Standard cost is a predetermined cost. It is a determination in advance of production, of what should be that cost. When standard costs are used for the purpose of cost –control, the technique is known as the standard costing. The costing terminology of the Chartered Institute of Management Accountants, London defines a standard cost and standard costing as follows:
“A determined calculation of how much costs should be under specified working conditions. It is built up from on assessment of the value of cost elements and correlates technical specifications and the quantification of material, labour and another cost to the prices and or wages rates expected to apply during the period in which the standard cost is intended to be used. Its main purposes are to provide bases for control through variance accounting for the valuation of stock and work in progress and in some cases, for fixing selling prices.”
Eric l. Kohler has defined standard cost as follows:
“Standard cost is a forecast or pre-determination of what actual cost should be under projected conditions, serving as a cost and as a measure of production efficiency or standard of comparison when ultimately aligned against actual cost. It furnishes a medium by which the effectiveness of the current result can be measured and the responsibility for deviations can be placed”
The main points in the above definition are:
- It is a pre-determined calculation of what cost ought to be under specific working conditions.
- It is built up by correlating standard quantity (of machine time, the labour time and material) and forecast of the future market trend for price standards (I.e., prices for materials wage rates and machine cost per hour etc.)
- It provides the basis for control through variance accounting.
- It provides the basis for valuation of stock and works- in progress and in some cases for fixing selling prices.
Standard Costing is the preparation of standard cost and applying them to measure the variations from actuals cost and analysing the cause of variations with a view to maintaining maximum efficiency in production. It is a technique which uses standards for cost and revenues for the purpose of control through variance analysis.
- Ascertainment of standard costs under each element of cost i.e., materials, labour and overhead.
- Measurement of actual costs.
- Comparison of the actual costs with the standard costs to find out the variances.
- Analysis of variances for the purpose of ascertainment of the reason for variances for taking. The appropriate action where necessary so that maximum efficiency may be achieved.
Standard costing is a technique which is complementary to the actual costing or historical costing system. Standard cost serves as yardsticks against which actual cost are compared to know the reason for inefficiencies. Therefore, actual costing system cannot be ignored even if the standard costing system is adopted.
The system of standard costing can be useful in all types of industries, but it is more commonly used in industries producing a standard product which are respectively in nature. Thus, standard costing is more widely applied in process and engineering industries and is not suitable for job order industries.
Even in jobbing industries where jobs differ from each other, there is considerable scope for the use of this system of costing. Though the product in such industries might not be of a repetitive and standard nature still the operations performed for the compilation of the job would be of a repetitive nature and standard can be laid down for the operations performed.
The standard cost of the job can be ascertained by adding up the standard cost of the operations involved in the job. Comparison of the actual cost and the standard cost of the operations will be helpful in controlling the cost operations and therefore, of job cost too.