Standard Costing: Definition, Features, Advantages, Disadvantages

  • Post last modified:10 March 2021
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What is Standard Costing?

Standard costing is a perfect system of controlling the costs and measuring efficiency and its development. It is a technique of cost reduction and cost control. It helps to provide valuable guidance in several management functions such as formulating policies, determining price level, etc.

The essence of standard costing is to set objectives and targets to achieve them, to compare the actual costs with these targets. Standard Costing is used to ascertain the standard cost under each element of cost, i.e., materials, labours, overhead.

Standard Costing can eliminate all kinds of waste. Through the application of this costing it can be ascertained whether or not the activities of production are going on according as the pre‐determined plan.

Definition of Standard Costing

Define Standard Costing as, “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 operation so that any remedial action may be taken immediately” Brown and Harward
Standard Costing is “the preparation and use of standard costs, their comparison with actual cost and the analysis of variance to their causes and points of incidence”. CIMA, London

Features of Standard Costing

With the help of above definitions the following Features of Standard Costing can be pointed out:

  1. In Standard Costing all costs are pre-determined in advance. These predetermined costs are compared with the actual costs incurred. The difference between the standard cost and the actual cost is known as the Variance. These variances are then analysed and reasons found out for taking corrective action.

  2. The standards are set based on the past records and performances.

  3. Comparison between actual performance and standard performance is shown by way of reports which are presented to the top management.

  4. Analysis of variances are made for taking appropriate action according to the nature of expenses, i.e. controllable and uncontrollable.

  5. In case of controllable costs if there is adverse variance, efforts are taken to prevent its recurrence. But in case of uncotrollable costs, the standards are revised.

  6. Standard Costing may be applied to any industry.

Objectives of Standard Costing

The Objectives of Standard Costing technique are as follows:

  1. Cost Control
  2. Management by Exception
  3. Develops Cost Conscious Attitude
  4. Fixation of Prices
  5. Fixing Prices and Formulating Policies
  6. Management Planning

Cost Control

The most important objective of standard cost is to help the
management in cost control. It can be used as a yardstick against which actual costs can be compared to measure efficiency.

The management can make comparison of actgual costs with the standard costs at periodic intervals and take corrective action to maintain control over costs.

Management by Exception

The second objective of standard cost is to help the management in exercising control over the costs through the principle of exception.

Standard cost helps to prescribe standards and the attention of the management is drawn only when the actual performance is deviated from the prescribed standards. It concentrates its attention on variations only.

Develops Cost Conscious Attitude

Another objective of standard cost is to make the entire organisation cost conscious. It makes the employees to recognise the importance of efficient operations so that costs can be reduced by joint efforts.

Fixation of Prices

To help the management in formulating production policy and helps in fixing the price quotations as well as in submitting tenders of various products.

This can be done with accuracy with standard cost than the actual costs. It also helps in formulating production policies. Standard costs removes the reflection of abnormal price fluctuations in production planning.

Fixing Prices and Formulating Policies

Another object of standard cost is to help the management in determining prices and formulating production policies. It also helps the management in the areas of profit planning, product-pricing and inventory pricing etc.

Management Planning

Budget planning is undertaken by the management at different levels at periodic intervals to maximise profit through different product mixes.

For this purpose, it is more convenient using standard costing than actual costs because it is done on a scientific and rational manner by taking into account all technical aspects.

Advantages of Standard Costing

In the areas of Accounting, Cost Accounting and Management Accounting, Standard Costing enjoys a significant place in acting as a cost controlling and cost reducing managerial tool. The utility of standard costing is unlimited. The following are some important merits.

  1. Proper Planning
  2. Efficient Cost Control
  3. Motivational Factor
  4. Comparison of Forecasting and Outcome
  5. Inventory Control
  6. Economical System
  7. Helpful in Budgeting
  8. Helps Formulate Policies
  9. Helps Distinguish Activities
  10. Eliminates Wastage

Proper Planning

Standard Costing helps to apply the principle of “Management by exception”. That is, the management need not worry over those activities which proceed in tandem plans. It is only on the issues of exceptions that they have to concentrate.

Efficient Cost Control

Standard Costing is a tool for the management to gain reduction in the cost and control over it. Under this technique, differences are analyzed and responsibilities are determined.

Motivational Factor

Labour efficiency is promoted and they are destined to be cost conscious. Standards provide incentives and motivation to work with greater effort. This increases efficiency and productivity.

Comparison of Forecasting and Outcome

A target of efficiency is set for the employees and the cost consciousness is stimulated. Since the process of standard costing allow an appraisal to be made of personnel, machines and method of working, current inefficiencies come to the notice and get eliminated.

Inventory Control

Standard costing facilitates inventory control and simplifies inventory valuations. This ensures uniform pricing of stocks in the form of raw materials, work‐in‐progress and finished goods.

Economical System

Standard costing system is economical system from the viewpoint that it does not require detailed records. It also des not require a big staff. It results in the reduction in paper work in accounting and needs very few records. Thus, there is saving of time as well as money.

Helpful in Budgeting

Budgets are prepared on the basis of standard costing. Standards which are set up in respect of materials, labour and overheads, are helpful in preparing various budgets. For example, flexible budget, sales budget, etc.

Helps Formulate Policies

This technique is a valuable aid to the management in determining prices and formulating production policies. Standard costing equips cost estimates while planning the production of new products.

Helps Distinguish Activities

Standard costing helps in distinguishing between skilled and unskilled activities. So the skilled worker only gives pays attention to improving the activities of the unskilled workers.

Eliminates Wastage

Through fixing standards, certain waste such as material wastage, idle time, lost machine-hours, etc. is reduced.

Disadvantages of standard costing

Following are some of the limitations or disadvantages of standard costing:

  1. Costly System
  2. Difficulties in Fixation of Standard
  3. Constraint for Service Industry
  4. Consistency of Standard
  5. Unsuitable for Non‐standardised Products
  6. Relatively Fixed Standards
  7. Difficulties for Small Industries
  8. Discouragement for Workers
  9. Inaccurate Diverse Results

Costly System

Because the Standard Costing requires highly skillful and competent personnel, it becomes a costly system too. For the same experts are paid high remuneration.

Difficulties in Fixation of Standard

It is always difficult to determine precise standard costs in a given situation which will coincide with actual cost when operations are over. Standard cost are determined partly by the past experience and partly by the cost projections based on advanced statistical techniques. Thus, uncertainties revolve around standards.

Constraint for Service Industry

Standard costing is applied for planning and controlling manufacturing costs. Thus, it cannot be applied in a service industry.

Consistency of Standard

Consistency of Standard because the standards of marginal costing fluctuate and vary time to time, it is difficult to always sustain and continue the same standards.

Unsuitable for Non‐standardised Products

Standard costing is expensive and unsuitable for job manufacturing industries as they manufacture non standardized products such as catering, tailoring, printing, etc.

Relatively Fixed Standards

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.

Difficulties for Small Industries

Difficulties for Small Industries’ establishment of standards and their implementation involve initial high costs. Standards have to be revised and new standards be fixed involving larger costs. Thus, small firms find it expensive to operate standard costing system. This system is not fit for each type of industries.

Discouragement for Workers

Sometimes the employees and workers are discouraged when the standards are fixed at a high level. The unreal high standards may adverse by effect the morale of workers rather than working as an incentive for better efficiency.

Inaccurate Diverse Results

Inaccurate and unreliable standards cause misleading results and thus may not enjoy the confidence of the users of this system.

Difference between Standard Cost and Estimated Cost

These are important point of Difference between standard cost and estimated cost:

S.No.Standard CostEstimated Cost
1.Standard cost aims at what the cost should be.Estimated cost is an assessment of will be.
2.Standard costs are planned cost which is determined on a scientific basis after taking into account certain level efficiency.It is based on the average of past figures, taking into consideration anticipated charges in future.
3.Standard cost lays emphasis on cost control, on setting the target against which actual performance is measured and if need be, corrective measures are sought.Estimated costs are used by the undertakings for fixing the selling price of the product.

Process of Standard Costing

  1. Setting of Standards
  2. Ascertainment of actual costs
  3. Comparison of actual cost with standard cost
  4. Investigate the reasons for variances
  5. Disposition of variances

Setting of Standards

The first step is to set standards which are to be achieved, the process of standard setting is explained below.

Ascertainment of actual costs

Actual cost for each component of cost is as- certained. Actual costs are ascertained from books of account, material invoices, wage sheet, charge slip etc.

Comparison of actual cost with standard cost

Actual costs are compared with the standards costs and variances are determined.

Investigate the reasons for variances

Variances arises are investigated for fur- ther action. Based on this, performance is evaluated and appropriate actions are taken.

Disposition of variances

Variances arise are disposed off by transferring it the relevant accounts (costing profit and loss account) as per the accounting method (plan) adopted.

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