These physical standards, which form the basis for calculating a standard cost, must be set with the utmost accuracy. For example, if it takes 2.4 hours to produce a unit of output, but the standard is set for 2.5 hours, there should be a favorable variance of 0.1 hours. Variance analysis helps management to understand the present costs and then to control future costs.

• A standard is a predetermined measurable quantity set in defined conditions against which actual performance can be compared, usually for an element of work, operation, or activ­ity.
• These physical standards, which form the basis for calculating a standard cost, must be set with the utmost accuracy.
• The success of standard costing system depends on the reliability, accuracy and acceptance of the standards.
• Therefore, the revision of standards should happen periodically, whenever it is needed.
• Basically there are two groups of standards- quantity standards and price standards.

Problems with Standard Costing

• The difference between the actual direct labor costs and the standard direct labor costs can be divided into a rate variance and an efficiency variance.
• If the net realizable value of the inventory is less than the actual cost of the inventory, it is often necessary to reduce the inventory amount.
• To be meaning­ful, while quantity standards should not be revised frequently, price standards essentially require periodic revision.
• Similarly, another objective of standard costing is to help the management of the business in controlling the costs of the business.
• Setting standard for overheads is more complex than the development of material and labour standards.

On the other hand, standards do not tell what costs are expected but rather what they will be if certain performances are achieved. This opinion is supported by the fact that both use predetermined costs for the coming period. When costs fall significantly outside the standards, managers are alerted that problems may require attention. Standard costing may be found unsuitable and costly in the case of industries dealing with non-standard products and repair jobs which keep on changing in accordance with customers’ specifications. If inaccurate standards are set, they can do more harm than good to the business.

Problems in Setting Standard Costs

(1) The standard should be fixed in such a manner, so that managers and workers should rely on them. (7) To provide a formal basis for asserting operational efficiency of the concern. (5) To apply the principle Partnership Accounting of ‘management by exception’ at operational level. Past records can be used only to assess ‘normal’ wastes, machine breakdown, level of effi­ciency, etc. Attainable standard includes wastes, machine breakdown, etc., which cannot be prevented. Inaccurate and unreliable standards cause misleading results and thus may not enjoy the confidence of the users of this system.

What is Standard Costing – 3 Important Steps: Establishing Cost Centres, Types of Standard Used and Setting of Standard

The inventory system where purchases are debited to the inventory account and the inventory account is credited at the time of each sale for the cost of the goods sold. Hence, the balance in the inventory account is constantly or perpetually changing. Under this system there is a general ledger account Cost of Goods Sold. To learn more, see Explanation of Inventory and Cost of Goods Sold.

Setting standard for overheads is more complex than the development of material and labour petty cash standards. It includes (1) Determination of standard quantity of material required, and (2) Determination of standard price per unit of material. Variances arise are disposed off by transferring it the relevant accounts (costing profit and loss account) as per the accounting method (plan) adopted. In other words, a business may not revise standards to keep pace with the frequent changes in manufacturing conditions.

What is the Process of Standard Costing?

To help the management in formulating production policy and helps in fixing the price quotations as well as in submitting tenders of various products. Standard Costing is used to minimize costs, improve quality, and increase efficiency. It also enables managers to compare actual results with expected results.

Standard costing (and the related variances) is a valuable management tool. If a variance arises, it tells management that the actual manufacturing costs are different from the standard costs. Management can then direct its attention to the cause of the differences from the planned amounts. The company usually conduct the testing to estimate a proper standard cost of each production unit. With this cost, they will be able to calculate the inventory valuation, cost of goods sold, which will impact the profit during the period.