Standard Costing

Standard Cost (SC)• A standard cost is a 'planned unit cost of a

product, component or service'.

• It is a carefully predetermined unit cost which is prepared for each cost unit.

• It contains details of the standard amount and price of each resource that will be utilised in providing the service or manufacturing the product.

• A standard cost card shows full details of the standard cost of each product.

Standard Costing• It is the preparation of standard costs.• Control technique that reports variances by

comparing actual costs to pre-set standards so facilitating action through management by exception.

• Management by exception is the practice of focusing on activities which require attention and ignoring those which appear to be conforming to expectations.

A standard• Benchmark measurement of resource usage or

revenue or profit generation, set in defined conditions.

• A number of bases which can be used to set the standard. These bases include– a prior period level of performance by the same

organisation;

– the level of performance achieved by comparable organisations;

– the level of performance required to meet organisational objectives.

When SC is used?

• Degree of repetition in the production process.– Mass production– Repetitive assembly work

• It can be calculated per task if there is a similarity of tasks.

The uses of standard costing• To value inventories and cost production for cost

accounting purposes. It is an alternative method of valuation to methods like FIFO and LIFO.

• To act as a control device by establishing standards (planned costs), highlighting (via variance analysis) activities that are not conforming to plan and thus alerting management to areas which may be out of control and in need of corrective action.

Standard Costing involves…• The establishment of predetermined

estimates of the costs of products or services

• The collection of actual costs • The comparison of the actual costs with

the predetermined estimates

Setting Standards for Manufacturing

Analysis ofHistorical

Data

Analysis ofHistorical

Data

TaskAnalysis

TaskAnalysis

Used in a established production Process

Used in a established production Process

Analyze the processof manufacturing

the product

Analyze the processof manufacturing

the product

What DIDthe product

cost?

What DIDthe product

cost?

What SHOULD the

product cost?

What SHOULD the

product cost?

A CombinedApproach

A CombinedApproach

Analyze the process for the step thathas changed, but use historical datafor the steps that have not changed

Analyze the process for the step thathas changed, but use historical datafor the steps that have not changed

Setting Standards

Setting standards for materials costs• Direct material prices will be estimated by

the purchasing department from their existing knowledge.– Purchase contract already agreed

– Pricing discussions with regular supplies

– Quotations and estimates from potential suppliers

– The forecast movement of prices in the market

– The availability of bulk purchase discounts

– Material quality required

• Direct labour rate per hour will be set – by discussions with the human resource

department– reference to the pay role– Any agreements with trade union(s)

• A separate average hourly rate or weekly wage will be set for each different labour grade / type of employee (qualification / experience).

Setting standards for labour rates

• Technical specification must be prepared for each product by production experts.

• Material usage and labour efficiency standards are known as performance standards.

Setting standards for material usage and labour efficiency

Performance Standards

Ideal standard• This is based on perfect operating conditions

(no wastage, no inefficiencies, no idle time, no breakdowns).

• Standards may be set at ideal levels, which make no allowance for inefficiencies.

• Variances from ideal standards are useful for pinpointing areas where a close examination may result in large savings in order to maximise efficiency and minimise waste.

• No allowance.

Attainable standard• Standards may also be set at attainable

(possible) levels which assume efficient levels of operation, but which include allowances for factors such as losses, waste and machine downtime.

Current standard

• Standards based on current performance levels (current wastage, current inefficiencies) are known as current standards.

• The disadvantage is that they do not encourage any attempt to improve on current levels of efficiency.

Basic Standard

• These are kept unaltered over a long period of time, and may be out of date.

• They are used to show changes in efficiency or performance over a long period of time.

• These are perhaps the least useful and least common type of standard in use.

• Standard variable overhead costs are usually charged to products using a standard rate per labour hour.

• Where labour hours are to be used as the basis for charging variable overhead cost.

• Careful analysis of overhead costs will be necessary.

Setting standards for Variable Overheads

• As per marginal costing no need to determine a standard unit rate for fixed OH.

• In the absorption costing system the standard overhead absorption rate is the same as the predetermined overhead absorption rate.

• The standard overhead absorption rate will depend on the total value of budgeted overheads for the forthcoming period and on the planned activity or production volume for the period.

Setting standards for Fixed Overheads

• Anticipated market demand

• Manufacturing cost

• Competing products and competitors’ action

• Inflation estimates

Setting standards for Selling Price and Margin or Contribution