Standard Costing: Meaning, Advantages and Disadvantages

STANDARD COSTING

Standard costing is a technique that establishes predetermined estimates of the cost of products and services and compares these costs with the actual costs as they incur. Standard costing can be considered as a yardstick to measure the efficiency with the actual cost incurred. Hence, standard costing is system of costing which makes a comparison between the standard cost of each product or service with its actual cost to determine the efficiency of the operation, with a view to take corrective actions at the earliest possible time.


Historical costs are the actual costs that are ascertained after they are incurred. During the initial stages of development of cost accounting, historical costing systems like process costing, contract costing, service costing etc. were available for ascertaining the costs. The historical costing methods are used to determine the cost incurred for the production of a particular products or completion of a particular job.

The historical costing systems suffer from several limitations; some of them are as follows:
* No basis for cost control
* No yardstick for measuring efficiency
* Delay in availability of information
* Expensive

Although standard costing attempts to overcome the limitations of historical costing system, it is not an alternative to the existing historical costing. Standard costing is the most widely used technique of controlling costs.

Thus, standard costing is the preparation and uses of standard costs, which involves the following process:
* Establishment of standard costs
* Ascertainment of actual costs
* Comparison of the above two and measurement of variances
* Analysis of variances
* Reporting to responsibility centers to take appropriate and necessary remedial actions.

The following are the advantages of the standard costing system:

* A standard costing is a rule of measurement established by authority, which provides a yardstick for performance evaluation.

* Standard costing system minimizes the wastage by detecting variance and suggesting for corrective actions.

* Under the standard costing system, cost centers are established and responsibility is assigned to the concerned departments and persons and thus it helps to increase the effective delegation of authority.

* A properly developed standard costing system with full participation and involvement creates a positive, cost effective attitude through all levels of management.

* The standard system encourages reappraisals of methods, materials and techniques that help to reduce the unfavorable variances.

* The standard costing system helps to draw management's attention towards those items which are not proceeding according to plan.

* Standard costing system makes the whole organization cost-conscious as it gives the focus to the standard cost and variance analysis.

* Standard costing system provides a basis for incentive scheme to workers and supervisors.

* Standard costing system simplifies the cost control procedures.

* Standard costing acts as an effective tool for business planning, budgeting, marginal costing , inventory valuation etc.

The following are the notable limitations or disadvantages of standard costing system:

* Standard costing system may be tedious, expensive and time consuming to install and keep up to date.

* The standard costing system controls the operating part of an organization only as it ignores the other items like quality, lead-time, service, customer satisfaction and so on.

* The standard costing system will become less useful in modern factories where the just in time principles are adopted.

* The standard costing system may not be applicable in case of small firms as it requires high degree of skill.

* The standard costing may not be very effective in those organizations where non-standardized products are manufactured and services are rendered.

Estimates are the expressions of of opinion based upon past experiences whereas the standard costs are based upon standard rate that are very carefully developed and set as scientifically as possible. However, both estimated costs and standard costs are related to future period of time but there are some significant differences between them. Some major differences between standard costs and estimated costs are listed below:

1. Estimated costs are the expressions of opinion based upon experience. Standard costs are based upon standard rates that are carefully developed and set as scientifically as possible.

2. Estimated costs are used by those firms that follow historical costing system. Standard costs are used by those organizations that follow standard costing.

3. Estimated costs are based on actual costs and anticipated costs. Standard costs are fixed after scientific analysis of relevant cost elements.

4. Estimated costs are based on approximation. Standard costs are based upon specifications.

5. Estimated costs are normally used as guideline for price determination, quoting the selling price etc. Main purpose of standard costs is to serve as a tool for cost control.

Although budgetary control and standard costing both are based on some common principles; both are pre-determined, comparison will be made with the actual costs and both system need a revision of the standards or the budget, these two systems have certain differences which are as follows:

1. Budgetary control deals with the operation of a department or the business as a whole in terms of revenue and expenditure. Standard costing is a system of costing which makes a comparison between standard costs of each product or service with its actual cost.

2. Budgetary control covers as a whole in terms of revenue and expenditures such as purchases, sales, production, finance etc. Standard costing is related to a product and its cost only.

3. Budgetary control is applicable to utmost all business organizations. Standard costing is applicable to manufacturing concerns producing standard products and services.

4. Budgetary control is concerned with a specific period and is based on the totals of amounts. Standard costing is concerned with the standard costs, which are worked out generally per unit of production.

5. Budgetary control is not based on standard costing system. Standard costing cannot exist in the absence of a budgetary control system.