Standard Costing: Meaning, Objectives, Types, Advantages and Disadvantages

An inventory account (such as F.G. Inventory or Work-in-Process) is debited for $834; this is the standard cost of the direct materials component in the aprons manufactured in January 2024. 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.

Calculating Standard Costs

• The next step is the classification of accounts of expenses, revenue, or assets under suitable headings and codes e.g., Direct Material OA to OA5.
• Putting material, labor, and manufacturing overhead costs into products that will not end up as good output will likely result in unfavorable variances.
• Likewise, another objective of this costing technique is to motivate employees.
• Better delegation of authority and responsibility – The authority can be delegated and responsibilities fixed for each department or individual on the basis of off-standard performances.
• This does not mean the actual costs will never be used, typically a company’s accountant will periodically update the variances as that information becomes available.

(2) Comparison of actual costs with the pre-determined standards is made, in order to determine variances. The object of standard costing is to plan operations systematically in advance to improve processes, methods and procedures. The purpose is also to secure low costs as well as keeping spoilage, waste and loss to the minimum. Similarly, when establishing a standard costing system, the management of the business should establish different cost centers within the business.

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When a dollar amount is assigned to labor, materials and manufacturing overhead, the budget can be completed. The standards should be fixed after a careful study of all technical processes and operations of the business. They should be fixed judiciously and should not be ideal but capable of being achieved. It will be appropriate to fix the responsibility of setting standards on a committee consisting of important persons such as Production Controller, Purchase Manager, Personnel Manager, Cost Accountant etc.

Classification and Codifications of Accounts:

Carefully planned and operated procedures, as required under this system in respect of recording of prices, time, quantities etc. might not have been adopted. A toning up of the variance analysis system can obviate this difficulty. If due care is taken and caution is exercised on the basis of scientific studies, correct Grocery Store Accounting standards may be set. However, expert knowledge and skill is required for fixing standards.

Tight standards act as disincentive to work and loose ones don’t provide any incentive at all. 3) Facilitation of Principle of Management by Exception – Standard Cost System works on the basis of principle of management by exception. Management needs to give concentration only on those areas where deviations occur, i.e., Actual performance is more or less than standards.

With standard costing, the general ledger accounts for inventories and the cost of goods sold contain the standard costs of the inputs that should have been used to make the actual good standard costing output. Differences between the actual costs and the standard costs will appear as variances, which can be investigated. Moreover, standard costing aids in the valuation of inventory on the balance sheet. By assigning standard costs to inventory items, businesses can maintain a consistent and reliable method for valuing their stock. This approach simplifies the calculation of cost of goods sold (COGS) and ensures that inventory valuations are not subject to frequent fluctuations.

• Because the company actually used 290 yards of denim, we say that DenimWorks did not operate efficiently.
• Furthermore, the management of the business, before setting up a standard cost system, should classify and codify all the relevant costs.
• Calculating inventory using standard costs is easier than using actual costs.
• Keep in mind that the standard cost is the cost allowed on the good output.
• Standard costing is a cost accumulation method that makes use of predetermined amounts known as standard costs.

Greater accuracy – The cost of new products can be estimated with greater accuracy. Work motivation – The standards provide incentive and motivation to work with greater gross vs net effort and care for achieving the standard. (7) Besides those mentioned above, the duration for which the standards are to be used should also be determined in advance. (1) Organisation Structure – Standard costing demands the existence of a sound organisation structure with well-defined authority relationships. The organisation chart showing such relationships is of considerable use in supplying the basic data with regard to different operations and the personnel in-charge of those operations. (8) The variance reports should be prepared in such a way that progress could be known at all levels of management.

Standard costing is used within cost accounting to calculate the expected costs of a product. The objective of this technique may include setting standards for different costs within a business and acting as a monitor and control tool. It can also be used to perform a variance analysis between standard costs and actual costs incurred to identify and inefficiencies within the processes of the business.