Men, machines and materials are more effectively utilised and thus economies can be effected in business together with increased productivity. (6) Review of Cost Accounting System – Standard costing is a projection of the existing system of cost accounting. It is, therefore, necessary to review the existing cost accounting system with particular reference to forms and records so that standard costing can be built upon the cost accounting system. (2) Technical and Engineering Studies – It is absolutely necessary to make a thorough study of the production methods and the processes required. It is equally necessary to have a thorough knowledge of material specifications, material and labour price projections, and work study and work measurement. Losses, both normal and abnormal, in each process should be gone into for a considerable period of time.
- They reflect accepted levels of effectiveness and efficiency.
- Traditional approaches limit themselves by defining cost behavior only in terms of production or sales volume.
- It can be charged to 100% every night without significantly deteriorating the battery over time.
- Budgets are projections for the future and therefore they are of great use to the effective functioning of the standard costing system.
- The system of standard costing, thus, involves various steps—from the setting up of standards to finally exercising control over costs.
This team of experts helps Finance Strategists maintain the highest level of accuracy and professionalism possible. Ideal standards are effective only when the individuals are aware and are rewarded for achieving a certain percentage (e.g., 90%) of the standard. Establishing cost centers is needed to allocate responsibilities and define lines of authority.
Contents
Definition of Standard Cost
In a manufacturing process, there are many variables due to which managers cannot predict the company’s actual costs in a production process. Standard cost, or “pre-set costs,” gives the basis for budgeting and reduces unpredictability to some extent. 4) Yardstick for Comparison – Standard Costing gives a suitable base for comparison of actual performance with predetermined standards. Standards can be fixed for any element of cost e.g., material, labour, overheads etc. The term “cost standard” should now be understood in sequence.
(3) Setting of standards for each element of cost such as material, labour and overheads. Other dictionaries have defined ‘standard’ as a criterion of excellence, “a norm”, “a measure of comparison” and “a model or example for comparison”. “Standard” has been defined in the difference between vertical and horizontal analysis the accounting literature, as “a yardstick”, “a benchmark”, “a gauge”, and “a sea level from which to measure altitudes”. This technique, if implemented in conjunction with the system of budgetary control, provides better and more successful functions of the business.
It includes direct material, direct labor, and manufacturing overhead costs. It is called the predetermined cost, estimated cost, expected cost, or the budgeted cost. In a standard costing system, the standard costs of the manufacturing activities will be recorded in the inventories and the cost of goods sold accounts. Since the company must pay its vendors and production workers the actual costs incurred, there are likely to be some differences. The differences between the standard costs and the actual manufacturing costs are referred to as cost variances and will be recorded in separate variance accounts.
More important, it helps the management to set a proper price and compete in the market. A variance is the difference between the actual cost incurred and the standard cost against which it is measured. A variance can also be used to measure the difference between actual and expected sales. Thus, variance analysis can be used to review the performance of both revenue and expenses.
What is Standard Costing – 6 Important Characteristics
Determination of the type of standard to be used is one of the basic requirements for introducing standard costing. The effectiveness of standard costing depends upon the standards set. As such, standards should be realistic and capable of attainment. Before one can clearly understand the concept of standard costing, the term “standard” needs to be understood. According to Webster’s New International Dictionary, standards are bases for measurement or comparison.
Often Doesn’t Provide Enough Information to Distinguish Product Units
The company uses standard cost to establish benchmarks for performance, cost allocation, budgeting, deciding sales price, and decision-making. Standard costs are sometimes referred to as preset costs because they are estimated based on statistics and management’s experience. Basically, management calculates how much each step in the production process should cost based on the market value of goods, median wages paid per employee, and average utility rates.
The components of this adjusting entry provide information about the company’s performance for the period, particularly about production efficiency and cost control. The difference between expected and actual costs is called variance cost. It may not always be possible to change standards to keep pace with the frequent changes in the manufacturing conditions. 1) Formulation of Pricing and Production Policies – Standard Costing helps the management to formulate pricing and production policies on the basis of estimated costs to be incurred. Estimated production and its cost provide the base for pricing policy and profit planning.
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Budgets fix the targets which the executives have to achieve. They create a sense of discipline, financial or otherwise, among employees at different levels. Budgets are projections for the future and therefore they are of great use to the effective functioning of the standard costing system. (2) Comparison of actual costs with the pre-determined standards is made, in order to determine variances. By receiving timely reports which compare actual with standard costs, management is able to locate areas of production inefficiency.
What is standard costing?
To avoid operating at a loss, company A must charge company B a transfer price for each laptop it purchases to sell to the public. The optimal transfer price is based on a number of factors, including the cost of the item and which entity receives the benefit of profits. The Chocolate Cow Ice Cream Company has grown substantially recently, and management now feels the need to develop standards and compute variances. A consulting firm was hired to develop the standards and the format for the variance computation. One standard in particular that the consulting firm developed seemed too excessive to plant management. The consulting firm’s standard was production of 100 gallons of ice cream every 45 minutes.
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If actual cost does not exceed standard cost, performance is treated as fully efficient. In ICMA’s definition of standard cost, the phrase “management’s standards of efficient operation” is important. The standard costing technique is used in many industries due to the limitations of historical costing. The normal cost will be used over a period of time, usually the business cycle of the company.
Standard costing is introduced primarily to ascertain the efficiency of cost performance. Accordingly, standard costing is a tool or technique of cost control. Traditional approaches limit themselves by defining cost behavior only in terms of production or sales volume. Often used in manufacturing for accounting for inventories and production. When actual costs differ from the standard costs, variances are reported. Standard costs are a nice jumping-off point for setting your sales price.
It does not, however, mean by this that standard costing is intended to control costs, and beyond this, it does not achieve anything else. This method tended to slightly distort the resulting unit cost, but in mass-production industries that made one product line, and where the fixed costs were relatively low, the distortion was very minor. Classification or grouping of accounts is essential for standard costing. Standard cost offers a criterion against which actual costs incurred by the business can be measured and analyzed. Variance reports quickly highlight unfavorable variances, but favorable variances rarely get the same attention.
Now, however, workers who come to work on Monday morning almost always work 40 hours or more; their cost is fixed rather than variable. However, today, many managers are still evaluated on their labor efficiencies, and many downsizing, rightsizing, and other labor reduction campaigns are based on them. Basic standards provide the basis for comparing actual costs over time with a constant standard. They are used primarily to measure trends in operating performance. DenimWorks purchases its denim from a local supplier with terms of net 30 days, FOB destination. This means that title to the denim passes from the supplier to DenimWorks when DenimWorks receives the material.
