What is the standard cost?
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 cost –control, the technique is known as standard costing.
Definition of Standard Cost and 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.
Meaning of Standard Costing
Standard Costing is the preparation of standard costs and applying them to measure the variations from the actual cost and analysing the cause of variations to maintain maximum production efficiency. It is a technique that uses standards for cost and revenues for 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 costs are used as a baseline against which real costs may be compared in order to determine the source of inefficiency in the system. It follows that the real costing system must always be considered, even if a traditional accounting method is employed. This system of costing may be advantageous in any business; however, it is most commonly used in industries that create standard commodities that are comparable in nature. Therefore, standard costing is more common in the process and engineering sectors, but is useless in the task order industry.
Even in jobbing industries where jobs vary significantly, there is a considerable possibility for implementing this costing system. While the product in many businesses may not be repetitive and standard, the activities required to do the task are, and standards can be established for the processes conducted.
The standard cost of the project can be determined by aggregating the standard costs of the job’s operations. Comparing the actual cost of operations to the standard cost of operations will assist in controlling the cost of operations and, thus, the work cost.
Advantages of Standard Costing
- Cost control – it would show variances and underlying causes thereof. Thus, management can better control the cost.
- Easy identification of sources of losses and wastages – A well functioning standard-costing system will allow tracking the expense heads leading to losses and wastages. Thus, appropriate steps can be taken.
- Proper inventory valuation – The effect of historical cost is eliminated in this costing approach, thus leading to more accurate valuation.
- Enhanced efficiency of operations
- Integration of accounts