In this competitive era, the foremost goal of the organizations to minimise the cost of production as much as it can as the resources are limited in business and manufacturing organisation’s. Cost accounting equips with abundant vital tools to accomplish these goals, one of them is known as standard costing.
What is Standard Costing?
- 1 What is Standard Costing?
- 2 Determination of Standard Costs
- 3 Advantages of Standard Costing
- 4 Disadvantages of Standard Costing
- 5 Variance Analysis
Being a vital branch of cost accounting, not only in India but across the world, standard costing has a great significance. It is an effective way to control costs. It is a process where the extra cost is evaluated on the basis of analysis done with past and present operations and other costs.
In the cost accounting, efforts are made to determine the cost of a product in advance, then compare it with cost to ascertain the differences.
As per the survey, it has concluded that standard costing is the method of determining the cost of creating statistics where standard and actual cost get compared. Whatever, the difference is as certain, known as a variance.
As per the theorists like Howard and Brown, standard costing is a process of accounting that analyses the standard cost of product and services with the actual cost to figure out the efficiency of operations, thereby remedial actions can be taken straight away.
Traits of standard costing
- Standard costing is a branch of accounting.
- The predetermined value or cost is known as standard cost.
- The service or cost or product is predetermined.
- The actual cost of the product and provider is ascertained.
- Variances are analysed to discover the reason.
- Variances are mentioned to control with a view to take corrective action.
- The assessment is made between the standard price and actual cost and variances are mentioned.
Which elements are used to verify a standard cost per unit?
There are six elements used to identify a standard cost per unit:
- Direct materials price standard
- Direct labour rate standard
- Direct labour time standard
- Direct materials quantity standard
- The standard fixed overhead rate
- The standard variable overhead rate
Components of standard costing
Standard costing has three components such as:
- Ensures standard or predetermined performance level
- Ensures the difference between the actual and standard cost
- Ensures a measure of actual performance
The fact is, the standard cost is used to analyze costs entirely to determine all three components of product costs: Direct material, direct labour, and overhead. A company’s manager uses standard costing to plan and cost in the management process, which includes planning for product costing, pricing, budget development, etc.
There is a difference in calculating the standard cost in service organization and manufacturing organization. In the first case, there is no direct material cost, but in the latter one, there is a cost that entered into the material, work-in-progress, and finished goods.
Determination of Standard Costs
Before determining the standard cost, the following steps should be taken:
- Set up of cost centres: The interested users need to set up cost centres before setting of Standards
- Organisation and Codification of Accounts: Classification of Accounts and Codification of various items of expenses and incomes helps quick ascertainment and analysis of valuable information.
Types of Standards to apply
To determine which standard should be used is an important step prior to establishing the standard cost. Let’s reveal the standards:
- Ideal Standard
- Basic Standard
- Current Standard
- Expected Standard
- Normal Standard
Classification for Standard Costing
The accomplishment of the standard costing system depends upon the consistency of requirements, thus the responsibility for placing popular is vested with the Standard Committee. It includes the following group:
- Production Manager
- Personnel Manager
- Purchase Manager
- Time and Motion Study Engineers
- Marketing Manager and Cost Accountant
Setting of Standards
The Standard committee is liable for developing standards for every component of costs such as Direct Material, Direct Labour, and Overheads.
Ways of Developing Standards
- The direct material price standard depends on a vigilant analysis of all possible price hikes up, amendments in available quantities, and new sources of supply in the succeeding accounting period.
- The direct labour rate standard is said by labour union contracts and company personnel policies.
- The direct materials quantity standard depends upon product engineering specifications along with the quality of direct materials, and productivity of machines, and the quality as well as the experience of the manpower.
- The direct labour time standard depends on the current time and motion studies of manpower and machines and records of their previous performance.
Advantages of Standard Costing
- Management by way of Exception: The standard costing is an example of control through exception. By reading the variances, management’s interest is directed closer to those items, which are not proceeding accordingly to the plan.
- Inventory Valuation: Standard costing makes stock valuation much less difficult, if the actual variety of physical gadgets within the stock is known, then the inventory cost is really decided by using multiplying the standard cost per unit via the physical devices.
- Cost Reduction: The technique of placing, revising and tracking requirements encourages a reappraisal of methods, materials and strategies accordingly leading to cost reductions.
- Budgeting is made less complicated: One of the greatest advantages of standard costing is to be observed in setting budgets for the organization and its departments. Once the preferred output units are recognized, then the budgeted cost is simply the output units desired multiplied by the standard cost per unit.
- Cost Control: A well-designed standard costing system seems as a yardstick against which all costs are analysed to decide whether or not the variance from the standard is favourable or destructive. It results in cost consciousness in the organization and in the end, enables the organization to manage costs.
Disadvantages of Standard Costing
- The system of standard costing is highly-priced to install: A lot of funds is spent in reading output requirements in terms of labour, materials and overheads.
- Hard to Understand: Some standard costing structures are overly problematic and are consequently no longer properly understood through line managers and employees. This makes their implementation tough.
- Obsolescence: In this technological era, standards grow to be out of date quickly. They consequently lose their control and motivational consequences.
- Time-Consuming: A lot of time is likewise spent in growing and putting in dependable standard costing systems.
Variance analysis is the method of computing the differences between standard costs and actual costs and finding out the causes of these differences. As per the surveys, it has concluded that variance is the difference between standard performance and real performance.
It is the method of scrutinising variance by means of subdividing the whole variance in any such way that management can assign obligation for off-Standard Performance.
Variance analysis has 4 steps:
- Compute the quantity of the variance.
- Determine the reason for any vital variance.
- Recognise performance measures that will track those activities, analyze the effects of the monitoring, and decide what is wanted to accurate the trouble.
- Take worthwhile steps.
Types of Variances
There are seven types of variances:
- Cost Variances
- Overhead Variance
- Fixed Overhead Variance
- Sales Variance
- Material Variances
- Labour Variances
- Profit Variance
1. Cost Variances
It is a difference between actual expenditure and the expected expenditure. It is comprised of two elements, which are:
- Volume variance: It is a difference in the actual versus expected unit volume of whatever is being analysed, multiplied by the standard price per unit.
- Price Variance: It is a difference in the actual versus expected unit volume of whatever is being analysed, multiplied by the standard number of units.
When you assemble the price variance and the volume variance, the combined variance seems the total cost variance for whatever the spending may be
2. Overhead Variance
It is a difference between the standard variable overhead and the actual variable overhead based on budgets.
How to calculate overhead variances?
Standard Variable Overhead – Actual Variable Overhead
In other words, (Standard Rate – Actual Rate) x Actual Output
Overhead Variance is sub-divided into two parts:
Variable Overhead Expenditure Variance:
VOEV = (Standard Output x Standard Rate) – (Actual Output x Actual Rate)
Variable Overhead Efficiency Variance:
VOEV = (Actual Output – Standard Output) x Standard Rate
3. Fixed Overhead Variance
It is a difference between the actual fixed overhead and the standard fixed overhead for actual output
How to calculate fixed variances?
(Actual Output x Standard Rate per unit) – Actual Fixed Overhead
Fixed Variance is sub-divided into two parts:
Fixed Overhead Volume Variance:
FOVV = (Actual Output x Standard Rate per unit) – Standard Fixed Overhead
Fixed Overhead Expenditure Variance:
FOEV = Standard Fixed Overhead – Actual Fixed Overhead
4. Sales Variance
It is the difference between the actual sales and budgeted sales of an organization.
How to calculate Sales variances?
(Budgeted Quantity x Budgeted Price) – (Actual Quantity x Actual Price)
Sales Variance is sub-divided into two parts:
Sales Price Variance:
SPV = (Budgeted Price – Actual Price) x Actual Quantity
Sales Volume Variance:
SVV = (Budgeted Quantity – Actual Quantity) x Budgeted Price
5. Material Variances
Material Variances is a difference between the standard cost of direct materials and the actual cost of direct materials used in an organization.
How to calculate material variances:
Standard Cost – Actual Cost
Material Variance is sub-divided into two parts:
Material Usage Variance:
MUV = (Standard Quantity – Actual Quantity) x Standard Price
Material Price Variance:
MPV = (Standard Price – Actual Price) x Actual Quantity
6. Labour Variances
It is a difference between the actual cost related to a labour activity from the standard cost.
How to calculate labour variances?
Standard Wages – Actual Wages
Labor Variance is sub-divided into two parts:
Labor Efficiency Variance:
LEV = (Actual Hours – Standard Hours) x Standard Rate
Labor Rate Variance:
LRV = (Standard Rate – Actual Rate) x Actual Hours
7. Profit Variance
It is a difference between the actual profit experienced and the budgeted profit level. It has four types:
Gross profit variance
Contribution margin variance
Operating profit variance
Net profit variance
Therefore, Variance Analysis is vital to figure out the difference between the actual and planned behaviour of an organization. In a case, it keeps avoided at regular intervals then it may delay in the management action to manage its costs.