What is Standard Costing System,Purpose & Process

What is standard cost?

Standard costs are used for planning and control. Standard costs are the vital part of budgeting process and variance analysis. Standard costs like Material, labour and overheads (administration, selling & distribution) costs are identified in advance. Material costs may be determined from the contract to buy material or existing figures adjusted for inflation. Labour costs are determined from employment legislation minimum wage requirements and negotiation with labour union. Overheads are determined from previous experience adjusted for inflation or anticipated costs due to changes in operations.

When standard costing is first time implemented actual data of the past years or competitors actual performance may form the basis of Standard costs.

Purpose of Standard Costing Systems or Method?

Standard costing system provides standard cost for budgeting purpose to plan future performance. Standards are established to communicate employees about economy and efficiency is required to achieve business objectives.

It can be used to motivate employee to achieve desired level of performance (ideal standards). It provides some allowances for wastage and idle time (attainable standards), it recognizes the fact the labour are likely to waste some material and will become absent for various reasons like sickness.

Standard costing provides standard costs for variance analysis to control business performance. Standards are compared with actual outcomes to find deviations and reasons for these deviations, so that corrective action can be taken. It helps in managing human resources by giving them signal that their performances are being measured, compared and analysed.

Rewards can be given and Disciplinary action can be taken based on pre-defined criteria communicated to them, so that decisions regarding whatever action taken can be justified to avoid resentment among workforce.

Standard Costing Process or Procedure

Standard costing is used for recording of material, labour, overhead. Data presented in the financial statements are recorded at actual cost. Some business chooses to directly record Direct costs (material and labour) at actual costs and indirect cost (overheads)at standard or budgeted cost as per normal costing systems, while other businesses choose to record all Direct and indirect costs firstly at standard cost. At the end of the reporting period, when company performs variance analysis, these variances (differences) are adjusted to standard costs to arrive to actual cost. Whatever the approach may be chosen, it gives the same results.

Standard costs may need to be revised during the periods if circumstances changes which initially used in the determination of standard costs like inflation rate. Then this new standard cost will be used from the point circumstances are changed.

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