Standard Costing Meaning
Standard Costing is the method of measuring the differences between the costs actually incurred in manufacturing and the expected costs under “standard condition”. Standard costing always refers to a specific costing rule which serves as the basis.
The differences between standard costs and actual costs are sometimes known as variances which appear in either a budget plan or a cost plan. It gives management significant insights about production, profit, and estimates.
Methods of Standard Costing
The following are methods of standard costing
- Ideal – Costing standards in such a method are established by considering ideal conditions. Usually, ideal standards do not serve realistic purposes but help set long-term goal maximization strategies.
- Attainable – This is used when a realistic but superlative performance is taken as reference. For instance, if a machine is currently producing 75 bulbs but has the capability to produce 100 bulbs.
- Current – The most realistic view of a business can be captured by the current standard. The level of performance with all the existing conditions is the current standard. It helps businesses establish ideal and attainable standards.
- Basic – It takes a fairly long-term perspective of the business. It encapsulates those costings that are basic in nature and do not change for a long time.
- Normal – When a business assumes normal conditions, it can either be favorable or unfavorable for the business depending on how it has performed in general. However, it can be difficult to gauge what is normal for the business.
Examples of Standard Costing
The following are examples of standard costing
A factory manager wants to present a budget plan for the next quarter. The factory produced 2000 units in the current quarter. An estimated total labor cost of US$ 1200 and the raw material cost of $10 per good were incurred to produce a sale of $28,000.
Based on the attainable standard, the next budget is predicted to cost 8% more in labor. The raw material cost per good should come down to $9 by increasing capacity to 2500 units. The factory expects to sell goods worth 30,000.
After quarter 2 results were out, the actual cost to the company was $25,000 due to a breakdown which happened in previous quarters as well. Analyze the variances in production and comment on the standards assumed. Raw material costs include all production costs.
The current quarter and next quarter budget are drawn on parallel and the following steps are carried.
Step 1 – Total Cost = Units x Raw Material + Labor Cost
Calculation of Total Cost of Quarter 1
- Total Cost = 21200
Calculation of Total Cost of Quarter 2
- Total Cost = 23796
Step 2 – Calculate Profit by using Profit formula = Sale – Total Cost
Calculation of Profit of Quarter 1
= 28000 – 21200
- Profit = 6800
Calculation of Profit of Quarter 2
=30000 – 23796
- Profit = 6204
Calculation of Profit Margin of Quarter 1
Profit Margin = Profit/ Sale
- Profit Margin = 24.3%
Calculation of Profit Margin of Quarter 2
- Profit Margin = 20.7%
Step 3 – The Actual Cost incurred in the next quarter is $25,000. This is more than the budgeted cost. Hence, we see a dip in profit margin.
Analysis – The company used the attainable standard of costing whereby it assumed reduced raw material cost. It, however, did not account for any anomaly such as breakdown which raised the costs. The factory manager should have made a consideration of past quarters to come up with better estimates.
Refer to the given excel sheet above for detail calculation.
A company might want to look into the different costs incurred in its operations around two production lines and analyze the variance. Given the following data, explain the difference.
All figures in US$
The total costs allocated to manufacturing (labor and machine) are 44,000. The company instead, spent 50,500. Thus, the company exceeded the budgetary allocation by 14.77%.
If we analyze the costs on a per-item basis,
The company has not managed its operations around production line B efficiently. The operation costs have gone up by 16.67% and the labor costs are up by 25%. The overall cost of production around Machine B (incl. Labor B) is 22,500 as against an allocated 19,000 (18.42%).
The management can take this insight as a means to improve production line B.
Advantages of Standard Costing
- Standard costing is a tool to analyze and subsequently enhance different efficiencies around production.
- Standard costing makes a good contribution towards budget plan preparation and cost-benefit analysis.
- It helps the business to maintain a uniform methodology around costing.
- Standard costing not only helps decision-makers in taking corrective actions but make plans for proactive actions in prospective budgets.
- Standard costing assumes costs of production to be repetitive in nature. This means that the costs incurred should be evident over a certain historical period in order to help set a standard way.
- It is not enough to analyze operations based on cost only. Any variance in production factors should be attributed reasonably to changes in qualitative and quantitative changes in businesses.
- The objective of motivating employees and improving performance simultaneously by setting the right costing standard is difficult.
- Data involved in costing can be very expensive, be it fetching or storing needs.
- Since standard costing involves a lot of forecasting, the estimates of and arguments around costing are always prone to errors.
Standard costing is all about establishing methods best suited to each business. It is always critical to incorporate factors like quality into the costing model. For example, a production plan gives 100 units of output and is estimated to yield 120 units in the next fiscal. This 20% increase might come at a cost of degrading quality of the product which must be considered in the budget plan.
Any standard among the above five commonly used should be set in such a way that there is enough motivation for the employees while being achievable and realistic as well.
In setting up different standards, management establishes the various factors affecting their business operations. Each of these standards can have a different impact on how a business measures its costs. However, each is prone to drawbacks and each has its advantages.
This has been a guide to what is Standard Costing and its meaning. Here we discuss the top 5 methods of standard costing along with examples, advantages, and disadvantages. You can learn more about accounting and budgeting from the following articles-