Standard Costing: Accounting Tools

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Introduction

* Meaning of Standard Costing:
Standard costing is simply the name given to a technique whereby standard costs are computed and subsequently compared with the actual costs to find out the differences between the two. These differences are then analyzed to know the causes thereof so as to provide a basis of control.

* Standard Costing:
According to BROWN and HOWARD “Standard costing is a technique of cost accounting which compares the standard cost of each product or service with the actual costs, to determine the efficiency of the operations so that any remedial action may be taken immediately”.

* Standard Cost:
A standard cost is a planned cost for a unit of product or service rendered. Standard costs represent excellent target costs that should be obtained. The institute of Cost and Management Accountants (UK) defines standard cost as “a predetermined cost, which is calculated from the management’s standard of efficient operation and the relevant necessary expenditure. It may be used as a basis for price fixing and for cost control through variance analysis.”

* Advantages of Standard Costing:
The advantages to be derived from a system costing will vary from one business to another. Much depends upon the degree of sophistication achieved and the acceptance by the management of utility of the system. Some of the advantages are as follows:- 1. Effective cost control: The most important advantage of standard costing is that it facilities the control of costs. Control is exercised by comparing actual performance with standards and taking action on the basis of variances so revealed. 2. Help in planning: Establishing standards is a very useful exercise in business planning with instills in the managements a habit of thinking in advance. 3. Provides incentives: The standards provide incentives and motivate to work with greater effort. Schemes may be formulated to reward those who achieve or surpass the standard. This increases efficiency and productivity. 4. Fixing prices and formulating policies: Standard costs are a valuable aid to management in determining prices and formulating production policies. For instance: - prices may be fixed by adding a standard margin of profit in standard cost. Similarly, standard costing furnishes cost estimates while planning production of new products.

* Disadvantages of Standard Costing:
Standard costing system suffers from certain disadvantages. This may be because of lack of education and communication and resultant misunderstanding on the part of managerial staff. Some of the disadvantages are:- 1. The system may not be appropriate to the business.

2. The staff may not be capable of operating the system.
3. A business may not be able to keep standards up-to-date. In other words, a business may not revise standards to keep pace with the frequent changes in manufacturing conditions. Firms may avoid revising standards as it is a costly affair. 4. Inaccurate and unreliable standards cause misleading results and thus may not enjoy the confidence of the users of the system.

* Setting of Standard Costs
The success of standard costing system depends on the reliability, accuracy and acceptance of the standards. Extreme care, therefore, must be taken to ensure that all factors have been considered in the establishment of standards. Standard costs are set for each element of cost i.e. direct materials, direct labour and overheads. These are described below:- * Setting standards for direct materials

* Material price standard.
* Material quantity standard.

Material price standard
This is a forecast of the average prices of materials during the future period. This standard is quite difficult to establish because prices are regulated more by the external factors than by the company management. The purchasing department notifies the standard prices after considering factors like:- a)...
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