Standard Costing – Uses & Limitations

Presented By

M Ravish Malgi – 208

Objectives

To understand the concept of Standard Costing.

To review the literature.

To identify the uses of Standard Costing in organization.

To explore the limitation of Standard Costing.

What is Standard, Standard Cost & Standard Costing?

Standard – It is used to refer to the predetermined rate e.g. Rs 10 per unit

Standard costs – They are predetermined cost which may be used as a yardstick to measure the efficiency with which actual costs has been incurred under given circumstance.

Standard Costing – This is a technique which uses standards for cost and revenues for the purpose of control through variance analysis.

Steps involved in Standard Costing

Setting standard costs for different elements of costs

Recording of actual costs

Comparing between standard costs and actual costs to determine the variances

Analyzing the variances to know the causes

Reporting the analysis of variances to management for taking appropriate actions wherever necessary

Variance

The deviation of actual cost from standard cost is called variance.

Variance is very important to evaluate the performance of company for increasing its efficiency.

We compare actual and standard cost to know whether it is favourable or unfavourable.

Types of Variance

Direct Material Variance: Shows the difference between the actual cost of material of actual units and standard cost of material of standard units.

Labor Variance: It is the difference between standard cost of labour for actual production and the actual cost of labour for actual production.

Overhead Variance: It shows the variance of all indirect cost. It is the difference between standard cost of overhead for actual output and actual cost of overhead for actual output.

Sales Variance: It is the variance which shows the difference between actual sales and standard sales.

Case Study

Problem: Effect of Assumed Standard Levels

Harden Company has experienced increased production costs.

The primary area of concern identified by management is direct labor.

The company is considering adopting a standard cost system to help control labor and other costs.

Solution:

Harden consulted an engineering company who suggested a Labor standard of 1 unit of production every 30 mins or 16 units/day.

The management thought such standards would have a negative impact & workforce wont be able to achieve the target. Management decided to set actual standard as 12 units/day.

Thus management decided to deploy dual standard method in which the workforce was told they were achieving 16 units/day but actual standard was set at 12 units/day or 40 mins/unit.

January February March April May June

Production (units) 5,100 5,000 4,700 4,500 4,300 4,400

Direct labor $3,000 $2,900 $2,900 $3,000 $3,000 $3,100

Quantity Variances:

Variance based on labor standard (one unit each 30

minutes) $2900 U $2,800 U $2,633 U $5,250U

$2,700

U $2,800 U

Variance based on cost standard (one unit each 40 minutes)$3100 F $3,033 F $3,200 F -0- $933U $3300 F

Uses of Standard Costing

To provide a formal basis for assessing performance and efficiency.

To Control Costs by establishing standards and analysis of variance.

To enable the principle of “Management by Exception” to be practiced at detailed operational level.

To assist in setting budgets in an organization.

To motivate staff and management.

To provide a basis for estimating.

To provide guidance on possible ways of improving performance.

Limitations of Standard Costing

Setting of standard is difficult task and it involves a high degree of technical skill.

Standard must be revised from time to time otherwise they lose importance.

It cannot be implemented in those industries which do not produce any standard product.

Sometimes it creates adverse psychological effects. If it is set at a high level its non-achievement results in frustration & it acts as a discouragement.

Too much care and attention are required to introduce as well as to keep up-to-date the system otherwise the very purpose of the system will be frustrated.

Limitations (contd.)

Every organization has different set of parameters to set standards for themselves. Thus, it may not be suitable in all types of organizations.

Management’s lack of interest in the standard costing makes it inefficient means of cost control.

Standard costing tends to measure performances in terms of difference between the actual and standards. But other non-financial measures such as maintaining and improving quality, on time delivery, customer satisfaction and the like are equally important in performance evaluation.

It does not give any motivation to improve their performance beyond the standards. Ex, sales person has already achieved his/her target to be entitled for bonus than he/she may not do further effort to increase sales.

"In the beginning God created man...and the costs followed afterwards."

Thank You