Comparing the actual costs with the standard costs to find the differences, i.e., variance. Thus, standard cost is a predetermined cost calculated well in advance of production on the basis of a specification of all the factors affecting costs and used in standard costing. Standard cost is like a model, which provides basis of comparison for actual cost. This comparison of actual cost with standard cost reveals a very useful information for cost control. While fixing standard costs, the fundamental principle to be observed is that the set standards are attainable so that these are taken as yardsticks for measuring the efficiency of actual performances. Basic standards provide the basis for comparing actual costs over time with a constant standard.
The materials cost variance is between the standard material cost for actual production in units and the actual cost. For example, the difference in materials costs can be divided into a materials price variance and a materials usage variance. The difference between the actual direct labor costs and the standard https://www.bookstime.com/articles/adjusting-entries direct labor costs can be divided into a rate variance and an efficiency variance. 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.
Classification of Standards – Based on Period of Operations and Based on Tightness and Looseness
9) Economy – In standard costing, standards are fixed in advance. Once standards are fixed development of cost, most of the clerical work is reduced. Thus it is an economical method of costing and brings efficiency in production. 7) Facilitate Co-ordination – When standards are fixed, the performance of various departments e.g., production, sales, purchase etc., is considered. In this way, standard costing enables coordination among all departments.
Since it is difficult to set correct standards, it is difficult to ascertain correct variance. It is costly, as the setting of standards needs high technical skill. When standards have been fixed, the section-heads safely delegate the responsibility to the workers. The standard of standard costing system activity can be measured through the costing reports. (i) Material Quality – Material quality affects the finished product. In order to fix responsibility for adverse variances in respect of material usage, it is necessary to carry out adequate inspection of materials and parts.
Understanding Cost Accounting
While standard costs can be a useful management tool for a manufacturer, the manufacturer’s external financial statements must comply with the cost principle and the matching principle. Therefore, significant variances must be reviewed and properly assigned or allocated to the cost of goods sold and/or inventories. Fixed overhead efficiency variance is that portion of volume variance which reflects output arising from efficiency being above or below standard.
Moreover, this allows costs to be easily traceable and comparable for that cost center with the standards set. Attainable standards, as the name suggests, are standards that are attainable. This attainable standards represent an optimal achievable standard and take into account predictable or expected wastage unlike ideal standards. However, the standard does not make any provisions for avoidable interruptions as these can be easily avoided by using improving the efficiency of the processes. This promotes a sense of accountability within the management and the employees of a business. Since attainable standards are developed with realistic goals, these can have a positive impact on the motivation of employees.
Standard Costing – Special Uses
The budgeting is successful if the standard cost is similar to the actual cost incurred. In case the actual cost exceeds the standard cost, the company must revise its production policies and increase efficiency to reduce the costs in the future. Standard costing is an alternative to the traditional cost layering systems such as LIFO (last-in, first-out) and FIFO (first-in, first-out). The main reason for adopting standard cost accounting is that it is time-consuming to collect details of the actual cost; therefore, standard costs are applied. To know about standard costing in detail, do read this article entirely.