost by impressing upon the employees that the costs incurred on production should not exceed the predetermined standards.
2. Preparation of Budgets: Standard costing offers reliable data for preparation of budgets. In fact standard costing and budgeting are complementary.
3. Motivation: When standards the realistic and attaintable, they can stimulate individuals to perform more effectively. Standards provide incentive and motivation to work. It motivates workers to strive for accomplishment of defined targets. This increases efficiency and productivity In all aspects.
4. Minimises Wastage: Use of standard costing leads to effective control on men, material and machines through optimum utilization of men, materials and machine-hours. It provides a check on numerous expenses of production, services, supervision and management, waste of time and materials can easily be detected.
5. Fixation of Price: Standard Costs are useful for cost estimates and price quotations. Standard cost plus a profit margin is a far superior basis for price fixation than actual costs.
6. Inventory Valuation: Value of Stocks on standard cost can be easily ascertained by multiplying the quantity of stock in hand by the standard price.
7. Projection of Profits: System of standard costing facilitates projections regarding costs for various types of productions. The techniques developed for controlling costs also contribute to better management of revenues and making reliable projection regarding profits.
8. Cost Consciousness: The system of standard costing creates an atmosphere of cost consciousness. Employees at different levels in the organization focus on cost economy.
9. Delegation of Authority: Safe delegation of authority and fixation of responsibility is possible when standards are established.
10. Fixation of Responsibility: Ascertainment of favourable and adverse variances and determination of controllability of factors influencing the variances helps in fixing responsibility on various responsible executives.
11. Measurement of Performance: Cost Standards can be an important instrument in evaluating performance. It provides measuring rod for measuring efficiency of different departments of the factory. Actual costs below standard costs indicate efficient performance, and actual costs exceeding standard costs indicate inefficiency.
12. Management by Exception: The system facilitates practice of 'management by exception'. In big concerns, it is not possible for higher levels of management to be intimately aware of the problems and possibilities for improvement of the various functions performed throughout the firm. The management can concentrate on the incidence, causes and consequences of adverse variances only.
13. Standardised Production Method: There will be standardisation of production processes, methods and operations. This assists in managerial planning for efficient operations. It will be a guide to management.
14. Employee Incentive: Standard costing can be used for making incentive payments to employees. Such payment can be linked to the amount of favourable variances.
15. Highlights Effect of Capacity Utilisation: Underutilization of capacity results in adverse capacity variance and attracts attention for finding out ways and means for better utilization of capacity.
16. Timely Reporting: Reporting to management is quicker and prompt under the system of standard costing because the data regarding standard costs, rates and variances are regularly available. As a result inefficiency does not remain hidden for long.
LIMITATIONS OF STANDARD COSTING
Standard costing is a useful technique for planning,
control and decision-making, but it should be used giving regard to following limitations:
1. Difficulty in Setting Standards: Establishment of standards is a difficult task requiring a lot of technical skill, imagination, experience and careful investigation into all aspects of costs. If all these factors are not in harmony, desired results will not be achieved.
2. Anticipated Conditions May not Appear: Standards are set in the light of conditions likely to prevail during the budget period. The actual conditions may be different from those anticipated rendering the standards obsolete.
3. Requirement of revisions: Standards should correspond to current conditions for best results. Current conditions change very rapidly. Revision of standard is a costly exercise and leads to a lot of associated problems. For this reason revision of standards may get ignored. This delay may be disastrous for effectiveness of the system, since old standards do even more harm
4. Frequent Revisions: In a situation where the technology, prices, duties and responsibilities of employees are fast changing, the standards require frequent revisions.
5. Dispute Regarding Bases for Standards: There may be difference of opinion whether the standards should be built around ideal conditions or realistic conditions. Too tough standards may be demoralizing and too lenient standards may fail to infuse efficiency.
6. Determination of Controllability Difficult: Variance analysis is useful, whereas deviations are linked with responsibilities. Cost control through variance analysis requires that causes for variances should be ascertained and segregated into controllable and non-controllable causes. Such segregation is not always easy. As a result fixation of responsibility also becomes difficult.
7. Expensive for Small Firms: Installation of system of standard costing may be too costly for small firms, though affordable for large organizations.
8. Unsuitable for Non-repetitive Operations: It is difficult to use standard costing, when working conditions do not permit standardisation of material contents, labour contents or the use of indirect services relating to different jobs, processes and services. Systems of standard costing cannot be used effectively in case on non-repetitive operations ,such as, contstriction of buildings, bridges, dams, etc.
9. Requires Cooperation at All Levels: Systems of standard costing can be effective only if employees at all levels cooperate in the process of formulating and achieving standards. Lack of interest by appropriate level of management renders the use of standard costing ineffective. 10. Adverse psychological effects on employees: Sometimes, use of standard costing creates adverse psychological effects on employees, if standards are set at a high level.
Inspite of the above limitations, standard costing is widely accepted and used. The advantages of standard costing may outweigh the disadvantages if the business is of Sufficient size to be able to use the variance analysis. The maximum benefit is obtained in industries producing standardised products which are repetitive in nature.