STANDARD COSTING

Submitted by

R.Subash

Reg. No. BC0150028

Under the Guidance of

Mrs. AGILLA
Assistant Professor

TAMIL NADU NATIONAL LAW SCHOOL

(A State University established by Act No. 9 of 2012)
Tiruchirappalli
Tamil Nadu 620 009

DECLARATION
1
I, R.Subash, do hereby declare that the project titled STANDARD COSTING
submitted to Tamil Nadu National Law School in partial fulfillment of requirement for
award of degree in Under Graduate in Law to Tamil Nadu National Law School,
Tiruchirappalli, is my original research work. It and has not been formed basis for
award of any degree or diploma or fellowship or any other title to any other candidate
of any university.

Counter Signed Signature of the Candidate

Project Guide

2
 ACKNOWLEDGEMENT

At the outset, I take this opportunity to thank my Professors. Agilla from the
bottom of my heart who have been of immense help during moments of anxiety and
torpidity while the project was taking its crucial shape.

Secondly, I convey my deepest regards to the Vice Chancellor Kamala

sankaran and the administrative staff of TNNLS who held the project in high esteem
by providing reliable information in the form of library infrastructure and database
connections in times of need.

Thirdly, the contribution made by my parents and friends by foregoing their

precious time is unforgettable and highly solicited. Their valuable advice and timely
supervision paved the way for the successful completion of this project.

Finally, I thank the Almighty who gave me the courage and stamina to confront
all hurdles during the making of this project. Words arent sufficient to acknowledge
the tremendous contributions of various people involved in this project, as I know
Words are Poor Comforters. I once again wholeheartedly and earnestly thank all the
people who were involved directly or indirectly during this project making which
helped me to come out with flying colors.

3
S.N TITLE
o
1 INTRODUCTION
2 Objectives of Standard Costing
3 Development of Standard Costing
4 Advantages of Standard Costing
5 Disadvantages of Standard Costing
6 Standard Cost Variances
7 Standard Cost Creation
8 Problems with Standard Costing
9 Conclusion

INTRODUCTION:
Meaning of Standard Costing:
It is a method of costing by which standard costs are employed. According to 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.
According to Wheldon, it is a method of ascertaining the costs whereby statistics are
prepared to show:
(i) The standard cost;

(ii) The actual cost;

(iii) The difference between these costs which is termed the variance.

But W. Bigg expresses:

Standard Costing discloses the cost of deviations from standards and clarifies these as
to their causes, so that management is immediately informed of the sphere of operations
in which remedial action is necessary.
Thus, from the above, it becomes clear that Standard Costing involves:
(i) Ascertainment and use of Standard Costs;

(ii) Recording the actual costs;

4
(iii) Comparison of actual costs with standard costs in order to find out the variance;

(iv) Analysis of variance; and

(v) After analysing the variance, appropriate action may be taken where necessary.

Objectives of Standard Costing:

The objectives of Standard Costing for which it is implemented are:
(a) It helps to implement budgetary control system in operation;

(b) It helps to ascertain performance evaluation.

(c) It supplies the ways to utilise properly material, labour and also overhead which will be
economic in character.

(d) It also helps to motivate the employees of a firm to improve their performance by setting
up a standard.

(e) It also helps the management to supply necessary data relating to cost element to submit
quotations or to fix up the selling price of a firm.

(f) It also helps the management to make proper valuations of inventory (viz., Work-in-
progress, and finished products).

(g) It acts as a control device to the management.

(h) It also helps the management to take various corrective decisions viz., fixation of price,
make-or-buy decisions etc. which will be more beneficial to the firm.

Development of Standard Costing:

Importance of Standard Costing cannot be ignored for the following and that is why the
same is well-developed in the present-day world:
(i) Compilation of Historical Cost is very expensive and difficult:
A manufacturing firm making large number of parts requires too much clerical work which is
required in order to compile the materials, labour and overhead charges to each and every
cost of parts produced for ascertaining the average cost of the product.

5
(ii) Historical Costs are inadequate:
In order to measure the manufacturing efficiency, historical costs are not practically adequate.
It fails to explain the reasons of increased cost or any change in cost structure.

(iii) Historical Costs are too old:

In many firms, costs are determined and selling prices are ascertained even before the
production startswhich is not desirable.

(iv) Historical Costs are not typical:

This is due to the wide fluctuation in market for which there is no relation between the selling
price per unit and cost price per unit.

Advantages of Standard Costing:

The following advantages may be derived from Standard Costing:

(i) Standard Costing serves as a guide to the management in several management functions
while formulating prices and production policies etc.

(ii) More effective cost control is possible under standard costing if the same is reviewed and
analysed at regular intervals for improvements and immediate action can be taken if
deviations from standards are found out which, ultimately, leads to cost reduction.

(iii) Analysis of variance and its measurement helps to detect inefficiencies and mistakes
which enable the management to investigate the reasons.

(iv) Since standard costs are predetermined costs they are very useful for planning and
budgeting. It also helps to estimate the effect of changes in Cost-Price-Volume relationship
which also helps the management for decision-making in future.

(v) As standard is fixed for each product, its components, materials, process operation etc. it
improves the overall production efficiency which also ultimately reduces cost and thereby
increases profit.

6
(vi) Once the Standard Costing System is implemented it will lead to saving cost since most
of the costing work can be eliminated.

(vii) Delegation of authority and responsibility becomes effective by setting up standards for
each cost centre as the supervisors or executives of each cost centre will know the standard
which they have to maintain.

(viii) This system also helps to prepare Profit and Loss Account promptly for short period in
order to know the trend of the business which helps the management to take decisions
promptly.

(ix) Standard costing also is used for inventory valuation purposes. Stock can be valued at
standard cost which can reduce the fluctuation of profit for different methods of valuation for
the same.

(x) Efficiency of labour is promoted.

(xi) This system creates cost-consciousness among all employees, executives and top
management which increase efficiency and productivity as well.

Disadvantages of Standard Costing:

The alleged disadvantages of Standard Costing are:
(i) Since Standard Costing involves high degree of technical skill, it is, therefore, costly. As
such, small organisations cannot, introduce the system due to their limited financial
resources. But, once introduced, the benefits achieved will be far in excess to its initial high
costs.

(ii) The executives are liable for those variances that are found from actions which are
actually controllable by them. Thus, in order to fix up the responsibilities, it becomes
necessary to segregate variances into non-controllable and controllable portions although that
is not an easy task.

(iii) Standards are always changing since conditions of the business are equally changing. So,
standards are to be revised in order to make them comparable with actual results. But revision
of standards creates many problems, particularly in inventory adjustment.

7
 (iv) Standards are either too liberal or rigid since the same are based on average past results,
attainable good performance or theoretical maximum efficiency. So, if the standards are very
high, it will adversely affect the morale and motivation of the employees.

Standard Cost Variances

A variance is the difference between the actual cost incurred and the standard cost against
which it is measured. A variance can also be used to measure the difference between actual
and expected sales. Thus, variance analysis can be used to review the performance of both
revenue and expenses.

There are two basic types of variances from a standard that can arise, which are the rate
variance and the volume variance. Here is more information about both types of variances:

Rate variance. A rate variance (which is also known as a price variance) is the
difference between the actual price paid for something and the expected price, multiplied by
the actual quantity purchased. The rate variance designation is most commonly applied to
the labor rate variance, which involves the actual cost of direct labor in comparison to the
standard cost of direct labor. The rate variance uses a different designation when applied to
the purchase of materials, and may be called the purchase price variance or the material price
variance.

Volume variance. A volume variance is the difference between the actual quantity sold
or consumed and the budgeted amount, multiplied by the standard price or cost per unit. If the
variance relates to the sale of goods, it is called the sales volume variance. If it relates to the
use of direct materials, it is called the material yield variance. If the variance relates to the use
of direct labor, it is called the labor efficiency variance. Finally, if the variance relates to the
application of overhead, it is called the overhead efficiency variance.

Thus, variances are based on either changes in cost from the expected amount, or changes in
the quantity from the expected amount. The most common variances that a cost accountant
elects to report on are subdivided within the rate and volume variance categories for direct
materials, direct labor, and overhead. It is also possible to report these variances for revenue.

It is not always considered practical or even necessary to calculate and report on variances,
unless the resulting information can be used by management to improve the operations or

8
 lower the costs of a business. When a variance is considered to have a practical application,
the cost accountant should research the reason for the variance in considerable detail and
present the results to the responsible manager, perhaps also with a suggested course of action.

Standard Cost Creation

At the most basic level, you can create a standard cost simply by calculating the average of
the most recent actual cost for the past few months. In many smaller companies, this is the
extent of the analysis used. However, there are some additional factors to consider, which can
significantly alter the standard cost that you elect to use. They are:

Equipment age. If a machine is nearing the end of its productive life, it may produce a
higher proportion of scrap than was previously the case.

Equipment setup speeds. If it takes a long time to setup equipment for a production
run, the cost of the setup, as spread over the units in the production run, is expensive. If a
setup reduction plan is contemplated, this can yield significantly lower overhead costs.

Labor efficiency changes. If there are production process changes, such as the
installation of new, automated equipment, then this impacts the amount of labor required to
manufacture a product.

Labor rate changes. If you know that employees are about to receive pay raises, either
through a scheduled raise or as mandated by a labor union contract, then incorporate it into
the new standard. This may mean setting an effective date for the new standard that matches
the date when the cost increase is supposed to go into effect.

Learning curve. As the production staff creates an increasing volume of a product, it

becomes more efficient at doing so. Thus, the standard labor cost should decrease (though at
a declining rate) as production volumes increase.

Purchasing terms. The purchasing department may be able to significantly alter the
price of a purchased component by switching suppliers, altering contract terms, or by buying
in different quantities.

9
 Any one of the additional factors noted here can have a major impact on a standard cost,
which is why it may be necessary in a larger production environment to spend a significant
amount of time formulating a standard cost.

Problems with Standard Costing

Despite the advantages just noted for some applications of standard costing, there are
substantially more situations where it is not a viable costing system. Here are some problem
areas:

Cost-plus contracts. If you have a contract with a customer under which the customer
pays you for your costs incurred, plus a profit (known as a cost-plus contract), then you must
use actual costs, as per the terms of the contract. Standard costing is not allowed.

Drives inappropriate activities. A number of the variances reported under a standard

costing system will drive management to take incorrect actions to create favorable variances.
For example, they may buy raw materials in larger quantities in order to improve the
purchase price variance, even though this increases the investment in inventory. Similarly,
management may schedule longer production runs in order to improve the labor efficiency
variance, even though it is better to produce in smaller quantities and accept less labor
efficiency in exchange.

Fast-paced environment. A standard costing system assumes that costs do not change
much in the near term, so that you can rely on standards for a number of months or even a
year, before updating the costs. However, in an environment where product lives are short or
continuous improvement is driving down costs, a standard cost may become out-of-date
within a month or two.

Slow feedback. A complex system of variance calculations are an integral part of a

standard costing system, which the accounting staff completes at the end of each reporting
period. If the production department is focused on immediate feedback of problems for
instant correction, the reporting of these variances is much too late to be useful.

Unit-level information. The variance calculations that typically accompany a standard

costing report are accumulated in aggregate for a companys entire production department,

10
and so are unable to provide information about discrepancies at a lower level, such as the
individual work cell, batch, or unit.

The preceding list shows that there are a multitude of situations where standard costing is not
useful, and may even result in incorrect management actions. Nonetheless, as long as you are
aware of these issues, it is usually possible to profitably adapt standard costing into some
aspects of a companys operations.

CONCLUSION:

Standard costing is an important subtopic of manufacturing cost accounting. Standard costs are
associated with manufacturing companies and are utilized to manage the costs of direct material,
direct labor, and manufacturing overhead.

In lieu of assigning actual or average costs of direct material, direct labor, and manufacturing
overhead and rolling these costs into their products, most manufacturers assign a standard cost to their
systems. This means that their inventories and cost of goods sold are valued using the standard costs,
and not the actual or average costs, of a product. The Manufacturers pays their vendors at actual costs
which can vary over time.

BIBLIOGRAPHY:

1. http://www.accountingtools.com/standard-costing
2. http://jdedwardsoracle.blogspot.in/2009/05/introduction-to-standard-costing.html
3. https://www.tutorialspoint.com/accounting_basics/cost_accounting_classification_of_
cost.htm
4. http://www.cimaglobal.com/Documents/ImportedDocuments/cid_tg_standard_costing
_and_variance_analysis_mar08.pdf.pdf

11