Standard costing is pre-determined cost.
It is determined in advance of production like cost of materials, wages or labour, overheads etc.
It is a management accounting tools for management control.
It is applied to compare the actual cost with variance.
It is used for following process:
Establishment of standard cost
To find out actual cost
To compare and measurement of variance
Analysis of variances
Reporting to related center for taking action
Definition of standard costing
According to ICMA, London, “A pre-determined cost based on technical estimate of materials, labour and overhead for specific time and work is standard costing.”
Materials
In manufacturing company, materials and labour are the most important factors for the production.
Raw materials are converted into semi-finished goods and finished goods with the help of labour.
While manufacturing the goods, all the input goods are NOT output or yield.
There are normal and abnormal losses.
When the company cannot stop or control loss of goods in natural basis; it is called normal loss.
Normal losses are weight loss, shrinkage, evaporation, rust etc.
When the company can stop or control loss but could not control, it is known as abnormal loss.
Abnormal loss is due to carelessness, fatigue, rough handling, abnormal or bad working condition, lack of proper knowledge, low quality raw materials, machine break down, accident etc.
We will study following materials variances in this topic:
Materials cost variance
Materials price variance
Materials usage variance
Materials mix variance
Materials yield variance
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Labour
In every manufacturing company and business organization needs human being resources.
These human beings may be the resource of administrators and labour.
Without labour, a manufacturing company cannot complete its production.
It is saying, “Talented, caliber and skilled manpower is the other assets of the business organization.”
There are three types of labour.
They are unskilled labour, semi-skilled labour and skilled labour.
Unskilled labour gets fewer wages but skilled labour gets the highest wages.
The payment made to the labour in exchange for its service is called labour cost.
It is a major part of the total cost of production.
Labour cost is also commonly called wages.
Labour cost or wages is one of the major elements of cost.
Labour cost represents the expense incurred on both direct and indirect labour.
Unproductive time is known as idle time.
It may be due to normal or abnormal reasons.
In idle time, workers have been paid without any production activity.
To identify the reasons for the idle time in the factory, an idle time card is maintained.
We will study following labour variances in this topic:
Labour rate variance
Labour efficiency variance
Labour idle time variance
Labour mix variance
Labour yield variance
Labour cost variance
Keep In Mind (KIM)
Cost variance |
Overhead cost variance (OCV): |
Materials cost variance (MCV) |
Three overhead variances are: |
Labour cost variance (LCV) |
Spending variance (SV) |
Overhead cost variance (OCV) |
Efficiency variance (EV) |
|
Capacity variance (CV) |
|
|
Materials variance (MCV) |
Labour variances |
Materials cost variance (MCV) |
Labour rate variance (LRV) |
Materials price variance (MPV) |
Labour efficiency variance (LEV) |
Materials usage variance (MUV) |
Labour idle time variance (LITV) |
Materials mix variance (MMV) |
Labour mix variance (LMV) |
Materials yield variance (MYV) |
Labour yield variance (LYV) |
|
Labour cost variance (LCV) |
Standard costing is very effective tool to control element of cost like direct cost and overhead.
The following preliminaries should be established:
Establishment of cost center
Types of standard
Setting the standard
Cost center is a location, person or item of equipment that ascertains or uses for the purpose of cost control.
Establishment of cost centers is necessary for fixing responsibilities.
The main objectives of cost account are:
Who or which department will do the work.
Who or which department will do the expenses.
Who or which department will control unfavourable variances.
Who or which department will bills receivable responsible etc.
Current standard
The standard fixed for short period is known as current standard.
It reflects the work performance.
It is not suitable for long period.
Generally, it is based on one accounting year period.
Ideal or perfect standard
It presents high level of efficiency.
Under this, everything should be perfect.
Such as best quality materials, expert labour, modern technology machines, time management, minimum loss of materials etc.
It is only hypothesis or theory.
It is not realistic and practicable.
Expected standard
It is based on past performance and present condition.
It is prepared for future but based on present.
If there is any changing in planning, it is modified.
Basic standard
If standard is maintained for long time, it is called basic standard.
These standards are revised only in changing of materials and technology.
Basic standard can’t serve for cost control because it is not revised for long time.
Normal or average standard
It is based on one trade circle.
Generally, trade circle is 7 to 10 years.
It may be difference than actual because it is based on average as well as for long time.
There are various types of standards.
Out of them, some important standard are direct materials, direct labour and direct overhead.
Direct material
Products are made by raw materials.
Raw materials are called direct materials.
Direct materials are based on standard quantity and standard rate.
While producing the goods, not only quantity is fixed but also rate of materials are fixed.
Direct labour
Under direct labour, standard time and standard wages are fixed.
Then time and motion study is analyzed.
Time can be fixed from past data.
Direct overhead
Under overhead, all the expenses except direct material and direct wages are included.
Both standard costing and budgetary control have same objectives of maximum efficiency and cost reduction.
It is possible by pre-determined standard and comparison with actual cost.
Although both are useful tools for management yet there are some differences.
Differences between Standard Costing and Budgetary Control
Bases |
Standard Costing |
Budgetary Control |
Based |
Standard costing is based on technical assessment. |
Budgetary control can be prepared on the basis of past figures adjusted to future trends. |
Covering |
It fulfills various product costing or element of cost only. |
It covers production, sales, purchase, cash, income, expenditures etc. |
Applicable |
It is applicable to manufacturing company, production or service. |
It is applicable almost all business organizations. |
Depends |
It is based on budgetary control. In the absence of budgetary control, standard costing cannot exist. |
Budgetary control has separate existence; It is not based on standard costing. |
Total or per unit |
Standard costing works on per unit of production or service. |
Budgetary control works on specific period with total amount. |
The main advantage of standard costing are:
The main objective of standard costing is to know perform evaluation established by management.
It minimizes the wastage by detecting variances and suggests to correction.
Under standard costing, cost centers are established.
The related cost department and persons are responsible for cost control.
Standard costing encourages to control unfavourable variances.
It helps to management attention toward not proceeding according to plan.
It is effective tool for business planning, budgeting, marginal costing, inventory valuation etc.
It provides a basis for incentive wage scheme to workers and supervisors etc.
The main disadvantage of standard costing are:
Standard costing system is not suitable for small industries because it needs high degree skill and cost.
It controls the operating part of organization but it ignores other items like quality, lead time, service, customer satisfaction etc.
It is useless where ‘just in time’ principle is adopted.
It may not be very effective where non-standard products are manufactured or service rendered.
Difference between planned cost and actual cost is variance.
If actual cost is less than planned, it is favorable variance.
On the contrary, if actual cost is more than planned, it is unfavorable variance.
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