What is Standard Costing?

The standard cost system is the expected cost per unit product manufactured and it helps in estimating the deviations and controlling them as well as fixing the selling price of the product. For example, it helps to plan the cost for the coming year on the various expenses. 

Variance Analysis 

The method of costing is used to find out the variances. Variance is the difference between the standard cost and actual cost. The variances are calculated for the management’s awareness of the deviations so that they could take corrective measures accordingly.  

For example, if the actual cost is greater than the standard cost, management can possibly anticipate a lower profit than expected. If the actual cost is less than the standard cost, however management might anticipate a higher profit than originally proposed. 

Cost Variances 

It is the difference between an actual expenditure and the expected expenditure. This variance is used as a monitoring tool when a business is attempting to spend in agreement with the amount stated in the budget. 

The cost variance formula comprises of two elements 

• Volume Variance: It is the difference in the actual volume against expected unit volume of whatever is being measured, multiplied by standard price per unit. 
• Price Variance: It is the difference in the actual price against expected price of whatever is being measured, multiplied by standard number of units. 

When the volume variance and price variance are combined, the combined variance represents the total cost variance for whatever the expenditure may be. 

What is the Need for Standard Costing? 

Other than controlling the deviations standard costing has many other benefits which initiate a need for it. 

• Estimating Future Cost – The standard cost is fixed taking all the relevant facts and future possibilities into consideration and therefore it helps in choosing the project based on its future profitability and opportunities. 
• Budgeting – Setting standard cost is possible only after foreseeing the future and thus creating a budget with the help of the estimations. 
• To eliminate cost overrun – The standard costs are set as a criterion of what should be the cost of the product and if the actual cost exceeds the standard cost the deviations are corrected and therefore it helps to eliminate the cost overrun. 
• Evaluating the staff's performance – The budgets help estimate the performance of the staff as to how effectively they work keeping in mind the standard cost and budget. 

Standard Costing Process 

Standard costing is a process consisting of several steps from estimating the budget to the removal of deviations. The process is as follows: 

• Establishing standards – The foremost step is estimating the standard cost based on the estimations of the managers, considering the future possibilities and trends. The standard is set for both cost and quantity. 
• Determining the Actual cost – After fixing the standard cost, there is also a need to determine the actual cost with the help of wage sheets, cost of material, labor, and overheads, etc. 
• Comparison between Actual and Standard Cost - The standard cost set must be compared with the actual cost in this step to derive a comparison between the two. 
• Determining the Causes of Variation – After comparing the standard cost and the actual cost if there is a variation between the two the causes for the deviation need to be determined to take corrective measures for the same. 
• Disposing Variances – The variances need to be disposed of after finding out the causes by taking corrective measures for the same.

Objectives of Standard Costing 

The primary objectives of standard costing are as follows: 

• Performance Measurement – The performance is analyzed by comparing the standard cost set as per the budget and the actual cost. How accurate is the performance and is it as per the standards set needs to be made sure and therefore standard costing assists with this objective by making the performance measurement possible?  
• Control – Standard costing makes possible the control of costs and resources by developing an effective basis for comparison between the set standards and the actual performance. The comparison helps in finding out deviations if any and takes corrective actions. 
• Fixing Selling price – The future possibilities are taken into account to set the standard cost and therefore it also helps in setting the selling price of the product as per the standard cost set. 
• Stock Valuation – Stock valuation is also one of the primary motives of standard costing which is facilitated by the same. The stock of the company is taken into consideration while setting the cost. 

Other Objectives are Facilitated with Standard Costing 

• It creates a basis for comparison for checking the performance of the company. 
• Decision making – helps in decision making as to how to perform the tasks that would lead to greater efficiency and profits. 
• Establishing Budgets – To set a standard cost a company first needs to set a budget along-side which it is going to work and the budget is prepared by considering future possibilities. 
• Motivates the staff to work towards efficiency and performance. 
• To create a sense of cost-consciousness amongst the workers also stopping the wastage of resources in this way. 
• Delegates the responsibility amongst employees and creates a sense of efficiency. 

Prerequisite for Effective Standard Costing 

• The standards set should be realistic and not imaginary so that the employees have a belief in achieving the target. 
• Quick reporting of variance analysis should be done to maintain the efficiency of the process. 
• Proper interest should be shown by the management in the process of standard costing. 
• To know the progress reports at all the levels the reports of variance should be developed accordingly. 
• This process of standard costing is mostly suitable for industries. 
• The standard process should be recorded clearly and should be easy enough and understandable. 

Common Mistakes and Pitfalls 

The standard costing process can be time-consuming but is critical for the performance of any industry or firm and therefore it should be given much importance. The standards set should not be based on trial and error but should be realistic and appropriate. 

The process is followed with great care; it could lead to greater efficiency and effectiveness in the performance of the enterprise. And not only it helps find out the variances and correct them but there are multiple advantages of standard costing and it helps the company to work within the budgeted limits and do not overrun costs which could lead to an increase in the selling prices of products. 

Context and Application 

This topic is significant in the professional exams for both undergraduate and graduate courses, especially for:   

• Bachelor of Business Administration
• Bachelor of Commerce       
• Master of Commerce