Standard costing introduction
It is a technique of costing that uses typical expenses. ICMA, London defines Standard Costing as “the preparation and use of standard costs, their comparison with actual costs, and the analysis of variances to their causes and points of incidence”.
Wheldon defines cost analysis as the preparation of data to indicate the standard cost, actual cost, and deviation between the two.
On the other hand, W. Bigg states: “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.”
Standard costing involves establishing and using standard costs, recording actual costs, comparing them to standard costs, analyzing variance, and taking appropriate action.
Standard costing has two objectives: (a) implementing a budget management system and (b) evaluating performance.
(c) It provides methods for appropriately using material, labor, and overhead in an economically sound manner.
(d) It also helps to drive workers of a company to improve their performance by establishing a’standard’.
(e) It also assists management in providing relevant cost-related data for submitting bids or determining a firm’s selling price.
(f) It also assists management in accurately valuing inventories (work-in-progress and completed items).
(g) It serves as a control device for the management.
(h) It also enables management to make different corrective choices, such as price fixing, make-or-buy decisions, and so on, that will benefit the organization.
Development of Standard Costing:
The importance of standard costing cannot be overstated for the following reasons, which are why it is widely used in today’s world:
(i) Compiling historical costs is quite costly and complicated.
A manufacturing business that produces a big number of parts needs a lot of administrative work to assemble the materials, labor, and overhead expenditures for each and every component produced in order to determine the average cost of the product.
(ii) Historical costs are insufficient.
Historical expenses are not a good indication of production efficiency. It does not explain why the costs have grown or how the cost structure has changed.
(iii) Historical costs are too old.
Many businesses decide expenses and selling prices before manufacturing begins, which is undesirable.
(iv) The historical costs are not average.
This is owing to the market’s vast volatility, with no relationship between selling price per unit and cost price per unit.
Advantages of Standardized Costing:
(i) Standard costing guides management in developing pricing and production strategies.
Standard costing allows for more efficient cost management by reviewing and analyzing at regular intervals for improvements. Taking fast action on deviations from standards may lead to cost reductions.
(iii) Analyzing and measuring variation identifies inefficiencies and errors, allowing management to address root causes.
(iv) Standard expenses are ideal for planning and budgeting since they are established. It also aids in estimating the impact of changes in the Cost-Price-Volume connection, which helps management make future decisions.
(v) Setting standards for products, components, materials, and processes enhances manufacturing efficiency, decreases costs, and raises profits.
(vi) Implementing the Standard Costing System may save money by eliminating most cost-related tasks.
To effectively delegate power and responsibility, define standards for each cost center so that supervisors and executives are aware of the standards they must uphold.
(viii) This method facilitates timely preparation of Profit and Loss Accounts for short periods, allowing management to make informed choices.
(ix) Standard costing is utilized for inventory value. Stock may be valued at standard cost, which reduces profit fluctuations due to various valuation methodologies.
(x) Increased labor efficiency.
(xi) The method promotes cost-consciousness among workers, executives, and senior management, resulting in increased efficiency and production.
Disadvantages of Standard Costing
(i) Standard costing is pricey due to the high level of technical competence required. As a result of their low financial resources, small organizations are unable to implement the system. However, once deployed, the advantages will far outweigh the hefty initial expenditures.
(ii) Executives are responsible for any deviations resulting from acts under their control. Thus, in order to reconcile the obligations, it is required to divide variations into non-controllable and controllable sections, which is not a simple process.
(iii) Business situations always change, thus standards must adapt accordingly. So, criteria must be updated to be equivalent to real outcomes. However, modification of standards causes several issues, notably in inventory adjustment.
(iv) Standards are either excessively permissive or restrictive as they are based on average historical achievements, achievable excellent performance, or theoretical maximum efficiency. As a result, setting very high expectations will have a negative impact on staff morale and motivation.