Standard Costing Types: Definition, Setting Standards,

  • Post last modified:20 March 2021
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What is Standard Costing?

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 operation so that any remedial action may be taken immediately.

Standard Costing involves the setting of pre-determined cost estimates in order to provide a basis for comparison with actual costs. A Standard Cost is a planned cost for a unit of product or service rendered. Standard Costing is universally accepted as an effective instrument for cost control in industries. It can be used in conjunction with any method of costing.

However, it is specially suitable where the manufacturing method involves production of standardized goods of repetitive nature.

Definition of Standard Costing

the planned unit cost of the product, component or service produced in a period. The standard cost may be determined on a number of bases. The main use of standard costs is in performance measurement, control, stock valuation and in the establishment of selling prices CIMA Official Terminology

From the above definition Standard costs can be said as

  • Planned cost
  • Determined on a base or number of bases.

Types of Standard Costing

Types of standards are as follow:

  1. Ideal Standards
  2. Normal Standards
  3. Basic or Bogey Standards
  4. Current Standards

Ideal Standards

These represent the level of performance attainable when prices for material and labour are most favourable, when the highest output is achieved with the best equipment and layout and when the maximum efficiency in utilisation of resources results in maximum output with minimum cost.

These types of standards are criticised on three grounds:

  1. Since such standards would be unattainable, no one would take these seriously.
  2. The variances disclosed would be variances from the ideal standards. These would not, therefore, indicate the extent to which they could have been reasonably and practically avoided.
  3. There would be no logical method of disposing of these variances.

Normal Standards

These are standards that may be achieved under normal operating conditions. The normal activity has been defined as “the number of stand- ard hours which will produce at normal efficiency sufficient good to meet the average sales demand over a term of years”.

These standards are, however, difficult to set because they require a degree of forecasting. The variances thrown out under this system are deviations from normal efficiency, normal sales volume, or normal production volume.

If the actual performance is found to be abnormal, large variances may result and necessitate revision of standards.

Basic or Bogey Standards

These standards are used only when they are likely to remain constant or unaltered over a long period. According to this standard, a base year is chosen for comparison purposes in the same way as statisticians use price in- dices. Since basic standards do not represent what should be attained in the present period, current standards should also be prepared if basic standards are used.

Basic standards are, however, well suited to businesses having a small range of products and long production runs. Basic standards are set, on a long-term basis and are seldom revised. When basic standards are in use, variances are not calculated. Instead, the actual cost is expressed as a percentage of basic cost.

The current cost is also similarly expressed and the two percentages are compared to find out how much the actual cost has deviated from the current standard. The percentages are next compared with those of the previous periods to establish the trend of actual and current standard from basic cost.

Current Standards

These standards reflect the management’s anticipation of what actual costs will be for the current period. These are the costs which the business will incur if the anticipated prices are paid for the goods and services and the usage corresponds to that believed to be necessary to produce the planned output.

The variances arising from expected standards represent the degree of efficiency in usage of the factors of production, variation in prices paid for materials and services and difference in the volume of production

Setting Standards

The process of setting standards is a valuable activity in itself. The success of standard costing system depends on the reliability, accuracy and acceptance of the standards.

If standards have been properly set and maintained, they are a sound basis for determining cost for various purposes. While setting the standards, the following points should be taken into consideration: duration of use of standard, reasonable standard of performance, level of activity.

For the given units standard sets for the following items are:

  1. Direct Material Cost
  2. Direct Wage Cost
  3. Direct Expense
  4. Factory Variable Overhead Cost
  5. Selling and Distribution Variable Cost
  6. Selling Price and Sales Margin

Standards for Material

It includes (1) Determination of standard quantity of material required, and (2) Determination of standard price per unit of material.

Material Quantities

After establishing the standard quality of material, it is more important and necessary to establish the standard regarding quantity of each material. Generally, quantities are expressed in terms of kilograms, feet, units and so forth.

Standards for Labour

This standard is determined with regard to the current rate of pay and any anticipated variations. It should be fixed for each grade of labour and for each operation involved. The standard hours are fixed for all categories of labour i.e., for skilled and unskilled labour. In these standards, number of hours and workers are established.

Material Prices

This is a forecast of the average prices of material 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. While setting standard prices, the past experiences, existing prices and anticipations should closely examine.

Price of material in the past, current prices and fluctuating trends are the base for determining standard of price.

Setting for Overheads

Setting standard for overheads is more complex than the development of material and labour standards. It is estimated for variable overheads and fixed overheads.

  • Variable Overheads: It may be recalled that variable overhead has been defined as a cost which tends to vary directly with the volume of output. It is assumed that the overhead rate per unit is invariable, irrespective of the quantity produced, so it is necessary to calculate only a standard cost per unit or per hour.
  • Fixed Overheads: Fixed overhead tends to be unaffected by variations in the volume of output. Therefore it is required to determine total fixed overhead for the period and budgeted production in units.

Standard Hour

Production is usually articulated in physical units such as tons, pounds, gallons, numbers, kilograms, liters, etc. When a company is manufacturing different types of products, it is almost impossible to increase the production, which cannot be expressed in the same unit.

Standard hour means a hypothetical hour, which represents the amount of work that should be performed in one hour under standard conditions.

Problems in Setting Standard Costs

The problem involved in setting standard costs include the following:

  1. Deciding how to incorporate inflation into planned unit costs.

  2. Agreeing a labour efficiency standard (e.g. whether current times, expected times or ideal times should be used in labour efficiency standard).

  3. Deciding on the quality of materials to be used, because a better quality of material will cost more, but perhaps reduce material wastage.

  4. Deciding on the appropriate mix of component materials, where some change in the mix is possible.

  5. Estimating materials prices where seasonal price variations or bulk purchase discount may be significant.

  6. Possible ‘behavioural’ problems.

  7. The cost of setting up and maintaining a system for establishing standards

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