ICAI Notes: Standard Costing | Cost and Management Accounting for CA Intermediate PDF Download

 Page 1


    
 
 
CHAPTER 
13 
 
LEARNING OUTCOMES 
 
STANDARD COSTING 
 
? Discuss the meaning of standard cost and variances.
? Differentiate between controllable and uncontrollable 
variances. 
? Analyse and compute variances related to material, labour 
and overheads. 
 
© The Institute of Chartered Accountants of India
Page 2


    
 
 
CHAPTER 
13 
 
LEARNING OUTCOMES 
 
STANDARD COSTING 
 
? Discuss the meaning of standard cost and variances.
? Differentiate between controllable and uncontrollable 
variances. 
? Analyse and compute variances related to material, labour 
and overheads. 
 
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
 
13.2 
 
1. INTRODUCTION 
Cost control is one of the objectives of cost management. Management of an 
organisation setups predetermined cost to compare the actual cost with the 
predetermined cost. Predetermined costs are standardcosts used for cost control 
and performance evaluation. Standard costing is a method of cost and 
management accounting which starts with setting of standards and ends with  
reporting of variances to management for taking corrective actions. The Official 
Terminology of CIMA, London defines standard costing as “Control technique that 
Standard Costing
Meaning of Standard cost 
and Standard Costing
Types of Standards
The Process of Standard 
Costing
Setting-up of Standard 
Cost
Types of Variances
Classification of Variances
Computation of Variance
Advantages and Criticism 
of Standard Costing
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
Page 3


    
 
 
CHAPTER 
13 
 
LEARNING OUTCOMES 
 
STANDARD COSTING 
 
? Discuss the meaning of standard cost and variances.
? Differentiate between controllable and uncontrollable 
variances. 
? Analyse and compute variances related to material, labour 
and overheads. 
 
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
 
13.2 
 
1. INTRODUCTION 
Cost control is one of the objectives of cost management. Management of an 
organisation setups predetermined cost to compare the actual cost with the 
predetermined cost. Predetermined costs are standardcosts used for cost control 
and performance evaluation. Standard costing is a method of cost and 
management accounting which starts with setting of standards and ends with  
reporting of variances to management for taking corrective actions. The Official 
Terminology of CIMA, London defines standard costing as “Control technique that 
Standard Costing
Meaning of Standard cost 
and Standard Costing
Types of Standards
The Process of Standard 
Costing
Setting-up of Standard 
Cost
Types of Variances
Classification of Variances
Computation of Variance
Advantages and Criticism 
of Standard Costing
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
STANDARD COSTING     
 
 
13.3 
reports variances by comparing actual costs to pre-set standards so facilitating 
action through management by exception.” 
In this chapter we will learn how standards are set for each cost component i.e. 
material, labour and overheads of a cost object.    
1.1 What is a Standard or Standard Cost? 
Standard cost is defined in the CIMA Official Terminology as “'the planned unit cost 
of the product, component or service produced in a period. The standard cost may 
be determined on a number of bases. The main use of standard costs is in 
performance measurement, control, stock valuation and in the establishment of 
selling prices.” From the above definition Standard costs can be said as 
• Planned cost 
• Determined on a base or number of bases. 
1.2 Why Standard Costing is Needed?  
Standards or Standard costs are established to evaluate performance of a 
responsibility centre. Apart from performance evaluation and cost control, standard 
costs are also used to value inventory where actual figures are not reliably available 
and to determine selling prices particularly while preparing quotations. 
Standard costing system is widely accepted as it serves different needs of an 
organisation. The standard costing is preferred for the following reasons: 
(a)  Prediction of future cost for decision making:  Standard costs are set after 
taking all present conditions and future possibilities into consideration. Hence, 
standard cost is future cost for the purpose of cost estimation and profitability 
from a proposed project/ order/ activity.  
(b)  Provide target to be achieved: Standard costs are the target cost which 
should not be crossed by the responsibility centres. Performance of a 
responsibility centre is continuously monitored and measured against the set 
standards. Any variance from the standard is noted and reported for 
appropriate action. 
(c)  Used in budgeting and performance evaluation: Standard costs are used 
to set budgets and based on these budgets managerial performance is 
© The Institute of Chartered Accountants of India
Page 4


    
 
 
CHAPTER 
13 
 
LEARNING OUTCOMES 
 
STANDARD COSTING 
 
? Discuss the meaning of standard cost and variances.
? Differentiate between controllable and uncontrollable 
variances. 
? Analyse and compute variances related to material, labour 
and overheads. 
 
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
 
13.2 
 
1. INTRODUCTION 
Cost control is one of the objectives of cost management. Management of an 
organisation setups predetermined cost to compare the actual cost with the 
predetermined cost. Predetermined costs are standardcosts used for cost control 
and performance evaluation. Standard costing is a method of cost and 
management accounting which starts with setting of standards and ends with  
reporting of variances to management for taking corrective actions. The Official 
Terminology of CIMA, London defines standard costing as “Control technique that 
Standard Costing
Meaning of Standard cost 
and Standard Costing
Types of Standards
The Process of Standard 
Costing
Setting-up of Standard 
Cost
Types of Variances
Classification of Variances
Computation of Variance
Advantages and Criticism 
of Standard Costing
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
STANDARD COSTING     
 
 
13.3 
reports variances by comparing actual costs to pre-set standards so facilitating 
action through management by exception.” 
In this chapter we will learn how standards are set for each cost component i.e. 
material, labour and overheads of a cost object.    
1.1 What is a Standard or Standard Cost? 
Standard cost is defined in the CIMA Official Terminology as “'the planned unit cost 
of the product, component or service produced in a period. The standard cost may 
be determined on a number of bases. The main use of standard costs is in 
performance measurement, control, stock valuation and in the establishment of 
selling prices.” From the above definition Standard costs can be said as 
• Planned cost 
• Determined on a base or number of bases. 
1.2 Why Standard Costing is Needed?  
Standards or Standard costs are established to evaluate performance of a 
responsibility centre. Apart from performance evaluation and cost control, standard 
costs are also used to value inventory where actual figures are not reliably available 
and to determine selling prices particularly while preparing quotations. 
Standard costing system is widely accepted as it serves different needs of an 
organisation. The standard costing is preferred for the following reasons: 
(a)  Prediction of future cost for decision making:  Standard costs are set after 
taking all present conditions and future possibilities into consideration. Hence, 
standard cost is future cost for the purpose of cost estimation and profitability 
from a proposed project/ order/ activity.  
(b)  Provide target to be achieved: Standard costs are the target cost which 
should not be crossed by the responsibility centres. Performance of a 
responsibility centre is continuously monitored and measured against the set 
standards. Any variance from the standard is noted and reported for 
appropriate action. 
(c)  Used in budgeting and performance evaluation: Standard costs are used 
to set budgets and based on these budgets managerial performance is 
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
 
13.4 
evaluated. This is of two benefits, one managers of a responsibility centre will 
not compromise with the quality to fulfill the budgeted quantity and second, 
variances can be traced with the responsible department or person. 
(d)  Interim profit measurement and inventory valuation: Actual profit can only 
be known after the closure of the accounts. But an organisation may need to 
prepare profitability statement for interim periods for managerial reporting 
and decision making. To arrive at profit figure, standard costs are deducted 
from the revenue. 
2. TYPES OF STANDARDS 
Types of standards are as below: 
(i) Ideal Standards: These represent the level of performance attainable when 
prices for material and labour are most favourable, when the highest output is 
achieved with the best equipment and layout and when the maximum efficiency in 
utilisation of resources results in maximum output with minimum cost.  
These types of standards are criticised on three grounds: 
(a) Since such standards would be unattainable, no one would take these 
seriously. 
(b) The variances disclosed would be variances from the ideal standards. These 
would not, therefore, indicate the extent to which they could have been reasonably 
and practically avoided. 
(c) There would be no logical method of disposing of these variances. 
(ii) Normal Standards: These are standards that may be achieved under normal 
operating conditions. The normal activity has been defined as “the number of 
standard hours which will produce at normal efficiency sufficient good to meet the 
average sales demand over a term of years”.  
These standards are, however, difficult to set because they require a degree of 
forecasting. The variances thrown out under this system are deviations from normal 
efficiency, normal sales volume, or normal production volume.  
If the actual performance is found to be abnormal, large variances may result and 
necessitate revision of standards. 
© The Institute of Chartered Accountants of India
Page 5


    
 
 
CHAPTER 
13 
 
LEARNING OUTCOMES 
 
STANDARD COSTING 
 
? Discuss the meaning of standard cost and variances.
? Differentiate between controllable and uncontrollable 
variances. 
? Analyse and compute variances related to material, labour 
and overheads. 
 
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
 
13.2 
 
1. INTRODUCTION 
Cost control is one of the objectives of cost management. Management of an 
organisation setups predetermined cost to compare the actual cost with the 
predetermined cost. Predetermined costs are standardcosts used for cost control 
and performance evaluation. Standard costing is a method of cost and 
management accounting which starts with setting of standards and ends with  
reporting of variances to management for taking corrective actions. The Official 
Terminology of CIMA, London defines standard costing as “Control technique that 
Standard Costing
Meaning of Standard cost 
and Standard Costing
Types of Standards
The Process of Standard 
Costing
Setting-up of Standard 
Cost
Types of Variances
Classification of Variances
Computation of Variance
Advantages and Criticism 
of Standard Costing
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
STANDARD COSTING     
 
 
13.3 
reports variances by comparing actual costs to pre-set standards so facilitating 
action through management by exception.” 
In this chapter we will learn how standards are set for each cost component i.e. 
material, labour and overheads of a cost object.    
1.1 What is a Standard or Standard Cost? 
Standard cost is defined in the CIMA Official Terminology as “'the planned unit cost 
of the product, component or service produced in a period. The standard cost may 
be determined on a number of bases. The main use of standard costs is in 
performance measurement, control, stock valuation and in the establishment of 
selling prices.” From the above definition Standard costs can be said as 
• Planned cost 
• Determined on a base or number of bases. 
1.2 Why Standard Costing is Needed?  
Standards or Standard costs are established to evaluate performance of a 
responsibility centre. Apart from performance evaluation and cost control, standard 
costs are also used to value inventory where actual figures are not reliably available 
and to determine selling prices particularly while preparing quotations. 
Standard costing system is widely accepted as it serves different needs of an 
organisation. The standard costing is preferred for the following reasons: 
(a)  Prediction of future cost for decision making:  Standard costs are set after 
taking all present conditions and future possibilities into consideration. Hence, 
standard cost is future cost for the purpose of cost estimation and profitability 
from a proposed project/ order/ activity.  
(b)  Provide target to be achieved: Standard costs are the target cost which 
should not be crossed by the responsibility centres. Performance of a 
responsibility centre is continuously monitored and measured against the set 
standards. Any variance from the standard is noted and reported for 
appropriate action. 
(c)  Used in budgeting and performance evaluation: Standard costs are used 
to set budgets and based on these budgets managerial performance is 
© The Institute of Chartered Accountants of India
COST AND MANAGEMENT ACCOUNTING 
 
13.4 
evaluated. This is of two benefits, one managers of a responsibility centre will 
not compromise with the quality to fulfill the budgeted quantity and second, 
variances can be traced with the responsible department or person. 
(d)  Interim profit measurement and inventory valuation: Actual profit can only 
be known after the closure of the accounts. But an organisation may need to 
prepare profitability statement for interim periods for managerial reporting 
and decision making. To arrive at profit figure, standard costs are deducted 
from the revenue. 
2. TYPES OF STANDARDS 
Types of standards are as below: 
(i) Ideal Standards: These represent the level of performance attainable when 
prices for material and labour are most favourable, when the highest output is 
achieved with the best equipment and layout and when the maximum efficiency in 
utilisation of resources results in maximum output with minimum cost.  
These types of standards are criticised on three grounds: 
(a) Since such standards would be unattainable, no one would take these 
seriously. 
(b) The variances disclosed would be variances from the ideal standards. These 
would not, therefore, indicate the extent to which they could have been reasonably 
and practically avoided. 
(c) There would be no logical method of disposing of these variances. 
(ii) Normal Standards: These are standards that may be achieved under normal 
operating conditions. The normal activity has been defined as “the number of 
standard hours which will produce at normal efficiency sufficient good to meet the 
average sales demand over a term of years”.  
These standards are, however, difficult to set because they require a degree of 
forecasting. The variances thrown out under this system are deviations from normal 
efficiency, normal sales volume, or normal production volume.  
If the actual performance is found to be abnormal, large variances may result and 
necessitate revision of standards. 
© The Institute of Chartered Accountants of India
STANDARD COSTING     
 
 
13.5 
(iii) Basic or Bogey Standards: These standards are used only when they are 
likely to remain constant or unaltered over a long period. According to this 
standard, a base year is chosen for comparison purposes in the same way as 
statisticians use price indices. Since basic standards do not represent what should 
be attained in the present period, current standards should also be prepared if 
basic standards are used. Basic standards are, however, well suited to businesses 
having a small range of products and long production runs. Basic standards are set, 
on a long-term basis and are seldom revised. When basic standards are in use, 
variances are not calculated. Instead, the actual cost is expressed as a percentage 
of basic cost.  The current cost is also similarly expressed and the two percentages 
are compared to find out how much the actual cost has deviated from the current 
standard. The percentages are next compared with those of the previous periods 
to establish the trend of actual and current standard from basic cost. 
(iv) Current Standards: These standards reflect the management’s 
anticipation of what actual costs will be for the current period.  These are the 
costs which the business will incur if the anticipated prices are paid for the goods 
and services and the usage corresponds to that believed to be necessary to produce 
the planned output.  
The variances arising from expected standards represent the degree of efficiency 
in usage of the factors of production, variation in prices paid for materials and 
services and difference in the volume of production. 
3. THE PROCESS OF STANDARD COSTING 
The process of standard cost is as below: 
(i) Setting of Standards: The first step is to set standards which are to be 
achieved, the process of standard setting is explained below. 
(ii) Ascertainment of actual costs: Actual cost for each component of cost is 
ascertained. Actual costs are ascertained from books of account, material invoices, 
wage sheet, charge slip etc. 
(iii) Comparison of actual cost with standard cost: Actual costs are compared 
with the standards costs and variances are determined.  
© The Institute of Chartered Accountants of India