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Standard Costing and Variance Analysis
Introduction
Standard Costing is an effective management tool for planning, co-ordination and control of business. It is a technique of cost control.
It gives better results when it is employed with budgetary control.
It has been devised to overcome some of the limitations of historical costing.
Definition
Standard Cost is, “a pre-determined cost” which is calculated from management’s standards of efficient operation and the relevant necessary expenditure. (ICMA London)
Standard Costing is, “the preparation and use of standard costs, their comparison with actual cost and the analysis of variances to their causes and points of incidence.” (ICMA London)
Thus standard costing involves:-
a) Pre-determination of standard costs.
b) Recording of actual costs.
c) Comparison of actual costs with standard costs to find out the difference between the two, is known as variance.
d) Analysis of reasons for variances.
e) Reporting to management for taking proper action.
Standard Cost and Estimated Cost
Both the standard costs and estimated costs are used to determine price in advance. The purpose of both the system is to control cost. The same accounting principles are used in standard cost and estimated cost.
Despite similarities, standard cost and estimated cost differ in their objects and purpose. The points of difference between standard cost and estimated cost are discussed as under
Estimated costs are based on historical accounting. It is an estimate of what the cost will be. It is a cost of guess work or reasonable estimate for the costs in future. On the other hand standard costs are based on scientific analysis and engineering studies. Standard costing determines what the cost should be.
Standard costs are used as a devise for measuring efficiency. The standards are predetermined and a comparison of standards with actual costs enables to determine the efficiency of the concern. Estimated costs cannot be used to determine efficiency. It only determines the expected costs. An effort is made that estimated cost should almost be near to actual costs.
The purpose of determining estimated costs is to find out selling price in advance to take a decision whether to produce or to make and also to prepare financial budgets. Estimated costs do not serve the purpose of cost control. On the other hand standard costs are helpful in cost control. The analysis of variance enables to take corrective measures, if necessary.
Standard costs are not easily changed. The standard are set in such a way that small changes in conditions do not require a change in standards. Estimated costs are revised with the change in conditions. They are made more realistic by incorporating changes in prices. Standard costs are more static than estimated costs.
Estimated costs are used by the concern using historical costing. Standard costing is used by those concerns which use standard costing system. Standard costing is a part of cost accounting process while estimated costs are statistical in nature and as such they may not become a part of accounting.
Advantages of Standard Costing:-
Standard Costing is a very useful managerial tool for cost control and cost reduction. The following are the main advantages of standard costing.
1) Standard costing is a valuable aid to management in formulating price and production policies and in performing managerial functions.
2) Standards serve as yardsticks against which actual costs are compared. Whenever variances occur, reasons are studied and immediate corrective measures are undertaken. Thus, it facilitates effective cost control and provides necessary information for cost reduction
3) It creates an atmosphere of cost consciousness among executives, foremen and workers. It also provides incentives to employees for efficient work.
4) Standard costing facilitates management by exception. It helps the management in concentrating its attention on cases which are below the standard set.
5) Standard costing helps in effective coordination through delegation of authority and responsibility. As a result, the management can control the affairs of various departments effectively.
6) Setting standards involves effective utilization of men, material and machines. It leads to economy and increased productivity in all business activities.
7) It simplifies costing procedures and reporting. It reduces clerical work since standard rates are fixed for material pricing, overhead allocation apportionment etc.
8) It makes the work of valuation of inventory easier. This is because inventory is valued at pre-determined costs.
Limitations of Standard Costing:-
1) Standard costing is an expensive technique for a small concern.
2) It is difficult to set accurate standard costs. Improperly set standards may do more harm than good.
3) It is not easy to distinguish variances as controllable or uncontrollable.
4) Since business conditions are changing, the standards are to be revised frequently. Revision of standards is a tedious and costly process
5) Standard costing cannot be applied fully to job order industries dealing in non-standardized products. It may be applied partially but it would not be effective.
6) If standards are too high or rigid, they will be unattainable. It will adversely affect the morale and motivation of employees and lead to resistance.
Despite the limitations, standard costing is widely used in industries as technique of cost control and cost reduction.