Standard Costing: Meaning, Objectives, Types, Advantages and Disadvantages
In this post, we will see the standard costing. This involves the definition, objectives, types of performance standards as well as the advantages and disadvantages of it.
Cost accounting is the department of accounting that, as the name suggests, deals with the registration, analyzing, and reporting of the prices of a business.
Standard Cost- Definition
Standard costing is a costing system, that is done to compare the standard costs and revenues with the real results, in order to succeed at the variances along with its causes, to notify the management about the differences, and take corrective measures, for its improvement.
What Does Standard Cost Mean?
Standard costs are sometimes related to as preset costs because they are calculated based on statistics and management’s expertise. Basically, management determines how much each step in the production method should cost based on the market price of goods, median wages paid per worker, and average utility rates. This calculated value is the standard cost. It's the price that the company should have to pay to produce a good.
Objectives of Standard Costing
Below are the objectives of standard costing:
- Help to provide guidance for improving efficiency
- To set standards for each type of cost
- To establish the principle of management by exception
- Act as a control device in implementing feedback of control cycle
- Helps to motivate employees by providing challenge targets
1. Help to provide guidance for improving efficiency
The primary objective of standard costing is to assist the management of the business in managing the costs of the business. Not only can standard costing help manage the costs of the business as a whole but also help the administration of the business identify any areas of the business where methods are ineffective and, thus, increase the costs acquired by the business. This will help to improve performance and help cost-cutting within the business where relevant.
2. To set standards for each type of cost
There are many diverse objectives of standard costing. The main objective of standard costing is to set standards for each type of cost acquired for a special product within the business. These costs involve material costs, labor costs, and expenses. This helps the administration or management of the business analyze any variances between the likely costs of the business and the actual costs acquired by the business during its processes.
3. To Establish the Principle of Management by Exception
Standard cost is just a decided estimate of the price of a product. It is an average expected unit price that a business built. Because it is the predicted average cost, the actual cost may vary. The actual cost may be above or below the predetermined estimate cost; however, only significant differences between the actual cost and standard should be reported.
4. Act as a Control Device in Implementing a Feedback of Control Cycle
Another objective of standard costing is to implement a feedback control cycle within a business. The management of a business carries out standard costing and utilizes the results obtained from examining the standard costs with real costs to decrease costs and improve the performance of the processes of a business.
5. Helps to Motivate Employees by Providing Challenge Targets
Likewise, another objective of this costing method is to motivate employees. When the employees of the business know the standards they must match, they are motivated to work efficiently. However, these standards must be possible and practical, or else they can have a negative impact on the motivation of employees. In addition, management shall need to identify the controllable and non-controllable parts for the evaluation of performance.
Types of Performance Standard in Standard Costing
Performance standards are used in order to set performance targets for the business. When establishing the standard costs of a business, there are many various standards that the management can utilize. These standards are determined in the form of either quantity or financial cost. The management of the business has to determine which standard they must accept that is suitable for the requirements of the business. The various types of standards are as follows.
1. Ideal Standards
Ideal standards, also recognized as perfection standards, are standards set with the theory of highest performance and no wastages within the processes for which costs are being discovered. They represent an ideal spot that can be reached if all the variables that impact the prices within a process go well without any delays. Ideal standards are hard to succeed in most work situations as gaps within a process are forced to happen. These standards can have adverse impacts on employee motivation if the employees are forced to follow an ideal standard and be punished for interruptions outside of their control.
2. Attainable Standards
Standards that are available. These attainable standards describe an optimal possible standard and take into account anticipated 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 available standards are developed with realistic goals, these can have a positive impact on the motivation of employees.
3. Basic Standards
4. Current Standards
While basic standards are utilized in a business over a long period, current standards are produced for a short period. These standards are produced and performed during particular things and once these things are over, the business returns back to long-term standards. Current standards are related to basic standards in that these do not support the management of the business to continually improve processes to improve efficiency.
Features of Standard Costing System
There are various features of a standard costing method. The characteristics are associated with the objectives of standard costing systems. These features are as follow:
- Monitoring and managing actual costs in accordance with the set standards.
- Discovering the decided estimate prices of various elements such as material, labor, and overheads.
- Balancing the standard costs estimated with the actual costs incurred.
- Obtaining variances between the actual and standard prices. These variances can either be beneficial for the business or adverse.
- Examining the variances and finding the reasons for these variances. This is done through the powerful study of the variances.
Factors to be Considered before the Establishment of Standard Costing System
There are several factors that require to be considered before establishing a standard costing system. The primary factor to consider is when setting standards within a standard costing system, the standards should be particular, calculable, achievable, relevant, and time-based. If the standards set do not match any of these terms, these standards cannot help the management of the business meet the purposes of standard costing. For example, if the standard set is not definite, then the management and the workers of the business will not understand what is expected of them.
Thus, when establishing a standard costing system, the management of the business should build different price centers within the business. Price centers are sections or areas of the business where prices are incurred. This provides standards to be set for particular cost hubs that are related to those centers. Moreover, this permits prices to be easily visible and similar for that cost center with the standards set.
Furthermore, the management of the business, before setting up a standard cost system, should plan and arrange all the relevant costs. This makes it more comfortable for various costs to be visible within the system. Moreover, classifying costs can also help the management identify high-cost areas and decrease the costs within those areas.
There are several advantages of a standard costing system for businesses. These benefits are as follows.
- Can help the management identify areas and processes within the business that are inefficient. Therefore, it can help with increasing the efficiency and effectiveness of different processes by cutting inefficiencies.
- Used in the preparation of budgets. It can assist with the preparation of more realistic budgets.
- Can be utilized along with other tools to resemble the real costs of the business toward standard costs to evaluate the performance of a business.
- Standard costs can be utilized to value the list of a business and placed the salaries of employees within the business.
- Can be utilized as a performance evaluation tool for managers of various cost centers within the business.
There are various disadvantages of standard costing systems as well. Some of these disadvantages are as below:
- Cannot be utilized for a cost-plus deal where consumers pay the business for real costs incurred along with a percentage of earnings. This is because the real costs of a product may be significantly diverse from its standard costs.
Standard costing is utilized within cost accounting to determine the predicted costs of a product. The purpose of this procedure may include setting standards for various costs within a business and working as a monitor and control tool. It can also be used to conduct variance analysis between standard costs and real costs incurred to know and inefficiencies within the processes of the business. There are different types of standards that can be set such as ideal, attainable, basic, and current standards. The characteristics of standard costing are related to the purposes of standard costing. Using a standard costing system may have its personal advantages and disadvantages.